Reserved Power Trusts: Firm Ground Vs Cracks And Fissures

Troubling Caselaw?

Particularly important are two recent trusts cases from Asia: Zhang Hong Li and others v DBS Bank (Hong Kong) Limited and others [2019] HKCFA 45 from Hong Kong, and Ivanishvili and others vs Credit Suisse Trust Ltd [2023] SGHC(I) 9 from Singapore. Although not binding to courts of other jurisdictions, they are of interest to the worldwide industry.

The first case has been discussed in previous IFC Reviews, but to simplify, the Court removed a threat to the reserved powers concept by rejecting the idea that even in a trust where the trustee’s investment powers are fully reserved away to a third party, the trustee retains a ‘residual high level supervisory duty.’ The trust deed had a full anti-Bartlett clause, which left the management of any underlying company to that company’s management team unless the trustee had “actual knowledge of any dishonesty,” and also had an indemnity except in cases of fraud, wilful misconduct or gross negligence. The family member appointed as the trust’s investment manager had prima facie investment credentials, and the investments she made, although risky and resulting in enormous losses to the trust, were permitted by the trust deed and were not dishonest. Therefore, even if such a supervisory duty could be ascribed to the trustee, its failure to act did not breach the anti-Bartlett clause or the indemnity.

The trustee in the second case was not so fortunate, despite having a substantial anti-Bartlett reserved powers clause and indemnity similar to those in the previous case. Again, the anti-Bartlett clause protected the trustee from liability for losses to its underlying companies unless it had actual knowledge of dishonesty, and also gave it a substantial indemnity. However, the trustee’s affiliated banking arm agreed to act as investment manager for the underlying company. Because they were the same group, the trust operatives were informed about the unauthorised withdrawals that their fraudster banking colleague was making, but they did not feel able to discipline him. The fraudster caused several hundred million dollars loss. Although the judge agreed with the previous case in that the trustee had no “residual high level supervisory duty”, he held that the trustee did have actual knowledge of dishonesty so the protection of the reserved powers clause was negated, as was the indemnity on the grounds of gross negligence by the trust staff.

In our opinion, these cases cast into sharp relief the conflicts set out in the introduction. In particular, they suggest that such trusts stand and fall on education in trusts, and whether a certain draftsperson anticipated a future scenario or a future trustee’s practical way of working, and of course often they will not. This is why we encourage a reserved powers treatment that is founded on the firm ground of statute, rather than bespoke-drafted clauses that can cause some trusts to fall through the cracks. Fortunately, both the BVI and Cayman Islands have strong statutory reserved powers regimes on which settlors and trustees can rely.

The British Virgin Islands (BVI) Response: The Virgin Islands Special Trusts Act (VISTA)

The key benefit of the always popular VISTA regime is that it provides a statutory solidity and backing to reserved powers trusts, removing possibilities for human error by the draftsman or day to day staff. The legislation does this by providing that, in a trust to which VISTA applies, one or more BVI companies shall be held directly by the trustee (which companies can then hold the various worldwide assets underneath). The trustee is prohibited from using its shareholder powers to sell or transfer those companies, even if it wished to. The trustee is also required not to exercise its other shareholder powers in a way that interferes with the management of those companies and their underlying assets: in practical terms, they must follow the instructions of the directors of those top BVI companies, which are often the settlor and their advisors.

Particularly important are the rules about the appointment and replacement of those directors, which can be contained in a schedule to the trust deed. They are bespoke, and the legislation does not prescribe their format, save to require that the trustee must follow them. We see:

• Rules requiring that on the retirement, death, etc of X director, Y director should be appointed.
• Rules that require the trustee to follow the directions of a third party on whom to appoint in such situations.
• Rules that develop the above option to a committee level with complex mechanics. Often this is done in multi-branch families so that each branch has a say on whom to appoint.

If things go wrong with underlying companies, certain persons can report them to the trustee to take action, but the responsibility is on those persons to report, and not the trustee.

VISTA is flexible in various other ways. It is possible to have VISTA apply only to parts of the trust fund (‘sub funds’), which can also have separate beneficiaries or provisions applying to them. This is useful in cases where a trust needs to be split in a divorce, but where it is not prudent to split the trust entirely. It is also possible, and common, to have VISTA switch on or off at certain predetermined dates. We see this used by entrepreneur settlors who want to handle the investments during their lifetime, but on their death, want to switch control to the trustee (through a qualified investment manager) to protect their children from inexperience.

The Cayman Response: Special Trusts (Alternative Regime) (STAR)

VISTA is a BVI-specific regime. While the Cayman Islands also has specific statutory language to reserve powers away from the trustee, it also possible to make use of the statutory regime known as STAR to do so. Some people assume that VISTA and STAR are different names for the same concept, but this is not so, and in some ways STAR is more advanced and flexible. STAR targets an entirely different issue by combining beneficiaries and non-charitable purposes (in the vast majority of common law jurisdictions, it is not possible to have these in the same trust). Beneficiaries are stripped of their usual powers to enforce the trust, which is instead given to an enforcer. However, a reserved powers element can be introduced via construction of the purposes. This can be done in two main ways:

• State that one of the purposes of the trust is to follow the directions of X person or group of people over the investment of the trust fund, thus effectively replicating the provisions of VISTA.
• Leave the investment of the trust fund in the trustee’s hands, but state that a purpose of the trust is to invest in cryptocurrency, or art, or to hold cars and property, in other words to remove the usual trustee ‘prudent investor’ problem at source.

Common To Both: Private Trust Companies

Existing in both the BVI and Cayman Islands, Private Trust Companies (PTCs) are an alternative source of trustee to institutional trust companies and, depending on the structure, can remove them from the picture altogether. They are typically used by multi-branch families or by wealthy families who do not wish to accept transferring their family organisations to a third-party trustee. The shareholders and members of such a PTC are clearly crucial. It is of course possible for the PTC shares to be held by the patriarch, but that brings problems of asset protection, tax residence, probate and succession that trusts are often used to avoid.

Alternatively, the PTC can be set up as a company limited by guarantee, orphaning the structure, although there can still be the questions of members and appointing directors. The option we probably see most is a further trust holding the shares, with its trustee an institutional trust company. Although that may sound like reintroducing the problem, the further trust will invariably be under the VISTA or STAR regimes, and so have no involvement in the affairs of the PTC or the underlying trust(s) and assets. Because the institutional trustee follows the instructions of the PTC board on most issues, and the instructions of the appointor on the appointment of the PTC board, the trustee fee will also be lower.

These different concepts can be combined. Here is a simplified demonstration recap of such a (BVI) structure, constructed via discussion with an UHNW family:

• An institutional trustee acts as trustee of a VISTA purpose trust. The roles of enforcer (a compulsory role in such trusts) and VISTA appointor of this trust are taken by the same company limited by guarantee, in which a corporate mechanism divides out the members and directors between wider family members.

This purpose trust holds:

• A Private Trust Company with directors appointed by the appointor of the purpose trust, through the internal corporate mechanism of that company limited by guarantee. Those directors will generally be a select group of more experienced family members and advisors.
• This PTC acts as trustee of several family trusts, each corresponding to a separate family branch. As a further check and balance, the company limited by guarantee has also been appointed as protector of these family trusts.
• These family trusts then hold shares in the top holding company of the family organisation. The protector mentioned above has certain veto powers over these.

As can be seen, statute-based reserved powers trusts can be just as flexible and bespoke as a purely drafted trust, but they give a firmer footing and clearer division of responsibilities between the parties, which is useful for when things go right — and when things go wrong.  

Matthew Howson
Matthew is Counsel with Harney Westwood & Riegels LLP in London, UK.

Henry Mander
Henry is a partner with Harney Westwood & Riegels LLP in the Cayman Islands.