Part 1 - An Introduction to Trusts and DIFC Trust Law
This is the first of a series of three articles which aims to provide a general introduction to the key principles of DIFC Trust Law. The article also looks briefly at trusts in the Dubai International Financial Centre.
Part II - An Introduction to Waqfs
The second article in this series will be published in Law Update in November 2006 and will look at the general principles underlying Islamic Waqfs.
Part III - Waqfs and Trusts- A Comparative Study
The third and final article in the series will be published in Law Update in December 2006 and will aim to provide some general insights into the similarities and differences between the trusts and waqfs and will look at some of the practical issues arising from the use of these structures in the GCC.
Part 1 - An introduction to trust and DIFC trust law
'A trust is a gift projected on the plane of time and, meanwhile, in need of management'.
An introduction to trusts
Historical development
The concept of a trust has its roots inthe legal principles of 'equity' which developed in England and in countries following the English common law tradition from the 11th century onwards. Equity has no direct equivalent in civil law jurisdictions but as the use of trust structures has become increasingly common, many civil systems have either incorporated trusts into their civil code or developed similar concepts such as the 'foundation' in Liechtenste in or the 'patrimony of affectation' which is covered for example by the Civil Code of Quebec.
What is a trust?
Broadly speaking, a trust is an obligation placed on a trustee by the person establishing the trust (the "settlor") to deal with the property that is the subject of the trust (the "trust property") in a particular way for the benefit of one or more beneficiaries-often under the guidance of a trust protector. The key characteristic of a trust is that it allows the legal ownership and beneficial interest (the "right to use" the trust property) to be separated.
How are trusts useful in practice?
A trust can be structured to provide personal and financial safe guards for the beneficiaries of the trust and is often used to achieve family, commercial or philanthropic goals. Tax considerations also play a role in certain jurisdictions. For example, a trust can offer:
separation of ownership and control;
protection of business and/or family assets for future generations;
expedited management of assets; and
access to 'nominee' arrangements whereby one party holds the legal ownership on behalf of another in order to preserve business or personal confidentiality.
What is trust property?
To be valid a trust must hold property which can include real estate, cash, shares and other investments as well as other assets such as paintings, carpets, antiques and jewelry. Trust property can also include future interests or rights to future ownership. To make trust property subject to the terms of the trust instrument, the settlor will transfer ownership of the trust property to the trustees of the trust.
What are trustees?
The trustees are the legal owners of the trust property who hold and administer that property for the benefit of the beneficiaries in accordance with the terms of the trust instrument. Individuals and certain corporations (or a combination of both) may serve as trustees. In some cases, a settlor can act as a trustee.
The trust instrument establishing the trust will usually specify the powers and duties conferred on the trustees in respect of the administration, investment and maintenance of the trust property. Where a trust deed is silent as to the duties of the trustees of the trust, case law (articulated by judges in previous decisions) and the principles of equity will apply. The exercise of the trustee's powers can be made subject to the consent of a protector (see below).
Subject to any express provisions of the trust deed, trustees are obliged to act impartially between beneficiaries and in good faith and to administer the trust for the benefit of all its beneficiaries using reasonable care and skill. Trustees should keep accurate and complete accounts and records of their dealings with the trust property and will need to pay taxes, duties and charges as applicable. If a trustee is a professional trustee, then a higher objective standard of care will be applied than for an unpaid individual.
In most cases, trustees will be prohibited from using the principal or income from the trust for their own benefit.Generally,a trustee may not borrow or buy from the trust and will be prevented from selling his or her own property to the trust.
What is a beneficiary?
A beneficiary is anyone who will or potentially may benefit from the property held in the trust. There can be one or more beneficiaries and each may enef it from the trust in a different way.
What is a settlor?
The settlor is the person who puts property into the trust structure and who determines how the income and property of the trust will be used. Trust property is usually put into the trust when it is created but property can also be added to the trust at a later stage.
What types of trust are available?
Most trusts fall into two main categories depending on how the income or benefitof the trust property is dealt with:
interest-in-possession trusts; and
discretionary trusts
What is an interest-in-possession trust?
In an interest-in-possession trust, the beneficiaries have a legal entitlement to the benefit of the income of the trust property but not to the trust property itself. This type of trust is commonly set up in a will. An example would be where the settlor specifies in his will that the benefit of the trust property is to go to 'to my wife for her life and then to my children'.
What is a discretionary trust?
In a discretionary trust, the benefitsofthe trust property are allocated at the trustees' discretion to any one or more of several beneficiaries ifatall). No beneficiary has a legal entitlement to the benefits of the trust property,but only a hope that the trustee will decide to confer benefits on them.A discretionary trust is often used to pass on trust property during the life time of the settlor whilst still retaining control over the trust property through the terms of the trust deed. There are three main types of discretionary trust: accumulation and maintenance trusts (although in the UK at least these have become less attractive since the promulgation of the Finance Act 2006)
general discretionary trusts
charitable trusts
Other trusts include the protective trust, the marriage settlement and the bare trust the latter is interesting in that it entitles the beneficiary to call for the trust property to be transferred to them. These types of trust will form the subject of a later article to be published in Law Update.
Briefly,an accumulation and maintenance trust is used where the intended beneficiaries are still young and since the Finance Act 2006 in the UK, such trusts must be established by a will.This type of trust is usually managed as a discretionary trust until the beneficiaries reach a specified age after which the trust property will either go to the beneficiaries or be managed as an interest in possession trust.
A general discretionary trust is used where the settlor wants to benefit a defined group of people but is unsure as to which members of the group are likely to need financial assistance in the future.The trustees can be given the power to enlarge the beneficialclassinthefutureshould the need arise. An example would be a general discretionary trust set up by the settlor for his existing and any future grandchildren that may be born after the trust is set up.
A beneficiary of ageneral discretionary trust has no legal entitlement to either the trust property or its benefits.There is no 'interest in possession' and the distribution of the benefits of the trust property are entirely at the trustees' discretion. When a beneficiary of a discretionary trust dies, his estate will not be affected since the capital of the trust usually will not be regarded as part of his estate. An English discretionary trust can last for 80 years and incomecan be accumulated for 21 years or more. A discretionary trust can be created during the lifetime of the settlor or in his will to become effective upon his death.
Charitable trusts can be created during the lifetime of the settlor or by a will. The requirements are that the trust must have truly charitable objects i.e. the relief of poverty, the advancement of religion, education or the public good. Charitable trusts can last in perpetuity i.e. forever.
A mixed trust may come about when one beneficiaryofadiscretionarytrustisgranted the right to receive the income of a proportion of the trust property. Part of the trust then becomes an interest in possession trust.
How long can a trust last?
It is usual to set out the duration of the trust in the trust instrument. The period specified can be for just a fewyears,perhaps during a person's widowhood or until a child reaches a certain age or marries. Non-charitable trusts can last for a maximum of 80 years whilst there is no time limit on the duration of a charitable trust. It is also common for a settlor to grant to the trustees the power to terminate the trust at their discretion.
What is a trust protector?
The role of a trust protector is a fairly recent development in modern trust law. Broadly, a protector will act as an independent safeguard of the settlor's wishes. His role is distinct from that of a trustee although he may be given certain powers under the trust (or have the ability to restrict the trustees in the exercise of their powers by with holding his consent). Care should be taken when drafting the trust instrument to ensure that that the powers vested in the protector do notturn him into a quasi-trustee since this could call the validity of the trust into question.
A protector may be an individual, a group of individuals acting by committee or even the settlor of the trust.
The role of the protector will depend on the drafting of the trust agreement. A protector can be appointed to protect the settlor's wishes particularly in cases where the settlor has no pre-existing relationship with the appointed trustees. Alternatively, a protector may be given powers to monitor the trustees' performance in the investment and administration of the trust property and may be given the right to limit the exercise the trustees powers. A protector who is familiar with the family of the settlor and the circumstances surrounding the creation of the trust may be appointed to liaise between the beneficiariesandthetrustees. A trust protector can also add flexibilitytothetrustsinceaprotectorcanbe designated by the settlor to deal with a range of possible future circumstance.
Whilst trustees are clearly in a fiduciaryposition, this is not necessarily the case for a trust protector since the scope of a protector's duty in exercising a power will depend on the settlor's purpose in conferring that particular power and on the terms of the particular trustee that apply to the protector.
Introduction to DIFC trusts
What is the DIFC?
The Dubai International Financial Center (the "DIFC") is a Federal Financial Free Zone located in Dubai. The DIFC has been granted authority to self-legislate in civil and commercial areas. In recognition of the importance of modern trust structures in the fieldsofwealthmanagement and estate planning, the DIFC has promulgated DIFC Law No 11 of 2005 (the "DIFC Trust Law") as well as further legislation governing trust service providers, investment trusts and real estate investment trusts (which will be looked at in more detail in a future series of articles in Law Update).
The DIFC Trust Law states that the 'common law of trusts and principles of equity' supplement the DIFC Trust Law except to the extent modifiedbytheDIFCTrust Law or any other DIFC Law.
What is a DIFC trust?
The DIFC Trust Law defines a trust as a right, enforceable solely in equity, to the beneficial enjoyment of property to which another person holds the legal title.
How are DIFC trusts governed?
Except as set out in the terms of the trust itself, DIFC Trust Law governs the duties and powers of a trustee, relations among trustees and the rights and interests of a beneficiary.
The terms of the trust itself however, prevail over any provision of the DIFC Trust Law except as to certain provisions dealing with the creation of a trust and relevant minimum standards.
How is a DIFC trust created?
A DIFC trust must be created by an instrument in writing (including a will or codicil). The requirements for the creation of a DIFC trust are that:
the settlor has the capacity to create a trust;
the settlor indicates an intention to create the trust;
the trust either:
has a definitebeneficiary(thiswillbe the case if beneficiarycanbeascertained now or in the future);
is a charitable trust under the terms of the DIFC Trust Law; or
is a non-charitable purpose trust under the terms of the DIFC Trust Law;
the trustee holds the property for the benefitofabeneficiaryorfora purpose (although a trust may have a definitebeneficiaryanda purposeatthe same time);
the trustee has duties to perform; and
the same person is not the sole trustee and sole beneficiary.
What is the duration of a DIFC trust?
A DIFC trust may continue indefinitely.Alternatively, it may terminate in accordance with the DIFC Trust Law or with the terms of the trust itself.
What types of DIFC trust are permitted?
The DIFC Trust Law permits the creationof charitable trusts. Specifically,acharitable trust may be created for:
the relief of poverty;
the advancement of education or religion;
the promotion of health or art;
the protection of the environment; or
any other purposes which are beneficialtothegeneralpublic.
The DIFC Trust Law also permits non-charitable purpose trusts, examples of which include the holding or investing in shares in a company or any other assets constituting the trust property if:
the purpose is possible and sufficientlycertain to allow the trust to be carried out;
the purpose is not contrary to public policy in the DIFC or unlawful under the laws of the DIFC; or
the trust instrument specifiestheevent upon the happening of which the trust terminates and provides for the disposition of surplus assets of the trust upon such termination.
A non-charitable purpose trust must appoint an enforcer who will have a duty to enforce the trust in relation to its non-charitable purposes. A person may not be appointed as enforcer of a trust in relation to its non-charitable purposes if he is also a trustee of the trust or has a conflictofinterest.
The DIFC Trust Law also makes specificprovisions for protective trusts in that the terms of a trust may make the interest of the beneficiaryliabletotermination.
In addition the terms of a trust may make the interest of a beneficiaryintheincome or capital of the trust propertysubject to:
a restriction on alienation or disposal; or
a diminution or termination in theevent of the beneficiarybecomingbankrupt or any of his property becoming liable to sequestration for the benefitofhiscreditors.
A trust under which the interest of a beneficiaryissubjecttorestriction,diminution or termination is a protective trust.
Who are the beneficiariesofaDIFCtrust?
The DIFC Trust Law provides that the beneficiariesofaDIFCtrustmustbe
identifiablebyname;or
ascertainable by reference to:
a class; or
a relationship to some person whether or not living at the time of the creation of the trust or at the time which under the terms of the trust is the time by reference to which members of a class are to be determined.
The terms of a trust may provide for the addition of a person as a beneficiaryor the exclusion of a beneficiaryfrombenefit.
A settlor or a trustee of a trust may also be a beneficiaryofatrust.
What are the duties of the trustees of a DIFC trust?
During the execution of his duties and in the exercise of his powers and discretions the trustee of a DIFC trust must:
act with due diligence as would a prudent person to the best of his ability and skill; and
observe the utmost good faith in accordance with the terms and purposes of the trust and with the DIFC Trust Law.
A trustee must keep accurate accounts and records of his trusteeship. A trustee must keep trust property separate from his personal property and separately identifi able from any other property of which he is a trustee. The DIFC Trust Law provides that a trustee must administer the trust solely in the interest of the beneficiariesorinfurtheranceofthepurposes of the trust.
Subject to the terms of the trust, a trustee is obliged, so far as is reasonably practical, to preserve the value of the trust property.
Except with the approval of the Court, or as permitted by the DIFC Trust Law, or as expressly provided by the terms of the trust, a trustee may not:
profitdirectlyorindirectlyfromhistrusteeship;
permit any other person to profitdirectly or indirectly from his trusteeship; or
enter into any transaction with the trustees or relating to the trust property which may result in a profitfor his own account.
A sale, encumbrance, or other transaction involving the investment or management of trust property which the trustee enters into for his own personal account or which is otherwise affected by a conflictbetweenthetrustee'sfiduciaryand personal interests is voidable by a beneficiary efected by the sanction unless:
the transaction was authorized by the terms of the trust
the transaction was approved by the Court;
the beneficiarydidnotcommencejudicial proceedings within the time allowed by the DIFC Trust Law; or
the beneficiaryconsentedtothetrustee's conduct or ratifiedthetransaction.
What are the general powers of a trustee of a DIFC trust?
Subject to the terms of the trust and his duties under the DIFC Trust Law, a trustee of a DIFC trust has the following powers in relation to the trust property:
all the same powers as a natural person;
any other powers appropriate to achieve the proper investment, management, and distribution of trust property; and
any other powers conferred by the DIFC Trust Law.
A trustee must exercise his powers only in the interest of the beneficiariesandinfurtherance and support of the purposes of the trust and in accordance with the terms of the trust.
A trustee may take reasonable steps to enforce claims of the trust and to defend claims against the trust.
What are the specific powers of a trustee?
Subject to the terms of the trust a trustee of a DIFC trust also has a detailed set of specific power asset tin lause 4 f the DIFC Trust Law.
Will a trustee be liable for breaches of trust?
Subject to the DIFC Trust Law and to the terms of the trust, a trustee must be liable for a breach of trust committed by the trustee or in which the trustee has concurred.
A trustee who is liable for a breach of trust must be liable for:
a) the loss or depreciation in value of the trust property resulting from such breach; and
b) the profit,ifany,whichwouldhaveaccrued to the trust property if there had been no such breach.
Where there are two or more breaches of trust, a trustee must not set off a gain from one breach of trust against the loss resulting from another breach of trust.
Can a trustee be liable in damages?
Except as expressly provided in the terms of the trust, a trustee is accountable to the trust for any profitmadebythetrustee arising from the administration of the trust even where no breach of trust has occurred.
Except as expressly provided in the terms of the trust and in the absence of a breach of trust, a trustee is not liable for a loss or depreciation in the value of trust property or for not having made a profit.
Can a DIFC trust have a protector?
A trust instrument may contain provisions by virtue of which the exercise by the trustees of any of their powers must be subject to the previous consent of the settlor or some other person as protector.
The trust instrument may confer on the settlor or on the protector any power, including without limitation the power to:
determine the law of which jurisdiction must be the governing law of the trust;
change the forum of administration of the trust;
remove trustees;
appoint new or additional trustees;
exclude any beneficiaryasbeneficiaryof the trust;
add any person as a beneficiaryofthe trust in addition to any existing beneficiaryofthetrust;
give or withhold consent to specifiedactions of the trustee either conditionally or unconditionally; or
release any of the protector's powers.
A person may charge reasonable remuneration for his services as protector unless otherwise provided bythe trust instrument.
When does DIFC law govern a trust?
The DIFC Trust Law provides that a settlor may, whether or not he is resident in the DIFC, expressly declare in the trust instrument that the laws of the DIFC must be the governing law of the trust and states that a term of the trust expressly declaring that the laws of the DIFC must govern the trust is valid, effective and conclusive regardless of any other circumstance.
How are DIFC trusts enforced?
The DIFC Trust Law provides that all matters arising in regard to a trust which is governed by the laws of the DIFC or in regard to any disposition of property upon the trust thereof will be determined in accordance with the laws of the DIFC.
However it should be noted that the DIFC Trust Laws will not operate to:
validate any disposition of property which is neither owned by the settlor nor is the subject of a power vested in the settlor;
validate any trust or disposition of immovable property situated in a jurisdiction other than DIFC in which such trust or disposition is invalid according to the laws of such jurisdiction the validity or otherwise under UAE Federal law of dispositions of immoveable property in Dubai will be of interest here;
validate any testamentary trust or disposition which is invalid according to the laws of the testator's last domicile;
affect the recognition of foreign laws (definedasanylawotherthanDIFC law) in determining whether the settlor is or was the owner of the settled property or is or was the holder of a power to dispose of such property;
affect the recognition of the laws of its place of incorporation in relation to the capacity of a corporation; and
affect the recognition of foreign laws prescribing generally, without reference to the existence or terms of the trust, the formalities for the disposition of property.
Without limiting the generality of these exceptions, the DIFC Trust Law also states that no trust governed by the laws of the DIFC and no disposition of property to be held in trust that is valid under the laws of the DIFC is to be held void or defective in any manner by reference to a foreign law.
Also, the capacity of any settlor in relation to the trust or disposition is not to be questioned nor is the trustee or any beneficiaryoranyotherpersontobesubjected to any liability or deprived of any right, by reason that:
the laws of any foreign jurisdiction prohibit or do not recognize the concept of a trust; or
the trust or disposition voids or defeats any rights, claims or interest conferred by foreign law upon any person by reason of a personal relationship to the settlor or by way of heirship rights or contravenes any rule of foreign law or any foreign, judicial or administrative order, arbitration award or action intended to recognize, protect, enforce or give effect to any such rights, claims or interest.
How are heirship rights enforced?
An heirship right conferred by foreign law in relation to the property of a living person will not be recognized as: affecting the ownership of immovable property in the DIFC and movable property wherever it is situated; or
constituting an obligation or liability for any purpose.
By Dr Hisham Marwah and Anja Bolz
© Al Tamimi & Company 2006
