Trust in change

  • Author : Clare Stirzaker
  • Date : December 2012
ABOUT THE AUTHORS: Clare Stirzaker is Vice President, Wealth Advisory, at Barclays. This article was prepared with the support of Alice Killingbeck, Assistant Vice President, Wealth Advisory, at Barclays

The rapid spread of political discord culminating in the Arab Spring has shaken the Middle East and has unquestionably affected the wealth-planning strategies of Middle Eastern clients. Clients are increasingly examining the need to diversify, not just in asset allocation, but also in asset location and asset structuring. At the same time, their succession planning objectives remain of constant and continuing importance.

As a result, increasing numbers of Middle Eastern clients and their advisors are now seriously considering the type of strategies and structures that should be implemented with offshore and onshore assets and, in particular, the extent to which trusts can help meet their objectives.

Separation is the key

Once clients have decided to create a trust, the next step for advisors may be to consider with the client the value of creating more than one trust for tax or succession planning purposes. The traditional push-back from clients in creating too many structures emanates from a common concern that such an approach is too burdensome and costly. However, the increasing significance of asset protection in the minds of clients is now making them more willing to consider the advantage of creating separate trusts, to help ring-fence and protect assets.

Local challenges

Historically, advisors have always preferred that Middle Eastern assets are kept in separate structures to non-Middle Eastern assets. This is primarily to protect the assets held on trust and the trustees from potential forced heirship claims after the death of a settlor, which will be instigated on the basis that the assets held in trust should form part of the settlor’s estate and pass in accordance with Shariah. As a result, it has always been prudent to segregate Middle Eastern assets from non-Middle Eastern assets and locate the trusts in a jurisdiction with strong anti-forced heirship laws, such as the Cayman Islands. Whether such structures would fully protect Middle Eastern assets from local claims remains debatable, but certainly they should help protect non-Middle Eastern assets if the trust has been validly created.

There is an increasing interest in the use of trust structures to hold Middle Eastern assets, but this has always been a difficult area to address because it is frequently unclear whether such a trust structure would truly be respected by the courts in the region. In addition, there are often local laws restricting the foreign ownership of Middle Eastern assets, which make ownership by offshore trustees more difficult. As a result, an offshore trust may not always provide the best solution and often the desired result may be better achieved through a family governance exercise, particularly for a family business. However, where a trust is deemed appropriate by all parties, a further step that can be taken to minimise the risk of forced heirship claims is to consider the ways the trust can comply with Shariah.

Shariah compliance

Private client advisors and trustees in most major offshore jurisdictions are becoming more familiar with Shariah and how its tenets can be incorporated into the design and administration of a trust structure. Therefore, where there is a desire to ensure that a trust complies with Shariah, there will often be discussions with the clients and their local advisors on the following types of topics: how to ensure that the settlement of assets on trust constitutes a valid gift for Shariah purposes; how the trust fund should be divided and distributed in accordance with Shariah after the settlor’s lifetime; whether it is possible for assets to remain on trust in certain circumstances; how to ensure that any investments made by the trustees are Shariah compliant; and whether it is possible to use the assets held on trust to deal with zakat – charitable payments.

However, such provisions in a trust can also pose practical difficulties for a trustee. For example, what is the most robust way to identify the zakat sum? What process should the trustees follow to identify Shariah heirs? Clients may want the trust fund to be divided in accordance with Shariah, but for a certain share to be held on trust until a child reaches a certain age or level of maturity, or to take into account unstable regimes, but will this be respected and upheld after the settlor’s lifetime?

If a client wishes a trust deed to take account of Shariah, then clearly it remains critical that both the trustees and the advisors pay careful attention to the drafting of the deed, not just to ensure Shariah compliance and to achieve the client’s objectives, but also to ensure that any practical issues for the trustees are carefully thought through to minimise their risk.

“There is increasing interest in the use of trusts to hold Middle Eastern assets”
Grand designs

In addition to the risk of forced heirship claims, there may now also be an increased risk of creditor or state claims against clients and their businesses, as a result of increased volatility in the region. However, segregation of assets in itself may not be sufficient to deal with such third-party commercial risk. The design of the structure is also key.

Whereas previously clients from the Middle East have sought to design trusts that permit them to retain the greatest degree of control, they are now more actively engaging in discussions on the benefits of discretionary trust structures and beginning to recognise that structures in which they have reserved extensive powers may not offer them the level of asset protection they require.

The all-important power of revocation also has to be considered against the backdrop of potential court orders. More than ever, clients should be alerted to the fact that this power could be used to their disadvantage if court orders are issued, as shown by the recent case of Tasarruf Mevduati Sigorta Fonu v Merrill Lynch Bank and Trust Company (Cayman) Ltd and others. Instead, advisors should focus on the provisions governing the hiring and firing of trustees and on outlining alternative ways of winding up the trust. For clients who remain reluctant to cede control to trustees, the appointment of third parties, such as protectors, may provide additional comfort and may enable them to compromise on the level of control they would otherwise exercise.

Recent political events have shone a light on the importance of well-designed trusts and, now more than ever, advisors need to ensure that there is no lacuna in the drafting that could give rise to later issues. For example, to give comfort to clients and trustees, careful thought needs to be given to what provisions should be included in the trust deed to deal with any emergencies, such as a state of war or revolution, or the issuance of freezing orders. If such events happen, should a client and their family be automatically excluded as beneficiaries of the trust? If so, should that exclusion be revocable?

The good trustee

Thought must also be given to how the trust is managed by the trustees. To provide maximum asset protection, it is important that the trustees do not simply follow the instructions of the settlor without thought. Equally, the identity of the trustees is key: if the trustee is a private trust company where all the directors are family members, to what extent have they been respecting the trust structure? When designing a trust structure, the identity and powers of trustees are critical if the trust is to stand the test of time.

In onshore regimes we trust

The introduction of the Dubai International Financial Centre (DIFC) Trust Law and DIFC Single Family Office Law provide interesting alternatives to holding regional assets in offshore trusts. However, questions surround the implementation of these laws, including whether such structures will be recognised in other Middle Eastern countries that are outside the DIFC. The laws are still in the early stages of their evolution, however, and there is certainly potential for development. As a body of precedent builds up behind them, it may be that, for Middle Eastern assets, these laws come to be viewed as appealing options for certain clients, alongside other onshore strategies, such as the use of lifetime gifts and debt solutions.

Where do we go from here?

Trusts continue to be the structure of choice for the offshore wealth of many clients, due to the legal and tax benefits they can provide. However, increasing attention needs to be paid to the design of trusts to ensure that they fully achieve the client’s legal objectives – a standard reserved powers trust deed may no longer remain the right solution for many Middle Eastern clients.

Increasingly, clients want to create trust structures to hold Middle Eastern assets, but it remains debatable whether offshore trusts can fully achieve clients’ legal objectives for such assets, unless due consideration is given to Shariah and to local laws (which may restrict foreign ownership and also levy tax on such foreign owners). The key asset of a family is often the family business, so a more appropriate step in the first instance may be a family governance exercise, which will deal with the management and devolution of the family business in an open and transparent forum. Subsequent principles can then be enshrined in corporate documents and potential trust or corporate vehicles, which may be created and managed both onshore and offshore.


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