The role of international financial centres (IFCs) in fostering legal innovation is one of their most significant, but least recognised contributions to the world economy. IFCs have historically borrowed and adapted legal concepts and language from each other, as well as from onshore jurisdictions, and have deepened the legal and regulatory structure of the global finance sector by doing so. IFCs have shaped existing statutes for new purposes and drawn on foreign precedents to expand their own case law to support the rapid development of specialised legal rules. This agility has enabled IFCs to meet otherwise unmet legal needs and to build expertise by handling large volumes of such transactions. This ability to innovate produces economic growth by redistributing risks, channelling capital to growth opportunities, sustaining business enterprise, and creating new products and services.
IFC Review readers are familiar with the leaders in these areas: BVI pioneered the international business company (IBC); Guernsey the cell structure; Jersey the incorporated cell structure; Anguilla and Dominica the offshore LLC; Panama (civil law); and St Kitts (common law) offshore private foundations. Why do some IFCs become leaders and standard setters? Is being first critical to success? Is a jurisdiction’s leadership position sustainable and likely to continue producing innovations? After all, soon after each of these pioneers launched their innovation, other jurisdictions followed by enacting their own statutes in these areas, sometimes using the first mover’s statute as a template and making only minor changes, sometimes seeking a different approach. Some of those adaptations went on to become market leaders themselves; others have never reached the high level of success of an early adopter. Our review identifies four characteristics that make a jurisdiction successful as a legal innovator:
We use five examples of legal innovations to identify the factors which make jurisdictions successful:
(1) international business company (IBC) statutes;
(2) limited liability company (LLC) statutes;
(3) cell company structure statutes;
(4) incorporated cell company structure statutes; and
(5) private foundation statutes.
These five were selected because they were all widely adopted; three originated in common law offshore jurisdictions (IBC, cell, incorporated cell) while one has a civil law origin (foundation) and one a mixed heritage (LLC). One (IBC) thrived through simplifying existing law; the others added more complex legal rules.
We focus on two measures of spread. The first is the time until 12 (just over a third) of the total group has adopted the innovation to signal sufficient acceptance of the innovation as a standard practice. These are the first movers. The second is how long it takes the next group or “middle half” of jurisdictions to adopt the innovation.[i] Once this group has adopted, we consider there is no longer a “first mover” advantage. By examining which jurisdictions are in the first quarter, “middle half”, and the last quarter, we can see if patterns exist among first-movers, steady seconds, and late adopters.
Company Law As Underpinning
Jurisdictions with a British legal heritage generally began to attract financial services using company/corporate law/legislation derived from existing English statutes and common law; IFCs with other heritages started with baselines derived from other sources (e.g. Curacao from Dutch law; Liechtenstein from Austro-Hungarian, German, and Swiss law) These initial statutes were often far out of date when the financial centre business began. For example, the Bahamas had a company law based on Britain’s 1866 company law. Some jurisdictions had no statute at all in place: Cayman had none when it separated from Jamaica and the creation of its first companies act in 1960 was a crucial first step down the road to becoming an IFC (or, indeed, having a modern economy at all).[ii] As offshore jurisdictions launched efforts to bring financial business to their territories, they modernised their laws often by drawing on counsel from a parent jurisdiction, as Cayman did in 1960 hiring English counsel to adapt English statutes at the prompting of the then-British Administrator. By using English models for their company laws,[iii] as many IFCs did, these jurisdictions had available both the substantial body of English precedent and the extensive literature on the English acts as aids in applying their own companies’ law. For example, Palmer’s Company Precedents, first published in 1877 and which had grown into a dense resource by the 1960s, provided an authoritative guide to resolving many practical issues within English-law based companies laws. The early non-common law offshore jurisdictions either had similarly robust metropolitan sources (the Netherlands Antilles and the Netherlands) or invested in developing their own (Liechtenstein’s Personen- und Gesellschaftsrecht (P.G.R.) – a comprehensive statute that a contemporaneous review said was “very rich in corporate forms”[iv]).
How We Chose Jurisdictions
We examine 36 jurisdictions to determine the spread of legal ideas through the offshore world. We compiled this list by examining various guides to IFCs, onshore governments’ blacklists, whitelists, and greylists, and lists from reports created by critics and supporters of IFCs alike. Our reasoning was that if either promoters and those seeking to limit IFCs’ activities thought that a jurisdiction was an IFC (particularly if they both thought so), it deserved inclusion. We excluded jurisdictions with narrow specialties in an area we did not examine.
FIGURE 1: Click to view the list of jurisdictions examined by the authors.
All of the innovations we examine had their origins in company law. Existing procedures, processes, and legal rules are either used or discarded to create the innovation. The IBC slimmed down company law to suit the narrower range of ownership structures which that entity served; the LLC mixed company law and partnership law (spiced with a dash of civilian legal thinking); the cell company drew on company law’s ability to bind third parties with respect to asset segregation between company and owners to offer additional layers of segregation; the incorporated cell added legal personality to those layers within a single company; and the private foundation (at least in common law jurisdictions) mixed ideas from company law into what had been conversations in trust law together with a heaping measure of civilian thinking. The rich legal heritage English and other onshore company law sources provided was a key factor in generating these innovations. Where this heritage is not present, putative jurisdictions like Sealand could not produce acceptable innovation and others like San Marino could only offer simple structures.
IFCs did not simply copy English or other onshore models. For example, the available English model did not provide for distinct entities for small companies after the Companies Act 1967 (although it still distinguished between public and private companies).[v] As a result, English companies of all sizes had to meet the same requirements for filing annual accounts, were forbidden to make loans to directors, and so on. While (perhaps) appropriate for the mix of entities operating in England and Wales, English law’s distinctions between shareholders and directors could “become a nuisance” for small companies offshore, which presented a quite different ownership profile.[vi] Moreover, they were a nuisance that served no purpose in the early days of offshore jurisdictions as the vast majority of companies created offshore had concentrated ownership and many were passive vehicles for holding assets. To make themselves attractive to their target clientele thus required IFCs to adapt, rather than merely copy, English or other model company laws. Once the door to change was opened, it remained ajar for further innovations.
These innovations also rest on IFCs’ company laws’ development of an interpretative tradition that includes some elements similar to that of Delaware company law. The two traditions differ in three respects important for our purposes.[vii] First, while both build extensive bodies of precedent on top of statutory frameworks, the English model is less completely codified than the Delaware model, so that more of the substance in the English model come from case law relative to the Delaware model.[viii] The statutory innovations we examine here all tend toward the Delaware end of the spectrum in their efforts at codification, providing greater certainty in those areas where the legal innovation branches off from the English common law or launches in an entirely new direction. A notable example of this – although one beyond our scope here – is the pioneering Trusts (Jersey) Law 1984, which set out a substantive statutory framework for the law of trusts and which many of Jersey’s competitors soon copied and adapted for their own use. Second, Delaware company law is less prescriptive than its English cousin, more frequently providing default rules rather than mandatory ones. The innovations we discuss here rely frequently on default rules, giving service providers room to experiment. Third, Delaware company law more frequently sets out broad principles, leaving it to the courts to flesh out the details later, while English law alternates between straightforward rules and leaving matters to the common law. Here, the legal innovations steer closer to the English tradition and often seek to provide certainty by clearly stating legal rules.
IFCs’ autonomy enabled them to diverge from the growing body of European companies law as well. Beginning in the early 1970s, the European Commission (EC) began to require European Economic Community (EEC) jurisdictions’ companies legislation to conform to the various directives aimed at harmonising the rules across a wide range of areas. The EC found harmonising company law a tougher problem to solve than it initially anticipated (especially in creating a “European company” entity, a concept first proposed in 1959 and not accomplished until 2001) and so moved relatively slowly in this area. When it did move, much of what the various EC Company Law Directives did was to add rigidities to the law (e.g. the Second Directive’s provisions on dividend distributions) which, even if beneficial in an EEC-wide context, made little sense for IFCs. Independent jurisdictions escaped these counter-productive (for their clients) additions; the autonomy that enabled dependent jurisdictions related to EEC members to be IFCs also protected them from the EEC’s desire to harmonise as well.
Indeed, IFCs moved in the opposite direction, in many cases using their adaptations of others’ statutes to simplify the law, reduce regulatory burdens that were inappropriate for the type of business they sought (e.g. relaxing requirements on the filing of accounts), and make creating companies more straightforward.
Most importantly, IFCs began to expand the range of entities explicitly addressed by their laws, and they did so much sooner than onshore jurisdictions. For example, in England innovation in entities (the limited liability partnership, the community interest company, the charitable incorporated organisation, and the European Company) did not appear until after 2000. Similarly, despite Liechtenstein’s pioneering 1926 creation of the private law foundation entity, other civil law jurisdictions did not produce their own comparable versions until after Panama’s adoption of its foundation statute in 1995.[ix] Well before 1995, IFCs were expanding the range of entities possible and they have continued to do so. Some, but not all, IFCs – most famously Bermuda but also an increasing number of other jurisdictions – combined measures to streamline creating entities with screening of who would be permitted to do so in order to protect their reputations. Others – such as England and Delaware – compete on speed, with internet-based service providers promising rapid incorporation. For example, one British agency claims a three hour “ready to trade” incorporation package complete with a “full business bank account”, while a Delaware agency suggests it can accomplish a filing “in as little as 10 minutes”.[x]
Another important distinction between IFC and onshore companies acts is the frequency with which they are amended.[xi] While, as noted above, the basic English statute is updated only infrequently, since 2010 the Bahamas has amended its companies act four times and Barbados and BVI amended theirs five times each. Most other IFCs follow similar patterns. Much as Delaware has gained a competitive advantage in the market for US incorporations by keeping its statute up to date (with six amendments since 2010) and drawing heavily on the community of Delaware corporate lawyers to decide priorities,[xii] IFCs are making investments in regular updates, speeding the development of an IFC version of company law which is built upon but distinct from their parent jurisdictions’ laws.
Thus, basing their innovations in English and other parent jurisdictions’ companies’ law gives the lawyers and judges working in IFCs common starting points for solving problems and the toolkits of sophisticated, well-developed sets of precedents on which to draw in finding solutions. This provides a crucial part of the legal foundation on which much of the IFC world is built. A precondition for innovation is thus the availability of a widely recognised legal tradition flexible enough to innovate, well-stocked with concepts with which to create new entities, open to new ingredients from other jurisdictions, and in the hands of a creative community and network of globally recognised experts able to combine ingredients in new ways. Much as curries have become as much a staple of English cuisine as South Asia, the ‘cooks’ in IFCs have expanded the menu of business entities by including some ingredients previously thought exotic. This requires more than a single entrepreneurial lawyer or government official. That might be enough – as it was to get Wyoming to create the LLC – to get a single statutory innovation adopted in a single jurisdiction. To create enduring innovation, however, takes a broader community and investment in building institutions beyond a single statute.
FIGURE 2: Click to view a graph which highlights the chosen jurisdictions and their adopted laws.
One of the first IFC business entity innovations was the creation of the International Business Company (IBC). Starting with the solid foundation of their companies laws, the first IFCs focused on legal provisions allowing creation of companies that would act only outside their jurisdictions of incorporation to receive tax exemptions or substantial discounts on local taxes. Both ring-fenced tax regimes (via the US-Netherlands tax treaty through Curacao and Aruba and the US-UK tax treaty through the British Virgin Islands) and “exempted company” structures quickly spread across the offshore world. These were simple structures, requiring little more than filing, recording, and fee-paying to create and additional fee-paying to continue entities.[xiii]
The first IBC Act to win widespread use was adopted in BVI in 1984 after the United States cancelled the extension of the US-UK treaty to BVI over treaty shopping concerns.[xiv] In this case, the driver for innovation was an outside action: the loss of the treaty reduced BVI government revenue by the amount it spent on education and so there was some urgency to the need to find a replacement product.[xv] Importantly, without the now-cancelled treaty, BVI had to make the IBC be more than a purely tax-driven structure. BVI hit upon the marketable combination of marrying simplicity and flexibility, combining certainty that non-BVI business by an IBC would not be taxed, streamlined procedures that kept costs down which allowed companies without members and statutory mergers, and statutory tools for restructuring and reorganisation. BVI also cleverly allowed company names to be written in Chinese characters, an innovation for a non-Chinese speaking jurisdiction and one that helped launch a boom in Chinese use of BVI and a relationship with China that continues to this day. In addition, BVI’s legal system gave it an advantage in that any future disputes among IBC owners would be resolved by courts with skilled judges and practitioners applying well-established legal principles, with an ultimate appeal to the UK’s Privy Council. The idea quickly spread across a number of jurisdictions, with statutes similar to, and often clearly copies of BVI’s adopted by over twenty.
An important innovation was that the BVI drafters of the 1984 Act drew heavily on Delaware law, taking advantage of that jurisdiction’s extensive investment over time at advancing its statute through the Delaware Court of Chancery as well as through amendments and – despite producing what Colin Riegels’ 2014 history of the law termed “grating jurisprudence” from the mixing of American statutory terminology with common law – the result became a market success.[xvi] The IBC was an innovation built on the existing BVI companies statute, which dated to the early 20th century and derived from English law.[xvii] The market leader for offshore companies when BVI launched the IBC was Panama, which had also used Delaware law (albeit the 1927 version) as the basis for its company law. BVI’s IBC provided a significantly more modern interpretation of the Delaware statute, well-drafted English language legislation, and a superior appellate court system. When the United States invaded Panama in 1989, it gave the BVI IBC a substantial boost from investors seeking political stability and the two statutes’ common heritage in Delaware law made transitioning from Panama to BVI easier for law firms and companies alike.
The BVI IBC Act’s Delaware DNA and the jurisdiction’s focus in drafting on solving practitioners’ problems were more than a matter of good luck, however. The primary draftsman for the BVI IBC Act, the BVI Attorney General Lewis Hunte, asked two experienced company law practitioners to aid him in drafting the law so he “could know what particular difficulties they experienced during the practice of company law. They were able to tell me and I was able to write a decent act.”[xviii] This connection between drafting and solving practitioners’ real world problems is a constant across IFCs, where both organised and informal means of consultation between the financial community, legal community, and government are a matter of course. While larger jurisdictions also can get feedback on legislative proposals, the regular contact and communication between financial sector practitioners and government officials gives IFCs a distinct advantage over their larger competitors.
FIGURE 3: Click to view a graph which shows the pattern of adoption of IBC Acts from 1984-2014.
To see the benefits of the BVI IBC Act’s mixed parentage, consider the differences between the English and Delaware approaches. One fundamental difference between English and Delaware corporate law is that the former, when it includes a topic in the statute, relies more heavily on rules while the latter makes greater use of standards in the statutory language. IBC acts took a more ‘Delaware-ish’ approach because when they slimmed down English companies law to suit their clients’ need for more flexible law, they made IBC laws more principles-based and less rules-based. Removing requirements not suited to companies privately held within families, ‘pocket-book’ entities used to hold passive assets, or entities used as stepping-stones to engineer treaty benefits had the possibly unintended but nonetheless beneficial effect of giving IBC’s courts more room to craft precedents to solve unanticipated problems.
One example of this lies in the law governing the role of directors. While Delaware relies on shareholder litigation over director’s duty of loyalty to shareholders to police directors’ taking of corporate opportunities, England has a relatively strict rule that prohibits classes of behavior and is arguably more suited to the long history of institutional shareholders in the UK.[xix] In the offshore world, however, where companies are much more likely to be owned by families, sole proprietors, or onshore businesses as sole shareholders, the more flexible Delaware approach without the culture of shareholder litigation common to publicly held Delaware companies provides greater flexibility for the owner of an IFC-based entity to avoid problematic conflicts with statutory language. Mirroring the institutional-investor-friendly English approach would be out of sync with the needs of the types of people and entities which are offshore business owners. The IFC approach is ‘thus neither fish nor fowl’ and so suits the quite different ownership patterns of IBCs while being freed from the English and American need to accommodate publicly traded enterprises.
The pattern of the IBC’s adoption was relatively rapid. Other jurisdictions quickly copied BVI’s structure (and often its statute’s language) and once the concept was established, it quickly spread. No doubt this was partly due to the elegant simplicity of the idea; there are few of the conceptual problems to solve that cells and incorporated cells pose and none of the tricky questions of translating civilian concepts into common law or vice versa raised by private foundations. Moreover, the IBC built directly on many jurisdictions’ earlier experiences with exempt companies and ring-fenced tax regimes as well as the previously imported companies laws.
In this instance BVI’s competitive advantage came both from being first and from delivering quality services in creating and managing IBCs. The problem for later entrants was that it was hard to distinguish their IBC and themselves from BVI’s statute and BVI. For example, in the 1997 edition of his Grundy’s Tax Havens, Milton Grundy (who had co-drafted Belize’s statute) commented on Niue’s statute that “A practitioner with a well-established channel for obtaining IBCs in the BVI or elsewhere may feel no need to move his business to Niue, but I dare say that the success of the jurisdiction will depend primarily on the marketing abilities of its promoters”.[xx] With a statutory scheme built around simplicity, there was little room for competing by adding bells and whistles and so long as BVI delivered high quality service, little room to compete in that dimension. Although some jurisdictions attempted to compete with BVI on price, Grundy concluded that – at least at the price levels for IBCs – cost was “overrated” as a decision factor.[xxi]
The IBC experience suggests one of the limits to the development of the law through jurisdictional competition. BVI’s initial act, along with its regular updates of its statute, and its investment in the regulatory infrastructure left relatively little room for competing alternatives to overtake it in the marketplace. The market discipline that competition provided was still useful; BVI might have stumbled and created an opening for a rival, so it paid for others to be prepared. Jurisdictional choice for IBCs were thus more likely to be determined by factors such as a convenient time zone, a service-oriented registrar, and the recommendations of law firms and consultants.
In the late 1990s and early 2000s, IBCs and exempt company regimes began to come under increased pressure from the OECD and EU, particularly with respect to whether or not these entities have sufficient economic substance to warrant legal recognition outside their home jurisdiction. In response, some jurisdictions have modified their overall corporate tax structure (e.g. Guernsey and Jersey’s adoption of “zero/10” corporate tax structures) to continue to compete in this market. The result has been effective tax competition, perhaps too effective to suit the higher tax rate jurisdictions in the EU, such as France and Germany. In response to this pressure, BVI evolved its IBC into the BVI Business Companies Act in 2004, phasing out the IBC Act in 2006.
One important consequence of BVI’s success with the IBC Act and its successor is to give BVI an important role in the network of offshore law firms. Of the firms regularly listed in The Lawyer’s ranking of top 30 offshore law firms, 15 have offices in BVI, the most of any jurisdiction in which those firms collectively operate. BVI’s connections through these firms to other IFCs both bring it business and mean that the BVI legal profession is closely connected to developments in other jurisdictions. This network helps distinguish BVI from those competitors which copied its statutes and highlights the critical role human capital plays in both turning well-drafted words on paper into successful legal innovations and keeping a jurisdiction at the forefront of a market.
One of the most successful innovations in business law in the past 50 years – and one which has spread around the world from humble beginnings as a solution to a single company’s needs – is the limited liability company (LLC), which illustrates the spread of ideas through legal networks.[xxii] The story has a straightforward beginning. The Hamilton Brothers Oil Company had experience with a Panamanian unincorporated business entity, the limitada. It then sought a US entity that provided the limitada’s limited liability and pass-through tax characteristics.[xxiii] The company’s lawyers drafted a proposed statute and shopped it first to Alaska (which failed to pass it in 1975 and 1976 “apparently for political reasons unrelated to the proposals”) and then to Wyoming, where the proposal met with a more enthusiastic reception. Once the statute was passed, the company, its tax advisors, and Wyoming battled with the US Internal Revenue Service (IRS) for several years over whether or not the new entity qualified for federal pass-through tax status. Few paid attention: only 26 LLCs had been established by 1988.[xxiv]
The IRS finally conceded pass-through tax status to the Wyoming LLC in 1988 and US use of the LLC quickly exceeded expectations because it provided corporation-levels of limited liability, without the extra layer of corporate tax, in a flexible format that allowed those designing entities maximum freedom to structure it as they wished. As the LLC’s popularity grew, the American Bar Association’s Tax and Business Sections established committees to study the LLC, identify issues, share resources, and help state legislative drafting committees pass their own LLC acts. These modifications of the Wyoming model were constrained by the need to preserve pass-through tax status and so considerable energy went into ensuring that other states’ LLC statutes passed muster with the IRS. An extensive effort by the bar spread the LLC to other US states and eventually prodded the IRS into issuing clear guidance on its tax status, which allowed the further development of the entity beyond the relatively narrow initial Wyoming version.
IFCs were quick to adopt their own versions of the LLC, starting with Anguilla and Dominica in 1994. [xxv] This pattern differed from the IBC adoptions, with rapid adoption by eight jurisdictions in a three-year period, then another 10 years before reaching the 12-jurisdiction mark. Some of the most well-established IFCs (Bermuda, Cayman, and Jersey) were among the late adopters although there were also well-established early adopters (Bahamas, Isle of Man).
Unlike the IBC, the key to the LLC is not simplifying the law but creating a new powerful and flexible business entity. LLCs’ deviations from corporate law norms and their mixture of quasi-partnership governance with a corporate-like limited-liability entity makes crafting an LLC statute more of an exercise in thinking through potential future problems and providing courts with guideposts to address those. As happened in the LLC’s spread among US states, each jurisdiction made its own modifications to their LLC statutes’ details, producing a diverse array of options for potential clients comparing jurisdictions. Jurisdictions’ existing mixes of entities helped shape their versions of the LLC. For example, Jersey already had a sophisticated limited liability partnership statute, revised in 2017, which provided many of the benefits of an LLC. The island nonetheless added an LLC entity to the mix, in part because Jersey believed that catering to the familiarity of US fund managers and investors with the LLC would bring it additional business.[xxvi] These differences demonstrate the diversity made possible by a wide array of jurisdictions.
FIGURE 4: Click to view a graph which highlights the spread of limited liability companies among IFCs.
IBCs had required excellence in execution by the home jurisdiction and so what BVI’s competitors needed to do was to meet or exceed BVI’s ability to deliver fast, quality service. LLCs demanded, in addition, a higher level of legal sophistication within the IFC legal community because LLCs’ significant design flexibility both gives them their advantage as a business entity and means there are fewer statutory safeguards built in. Thus, as the LLC spread among IFCs, the jurisdictions’ legal and financial communities played critical roles in adapting the concept to each jurisdiction’s market and other legal systems.
The presence of a legal community with depth has proven critical to using an IFC LLC to its full potential. Clients still wanted fast, quality service in registering their offshore LLC but they also needed a higher degree of professional assistance to take full advantage of the opportunities the LLC offered than was the case with the IBC. This underscores the importance of the human networks within and among jurisdictions. Copying the “best” LLC statute from elsewhere will do little to advance a jurisdiction if it does not have the expertise within its legal and financial communities to identify opportunities for using LLCs and for crafting specific implementations of LLCs to enable clients to take advantage of those opportunities. Given the volume of activity surrounding the expansion of the LLC globally, and the need both to compete against and learn from US jurisdictions’ LLCs, practitioners and regulators need a global network to make their jurisdictions’ LLC statute a success.
It is also important to see that many IFCs quickly identified the potential of the LLC and took steps to add it to their legal vocabulary. Building on ideas from elsewhere, in this case from Panama via the United States, and then transmuting the import into a jurisdiction’s own offering is an important way that IFCs drive the global conversation forward. It takes experimentation to get the right balance in structuring new legal entities. Adding IFCs to the mix was the innovation equivalent of turning several dozen versions of Thomas Edison’s famous laboratory loose on the concept. Just as it took Edison’s teams of technicians seemingly endless experiments to perfect the light bulb, so having many IFCs stress testing the LLC is rapidly pushing the entity forward in a way that leaving to larger jurisdictions might occur only over decades.
Protected Cell Companies & Incorporated Cell Companies
If the LLC is a relatively straightforward import of a foreign legal entity, the development of protected cell companies is an original development in IFCs. This entity, also known as the segregated portfolio company and by several other names, and its further development into incorporated cell companies,[xxvii] enabled the limitation of an entity’s creditors’ rights to particular assets within the entity rather than all of the assets.[xxviii] While such a structure can be constructed contractually, it does not solve the problem of how to bind third parties to the limits created by contracts to which they are not a party.[xxix] Creating a statutory structure for the asset segregation that permitted multiple asset pools within the overall entity enhanced the structure’s value. Being able to do so without incurring the transactions costs of creating multiple new entities made the new entity cost competitive.
The cell company first appeared in complete form in Guernsey in 1997, although there were precursors scattered among various jurisdictions, including Delaware’s 1996 creation of the series LLC.[xxx] Although, as Nigel Feetham and Grant Jones note in their comprehensive treatise on cell companies, there are examples of contractual cell companies predating any legislation and Bermuda provided a private act version in 1992, the Guernsey statute solved several problems with the contractual form and made the entity widely available. Most crucially, it allowed some confidence that the liability limitation could be applied against those not party to any contracts creating asset segregation.
Like the LLC, the cell company was the result of a legal entrepreneur’s vision. It originated in conversations future Guernsey regulator Steven Butterworth had while working in Cayman. While talking with a group of podiatrists forming a captive insurance company at a reception, Butterworth learned that
[t]here were several firms of podiatrists owning and participating in the association captive insurer. As podiatry skills varied throughout the association, those with better loss prevention methods were fearful that the losses of their lesser brethren would eat into their own profits. Thus they all separately engaged lawyers whose task it was to protect their client’s assets as far as they were able to.
The thought was of a company that had separate parts, with statutory force, each protecting a block of assets from the liabilities of the other parts, whilst still being a single legal entity.[xxxi]
Butterworth took his idea with him when he moved to Guernsey and in 1994, he persuaded the funds industry there to support the idea. Butterworth worked with Advocate Nik van Leuven to draft legislation and van Leuven introduced new ideas into the concept, including the idea of shares in cells. As Butterworth notes, “Before I saw the draft legislation, I could see numerous insurance uses – rent-a-captives, association captives, life companies for high net worth individuals, composites, joint ventures and securitizations etc., but once I realized that the legislation was an extension of company law, as an ex-practitioner in offshore company management, I could envision myriads of opportunities, especially in the asset management sector”.[xxxii] He was right. Once Guernsey had shown the way, the idea for an entity with the ability to legally segregate assets within a single structure quickly spread throughout to other IFCs.
FIGURE 5: Click to view a graph which shows the spread of cell company adoption amongst IFCs.
This spread of legislation was critical. If this had remained a Guernsey-only entity it might well have been just a curiosity. With LLCs, the rapid fire spread in the United States gave the entity a degree of respectability and a ready customer market for offshore LLCs. In the same way, the remarkably rapid spread of the cell company from Guernsey to other jurisdictions added the concept to the global legal vocabulary quickly and so enhanced its value. And this rapid spread outside the initial target market of captive insurance and funds to securitisation and other fields as well as the speedy evolution of cell statutes in sophistication and depth demonstrate the benefits of jurisdictional competition. Further, the interchange in experience between series LLC and cell company structures has proved beneficial for both, expanding the universe of concepts on which practitioners can draw in solving problems for clients.
While the protected cell company created a regulatory wall between cell assets, the individual cells still lacked individual legal personality as that derived from the core. This restricted cells’ ability to contract with one another and complicated spinning off a cell into a new entity. The development of incorporated cell companies (ICC) provided a means to give cells (or, as in Cayman, entities cells owned) their own legal personality, making the structure more robust and more flexible, although at the cost of some additional complexity. Although not as widespread (yet) as the other innovations examined here, the ICC quickly began to spread after Jersey adopted the first ICC statute in 2006. As the most complex of the entities described, it is not surprising to find that its spread to date has been primarily among the larger IFC jurisdictions with the better developed legal infrastructure.
FIGURE 6: Click to view a graph which demonstrates the spread of incorporated cell companies amongst IFCs.
The spread of the cell company and the development of the incorporated cell company highlight the role of entrepreneurs as a key ingredient in the human networks that develop and transmit innovations. While the term is most commonly associated with new products like the smartphone, it applies with equal force to the market for laws. Joseph Schumpeter, one of the few economists to pay close attention to entrepreneurship, defined the role of entrepreneurs as the “doing of new things or the doing of things that are already being done in anew way (innovation).”[xxxiii] Butterworth and van Leuven played this role, but so too did the numerous other advisors, managers, and lawyers involved in finding ways to use and modify the cell company structure. Fostering this role is crucial for IFCs’ long-term success. Virtually every successful IFC has its set of entrepreneurial success stories surrounding its origin: Curacao and Anton Smeets; Cayman and Vassel Johnson, William Walker, John Maples, and Douglas Calder; Jersey and Colin Powell; Bermuda and Fred Reiss. What is critical is that as IFCs mature, they continue to provide a hospitable climate for such entrepreneurs. One of the dangers that the various OECD/EU anti-IFC initiatives pose is that they will be successful in dampening future innovation with much red tape, so that when a future Butterworth next has the idea to “do a new thing”, it is no longer possible.
These developments had a significant impact on the market. An important part of the early cell market was the formation of cell captives by insurance managers, who then rented individual cells to clients, saving the clients the considerable fixed cost of establishing a captive. In essence, it enabled insurance managers to sell the insurance equivalent of “condos” instead of “single family homes”. When incorporated cells appeared, offering additional asset segregation, the extra cost of incorporating a cell lessened the differential, pushing a portion of the market into single parent captives and changing the market for cell companies to be more focused on segregation of risks within a captive for a single owner. In this case, changes in the law drove changes in the marketplace – requiring a dynamic insurance sector able to adapt to what seems likely to have been an unanticipated consequence of the introduction of ICCs.
The rapid extension of the cell company to the incorporated cell company illustrates how IFCs compete through qualitative enhancements rather merely than on price or speed. Cell company structures solve clients’ problems more cheaply than the competing means but they are not simple, cookie-cutter solutions by any means. By facilitating cells and incorporated cells, IFCs give their communities of creative problem solvers complex tools requiring skill in deploying them. Moreover, these developments continue to spur additional competitive responses, as with Vermont’s efforts to create an entity that allows segregating pools of assets within a captive without using cells at all.
Liechtenstein launched the private foundation entity in 1926 in the Personen- und Gesellschaftsrecht (P.G.R.) as an “original and visionary creation of Wilhelm and Emil Beck,” the P.G.R.’s draftsmen.[xxxiv] Over the next 70 years, those wanting to make use of this entity had no other choice than to use Liechtenstein, suggesting the greater difficulty in translating civil law, German-language entities into the primarily English-language and common law world of IFCs. Perhaps this was due to the P.G.R.’s reputation as a challenging statute for non-German speakers.[xxxv] Whatever the reason, it took almost 70 years before Panama became the first civil law offshore jurisdiction to create a version in 1995; St. Kitts followed by being the first to import this civilian entity into a common law environment in 2003.[xxxvi] Almost two dozen more IFCs have followed, as well as two US states (New Hampshire and Wyoming).
FIGURE 7: Click to view a graph which displays the pattern of adoption of private foundation laws amongst IFCs.
Much of the rapidly growing literature on common law jurisdictions’ private foundation statutes focuses on comparing trusts and private foundations, with analysts generally suggesting that foundations are primarily “a more reassuring structure for the investor who has been brought up without the common law atmosphere in which trusts feature as an everyday family arrangement.”[xxxvii] The core legal differences between a private foundation and a trust is the former’s status as an entity with legal personality and the lack of trust-like information rights for foundation beneficiaries. Practically, in most IFCs, a trust and a foundation can provide a settlor/founder equally extensive roles, leading Caribbean Court of Justice judge and leading trusts expert Sir David Hayton to suggest that “there is little to choose between a trust and a foundation since they are such versatile and adaptable vehicles.”[xxxviii] Why then bring in a new entity which seems to offer, as one commentator put it, only a different “legal texture”?[xxxix]
Marketing jurisdictions’ services to potential clients from civilian and Islamic law jurisdictions is no doubt part of the motivation for creating a private foundation law, but it is not the whole story. After all, apart from those already involved with a trust or highly trained lawyers, few individuals in the common law world are aware of more than the vaguest notions of the highly complex and technical area of trust law. Trust solutions largely come from trust lawyers solving clients’ problems, not clients demanding specific legal forms for the solutions to their problems.
Moreover, the private foundation is not simply a trust-analogue whose legal personality or other features will sooth an anxious potential civilian or Islamic law client. While it is true that these (and other) clients’ problems will frequently be able to be solved by either a trust or private foundation solution, the difference is not merely between a grantor-trustee-beneficiary relationship and an entity with legal personality. A crucial difference is that the former is embedded in a wide array of precedent that guides both practitioners and judges and which makes, in most cases, outcomes more predictable. The common law foundation lacks that supporting infrastructure, which means it must find answers to questions in the jurisdiction’s statute in the global practice of private foundation law – what Johanna Niegel, the long-time editor of Trusts & Trustees’ annual review of private foundation laws, terms the “factual harmonization” of the law[xl] – or by drawing in concepts from elsewhere in their jurisprudence.
This is both a danger and an opportunity. Many of these jurisdictions have long been selling the advantages of the connection of English common law to their legal systems. The danger is that with the private foundation, they may find that they are walking on the high wire without that net. The opportunity is that foundation law can evolve new solutions to problems since the common law can be a constraint as well as a support. For example, many IFCs have, over the years, changed through statutes the common law rules on accumulation periods and perpetuities periods to enhance their competitive position in competing for trusts. Freed of those constraints, creative lawyers and financial advisors may discover new solutions to their clients’ problems.
What makes the common law jurisdictions’ adoption of private foundation laws interesting is the scope provided for unanticipated future uses to develop. The closest parallel may be the spread of the LLC. Like the LLC, the private foundation was imported from the civilian legal world into common law jurisdictions to solve a specific problem for a particular set of clients. Just as the LLC’s initial spread from Wyoming to other US jurisdictions required wrestling with a broad array of legal questions left open by the LLC’s differences from traditional business entities, so too the common law private foundation requires developing law to fill the interstices in the statutory frameworks. Moreover, just as the LLC evolved from Wyoming’s initial simple model into a more diverse pool of entities, the IFCs are already innovating, as with the Caymanian “foundation company,” the DIFC’s ‘STAK’, or New Hampshire’s grant of “trust functions” to its private foundations.
We again see the value to IFCs of their ability to call on a diverse network of practitioners and connections across jurisdictions to make the common law foundation a success. As common law private foundations inevitably encounter problems in practice, access to the experience solving those problems under Liechtenstein law and the experience of civilian lawyers forming and advising private foundations will be invaluable. IFC regulators adapting existing regulatory schemes to the context of private foundations will need to be entrepreneurial themselves in order to mesh these concepts into existing legal practice. IFCs as jurisdictions will have to advocate in international fora to gain the appropriate treatment of these new entities under tax laws and treaties and to secure their recognition. For example, as “not trusts”, foundations will not be covered by Hague Convention on the Law Applicable to Trusts and on their Recognition, potentially raising recognition issues.
We think that the developments of new business entities, which we have described here, are conclusive refutations. The track record presented of innovation and continued refinement of business entities refutes the claim that IFCs are provoking a regulatory ‘race to the bottom’ among jurisdictions and show instead that they are engaged in a ‘race to quality’. In each case, IFCs have enhanced the global legal system through their innovations, benefiting not only those who use IFC entities but the even larger group that has used onshore entities influenced by IFC developments.
Further, our survey of the evolution of the legal regimes in IFCs suggests strategies for IFCs seeking to grow their role in the global economy. The strategies are to invest in promoting the human capital of their networks of advisors and regulators. Without those networks and their connections to other jurisdictions, IFCs would be less able to maintain their leadership in developing the structures and entities that support a more dynamic global economy. Second, competition has moved away from cost and speed and is now taking place in enhancements of quality. The PCC to ICC evolution is a particularly dramatic illustration of this phenomenon. Third, the distinctive IFC legal culture, which has mixed elements from UK, US, Liechtensteinian, Panamanian, and other sources as well as genuine innovation from within IFCs to create these entities, is a valuable contribution to the global legal system – including to onshore jurisdictions. If New Hampshire has copied the offshore private foundation entity, if Vermont is pushing the boundaries on asset segregation, if US states are finding their LLC statutes influenced by ideas from IFCs, then those jurisdictions share an interest with IFCs to defend their use. IFC critics and opponents focus on tax competition. Trumpeting the significance of IFC innovation is an opportunity to broaden understanding of the IFC contribution to law and the global economy. The speed of change is a challenge for all jurisdictions – large and small, but also creates opportunities. IFCs have shown their value as the incubators for innovation with the know-how and ability to contribute to a stronger and potentially more just global economy.
IFCs are not just smaller versions of large jurisdictions; they bring a unique ability to innovate in solving some of the most fundamental economic problems. PCCs and ICCs help redistribute risk; LLCs and private foundations help organise multijurisdictional and family businesses (as IBCs did previously). Failing to recognise that innovation or shutting it down will impoverish not just the residents of IFCs but all those who would have benefited from these innovations. As we look to the further complications caused by COVID-19 and the resulting economic shutdowns, the need for rapid, targeted, testable, and readily transmittable innovation is at a premium. IFCs have much to offer the worldwide business, legal, and regulatory communities in meeting the challenge.
[i] For clarity’s sake, we use the year in which the statute in question was passed, not the year it was implemented.
[ii] Tony Freyer and Andrew P. Morriss, Creating Cayman as an Offshore Financial Center: Structure & Strategy since 1960, 45 Arizona State Law Journal 1300 (2013).
[iii] Some jurisdictions’ modernisation efforts looked to other models: Barbados based its 1982 company law reform on Canadian law, reflecting a growing customer base among Canadian businesses. Nevis based its 1989 reform on Delaware law (following Panama, which had copied Delaware’s statute in 1929), looking to capitalise on potential Panamanian customers’ unease with the Noriega government’s ties to drug cartels (which prompted the US invasion in December of that year).
[iv] Marcus Wyler, The New Civil Law of the Principality of Liechtenstein, 8(4) J. Comp. L. & Int’l L. 197, 204 (1926).
[v] Paul L. Davies, Gower and Davies’ Principles of Modern Company Law (8th ed.) (London: Sweet & Maxwell 2008), p. 13-14.
[vi] Davies, supra, p. 6.
[vii] For the most part we are using “Delaware” as a synonym for “American” in our discussions of companies law. Although every US state has its own companies act, none but Delaware has substantial international influence.
[viii] As the historical section of the 1979 edition of Gower’s Principles of Modern Company Law (a section sadly dropped in later editions) explained, “No attempt has ever been made to codify English company law. … Behind the Acts is a general body of common law and equity applying to all companies irrespective of their nature, and it is there that most of the fundamental principles will be found”. L. C. B. Gower, Gower’s Principles of Modern Company Law (London: Stevens & Sons, 4th ed., 1979), p. 8.
[ix] Paolo Panico, New foundation legislation in common law jurisdictions: a ‘second generation’? Trusts & Trustees 24(6): 511 (2018).
[x] Swyft Filings, Incorporate Online Today in as little as 10 Minutes, available at https://tinyurl.com/y4g3mow3 (Delaware); Archers Corporate Services, Register a Company Online, available at https://tinyurl.com/yxcs9wup (England).
[xi] As Paul Davies and Sarah Worthington explain, “One major difficulty attending legislation as long as the Companies Act is that a major commitment of parliamentary time by the Government is required to get such legislation onto the statute books. Once there, ministers are likely to take the view that company law has had its turn for some while and will be reluctant to devote additional parliamentary time to proposals for its further reform”. Paul L. Davies & Sarah Worthington, Gower’s Principles of Modern Company Law (10th ed.) (London: Sweet & Maxwell 2016), p. 54.
[xii] Larry E. Ribstein & Erin Ann O’Hara, Corporations and the Market for Law, 2008 Univ. Ill. L. Rev. 661 (2008).
[xiii] Some of these early efforts used the name “International Business Company” for such companies. Barbados, along with Antigua, Grenada, Jamaica, and St. Vincent and the Grenadines, experimented unsuccessfully with special tax regimes for what they called IBCs in the 1960s and 1970s. As Bruce Zagaris noted in a 1981 review, these efforts led to legislation that was “seldom used” in any of the jurisdictions adopting that earlier model. Bruce Zagaris, Barbados Develops as a Low-Tax Jurisdiction, The International Lawyer 15(4): 673, 676 (1981).
[xiv] Craig M. Boise & Andrew P. Morriss, Change, Dependency, and Regime Plasticity in Offshore Financial Intermediation: The Saga of the Netherlands Antilles, 45 Texas International Law Journal 377 (2009).
[xv] Jason Smith, Interview, Lewis Hunte, BVI Beacon (Sept. 20, 2012) at 10, available at http://micro.harneys.com/wp-content/uploads/2014/07/Lewis-Hunte-interview-BVI-beacon.pdf .
[xvi] Colin Riegels, British Virgin Islands: A Tough Act to Follow, Legal Week (July 20, 2014) available at https://www.mondaq.com/Wealth-Management/327334/A-Tough-Act-To-Follow
[xvii] Smith, Interview, supra note 15, at 10.
[xviii] Smith, Interview, supra note 15, at 10.
[xix] See Martin Gelter & Geneviève Helleringer, Corporate Opportunities in the US and in the UK, in Research Handbook on Fiduciary Law (Andrew Gold & Gordon Smith, eds.) (Edward Elgar, 2018).
[xx] Milton Grundy, Offshore Business Centres: A World Survey (7th ed.) (London: Sweet & Maxwell, 1997), p. 119.
[xxi] Grundy, supra, p. vi.
[xxii] The history of the LLC in the United States is thoroughly described in Susan Pace Hamill, The Story of LLCs: Combining the Best Features of a Flawed Business Tax Structure, in Business Tax Stories (Steven A. Bank & Kirk J. Stark, eds.) (2005).
[xxiii] At least some accounts trace the limitada back to the German GmbH, filtered through the French S.A.R.L., and into Panama via within-the-family civilian law borrowings. Closing the loop, Panama adopted a revised statute in 2009 for its version of the LLC. U.S. corporate law expert William Carney argues the true source for the LLC is the English unincorporated joint stock company and links the specific language in the original Wyoming statute to various existing Wyoming business entity statutes provisions. William J. Carney, Limited Liability Companies: Origins and Antecedents, 66 U. Colo. L. Rev. 855, 856 (100
[xxiv] Joseph P. Fonfara & Corey R. McCool, The Wyoming Limited Liability Company: A Viable Alternative to the S Corporation and the Limited Partnership? 23 Land & Water L. Rev. 523, 523 (1988).
[xxv] A number of jurisdictions permit the use of “LLC” in company names but have not changed their underlying business entities laws to provide the features of the LLC. For example, __
[xxvi] Jersey introduces LLC legislation in bid to attract US investment, International Investment (13 Sept. 2018) available at https://www.internationalinvestment.net/internationalinvestment/news/3500346/jersey-introduces-llc-legislation-bid-attract-us-investment
[xxvii] For simplicity’s sake, we’ll call all of the unincorporated cell versions “cell companies” and the incorporated cell versions “incorporated cell companies”.
[xxviii] Nigel Feetham & Grant Jones, Protected Cell Companies: a guide to their implementation and use (2nd ed.) (London: Spiramus Press, 2010), p. 13.
[xxix] Feetham & Jones, p. 13.
[xxx] There are important differences between cell companies and series LLCs including the greater separation between cells that cell companies provide.
[xxxi] Steve Butterworth, Foreword, in Nigel Feetham and Grant Jones, Protected Cell Companies: a guide to their interpretation and use (2nd edition, 2010) at xvi.
[xxxii] Butterworth, supra note _, at xvi-xvii.
[xxxiii] Joseph A. Schumpeter, The Creative Response in Economic History, in Essays on Entrepreneurs, Innovations, Business Cycles, and the Evolution of Capitalism 223 (Richard V. Clemence, ed.) (2008 ).
[xxxiv] Paolo Panico, New foundation legislation in common law jurisdictions: a ‘second generation’? Trusts & Trustees 24(6): 511 (2018).
[xxxv] As Grundy put it, “To get any kind of grip on the P.G.R. is an intellectual task not lightly to be undertaken, especially for those whose mother tongue is not German, but this has not prevented certain Liechtenstein entities from acquiring a wide popularity”. Grundy’s Tax Havens: A World Survey (Milton Grundy, ed., 6th ed., 1993), p. 57.
[xxxvi] Liberia has a claim to be the first, having enacted a statute in 2002, but its statute seems to have been little noticed. Paolo Panico, Private Foundations: Law and Practice (Oxford: Oxford University Press, 2014), p. 7.
[xxxvii] John Goldsworth, A trust lawyer looks at foundations, Trusts & Trustees 11(5): 4 (2005), For example, New Hampshire’s adoption of a foundation act was explicitly done in anticipation that it would attract wealth management business for clients in civil law jurisdictions to the state. Thanda Fields Brassard, Steven Burke, Von Sanborn, & Constance Shields, The New Hampshire Foundation Act: A Solid Foundation for Wealth Management on a Global Scale, Tax Management Estates, Gifts, & Trusts Journal 44(2): 1-7 (2019).
[xxxviii] David Hayton, Foundations and Trusts Contrasted, Trusts & Trustees 17(6): 462 (2011).
[xxxix] Francisco Schurr, Wealth preservation by using trusts or private foundations in a civil law environment, Trusts & Trustees 25(6): 587 (2019).
[xl] Johanna Niegel, Laying a foundation for Europe, Trusts & Trustees 13(5): 123 (2007).
Andrew P. Morriss Andrew Morriss is Professor of the Bush School of Government & Public Service and School of Law at Texas A&M University. Prior to this position, he was the Dean of the Texas A&M School of Innovation, the Dean of the Texas A&M School of Law, the D. Paul Jones & Charlene A. Jones Chairholder in Law at the University of Alabama, the Ross & Helen Workman Professor of Law at the University of Illinois, and the Galen J. Roush Chair in Law at Case Western Reserve University.
Charlotte Ku Charlotte Ku is Professor and Director of Global Programs at Texas A&M University School of Law. Her specialties include international law and global governance. She has previously served as Professor and Assistant Dean for Graduate and International Legal Studies at University of Illinois College of Law, Acting Director of Lauterpacht Research Centre for International Law at University of Cambridge, and Executive Director and Executive Vice President at American Society of International Law.