Asset Protection Trusts

INTRODUCTION

There has been a good deal of interest in recent years in what are known as asset protection - or sometimes creditor protection trusts - and the subject has been much discussed at seminars dealing with offshore trusts. The reason for the interest is understandable, particularly from residents in the United States of America. There, court awards (eg damages in professional negligence claims) have reached such heights that the result can be total ruin for the individual concerned. How much more attractive, therefore, to be able to put aside a nest egg beyond the reach of his creditors, which he can enjoy later if the axe should fall and which will enable him and his family to live comfortably.

Is the Cayman Islands a safe haven for his assets? Until 1989, the answer was almost certainly not. The law on the subject was governed by an ancient statute passed in England in 1571 during the reign of Elizabeth I which rendered void any disposition intended to defeat, delay or hinder the interests of creditors. In appropriate circumstances, that had the effect of allowing a creditor, who may not have existed at the time of the creation of the settlement, to set aside a disposition to trustees leaving the trustee in the disastrous position of not only receiving no fees to cover his professional trusteeship, but possibly also out of pocket for the expenses of defending the "trust". In 1989, the legislature in the Cayman Islands passed The Fraudulent Dispositions Law, 1989 which replaced the Statute of Elizabeth with a more modern and moderate regime which set out to protect the interests of legitimate creditors but at least give some comfort to settlors (and, even more so, to trustees) of trusts established under the laws of the Cayman Islands. The Cayman Islands now has the Fraudulent Dispositions Law (1996 Revision).

FRAUDULENT DISPOSITIONS LAW (1996 REVISION)

The effect of the Fraudulent Dispositions Law (1996 Revision) is to render voidable (at the instance of a creditor prejudiced thereby) any disposition made with an intent to defraud and at an undervalue. It should be noted that the test for setting aside such a disposition is twofold: it must be with intent to defraud and also at an undervalue.

Intent to defraud at an undervalue

"Undervalue" is defined as either no consideration or a consideration for the disposition significantly less than the value of the property being disposed.

"Intent to defraud" is defined as meaning "an intention of a transferor wilfully to defeat an obligation owed to a creditor."

"Obligation" is defined as meaning an obligation or liability (including a contingent liability) which existed on or before the date of the disposition and of which the transferor had notice. The question of whether actual notice is necessary has not yet been determined but it seems most likely that constructive notice would be sufficient. It would seem unlikely that the courts would assist a transferor to defeat his creditors where he knew or ought to have known of their existence.

"Creditor" is defined, rather simplistically, as being a person to whom an obligation is owed.

The result is that a disposition made even at an undervalue (such as a disposition to trustees) is safe from the attack of creditors unless they can show an intent to wilfully defraud creditors then existing. Even if such an attack succeeds, the disposition is only set aside to the extent necessary to satisfy the creditors prejudiced by the disposition. It should be noted that the statute specifically provides that the burden of proof of the transferor's intent to defraud is placed squarely on the creditor seeking to set aside the disposition. It is, however, unlikely that he would have to show a specific intent to defraud him; it will probably be sufficient to establish a general intent to defraud, although this point remains to be determined by the courts.

As a final saving, the statute provides that there is a limitation period of six years after the disposition which prevents any action being taken to set aside the disposition after that time.

Protection for trustees and beneficiaries acting in good faith

If the court is satisfied that a trustee has not acted in bad faith in receiving the property, the trustee will be able to retain sufficient to pay its entire costs incurred in defending the proceedings (not merely court taxed costs) and also will be entitled to retain its proper fees and costs incurred in administering the trust, as would any predecessor trustee who had similarly not acted in bad faith.

Any beneficiary who has received a distribution properly from the trust fund in terms of the trust will be entitled to retain that distribution provided that he has not acted in bad faith.

Cayman as jurisdiction of choice

With the passing of this legislation, the Cayman Islands became an attractive jurisdiction in which to locate asset protection trusts, provided that the settlor acted before the claims arose. It is obviously too late for the settlor to act when he is already aware of outstanding claims (which is of course the most common time when enquiry is made). However, an individual can, before embarking on a course of conduct which could give rise to claims, set aside a fund to look after himself and his family if the worst happens. With the ever-spiralling cost of professional indemnity insurance, this may be an attractive prospect for many professionals who in the past have been exposed to large awards of damages for tortious claims. In many ways, it is similar to a prudent businessman incorporating a limited liability company for the purpose of embarking on a speculative undertaking. Of course, tortious liability remains the responsibility of the individual committing the tort, but by proper planning and responsible behavior, the prospects can be improved.

It is fair to say that while the Cayman Islands have been often mentioned as a suitable place for establishing asset protection trusts, the local trust companies have not unreservedly welcomed that role. There is a concern among them that the reputation of the jurisdiction will suffer if it is seen to be offering a shelter for the unscrupulous - what has been referred to as a "rip-off artists charter". There is also perceived to be a moral barrier to being a party to assisting individuals avoid liabilities to creditors, although this attitude is somewhat inconsistent in a jurisdiction which thrives to a large extent from the incorporation of limited liability companies. However, there is no doubt that if the situation justifies it, a trustee can be found and attitudes are certainly softening. There is certainly a large body of professional expertise available in the Cayman Islands to act as trustees.

BANKRUPTCY

There is perhaps a word of caution still needed. The Bankruptcy Law (1997 Revision) of the Cayman Islands still allows a trustee in bankruptcy appointed under that statute to set aside a settlement (other than a marriage settlement or made in favour of a purchaser or incumbrancer in good faith and for valuable consideration) if the settlor becomes bankrupt within two years of the settlement, or within ten years unless the parties claiming under the settlement can show that the settlor was at the time of the settlement able to pay his debts without the aid of the property settled. The statute, however, only applies to individuals personally present in, ordinarily resident or having a place of residence in the Cayman Islands, or carrying on business in the Cayman Islands, either personally or through an agent or manager, or through a partnership. That will presumably strictly limit the application of the statute as far as most creators of asset protection trusts are concerned, but it is worth bearing in mind.

In relation to bankruptcy elsewhere, it should be emphasised to the settlor that he may have to export himself from his present jurisdiction in the event of his bankruptcy if he intends to reap any benefits from his asset protection trust. There is little point in having trustees make distributions to him which will have to be paid directly to his trustee in bankruptcy. This is a factor which many potential settlors tend to ignore but should not as it will obviously have a significant impact on their lives.

STRUCTURE

We are often asked what an asset protection trust looks like. There is no easy answer other than that it ought to reflect the settlor's intentions just as any other trust would. Indeed, all trusts are in essence asset protection trusts being designed to preserve assets for the enjoyment and benefit of their beneficiaries. There are, however, a number of factors to be considered when establishing an asset protection trust in the Cayman Islands, some of which are discussed below.

Irrevocable trust

The trust should be irrevocable (preferably) or, if revocable, its revocability should cease on the bankruptcy of the settlor. There is no point in establishing an asset protection trust which can be revoked by the settlor's trustee in bankruptcy.

Discretionary trust

The interest of the settlor (if any) should be such that it cannot be attacked by his trustee in bankruptcy. For this purpose, it would probably be most convenient to use a form of discretionary trust.

Limit powers on bankruptcy

The powers (if any) reserved to the settlor should be carefully considered. Clearly any power reserved to a settlor could be exercised by his trustee in bankruptcy. It may therefore be necessary to limit such powers or terminate them on the bankruptcy of the settlor.

Independence of trustee

Similarly, it is important that the trustee must act independently and not slavishly follow the wishes of the settlor. Recent authorities have considered trusts which followed such a course to be a mere sham and have set them aside.

Solvency of settlor

The trustee should satisfy himself that the settlor is solvent when he creates the settlement or adds property to it at any time thereafter, and that the settlor is not aware of any claims or potential claims (eg claims under a personal guarantee).

Settlor offshore

The settlor should not be physically present or resident or carrying on business in the Cayman Islands at the time of creation of the settlement, or at any time subsequently when property is transferred into the trust.

"Caymanise" trust property

The property being transferred to the trust should be to the extent possible "Caymanised", that is treated as property in the Cayman Islands for the purpose of Cayman Islands conflict of law rules. One way to achieve this would be for the settlor to incorporate a company in the Cayman Islands, transfer the property intended to be settled to the company, in consideration for the issue of shares to him (which would be a valuable consideration and not a transfer at an undervalue) and thereafter settle the shares on the trustee. This ought to ensure that, so far as the courts in the Cayman Island at any rate are concerned, the property being transferred under the disposition which is being attacked is within the jurisdiction of the Cayman Islands courts.

Location of trust assets

The trust assets should to the extent possible be kept out of any jurisdiction where any significant risk of attack is feared, eg the residence or domicile of the settlor, or where he carries on business.

Purpose of trust

The trust should have a higher aim than simply asset protection, which should merely be ancillary to a wider reaching plan, eg to provide for the settlor's family. Similarly it is probably advisable not to be to greedy and to refrain from settling the whole of the settlor's property in trust. While this is not an absolute point, it will be of assistance in any attempt to show that the settlor was not acting in bad faith. Similarly, it is useful for the settlor to produce personal financial statements dated immediately following any transfer into trust, together with an affidavit by the settlor swearing that, following the transfer into trust, the settlor could meet his debts as they fall due.

Protect from risk of litigation

Although not a legal point, the trustee ought to bear in mind that an asset protection trust is by its very nature a potential invitation to attack from the settlor's creditors and the trustee may well become involved in litigation to defend the establishment of the trust. He should, therefore, as well as taking into consideration the points made above, consider whether it is economically justifiable for him to accept the risk. He should also ensure that sufficient assets will be available to him to fund such litigation. It may well also be appropriate to ensure that distributions from the trust fund are restricted until all applicable statutory limitation periods have expired.

CONCLUSION

If such prudence and forethought is applied to its creation, an asset protection trust established under the laws of the Cayman Islands will have every prospect of achieving its objective. Indeed, the legislation in the Cayman Islands has been deliberately framed in what is perceived as a conservative approach, rather than following the innovative and aggressive approach taken by some other jurisdictions. The hope is that a foreign court will be persuaded it is proper to uphold the disposition in that it is consistent with legal principles applicable in its own jurisdiction and does not offend any principle of public policy there. Time alone will tell if this hope is realistic.

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.