Landscape
There has been a growing trend over recent years for the development of bespoke and complex holding structures to accommodate the needs and sensitivities of ultra-high net worth individuals. Often, the clients originate from civil law jurisdictions and as a consequence are unfamiliar with trusts and the fiduciary relationship created. There is (understandably) suspicion.
Whilst there are many robust structuring options available, such as the rebooted foundation and corporate and partnership solutions, trusts remain a popular option and advisers have developed various techniques to alleviate some of the concerns, whilst maintaining the integrity of the structure. The introduction of a coherent structure of governance that enables the settlor and the beneficiaries of the trust to interact with the trustees in a productive way going forward is usually central to these structures.
A question of control
The question of control is often at the heart of discussions with clients seeking to set up holding structures for succession purposes.
Who is this trustee and why would I transfer my most valuable assets to them? Why would I trust these strangers to facilitate and implement the vision of my legacy for my family? I want security, but I also want control!
These not uncommon concerns have been met by the development of mechanisms designed to enable influence to be retained by the client, whilst securing all of the other benefits offered by trusts. A popular option has been the appointment of a private trust company (‘PTC’) structure instead of an institutional trustee.
Cold comfort?
The use of a PTC, in conjunction with an internal governance system, can go some way to appeasing clients who are concerned about loss of control – but there are risks and pitfalls that should be considered. These structures are not always the panacea that they promise to be. The introduction of multi-layered governance is not always necessary and does not always achieve the desired end. Often, weakness in the structure is only tested at crisis point. Most importantly, consideration needs to be given to whether the layers of complexity being proposed do actually offer the protections that are needed by the client – and that the fiduciary nature of some of the offices created is fully appreciated.
The Private Trust Company Structure
A typical private trust company structure would see an institutional trustee owning the shares in a PTC via a purpose trust established for this very reason. The directors of the PTC itself are likely to be a combination of family members, trusted advisers and independent professional trustees. The PTC will, typically, be trustee of a flexible discretionary trust.
So called ‘control’ or ‘influence’ is reserved to the settlor (or a trusted adviser of the settlor) in a variety of ways throughout the structure:
- Purpose trust: by the appointment of a (statutorily required) enforcer mechanism through the purpose trust itself. It is often said that this role is key - the office holder will also often be entrusted with the power to remove the trustee of the purpose trust and appoint it with someone of its choosing. The trustee is, of course, the shareholder of the PTC and so as such it should have the power to remove directors. The settlor will often be the appointor i.e. he will have the power to appoint and remove the enforcer.
- PTC: the directors of the PTC are the decision makers and their identity is fundamental to the character and operation of the structure – family members, professionals and business associates may all win a seat at the table.
- Discretionary trust: at the other end of the structure, the trust of which the PTC is trustee will often provide for the office of protector. The protector will typically have the power to appoint and remove trustees, but will also be empowered with several so called veto or consent powers enabling them to provide a check and balance against the exercise by the trustees of various of the more significant powers (for example, the power to distribute capital to beneficiaries or the power to add or remove the beneficiary from the class of discretionary beneficiaries). Again, the settlor will often be the appointor and so have the power to remove the protector and appoint a replacement.
Influential settlor v reserved powers v sham
The governance mechanisms built into a typical PTC structure are designed to ensure that the settlor retains influence over the structure. This is significant – considerable weakness may be introduced into a structure where a settlor seeks to retain control rather than influence. This is a nuanced but significant distinction.
Where a settlor is desirous of retaining control over specified decisions, consideration should be given to the overt reservation of power under the governing law of the trust (and provided such a reservation does not give ride to any tax risk), rather than a reservation of power via the ‘back door’.
In light of the Pugachev decision very careful consideration must be given to the role played by the settlor in the governance of the structure.
Square peg round hole?
A typical PTC structure provides for multiple offices. Appointors, protectors, enforcers and directors of the PTC, to name a few (there may be others – for example, investment or distribution committees etc).
However, for this multi-layered governance system to add value, rather than simply complexity and expense, the ‘right’ people should be appointed to the roles.
There is little point created a multiplicitious governance system, if the same individual or entity is appointed to each office.
Consider for example a common fact pattern – the same individual (likely the settlor) is the appointor of both the purpose trust (that owns the PTC) and the substantive trust for beneficiaries. The appointor then appoints the same individual as enforcer of the purpose trust and as protector of the substantive trust.
What value does this add? Does it undermine one of the perceived benefits of a PTC? Arguable, yes.
The role of enforcer of the purpose trust will often be expanded beyond that required by statute by the introduction of ‘protector’ type powers. Thus, the enforcer has the power to appoint and remove the institutional trustee, who is the shareholder of the PTC.
The protector is likely to have express power to remove the trustee and appoint a replacement. Consequently, both the enforcer and the protector can influence the decision makers of the trust – the enforcer with influence over the identity of the directors, and the protector with direct power over the identity of the trustee of the substantive trust.
Whilst this mechanism provides some comfort against the risk of the PTC via its directors behaving improperly, it introduces another, separate, vulnerability. What if the enforcer/protector behaves improperly? Yes, the appointor (if in existence) may have the ability to address the issue, but it may be too late. The damage may be done.
The enforcer and the protector offices should be independent of one another. If that is not possible, it may be that there is little value in creating both roles.
This is just one example of how conflicts can arise if one individual is appointed to multiple offices throughout the structure.
The lesson learned may be that rather than shoe-horning a limited number of individuals into a series of roles, governance should be built around the individuals whom the settlor trusts and wishes to be involved. That may, ultimately, steer the planning away from a classic PTC structure.
Keep it personal?
The settlor must also understand whether the powers reserved to him and others are personal or fiduciary. The influence the settlor can reserve to himself through the appointor function is typically represented as being personal in nature and therefore exercisable at will. However, the analysis is not so straightforward for the protector (or an enforcer with expanded powers).
Recent trends in case law indicate that these offices are more likely to be fiduciary in nature. If that is the case, do they really do what they are often represented to do?
Board room politics
The constitution of the board of directors must be decided with care. There are many options – with a board made up of entirely family members at one end of the spectrum and a board with only professionals at the other. Both of these options have arguable limitations, but there is no right or wrong decision here, provided that the directors fulfil their duties and behave properly.
More relevant for the purposes of this discussion is the power the shareholder has over the board of the PTC. In a contentious situation, is it right to simply say the shareholder can remove a director and replace him with a person of their choosing?
The PTC’s articles, local employment law and the jurisdiction of the local courts should all be considered. The removal of a director may not be as straightforward as hoped, depending on the circumstances.
Conclusion
As advisers we must ensure that our clients understand the weaknesses inherent in the complex solutions we propose – a case law develops these are thrown into sharp focus. Equally, it is incumbent upon us to understand the risks which are of real concern to our clients and ensure that these are addressed and tested for weaknesses.
As a minimum we must ensure that the offices of governance proposed are populated so as to mitigate against the risk of concerns identified. We must also ensure that our clients have a full appreciation of the nature of the powers conferred on these office holders.