Laying the foundations
19 June 2006
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A fascinating game of mix and match is being played in some of the financial centres that cater to the world's wealthy individuals and families, as jurisdictions that belong to the civil law and common law traditions seek to borrow some of each other's structures to boost the range of options they can offer high net worth clients.
The Channel Islands of Jersey and Guernsey are deliberating separately on proposals to incorporate foundations, a structure first established in Liechtenstein, into their legislation. Although - in part due to the pressure of other legislation, in part because of a rather cumbersome law-making process - it is likely to be about a year before they reach the statute book in Jersey and probably even later in Guernsey.
Lawyers in the two jurisdictions say that the driving force behind the proposals is a desire to offer an alternative to clients from civil law jurisdictions who are unfamiliar - and perhaps uncomfortable - with the idea of trusts.
However, foundations are expected to appeal especially to clients from the Middle East and Asia who want more control over the assets they settle than can be provided even by the new purpose trusts being introduced in both jurisdictions.
Meanwhile, Switzerland is following Luxembourg in moving through the process of ratifying the Hague Convention on the Law Applicable to Trusts and on their Recognition.
If Switzerland completes the ratification process as planned this year, it will bring the number of civil law jurisdictions to have adopted the convention to five, after Italy, Malta, the Netherlands and, of course, Luxembourg.
As in Luxembourg, pressure to adopt the convention has come in Switzerland from the financial sector, which has become frustrated by the lack of legal certainty in the way trusts have been treated by Swiss courts over the years.
Ratification is expected to help Switzerland's extensive trust administration fight off growing competition from rival wealth-management centres such as Singapore.
The foundation structure
The foundation was first introduced in Liechtenstein in 1926 and over the years it has become a popular structure for the management of family wealth. Over the past decade or so this has started to attract imitators in other offshore financial services centres, starting with Panama (1995), the Netherlands Antilles (1998) and the Bahamas (2004).
Rupert Evans, a partner with Ozannes in Guernsey, who chaired the working group on changes to the island's fiduciary legislation, says: "The idea was looked at in the light of developments in many other jurisdictions, particularly Anglo-Saxon or common law jurisdictions, which all seem to regard foundations as a useful tool and something that helps
market the jurisdiction; and Guernsey was no exception.
"There is a feeling that clients based in civil law jurisdictions are more familiar and happier with foundations. To cater to them, it was felt that it would be worthwhile investigating and the general conclusion was that we should go with it. It has been decided in principle that foundations should be part of Guernsey's armoury."
Evans' working group noted that there is no single definition of a foundation, but identified a number of common features across the jurisdictions that now offer them. Foundations are created by one or more founders who provide assets to them and who may have the power to revoke the foundation or add or remove beneficiaries. They have legal personality and are inscribed on a public register and hold assets for the purposes set out in their constitutive documents, made up of a public charter and private rules or articles that set out their operations in detail.
Unlike trusts, foundations are administered under contractual, rather than fiduciary principles. They are run by an executive council or board responsible for fulfilling the purpose set out in the charter, and may have beneficiaries, depending on their purpose, or an adviser or protector if the constitutive documents so stipulate.
Timetable for legislative change
Jersey's foundation proposals are now at the stage of draft legislation, following the issue of a consultation paper at the end of 2004, but it has been in a queue behind amendments to the territory's trust legislation, which were passed by the legislature in April and are now being considered by the Privy Council, which must approve all Jersey primary legislation.
Carey Olsen partner Paul Matthams says: "Jersey legislation sometimes has a tendency to take rather longer than some of us think. If the legislation does not come before the States of Jersey before the early autumn, the requirement for the Privy Council normally adds six months, so we would be unlikely to see anything in force until the spring of 2007."
The timetable is even more vague in Guernsey, where the launch of foundations seems set to follow that of its neighbour. Evans says: "It will be necessary to draft primary legislation, but when that will happen is difficult to say because changes to existing trust legislation will probably take priority. There definitely will be foundations in Guernsey, but it would be a brave man who said exactly when it was likely to happen."
According to Matthams, the foundation will sit somewhere between a trust and a company in the range of Jersey financial structures. He says: "The fundamental reason for doing it is to be of use to clients in jurisdictions that don't particularly understand trusts. It's a financial services product that tries to combine the flexibility of the trust with the transparency of the company, in that a foundation would be a distinct legal entity that will have to be registered and for which a public search can be carried out."
He notes that, as a Jersey legal entity, foundations there will have to meet the same kind of due diligence requirements, such as anti-money laundering safeguards, that apply to trusts and companies.
Under the island's financial services legislation there will be licensing of service providers, including members of a foundation's council, but it is unclear at this stage whether this will be done by extending existing provisions covering the provision of registered offices and trustee services, or by introducing a completely new category of licensed activities.
continued #While most advocates of foundations in common law jurisdictions say they will address the needs of European clients, Matthams believes the greatest interest may come from further afield. "There has been demand in recent years for structures where the settlor or originator still wants to keep quite a heavy degree of control," he says. "That's particularly true of clients from the Middle East and Asia, which, to some extent, has also driven changes to the law which allow settlors to have a greater say in the running of trusts.
"Under a foundation, as long as you've got the right provisions in the documentation, the founder can play a fairly significant role. I expect the take-up to be quite high, particularly from clients in Asian jurisdictions, although probably not from clients in the UK, for whom trusts have worked perfectly well so far."
Luxembourg and Swiss ratification
Similar logic lies behind the willingness of Luxembourg and Switzerland to adopt the Hague Convention on trusts, which has also been ratified by the UK (along with the Isle of Man, Bermuda, the British Virgin Islands and Gibraltar), Australia, Canada and Hong Kong, and signed, but not ratified, by the US, Cyprus and France.
In Luxembourg's case there was the added incentive that adoption has ensured recognition by other signatories of its own structure known as the fiducie, a fiduciary contract that closely resembles a trust and was first recognised under a 1983 decree. However, there are indications that with trusts fully recognised in the Grand Duchy, the usefulness of the fiducie has waned.
Luxembourg's legislation of July 2003 ratifying the Hague Convention also amended the 1983 legislation, by extending the range of quasi-trustees of a fiducie from Luxembourg banks to foreign institutions and other organisations, including investment managers and corporate funds, pension funds, insurance and reinsurance companies and national or international public bodies active in the financial sector.
Lorang & Wingerter private client lawyer Alain Lorang says: "Foreign trusts now enjoy full recognition in all their aspects in Luxembourg. It is important for succession issues because of Luxembourg's civil law forced heirship rules, because the trust offers a way of arranging inheritance under common law. Even before the legislation was passed, there was at least one court decision recognising the provisions of a foreign trust rather than civil law succession rules."
Lorang adds that Luxembourg financial institutions are, in fact, keener to use foreign trusts than the fiducie because the latter exposes them to reputational risk as a party to the fiduciary contract. "If they want to have the effect of a trust they use a foreign trust, because it is recognised," he says. "You don't need a Luxembourg trust structure. When the fiducie was first introduced there was a lot of interest from banks in acquiring fiduciary companies, but you don't see that any more."
Meanwhile, a bill to ratify the Hague Convention and to amend the country's legislation on international private law was approved by Switzerland's first chamber of Parliament last month. The legislation is due to be considered by the second legislative chamber within the next few months and if there is no political opposition, passage can be completed later this year, allowing the convention to take effect in 2007. n
Simon Gray is a freelance writer and former editor of International Money Marketing