Asset Protection In The Channel Islands

Introduction

Asset protection can be achieved by using a variety of different structures, including a trust, foundation, company, limited partnership or a combination of the aforementioned; for example having a trust with an underlying company holding assets.

The term "Asset Protection" can be slightly confusing because no type of trust, foundation, company or partnership under Jersey or Guernsey law is specifically designated an "Asset Protection" structure as if to suggest a particular type of structure existed for this purpose. Whatever structure is used, its purpose is to protect assets, though the reasons why assets need to be protected will vary.

The primary purpose of asset protection structures is to protect against claims made by creditors and consequently are often used for persons embarking on a risky business venture or persons asked to give personal guarantees to the activities of that business. This note considers the extent to which Jersey and Guernsey trusts can be used in this way.

Asset Protection - the Basics

An asset protection structure is established by a person (the transferor) transferring his assets to the structure, whether a trustee, foundation, company or otherwise. In the asset protection scenario, the transferor usually wishes to divest himself of all of his substantial assets, which, on his bankruptcy, would leave little to his creditors. It is up to the transferor how much of his assets he transfers to the structure.

The strategy of divesting assets for asset protection is to ensure that the assets are as remote as possible from the creditor. This means structurally remote, e.g. in a trust with an underlying company, none of which can be said to be controlled by the settlor, and jurisdictionally remote, that is, in this case, there is no nexus to Jersey and Guernsey.

That a creditor "cannot find" the assets or that the assets are expensive to pursue is a significant strategy in establishing an asset protection structure. For this reason it is often suggested that transferring the transferor's primary residence, or illiquid assets, to an asset protection structure may not be beneficial.

This is particularly where the creditor, debtor and asset are all in the same jurisdiction. If a structure is established with the intention of protecting assets from claims by creditors and others, it is obviously essential that very careful consideration should be given to the terms of the constitutional documents of the structure to ensure that the risk of the property being vulnerable to attack is eliminated as far as possible. In general, the following "rules of thumb" should be followed:

• the structure should have no affiliation with a jurisdiction in which a claim might be brought, recognised or enforced or in which an injunction might be ordered;
• ideally, the transferor should have no beneficial interest in the property;
• it is important that the transfer of property is irrevocable to avoid any argument that a power of revocation is a property right capable of being assigned to the creditor;
• the transferred property should not be situated in the jurisdiction where the transferor (or beneficiaries if applicable) are resident;
• the transferor should not have any control of the structure and independent persons should be appointed to administer and control the structure. Consequently, the transferor may wish to be appointed as an investment adviser to the structure. If so, control of the property must be expressly divided between investment discretions, controlled by the transferor, and distribution discretions, controlled by the administrators;
• if a trust and/or foundation is used, the following should be applied:
• • as few as possible (and ideally no) powers should be reserved to the settlor or founder (as applicable) or someone affiliated with a jurisdiction of the type referred to above;
  • the settlor or founder should consider vesting supervision of the trust or foundation in a committee of protectors or guardians (as appropriate) (which may include the settlor or founder);
  • the settlor of a trust should not be appointed a protector since courts have considered this to permit the settlor a significant control over trust assets by being appointed a protector. It is entirely possible that, by analogy, the same principle may be applicable to a founder being appointed a guardian of a foundation;
  • the constitutional documents should state that no one from where the jurisdiction of the settlor, founder or beneficiaries is resident (or one in which the claim is likely to be made) may be appointed as a trustee or protector (if a trust) or a council member or guardian (if a foundation) and that if such a person is appointed, the existing trustee or council members may remove that person immediately;
  • an express provision should be incorporated in the constitutional documents to the effect that the governing law and the forum of administration cannot be changed to that of the jurisdiction in which the settlor, founder or any beneficiary is domiciled or resident (or one in which the claim is likely to be made) and that no trustee or council member may be appointed who is resident in that jurisdiction.

Asset Protection - Legal Principles

The main area of attack of these types of structure is by a creditor seeking to have the transfer of assets set aside on the basis that the transfer was entered into at an undervalue with the intention of defrauding creditors.

The principle is not new: it derives from the Roman law actio Paulina ("Pauline Action", which still forms part of Jersey and Guernsey's customary law) and can be traced through the Statute of Elizabeth (the Fraudulent Conveyances Act of 1571). The modern English legislation (Insolvency Act 1986) interprets "creditors" as meaning creditors at the time of transfer and future creditors (who need not be in the transferor's contemplation at the time the transfer is made). Other Statute of Elizabeth jurisdictions (i.e. Australia, New Zealand, the US) share these roots.

Whilst certain jurisdictions (like the Cayman Islands or the Bahamas) have enacted debtor friendly legislation and hold themselves out as "Asset Protection" jurisdictions, no jurisdiction allows defrauding existing creditors, nor protects a transfer of assets that results in the transferor becoming immediately insolvent.

A fraudulent disposition claim in Jersey and Guernsey may be brought by way of a Pauline Action. The essential elements of a Pauline Action are set out in the judgment of Re Esteem Settlement [2002] JLR 53, a decision of the Royal Court of Jersey. (The Guernsey Court of Appeal held in Flightlease Holdings Guernsey Limited et al v International Lease Finance Corporation (55/2005) that the elements set out in a Jersey case called Re Esteem summarised the relevant Jersey (and Guernsey) law). The ingredients of a Pauline Action are:

• the person bringing the Pauline Action must have been a creditor at the time of the transaction under attack;
• for the purposes of a Pauline Action, a person is properly described as a "creditor" if the facts giving rise to the claim pre-date the transaction under attack;
• the creditor seeking to set aside a transaction must show that the debtor [the transferor] was insolvent at the time of the transaction under attack, or rendered insolvent by that transaction;
• the debtor's insolvency is measured on the balance sheet test;
• in order to succeed in an action to set aside a transaction, the creditor must show that the debtor carried out the transaction (e.g. the settlor settled the trust) with the intention of defrauding his creditors; and
• if the debtor carried out the transaction for more than one purpose, it suffices that the intention to defraud was a substantial purpose.

In Re Esteem it was established that a Pauline Action in Jersey was an action personnelle mobilière, and that for this type of action the limitation period for bringing a claim is 10 years. A shorter limitation period of 6 years exists in Jersey and Guernsey, which is the limitation period for droits personnelles (rights to demand performance or payment). Two Guernsey authorities appear to have been decided on principles akin to the Pauline Action but do not specifically refer to the elements of a Pauline Action, Morgan v Donaldson (18 July 1985) and Le Ray v Martel (7 July 1747). In Morgan it was held that:

Neither Jersey or Guernsey have statutory provisions preventing transactions at an undervalue entered into with the purpose of putting assets beyond the reach of a person who is making or may at some time make a claim against him, such as s.423 of the UK's Insolvency Act, 1986.

Confidentiality

It is important to choose a jurisdiction which offers strong confidentiality laws. Jersey and Guernsey are such jurisdictions.

Asset Protection in Jersey and Guernsey - Conclusions

The requirements of the Pauline Action suggest that creditors will only be able to bring claims in limited circumstances. In particular, the onus is on the creditor to demonstrate firstly that he was a creditor at the time the transfer of assets was made, and secondly, that the transferor was insolvent (or became insolvent) when the transfer was made. Also, the creditor is restricted to a period of 6 years in which to bring a claim.

Provided the "rules of thumb" set out above are followed, there are many good reasons to consider asset protection structures. As a practical matter, often asset protection structures work because a creditor must weigh the costs of finding and pursuing assets against the claim itself, rather than the merits of the structure itself. This again supports the view that the asset protection structure should be located in a remote jurisdiction, with liquid assets, that are easily movable.

Furthermore, the strength of the structure will depend, in part, on the transferor's willingness to be declared insolvent. Being declared insolvent could have a seriously detrimental effect on a person's professional reputation and may lead to disciplinary sanctions for those people who are part of a regulated profession. Another difficulty is that, even if the transferor requests back to him the property transferred to the structure, the independent persons administrating the structure may refuse. The structure has been set up to eliminate the transferor's control and there is no guarantee that the independent administrators will distribute those assets to him.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.