Question of trusts

Sharia trusts’ use of forced heirship rights tends to fragment share ownership down the generations, in some cases sparking disputes. Toby Graham advises on what to watch out for.

Trust and family disputes are on the increase. In particular, there is some vulnerability within sharia trusts – although there are ways in which these risks can be mitigated.

What is a sharia trust?

It is simply a trust that replicates the rights and restrictions of the settlor’s family under the sharia law of their country of domicile. This bypasses complex probate formalities.

Another reason for a sharia trust is to hold surplus wealth for a rainy day. Sharia law and practice are prescriptive: sharia heirs have forced heirship rights to fractional shares in the ascendant’s estate.

There are also investment restrictions. It would be possible, with careful drafting, to give effect to such rights and restrictions in an Anglo-Saxon trust – but settlors usually prefer greater flexibility over the timing and amount of any benefit from the trust.

For this reason a discretionary trust is more common, accompanied by a ‘letter of wishes’ (LoW) asking the trustees to take account of sharia law when exercising dispositive and administrative discretions.

The trust is likely to have offshore trustees, and the trust period is likely to extend beyond the settlor’s life, thus ensuring that the trust assets do not have to be distributed at death, but remain in the trustees’ hands for a rainy day.

The flexibility that is the genius of the discretionary trust can also be its undoing in this context, for the following reasons:

• Lack of understanding, on the one hand, of trustees (and their advisers) about sharia principles and, on the other hand, of Muslim families about trust concepts.

• Practical difficulties with running sharia trusts. Trustees are usually resident offshore, far removed from the settlor and their family. For geographical, cultural and linguistic reasons, the settlor and their family frequently give carte blanche to trusted advisers to deal with trustees.

Powers of attorney conferring wide powers on these advisers, with few checks and balances, are commonplace. Powers of attorney are also likely to be governed by the law of the settlor’s domicile.

These arrangements mean it is difficult for the trustees to contact the settlor and their family other than through the gatekeeper – and the trustees do not know whether the gatekeeper is keeping their principals in the loop.

Sharia law contains complex rules about investments, which are incompatible with general investment powers usually conferred on trustees in modern discretionary trusts. sharia clients often want control over investment decisions.

One solution is for investment discretion to be taken out of the trustees’ hands and given to the settlor, or their advisers, who are given powers to direct trustees’ investments and require trustees to follow such directions.

There are likely to be provisions that protect the trustees – for instance, providing that if directions are followed the trustees are protected, providing there is no duty to make enquiries into the directions given and disapplying the Bartlett duties in relation to trust-owned companies.

The power to direct trustees in making investments is likely to be fiduciary. The trustees would be placed in a difficult position if they believe the power has been exercised in a way that is contrary to the best interests of the beneficiaries.

Differences of interpretation

There are various schools of Islam, each with slightly different rules about the sharia forced heirs’ fractional entitlements. The LoW needs to identify a particular school precisely and, ideally, a particular scholar with whom the trustees can confer.

One common way of avoiding differences of interpretation is for trustees to rely on the inheritance deed of the settlor’s local sharia court, pronouncing on the identities of their sharia heirs and the size of each of their fractional share. Some LoWs contain complex formulae for the heirs’ fractional shares in particular situations. But some suggest that this is to be avoided because it may be regarded as too prescriptive and contrary to the discretionary nature of the trust.

The validity of the trust and the transfer of assets to the trustees is a preliminary issue outside the scope of Article 8 of the Hague Convention, and therefore not determined by the governing law of the trust. Under common law conflict principles, it is likely to be governed by the law of the settlor’s domicile (moveable property), or if immovable, by the law of the situs of the property.

Generally speaking, sharia law does not invalidate gifts to trustees, provided they are not made during the settlor’s death illness. While sharia has forced heirship, there are no provisions for clawing back dispositions made during the settlor’s lifetime.

Many substantial sharia fortunes derive from trading businesses. Share ownership of these businesses becomes fragmented down the generations, with sharia heirs each owning small fractional shares.

The result is that no one within the family has a controlling interest. It is commonplace for the family to agree to give the management of the business to the eldest male, with other family members having little or no involvement in the running of the business.

Problems arise if the business underperforms or if the person entrusted with its management starts to act as if he were the sole owner. This can lead to a divisive power struggle for control, placing the business in limbo.

Key lessons

There are several lessons for trustees and other intermediaries dealing with sharia clients. First, ensure that client due diligence (CDD) checks are applied into assets to be settled into the trust. Ensure that the settlor understands the options available to them.

If they choose a discretionary trust, ensure that they understand the extent of the trustees’ dispositive discretions. If sharia is relevant in the administration of the trust, make sure that the trustees have access to appropriate sharia advice.

Care needs to be taken in drafting the trust instrument. Advice should be sought from suitable experts with sharia and trust expertise.

Take care when dealing with representatives of the settlor and their family. Ideally, the trustees should ensure that there is direct access to the settlor and beneficiaries, who should be consulted regularly.

Trustees need to be cautious about trading businesses. They should only take them on if they have the relevant expertise and time and, ultimately, control of the business.

Finally, when a family quarrel is brewing, avoid the temptation to bury your head in the sand. Disputes can be bloody for all concerned and wasteful of time and expense.

A more consensual approach is needed to find a solution at an early stage – if possible without recourse to litigation. This might well involve mediation with a respected mediator with relevant knowledge and expertise.

Toby Graham is head of contentious trusts and estates at Farrer & Co