A safe haven in the sun

Until recently, the effectiveness of the Cayman Islands as a safe haven for the investors' nest egg was under question. Could the islands afford any protection against the creditors of a settlor who set up a Caymans trust to protect assets?

This question was brought about by an old English statute, the Fraudulent Conveyances Act 1571 (more commonly known as the Statute of Elizabeth), and the issue of its applicability to Cayman law.

The effect of the statute is to render void any disposition which was intended to defeat or delay the interest of creditors. This not only applied to creditors who existed at the time of disposition of property into trust, but also in certain circumstances to future creditors to allow them to strike down the transfer and render the settled property available to satisfy the claims of the aggrieved creditor. This is a most unsatisfactory situation for the settlor and possibly even the trustees who may not be able to collect any fees from the trust or recover the costs which they have incurred.

Why should this situation exist when at the time of the disposition into trust the successful creditor had no claim against the settlor?

This was the impetus for the passing of the Fraudulent Disposition Law 1989 which attempts to reach a reasonable compromise between the rights of creditors and those of the settlor. It expressly excludes and supersedes any of the previous laws of the Cayman Islands, including the Statute of Elizabeth, previously in effect.

The law would, on this construction, also exclude section 107 of the Bankruptcy Law (Revised), which is the equivalent of section 42 of the English Bankruptcy Act 1914.

Even if the law does not exclude section 107, the section only applies to individuals present in or carrying on business in the Cayman Islands through a manager, agent or partnership.

The law deals with the issue simply by applying two tests: was the disposition made with the intent to defraud; and was it at an undervalue? The law requires both elements to exist at the time of the disposition for the disposition to be deemed fraudulent.

In relation to trusts, the only element normally in issue is whether the settlor made the disposition with the intent to defraud, since the disposition into trust will, by its nature, be at an undervalue.

The "intent to defraud" means an intention of a transferor wilfully to defeat an obligation owed to a creditor. 'Obligation' means an obligation or liability (including a contingent liability) which existed on or prior to the date of the relevant disposition and of which the transferor had notice.

The question of whether notice includes constructive notice remains to be determined.

The burden of proof on establishing intent to defraud on the part of the settlor is placed on the aggrieved creditor.

The law does not state the same in relation to the issue of whether the disposition was at an undervalue, but one would expect the creditor to bear this burden of proof also.

In any event, the law specifies a limitation of action period which is six years from the date of the disposition. Therefore, a creditor will be barred from proceeding with a claim if it has not been initiated within the six-year limitation period.

This holds true even if the creditor could have established that the settlor had a general or specific intention to defraud at the relevant time of the disposition into trust. And the law applies to dispositions made before it came into effect.

What happens where a creditor has brought a claim within the time period, satisfied his burden of proof in respect of tests and succeeded in having the disposition set aside?

The parties most likely to suffer in such a scenario are the trustees and the beneficiaries of the trust. Accordingly, the law provides that if the court is satisfied a trustee has not acted in bad faith by accepting the property on trust, the trustee will have a priority claim to the trust fund in respect of his professional fees for acting as trustee, his costs of administering the trust and his costs in defending the action, on a full indemnity basis.

Similarly, any beneficiary of the trust who has received a distribution from the trust will be entitled to retain that disposition free of any claims by a successful creditor, provided the distribution was in accordance with the terms of the trust and the beneficiary has not acted in bad faith.

The Law clearly strikes a balance between the rights of creditors and the rights of the settlor acting in good faith, by allowing a reasonable period (six years is the norm for most contractual claims) within which a creditor can bring his claim. At the same time it gives the settlor protection against creditors who may not have existed at the time of the disposition of the settlor's property into trust. In addition, the law seeks to properly protect innocent third parties who have acted in good faith.

The Cayman Islands is a highly reputable and well-known offshore jurisdiction in which to do business and a fair jurisdiction in which to set up asset protection trusts.

From the settlor's perspective, the fact that he is protected from future creditors bear this out. From the creditor's perspective, this is evidenced by the fact that he should succeed in his claim where it existed prior to, or at least concurrently with, the disposition, provided that he initiates proceedings prior to the expiry of the six-year limitation period.

The Cayman Islands does not wish to be seen to be protecting unscrupulous individuals from their rightful creditors, but if a creditor had no claim at the time of the relevant disposition, the Cayman courts will not recognise that creditor.