This paper is written against the backdrop of my previous
article entitled "Building Legacy on a Foundation, Part
I" published in InsightPlus issue of October 2017.
Part II seeks to contrast key features of a private foundation with
those of a common law trust. While both structures are similar in
many respects, it is their differences that can distinguish them as
the suitable vehicle of choice in a particular estate plan.
It is helpful to bear in mind that the differences in the
characteristics and functionalities between a private foundation
and a common law trust arise chiefly from two fundamental
distinctions, namely, the legal traditions that birthed the
respective concepts (civil law vs. common law), and the status of
the structures (legal personality vs. legally recognised
relationship).
(i) Ownership of Assets
As a legal personality, a foundation owns its assets
absolutely and indivisibly. In general, the civil law tradition
does not countenance split ownership of assets. A trustee, on the
other hand, only claims legal ownership of the trust assets while
the beneficial ownership rests in the beneficiaries. The split in
legal and beneficial ownership means that these properties do not
form part of the trustees' own estate. They must be accounted
for as a segregated fund.
(ii) Duration
A foundation can exist indefinitely as a legal entity, unless
the applicable legislation or its constituent document limits its
duration. The original common law position
vis-à-vis trusts on the other hand imposes a rule
against perpetuity in respect of the ownership of trust assets.
Nevertheless, several jurisdictions have taken the step to abolish
this rule against perpetuity. For example, a trust established
pursuant to the Labuan Trusts Act 1996 (LTA 1996) can exist for
unlimited period.
(iii) Contracting
A foundation contracts in its own name and can sue or be sued
in its own name. A trust, not being a legal entity, is represented
by the trustee for all intents and purpose. Hence, the trustee
contracts personally. The unfortunate consequence is that the
trustee will be personally liable for any breach of contract to the
extent of the trustee's own estate. In some jurisdictions,
special legislations have been introduced to limit the
trustee's liability. In practice, it is also common to
negotiate with the other contracting party to accept a restricted
liability, for example, confining it to the extent of the trust
funds.
Another disadvantage arising from a trustee having to contract
in trustee's own right is that, in the event of a change of
trustee, the contracts must be assigned or novated.
(iv) Mobility
A foundation owes its existence to the enabling legislation in
its country of establishment. In principle, it cannot be relocated.
In order to move ownership of its assets to another country, the
assets have to be transferred by the foundation to another
foundation established in the other country. And in that
circumstance, there is no continuation of ownership. Most
foundation legislations overcome this problem by allowing
redomiciliation of a foundation. For example, the Labuan
Foundations Act 2010 (LFA 2010) permits redomiciliation of a
foundation established thereunder.
A trust on the other hand is inherently mobile. If the trustee
is an individual, he is capable of moving to the designated new
jurisdiction and continues running the trust. The trust document
can also provide for the continuation of the trust in spite of
change of country of ownership by the old trustees transferring the
trust property to the newly appointed trustee in another
jurisdiction to take over the operation of the trust, and changing
the governing law, provided of course that the initial trust is not
invalidated.
(v) Operational and Structural
Framework
As a statutory entity, the operational and structural
framework of a foundation is subject to the provisions of the
relevant statute. In this respect, the general trend in foundation
legislations is to provide a bare-bone structure for its operation
consisting of a few mandatory rules while leaving a wide berth for
the founder to flesh out the details. The founder is given much
discretion in determining how he/she wishes the foundation to be
structured and to operate.
On the other hand, being a brainchild of the common law, the
concept of trust is governed by an abundance of case law that
determines and guides how a trust is to operate, subject to any
statutory provisions which may have varied the common law position.
Lawyers and judges are guided by these judicial decisions in their
approach to, and interaction with, the trust. This also means that
any interstices in the provisions of the trust deed can be fleshed
out by the case law.
(vi) Position of Founder vs. Settlor
The founder of a foundation and the settlor of a trust may be
said to be in a position to retain similar extent of influence
after the establishment of their intended structure. Both can
reserve certain powers, such as the power of revocation, the power
to amend the structure, or the power to replace members of
governing body or trustees.
It may justifiably be observed however that the reservation of
powers by a settlor requires more care and attention. If the effect
of the reserved powers leads to a conclusion that the trustee is
merely holding the trust assets to the order of the settlor, and
that the settlor in reality remains the full beneficial owner of
the trust assets, the trust will be held to be a sham as far as the
ostensible beneficiaries or purposes are concerned. No similar
outcome exists in the case of a foundation. The founder may give
very specific instructions to the governing body without concern
over affecting the validity of its establishment. This is because a
foundation derives its validity from its incorporation.
(vii) Position of Beneficiary
As noted above, a beneficiary of a trust has equitable
interest in the trust assets. On the other hand, generally, a
beneficiary of a foundation does not have any interest in the
foundation assets or any preferred obligation binding the
foundation if it becomes insolvent or is liquidated. This crucial
difference gives rise to other important ramifications. For
example:
- Trust beneficiaries can, via the tracing process, make
proprietary claims against assets found in the hands of third
parties, subject to certain exceptions. Trust beneficiaries also
have the right to see trust accounts with supporting documents. The
position of foundation beneficiaries stands in stark contrast.
Unless a founder provides in the constituent documents specific
rights upon the beneficiaries vis-a-vis the foundation and
the governing body, foundation legislations are usually meagre in
conferring meaningful rights upon the beneficiaries.
- If all trust beneficiaries are ascertained, of full capacity
and of one mind, they can require the termination of the trust and
the distribution of the assets to them. This is the traditional
position of a proprietary trust (Saunders v. Vautier)
although many jurisdictions have abolished this right so as to
facilitate the fulfillment of the settlor's intention.
Foundation beneficiaries on the other hand do not enjoy similar
right.
(viii) Position of Governing Body and
Trustee
The governing body of a foundation may be given a wide a range
of powers and duties by the constituent documents. These duties are
owed only to the foundation and not the beneficiaries. To
counterbalance the power of the governing body, most foundation
laws give the founder the option to set up other internal entities
to "police" the conduct of the governing body. In some
instances, the foundation legislation itself implants safeguards
such as requiring the governing body to have as its members a
specified number of local licensed trust officers.
As the governing body of a foundation owes its duties to the
foundation, it cannot seek relief from liability from the
beneficiaries or the court. It is however not unusual for a
foundation's constituent documents to be drafted so as to
exempt the governing body from liability for a breach of standard
care other than one resulting from wilful misconduct or dishonesty.
The foundation's regulations may also provide for the granting
of relief by a specified person, for example, the supervisory
person. Further, the relevant foundation legislation may permit
relief to be granted by the court, as in case of the LFA 2010.
In the case of a trust, the common law also confers on the
trustees a wide range of duties and powers, subject to such
restrictions or enlargement specifically provided for by the trust
instrument. The duties are owed to the beneficiaries and this
provides the beneficiaries with the standing to monitor or
"police" the trustee's conduct, including seeking
intervention by the courts where appropriate. In turn, the trustees
may be relieved or indemnified for breach of trust by the
beneficiaries. In addition, trustees may also be excused by the
court if certain conditions are met, for example, if they had acted
honestly and reasonably and ought fairly to be excused for the
breach and for omitting to have earlier sought advice from the
court.
(ix) Validity of Structure
The question of validity/effectiveness of each structure is
dealt with differently. As mentioned above, if the construction of
a trust evidences an arrangement to act as a smokescreen for the
trustee to hold the trust assets to the order of the settlor, the
trust will be considered a sham. The court will find that there is
a true bare trust for the settlor as he has in fact not divested
his beneficial interest in the property.
A foundation, on the other hand, comes into existence as a
"legal person" by virtue of its incorporation in
accordance with the registration formalities. The apparent or
secret agenda of the founder concerning the use of the foundation
does not affect its validity. However, if a foundation is created
as a façade to hide or dissipate the founder's assets,
there may be a piercing of the veil of legal personality to enable
the court to treat the assets of the foundation as the assets of
the founder.