The use of trusts in wealth management and estate planning means transferring legal control of trust assets to a third party, namely the trustee of the trust. The trustee of a trust holds the trust assets subject to the terms of the trust deed for the benefit of the beneficiaries of the trust.
Handing over ownership of assets to a third party fiduciary with which there is no previous relationship is a huge leap of faith for individuals who wish to establish a trust structure. However by establishing a Private Trust Company ("PTC"), the trust assets can be owned and managed from an offshore environment with the Settlor, family and trusted advisors being part of the decision making process in relation to dealings with those assets and distributions from the trust and at the same time, through an administration agreement with the third party fiduciary, ensuring the trust is managed professionally.
A PTC may not be appropriate for every trust and a popular alternative is to include in the trust deed the appointment of a person who can appoint and remove the trustee, often identified as a Protector. However for some settlors, that will not be sufficient comfort and they will want to have more control over the trust assets and who is to benefit from them.
There are many other significant advantages to having a PTC, particularly where the trust is to own a family-operated business and a risky asset. For example, many third party fiduciaries may decline to be involved in ownership of such assets in which case it is the third party fiduciary who might encourage the settlor to create a PTC. Although the third party fiduciary may not necessarily sit on the board of a family operated business, often the shareholder needs to make commercial decisions and the speed of response is likely to be quicker and less cautious with a PTC.
Factors to consider in establishing a PTC are:
- Importance of settlors understanding the obligations of the PTC
- How to manage issues of self-dealing
- Importance of the settlor not retaining control of the trust assets
- Regulatory issues
- The Administration Agreement with the third party fiduciary
- What type of structure to use in establishing a PTC
Importance of clients understanding obligations of the PTC
The settlor and/or family members on the board of the PTC need to understand that being a trustee is not just an administrative role. There are obligations to ensure the PTC fulfils its duty as trustee, complying with the terms of the trust deed and through its directors, exercising fairness amongst the beneficiaries, not being unduly influenced by personal circumstances when making decisions. This applies particularly to those who are both directors and beneficiaries where issues of self-dealing will come into play.
Corporate formalities must be observed and professional standards maintained. This includes maintaining accounts, minutes of meetings and trust powers exercised and documented. This is important to ensure the trust is not attacked as a sham and to limit the potential for a "dog leg" or derivative claim based on a director of a company's duty to "exercise the care, diligence and skill that a reasonably prudent person would exercise" in carrying out the director's duties in relation to the company. The right to performance of this duty where the company is a trustee, could be claimed to be an asset of the trust and, where a director is alleged to have breached the duty, it could be claimed that the beneficiaries of the relevant trust can enforce performance of the duty in circumstances where the corporate trustee will not do so.
In HR v JAPT (1997), the English High Court refused to grant an application to strike out a dog-leg claim in circumstances where the corporate trustee of a pension scheme was worthless. Its sole asset was 30p in cash, it had no insurance, no premises and the sole activity of its directors was the management of the scheme, of which they had the exclusive conduct.
Dealing with issues of self-dealing
A director of a PTC may also be a beneficiary of the trust. It is therefore important that issues of self-dealing or conflicts of interest are addressed:
- The rule is that a trustee must not use or deal with trust property or exploit his/her own position for his/her own private advantage. If he/she does, then they are personally accountable for profits or losses.
- A trustee who is also a beneficiary would have a conflict of interest in making decisions.
However, this does not apply if the trust confers express authority on the trustee to enter into transactions or make decisions in which he/she has a personal interest.
It is, therefore, important that in circumstances where there is a PTC of a trust, that the trust deed includes specific provisions to allow for self-dealing.
Importance of Settlor not retaining control of the trust assets
Family members sitting on the board must not act as mere nominees of the settlor; it is extremely important to demonstrate that control of the assets has left the settlor and his family.
Two recent cases on the point of settlor control are:
- MezProm Bank V Pugachev & Ors  EWHC 246 (Ch)
- Webb v Webb  UKPC 22.
In the first case, Sergie Pugachev, a Russion oligarch, established five New Zealand trusts to hold various substantial assets. There were separate bespoke newly formed corporate trustees for all five trusts, the directors and shareholders of which were two New Zealand solicitors who prepared the trust deeds. All five trust deeds were almost identical. The deeds appointed Mr Pugachev as the Protector and most powers of the trustee, including distributions, investments and appointments of beneficiaries were subject to his consent.
The claimants, being the liquidators of the failed bank, claimed Mr Pugachev had taken funds from the bank. Arguments were submitted:
- that the trusts were "illusory" in that they had the appearance of a trust but under which the settlor retains such control that the proper construction is that he did not intend to give or part with control over the property sufficiently to create a trust; and/or
- that the trusts were shams.
The significant difference between an illusory trust and a sham trust is that with a sham trust it is necessary to prove that all the parties to the trust, including the trustees, were aware or were reckless in not knowing of the intention to mislead others that a trust had been created. With an illusory trust it is only necessary to consider whether on a proper construction there was no intention to part with control over the trust assets.
The court decided that the sham argument had been proved and it would be contradictory to also support the illusory trust argument as there was effectively no trust in which the Settlor retained control.
In the second case, Webb v Webb, the Privy Council recently heard an appeal from the Court of Appeal of the Cook Islands concerning challenged trusts. In that case, the Court of Appeal had found that "the two deeds of trust fail to record an effective alienation of the beneficial interest in the assets in question. The powers retained by [Mr. Webb] meant that at any time he could have recovered, and still could recover, the property, which he had purported to settle on the trusts. The trusts are therefore invalid." A majority of the Board of the Privy Council effectively upheld this finding, concluding at  that, "the Court of Appeal was plainly entitled to find as it did that the trust deeds failed to record an effective alienation by Mr Webb of any of the trust property. The bundle of rights which he retained is indistinguishable from ownership."
The trust was in effect an illusory trust.
Both these cases concern the trust deeds giving the settlor considerable rights by which the settlor has not effectively given up beneficial ownership of the assets settled into the trusts.
By analogy, if a settlor effectively controls the PTC, there would be a good argument that he or she has not given up beneficial ownership and the trust could fail.
It is therefore important that the settlor and family members of the PTC are in the minority on the board of the PTC. This may also be relevant for tax residency of the PTC.
The PTC should therefore have on its board professional individuals, preferably in the jurisdiction of the trust.
Regulation of PTCs
Consideration needs to be given as to whether or not the PTC is undertaking a regulated activity under Isle of Man Financial Services Act 2008 (FSA2008).
Under the FSA2008 an activity is a regulated activity if it is a financial services activity of a specified kind (such as trust services) and it is undertaken by way of business.
The FSA2008 requires persons carrying on a regulated activity to hold a licence. However one of the exemptions in the 2011 Exemption Regulations is where the sole purpose of a company is (a) to provide services in respect of a specific trust or trusts; and (b) which does not otherwise undertake or, directly or indirectly, hold itself out to the public as undertaking, trust services on condition that —
- the administration of the trust or trusts is carried out by a person licensed to do so, and
- that person has notified the Authority in writing of the name of the company.
There is no definition in the legislation of term "by way of business".
The circumstances of each PTC will need to be considered to determine whether or not it is undertaking a regulated activity "by way of business". Some might adopt a cautious approach and follow the provisions of the exemption for PTCs in the 2011 exemption regulations. However, this does mean that the PTC is subject to a regulatory regime.
Administration Agreement with Fiduciary Licence Holder
Assuming a PTC adopts the exemption regulations or decides it is in any event appropriate to have an administration agreement with a fiduciary licence holder, the agreement will cover such matters as:
- Maintaining accounting records and preparing financial statements
- Access to the bank accounts
- Arranging trustee meetings and keeping accurate minutes of decisions made
- Keeping up to date CDD of directors and beneficiaries
- Safe keeping of documents evidencing title to trust assets
- Assisting with implementation of trustee decisions
The Type of Structure to use as the PTC
The typical structure used in the Isle of Man for creating a PTC is either a 1931 Act or 2006 Act company.
It is important that the shares of the PTC are not owned by an individual as this would effectively give control of the PTC to that individual with the ability to appoint and remove the directors.
Often with a PTC the shares of which are owned by a purpose trust. A purpose trust exists for a specific purpose (such as holding the shares of the PTC) and does not have individual beneficiaries.
The purpose trust could have as its trustees (in addition to an IOM regulated trustee) the directors of the PTC.
An alternative to a purpose trust owning the shares of the PTC is an Isle of Man Foundation which is a separate legal entity and is managed by its council.
A step further to simplifying the structure and reducing the cost for establishment and administration could be to establish an IOM Foundation as the PTC, or "PTF". Its rules could be tailored specifically for the circumstances of the particular family trust with provisions to deal with decision making and conflicts of interest and self-dealing in an easier way than in the articles of association of a company.
PTCs remain an appropriate vehicle for individuals who want the benefit of parting with ownership of assets into a trust structure whilst personally and through family and trusted advisors retaining some element of control as directors of the PTC through decision making in relation to the trust assets and how the beneficiaries are to benefit.
Licensed trust companies in the Isle of Man can offer to set up the PTC structure and enter into an administration agreement to ensure the trust is managed professionally.
This is particularly important for the directors of the PTC, to reduce the risk of beneficiary derivative claims.
Licensed trust companies may wish to provide director services with the settlor and his family and trusted advisors. It may indeed be necessary for the majority of the board to be resident in the Isle of Man to help demonstrate that mind management and control of the PTC is from the Island.
If a Foundation is created to act as the PTF, then similar principles will apply as for a PTC but replacing directors with council members and no requirement for a separate structure to hold shares, as there are no shares in a PTF. It could be that potential derivative actions would not apply to a PTF.
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.