The term "Asset Protection Trust" can be slightly confusing because no type of trust under English, Jersey or Guernsey law is specifically designated an "Asset Protection Trust" (as if it were a particular type of trust). The purpose of every trust is to protect assets, though the reasons why assets need to be protected will vary from one trust to the next.
However, the term "Asset Protection Trusts" has developed as a term of art, and a number of jurisdictions, notably the Cayman Islands, Bahamas, Anguilla, and the Cook Islands have enacted debtor friendly legislation and are known as "asset protection" jurisdictions. The primary purpose of such trusts is to protect assets against claims made by creditors and such a trust is used for persons embarking on a risky business venture or persons asked to give personal guarantees relating 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
Like all trusts, an asset protection trust is established by a person, (the settlor) transferring his assets to a trustee. In the asset protection scenario, the settlor 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 settlor how much of his assets he transfers to the trustee. Where Jersey and Guernsey real estate is involved, a settlor would need to bear in mind the costs of transferring such assets into trust. A transfer of Jersey and Guernsey real estate will attract only nominal document duty where the beneficial owner remains the same (subject to Greffier's clearance). Unregistered bonds will not trigger a charge, but duty of 0.5% of the value of the property is payable where registered bonds have to be re-registered.
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, ie: 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 trust. For this reason it is often suggested that transferring the settlor's primary residence, or illiquid assets to an asset protection trust would not be beneficial. This is particularly where the creditor, debtor and asset are all in the same jurisdiction.
If a trust 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 trust instrument to ensure that the risk of the trust property being vulnerable to attack is eliminated as far as possible. In general, the following "rules of thumb" should be followed:
- The trustee 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 settlor should have no beneficial interest in the trust property (other than a contingent reversionary interest) (although in practice this is often a step too far for many settlors);
- In light of the recent decision in Tasarruf Mevduati Sigorta Fonu v Merrill Lynch Bank and Trust Company (Cayman) Limited, Demirel, and Others (namely that a power of revocation is a property right that is capable of being assigned to a creditor) it is important that the trust should be irrevocable;
- the trust assets should not be situated in the jurisdiction where the settlor or beneficiary(ies) are resident (this typically makes the settlor's primary residence unattractive for an asset protection trust).
- as few as possible (and ideally no) powers should be reserved to the settlor or someone affiliated with a jurisdiction of the type referred to above;
- the settlor should consider vesting supervision of the trust in a committee of protectors (which can include the settlor).
- the settlor, any beneficiary should not be appointed as trustees and the trustees appointed should be entirely independent of them;
- the settlor should not be appointed the protector since courts have considered that permitted the settlor in each case significant control over trust assets by being appointed a protector
- the trust instrument should state that no one from where the jurisdiction of the settlor or beneficiaries is resident (or one in which the claim is likely to be made) may be appointed as a trustees or protector and that if such a person is appointed, the existing trustee may remove that person immediately;
- an express provision should be incorporated in the "flee clause" to the effect that the governing law and the forum for the trust's administration cannot be changed to that of the jurisdiction in which the settlor or any beneficiary is domiciled or resident (or one in which the claim is likely to be made) and that no trustee may be appointed who is resident in that jurisdiction;
The settlor may wish to be appointed as an investment adviser to the trust. If so control of the trust fund must be expressly divided between investment discretions, controlled by the settlor and distribution discretions, controlled by the trustees.
Asset Protection - legal principles
The main area of attack of these types of trusts is by a creditor seeking to have the transfer of assets into trust 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 (the "Pauline action", which still forms part of Jersey and Guernsey's customary law - see below) 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 settlor's contemplation at the time the transfer is made). Other Statute of Elizabeth jurisdictions (ie: Australia, New Zealand, the US) share these roots.
Jurisidictions which hold themselves out as "Asset Protection" jurisdictions have legislated specifically to ensure that:
- the capacity of the settlor, and the validity of the a trust is governed exclusively by that jurisdiction (irrespective of a foreign judgment to the contrary);
- negates the Statute of Elizabeth that permits future creditors to have an action as long as the settlor was solvent immediately after making the disposition;
- imposes the burden of proof on the creditor to show that there was an intention to defraud him by the transfer of the relevant assets into trust;
- reduces the time period where a creditor must commence proceedings from the date of the disposition. The Bahamas, Anguilla and the Cayman Islands have Fraudulent Dispositions laws which impose varying time limits from 3-6 years. It should be noted that no jurisdiction allows defrauding existing creditors, nor protects a transfer of assets that results in the Settler becoming immediately insolvent.
The law in Jersey and Guernsey
Jersey and Guernsey are not an asset protection jurisdictions. They do not have a fraudulent dispositions law as described above, although it has enacted the Cayman Islands equivalent described at paragraph 3.3 above. (Although this would be of no practical benefit if all the parties were in Jersey or Guernsey). As described below, the Pauline Action also has the advantage over Statute of Elizabeth jurisdictions because future creditors are not protected.
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 [emphasis added];
- 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 settlor] 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 [i.e. 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). Droits personnelles are governed by the Loi Relative aux Prescriptions 1889, which states that a limitation period of 6 years applies. 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:
"Anyway it is held as part of our law that the gift of things or chattels does not necessarily imply that the donee is responsible for the debts of the donor, but if at the time of the gift the donor knew or ought to have known that he was not solvent, or because of the donation there was not left to him sufficient to satisfy his creditors, then these who are defrauded by this gift can revoke by an action the gift which is made, even if the donee didn't have knowledge of the fraud of the donor ... Now that is the Customary Law ..."
In Le Ray, a conveyance was set aside on the grounds that it was "fictitious and fraudulent". 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.
Asset Protection - Shortc omings
The main line of attack is that which is described at paragraph 3.1 above. Alternatively (or in addition) a creditor could attempt to argue that the trust was a sham, because the settlor continued to treat the trust property as his own and the trust was merely a screen to shield the settlor's resources. This is usually a difficult argument to make especially if the points made at paragraph 2.3 are taken.
Finally, there is also a risk (in theory at least) of a claim being made by a member of the settlor's family on the grounds that a transfer of assets into trust undermines Jersey and Guernsey forced heirship rules, depriving the family member of his or her legitime. It seems unlikely that this would succeed, given that it would not be the purpose of the trust (and the settlor's family would almost certainly be included in the class of beneficiaries).
It is important to choose a jurisdiction which offers strong confidentiality laws. Jersey and Guernsey are such jurisdictions, although again, the creditor will find it much more difficult if the assets were located out of either Jersey and Guernsey, in a jurisdiction providing secure confidentiality laws.
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 - good news for the settlors of Jersey or Guernsey trusts. In particular, the onus is on the creditor to demonstrate firstly that he was a creditor at the time the transfer of assets into trust was made, and secondly, that the settlor 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 principles set out at paragraph 2 are followed, there are many good reasons to consider asset protection structures, but (and I believe this to be significant) there are important reasons (described above) why Jersey and Guernsey-resident settlors might prefer to establish a trust in a different jurisdiction and not in the jurisdiction where they are resident, and why transferring one's primary Jersey and Guernsey residence into trust may not be an effective asset protection technique.
As a practical matter, often asset protection trusts work because a creditor must weigh the costs of finding and pursuing assets against the claim itself, rather than the merits of the trust itself. This again supports the view that the asset protection trust 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 settlor's willingness to be declared en desastre. Being declared en desastre 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 settlor requests the trustee to transfer trust assets back to him, the trustee may refuse. The structure has been set up to eliminate settlor control and there is no guarantee that the trustee will distribute those assets to him as this may not be in the best interests of the beneficiaries of the Trust.
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.