With a successful family-owned business, one of the biggest worries of first- generation business owners as they pass control and ownership of the business down to children, grandchildren, and further generations, is that during this long journey, the business is exposed to the vagaries of the successive owners.
Such ownership can be disrupted or even lost through divorce, lawsuits, disability, death, and related estate battles, for example, and depending on the ownership structure, the business could even be vulnerable to a hostile takeover. To avoid jeopardising the welfare and continuation of their business, while continuing to allow the benefits and control to pass down the family, forward-thinking owners are successfully implementing a plan involving a purpose trust.
A purpose trust is quite different from the typical trust in that the purpose trust has no beneficiaries. Rather, it is established for a purpose. To illustrate, a purpose trust may be established (and funded) to own and maintain a collection of automobiles, to maintain a family compound, or, as suggested above, to preserve and maintain a family business. In the typical trust, the performance of the trustee is monitored by the beneficiaries, who can enforce the trust if the trustee is not meeting its responsibilities. Since the purpose trust has no beneficiaries to enforce the trust, it must have an enforcer (typically an independent party), appointed under the terms of the trust, to ensure that the trustee carries out its duties, acting in accordance with the trust purpose. A purpose trust will fail if there is no enforcer, so if the trust provisions are not clear in that regard, the court will appoint one.
Not every jurisdiction recognises purpose trusts, and those that do are not all equal, so a careful examination of the available jurisdictions is essential. Some of the common non-US jurisdictions are the Cayman Islands, Jersey, the Bahamas, and Bermuda. And although many US states allow purpose trusts, South Dakota is the only one that at this time has a stand-alone purpose trust statute. Furthermore, only a few states allow perpetual purpose trusts, which in a case of business succession is usually an essential requirement. Thus, currently, if a US purpose trust is desired, South Dakota would be the logical choice; although if there are pre-existing ties, such as a connection with an eligible trustee and the right to continue in perpetuity, that state may also provide a workable alternative. In any event, with such an important long term project, expert advice is, of course, essential.
The purpose trust is a unique vehicle, and until recently, it has rarely been used in the US. As a result, there are some tax issues as yet unresolved by the Internal Revenue Service. For example, the only US tax ruling relating to a purpose trust has been one in 1976 dealing with a pet trust (also considered a purpose trust), and nothing more since then. Thus, any business owner considering a purpose trust would be well-advised to consult with an expert, as despite the absence of cases or rulings, there are still certain concepts and tax rules that offer some guidance.
The design of the purpose trust in a manner that will accomplish its purpose and avoid adverse tax consequences can be as varied and sometimes as complicated as the nature of the purpose, the property (if any) held in the trust, and the parties involved in the overall picture. To illustrate, a trust for the maintenance of a collection of automobiles will be far simpler than one to construct and maintain a recreational park to continue in perpetuity. As for a trust to carry on a business, that may be one of the most challenging of all, but when carefully thought out and properly done, such a trust can accomplish the owners’ objectives. Those objectives typically include the following:
There are several ways in which the foregoing can be accomplished, the scope of which is beyond this discussion, but they often include a plan where all or a majority of the voting shares of the company are owned by the purpose trust and non-voting shares are owned by a separate trust for the benefit of the family, and others, if desired, The terms of the purpose trust would call for willing and able family members to be appointed to serve as officers and /or directors of the company, possibly but not necessarily in control. Some owners have elected to have experienced independent parties or long -term key employees play a part in the company management. The trust would prohibit the sale of company shares (some US states may prohibit a permanent restriction on share transfer) or the relinquishment of control. The objectives of the original owners would be clearly stated and reflected in the trust as the primary trust purpose (the trust may have secondary purposes). Often, the trust provides for the appointment of a protector to make ’adjustments’ to the trust in the event of unforeseen circumstances. Note that any of the key parties in the purpose trust (trustee, enforcer, protector, investment advisor) can be in the form of a committee.
If the goal is long term continuation of the family business with protection against outside interference, the purpose trust may provide a unique and optimum solution.
Alexander A Bove
Alexander A. Bove Jr. of Bove & Langa, is an internationally known and respected trust and estate attorney with over thirty-five years of experience. He is Adjunct Professor of Law, Emeritus, of Boston University Law School Graduate Tax Program, where he taught estate planning and advanced estate planning for eighteen years. Prior to that he taught estate planning for four years at Northeastern University Law School. In 1998 he was admitted to practice as a Solicitor in England and Wales. In addition to his J.D. and LL.M. degrees, in 2013, he earned his Doctorate in Law from the University of Zurich Law School.