This technical briefing paper summarises the main characteristics of an Isle of Man foundation under the Foundations Act 2011. This paper relates to the Act; the rules of the foundation may make different or additional provision in most areas.
It is likely that foundations will be used mainly for private wealth and charitable purposes, although there is no reason why they could not be used in a commercial context also. A foundation can be the equivalent of a family trust, used to benefit successive generations of family members; or as a charitable foundation operating in a similar way to a charitable trust. Or a foundation could be the equivalent of a purpose trust and could have as its objects the ownership of assets. A foundation might for example be preferred instead of a trust (a) to own assets which are wasting or risky (b) to hold "orphan" assets, for example the shares in an SPV in a financing structure or in a private trust company or (c) where the client is more familiar with civil than common law jurisdictions and thus understands a foundation better than a trust.
Foundations have long existed in the law of continental jurisdictions, but common law jurisdictions are increasingly legislating to introduce the concept. The Explanatory Notes to the Foundations Bill 2010 state that foundations will add to the number and range of products available to the financial services sector in the Isle of Man; and that foundations will provide a new vehicle which may permit entry by the Isle of Man into new markets in an increasingly competitive environment.
A foundation has been called an independent self-governing legal entity, but can also be regarded as a cross between a trust and a company, as it has some of the characteristics of both. For example, unlike a trust, which is a legal relationship rather than a legal person, but like a company, a foundation is a legal person.
While a trust is a private arrangement which is in general not a matter of public record, the existence of a foundation will be a matter of public record. That said, private matters can be contained in the foundation rules, which are not a public document. Like a trust, the persons or purposes to benefit from a foundation are not its members, but are beneficiaries or objects specified in the foundation instrument and rules.
Under a trust legal or equitable title to assets is owned by the trustees while the beneficiaries together have the beneficial title; however a foundation beneficially owns its own assets. A beneficiary under a foundation has no interest in the foundation's assets, although a beneficiary can apply to Court to enforce a benefit to which the beneficiary is entitled under the foundation instrument or rules.
The council of a foundation equates to the trustees of a trust or board of directors of a company; however, the liability of a council member for a wrongful act is more aligned with the rules relating to directors than the strict liability which can attach to a trustee. A service provider might therefore, from a risk management point of view, prefer to be the member of the council of a foundation rather than a trustee. It is, however, worth noting that insurance purchased by a foundation may not cover a council member in respect of a liability to the foundation.
A foundation is required to keep books and records, and prepare financial statements in certain circumstances, in a manner similar to a company. Unlike a trust, a foundation must have a registered agent (being a holder of a class 4 licence issued under the Financial Services Act 2008), and the address of the registered agent is the foundation's business address.
A foundation is established by an application to the Registrar of foundations by a class 4 (corporate services) licenceholder. The founder is the person who instructs the class 4 licenceholder to make the application. The founder could be another company in the class 4 licenceholder's group, if for example it was desired to establish "shelf" foundations.
The application must include the foundation instrument (in English), which must specify the name (ending with the word "Foundation"), objects, names and addresses of the members of the council and registered agent of the foundation. Changes in these must be notified to the Registrar within one month. The foundation instrument will be a public document; the name of the founder will not (as such) be on the public record, although could be if for example he is a council member.
Personality and capacity
A foundation is a legal person with the name specified in the register, capable of suing and being sued, and holds its assets for its objects. A foundation is (subject to any restriction arising under any enactment or rule of law) capable of exercising all the rights, powers and privileges of an individual except it may not directly engage in commercial trading that is not incidental to the attainment of its objects, and regulations by the Isle of Man Treasury may further restrict the activities of foundations. At present, there are no such regulations.
Given that the Act provides that a foundation exists, as a matter of Isle of Man law it will not be possible to argue that a foundation is a sham. Accordingly, it may be possible for the rules to give the founder many more rights than might be safe in the case of a trust. That said, the usual management and control issues will still apply.
The foundation rules
A foundation must have foundation rules. These are not a public document. The initial rules must be approved by both the founder and the class 4 licenceholder. If not in English, an accurate translation must be provided to the registered agent. The rules must provide for the establishment and proceedings of, and changes to, the council; they may provide for decisions of the council to be subject to the approval of a specified person; they must provide for the appointment, retirement and remuneration of the registered agent; contain rules in relation to the office of any enforcer; rules in relation to any initial and further dedications of assets; and rules about any limit on the duration of the foundation and the destination of surplus assets on a winding up. The rules may provide for or restrict amendments to the foundation instrument or the foundation rules; except that a charitable object cannot be replaced by a non-charitable object, any amendments can be permitted.
The foundations objects
The objects for which the foundation is established must be specified in the foundation instrument. The objects may be charitable, non-charitable or both, and may be to benefit a person or class of persons or to carry out a specified purpose. It is sufficient for the foundation instrument to provide that the persons may be determined in accordance with the foundation rules, which would avoid the identity of the beneficiaries being on the public record. If a foundation has the provision of benefits to persons as one of its objects, the foundation rules may provide for a power of addition or exclusion.
A beneficiary is a person who may benefit under the foundation instrument or rules. A beneficiary who becomes entitled to a benefit may enforce such in the Isle of Man High Court, provided he does so within three years of becoming aware of the entitlement (that period is extended if the beneficiary is under 18).
If an object of a foundation is to carry out a specified non-charitable purpose, the foundation must have an enforcer in respect of that object. Any other foundation may, but is not obliged to, have an enforcer (charitable objects are enforced by the Attorney General). The enforcer has a duty to take reasonable steps to ensure the council carries out its functions, and may require the council to account to him. The enforcer must be identified in the foundation rules, which must provide for his retirement and remuneration. The founder can be the enforcer.
Funding the foundation
Assets are added to the foundation by dedication. A foundation need not have an initial dedication of assets, and assets can be dedicated to the foundation after it is established in which case the details of the dedication must be specified in the foundation rules. A "dedicator" is a person, other than the founder, who dedicates assets to the foundation. A dedicator is a "person with sufficient interest" (see below) but otherwise has no statutory role in the foundation.
The foundation's council
A foundation acts through its council. The council must have at least one member who, if an individual, must be at least 18, however it does not appear that any council member need be resident or regulated in the Isle of Man and a company may be a member of the council. The council must conduct the foundation's affairs in accordance with the foundation instrument and rules. The members of the council must act honestly and in good faith with a view to the best interests of the foundation and exercise the care, diligence and skill that reasonably prudent persons would exercise in comparable circumstances.
Council decisions are to be taken by resolutions at a meeting of the council, or consented to in writing or electronic communication by all (or a majority of, if so provided in the foundation rules) the council members. A council member cannot be relieved by the foundation instrument or rules, or by a contract between him and the foundation, of liability for fraud, wilful misconduct or gross negligence.
A foundation may purchase insurance cover in respect of council members, but it must not include insurance in respect of any liability the council member may incur to the foundation. However the principal person to whom a council member owes duties, and to whom he may therefore have a liability, is the foundation itself. In comparison, a 1931 Act company may purchase for a director insurance against liability in respect of any negligence, default, breach of duty or breach of trust of which he may be guilty in relation to the company; and trustees, if a power to do so is expressly conferred by the terms of the trust, may insure themselves at the expense of the trust against liability for breach of trust.
A foundation must have a registered agent. This activity will be within class 4 of the Regulated Activities Order 2009. The class 4 licenceholder who applies to establish the foundation automatically becomes the first registered agent; changes are then regulated by the foundation's rules. The retirement or removal of the registered agent cannot take effect until a new registered agent is appointed.
Registration of charges
There is no requirement to register charges or other security interests created by a foundation. Accordingly there is no provision that security interests are statutorily avoided if a foundation becomes insolvent.
Unless the foundation rules provide otherwise, a foundation must provide a "person with sufficient interest" in the foundation with a wide range of information as soon as practical after he requests it. The foundation rules can prohibit the provision of information; it would appear that such prohibition need not be general but may relate to particular persons or classes of persons. If such a prohibition applies, the person requesting the information may apply to Court to obtain the information in certain circumstances.
Persons with sufficient interest
These are the persons with standing to obtain information from a foundation or, if the foundation rules prohibit such, to apply to Court for that information, or to apply to Court to enforce the foundation instrument and rules. The definition of the expression "person with sufficient interest" includes the foundation, the founder, a dedicator, a council member, an enforcer, a beneficiary, and the Attorney General (in respect of charitable objects). It also includes a person who the High Court determines to be a person with sufficient interest, if the Court considers that the person's interest in the foundation is sufficiently close that the person ought to be treated as a person with sufficient interest.
Application to Court for directions
The High Court has jurisdiction under the Act to give directions in relation to various matters, including the interpretation of a foundation's instrument and rules, as to the manner in which the foundation should be administered, and as to the rights of beneficiaries. This is similar to the High Court's jurisdiction in relation to trusts.
A foundation must include its name, business address and registration number in all written (including electronic) communications. A foundation's "business address" is that of its registered agent. The foundation must keep proper books and records at an address (within or outside the Isle of Man) as the council decides, and notify the registered agent of that address
(if not the business address). A foundation must keep reliable accounting records sufficient to enable the financial position of the foundation to be determined with reasonable accuracy at any time; and allow financial statements to be prepared. If financial statements are prepared there are certain requirements as to what they must include (balance sheet, etc). If accounts have not been prepared for 18 months, a person with sufficient interest may require that they be prepared. The registered agent may inspect and make copies of the foundation's records. An annual return to the Registrar is required, and a foundation must notify the Registrar of amendments to the foundation instrument.
Borrowing and lending
A foundation is as mentioned above capable of exercising all the rights, powers and privileges of an individual. It can accordingly borrow and lend funds, and may grant security (including fixed or floating charges) over its assets. A loan agreement with a foundation as borrower would be similar to that for a company, in relation to representations, undertakings and events of default; likewise the security documents.
Lending to a foundation seems closer to a company than to a corporate trustee. The latter may act as trustee of other trusts, it will be concerned with contractual ring-fencing or limitations of liability, and will want representations etc to relate to the particular trust. In contrast, like a company, the foundation will not borrow in a particular capacity but in respect of its undertaking generally.
A lender to a company will often take a charge over shares issued by the company, however (as in the case of lending to a trust) a lender to a foundation will probably not be able to take equivalent security; the lender might consider alternatives conferring equivalent rights, for example the right to change the Council if an event of default is continuing. Whether such rights are best contained in the foundation's rules or in the finance documents would need to be considered.
A foundation may not directly engage in commercial trading that is not incidental to the attainment of its objects; such commercial trading would be ultra vires and finance provided for the purpose of such commercial trading may not be recoverable. A lender to a foundation may therefore need to take steps to satisfy itself that this restriction is not engaged. To the extent that this is a question of fact, it would not be covered by a legal opinion. An amendment to the foundation's objectives, or carrying on the activity through an underlying company, may avoid the problem.
The powers of the Council can be restricted by the foundation's rules; for example, the rules may provide that borrowing requires the consent of a particular person. If the Council exceeds its borrowing powers, the borrowing will be irregular, however it is not clear to what extent the lender will be prejudiced by such irregularity. It may therefore be sensible for a lender to satisfy itself that any borrowing is in accordance with the foundation's rules.
The following filings will be required in relation to a foundation. The application to the registrar to establish the foundation must be filed with the foundation instrument and prescribed fee. An annual return to the registrar is required. Changes to the foundation instrument must be notified to the registrar; this includes any change to the foundation's objects, name, registered agent or council member's names and addresses. The Assessor will presumably require an annual income tax return in the same way as for a company.
There is no limit on the duration of the existence of a foundation; if it is to be wound up on the happening of an event or expiry of a fixed period, the foundation rules must specify the event or period. The foundation rules must also specify what is to happen to any assets of the foundation that remain should the foundation be wound up and dissolved. Regulations in respect of the winding up and dissolution of foundations are made by the Treasury. Subject to those regulations, bankruptcy rules are applied in certain respects.
Regulations in respect of the migration of foundations to or from the Isle of Man are made by the Treasury.
Conflict of laws
All questions that arise in respect of a foundation or the dedication of assets to a foundation are required by the Act to be determined solely under Isle of Man law, and there are provisions in relation to foreign heirship and similar rights.
A person carrying on "relevant business" within the Proceeds of Crime (Money Laundering) Code 2010 or the Prevention of Terrorist Financing Code 2011 that deals with a foundation will need to apply the Codes. In summary, foundations seem no more onerous for AML purposes than trusts or companies.
The Codes mandate identification of the "beneficial owner", defined as the natural person(s) who ultimately owns or controls the foundation or on whose behalf a transaction is being conducted. A typical foundation will be controlled by the Council, the members of which will therefore be within the definition of "beneficial owner". Since, typically, beneficiaries have no voting rights, they cannot be considered to be controllers.
Nor it seems will beneficiaries "own" the foundation because they do not have rights which amount to ownership1, nor does the Council or the foundation act on behalf of the beneficiaries. Accordingly, typically the beneficiaries would not be "beneficial owners". That said, each case depends on its own facts; for example if one beneficiary was entitled (as of right) to distributions of all profits and to all assets distributed in a winding up of the foundation, and to trigger that winding up, that could equate to ownership (in the same way as such interests in a company, for example a guarantee company, might amount to ownership).
If under the rules of a foundation a person (for example, the founder or the enforcer) has such significant rights as amount to "control" then he will be within the expression "beneficial owner" also. This can only be determined on an examination of the particular rules. If, for example, a person has under the rules of a foundation the right to veto all Council decisions, "control" of the foundation may be with that person and the Council together.
A foundation is a "legal person" not a "legal arrangement" under the Codes (see paragraphs 3.2.1 and 4.7 of the FSC AML Handbook September 2011). This has consequential implications under the Codes; for example, paragraphs 5(3)(c) (identify any known beneficiaries) and 5(3)(d) (identify the settlor) apply only in the case of legal arrangements so would not apply to a foundation. That said, paragraph 5(3)(h), which requires the relevant person to obtain information to understand the ownership and control structure of the applicant, is probably sufficiently wide to require identification of the beneficiaries; and paragraph 6(4)(d) which requires the taking of reasonable measures to establish the source of funds will probably require identification of dedicators. In any event, a relevant person making a payment to a beneficiary of a foundation will be required by paragraph 5(4) of the Code to identify the beneficiary and verify that identity.
It does not appear that the Codes require that the founder, per se, be identified. The founder is the person who instructs the class 4 licenceholder to make the application to establish the foundation, however that role alone does not bring the founder within the Codes.
A relevant person will also wish to have regard to any guidance issued by the FSC in relation to foundations and AML. Despite what may be the strict legal position under the Codes, a relevant person might decide to treat foundations as companies, for the purposes of verifying legal status and control; and as trusts, for the purposes of identifying known beneficiaries.
Isle of Man tax
A foundation will be a "corporate taxpayer" for the purposes of the Income Tax Act 1970.
Contrast with a Jersey foundation.
Although the legislation is similar, there are differences of language (for example, the foundation instrument is in Jersey called the foundation charter). There are also a number of substantive differences:
- An Isle of Man foundation must have a suitably licensed registered agent; a Jersey foundation must have a suitably licensed council member.
- An Isle of Man foundation for beneficiaries need not have an "enforcer"; all Jersey foundations must have a "guardian".
- The foundation instrument in the Isle of Man must be in English; the charter of a Jersey foundation need not be in English.
- Filing of identities of council members is obligatory in the Isle of Man, optional in Jersey.
- Winding up events/rights are in the foundation rules in the Isle of Man, in the charter in Jersey.
1. Ownership consists of innumerable rights over property, for example of exclusive enjoyment, of destruction, alteration and alienation; these rights are conceived as merged in one general right of ownership (Halsbury's Laws, 4th ed. reissue, vol. 35, para. 1227).
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.