The trust offshore.

• Author: Duckworth, Antony G.D.
• Position: Symposium: The International Trust, part 2

The Trust Offshore

1. INTRODUCTION

   The English trust, transplanted to offshore financial centers, has found a hot-house environment in which law and practice have developed swiftly in recent years--too swiftly for some, not swiftly enough for others. This is the story of a long-established legal mechanism being employed to meet new requirements and conditions, and of governments who understand that their economies depend upon the success of their financial centers. In England, by contrast, the trust has continued to cater largely to domestic requirements and, though there has been some change in these requirements, successive governments have ignored calls for reform.

2. IN THE BEGINNING ... TAXATION

   I was not present at the birth of the offshore financial centers or of their trust business, but I am told that the mother was taxation. Perhaps that is an oversimplification, but I do not doubt that taxation was the major influence. The typical settlor was a taxpayer from one of the major common law countries, and his primary motive for going offshore was tax avoidance. But there were also a few settlors from other places, some motivated by estate planning considerations (the trust allowing them to make property arrangements which could not be made at home), some by fear or distrust of rulers. With the Second World War vividly remembered, the Cold War in progress, widespread exchange controls, and much of the world under socialist, repressive, or untested regimes, the wealthy man (or corporation) might understandably seek to invest in the United States or other "safe" countries, and to hold these investments in a way that would protect them from any rapacious tendencies on the part of his own or neighboring governments. In those days, the Swiss account was the standard answer for fearful individuals, but some thought Switzerland too close to the Iron Curtain. Bermuda and the Bahamas had the geographic advantage and also a flexible legal mechanism by which the client could obtain continuing protection for his family.

   As far as I know, tax considerations did not in any of the offshore centers lead to a significant change in trust law. One should not be surprised by that; the trust already had a long history as a tax-avoidance mechanism. It already provided the tax planner with the ability to construct practically any property-holding arrangement of which he could conceive. Of course, taxation did affect trust practice--and still does--but, as tax regimes differ and change, the influence has been mostly of a patchy and transitory nature.

   The only pervasive and lasting effect has been the popularity of the discretionary trust in which the trust instrument defines the class of beneficiaries and leaves it to the trustee to decide what, if anything, a beneficiary is to receive, and when. Initially, this held out substantial tax advantages in many tax regimes--because the beneficiary had no quantifiable interest. It was not long before the major common law countries adopted measures to close off that particular tax-avoidance technique, but by then the discretionary trust had endeared itself to the institutions that provide trust services. It was seen as a simple and convenient instrument, easily adaptable to the client's requirements by means of a letter of wishes, an informal document in which the settlor sets out in precatory form his wishes regarding the exercise of the trustee's distributive discretions. To those unused to this practice it may seem a strange way of doing things, but it certainly provides great flexibility; and that is a highly desirable feature--unless and until it is penalized by the relevant tax regime. No settlor can predict the needs and circumstances of those he wishes to benefit; and there is no reason to suppose that the next fifty years will see any fewer changes than have occurred in the last fifty years in relation to investment, taxation, and the general condition of the world.

   On the other hand, the settlor must, of course, be advised that there will probably be no legal recourse if the trustee disregards the letter of wishes. Some settlors are reassured that this is unlikely to occur if a responsible professional trustee has been chosen and, certainly, most professional trustees are only too happy to have guidelines. If anything, their tendency is to give too much regard to the letter of wishes and not enough to other relevant considerations. If the settlor requires greater reassurance, one solution is to provide a watchdog mechanism, perhaps a protector equipped with a power to replace the trustee.(2) Another more direct solution, but less common, is to give some legal effect to the letter of wishes by providing in the trust deed that the trustee must pay due regard to the letter. The wording of that clause requires care to achieve the right balance between flexibility and reassurance, and such clauses are difficult to standardize (because so much depends on what sort of wishes the settlor wants to express), which may be why they are not more common.

   Sometimes the discretionary trust with letter of wishes is used when the settlor is not in fact looking for flexibility and does not really want the trustee to exercise discretion; in these cases, the letter of wishes is specific about the distributions that are to be made, or it calls on the trustee to act on the recommendations of a specified person. Whatever the reason, and sometimes it is simply that the settlor does not want to incur the expense of legal advice, this arrangement is unsatisfactory in several respects, not least that it raises the question of whether the trust deed is a sham. Happily, offshore trustees have become more sensitive in recent years to the question of sham and, indeed, the other dangers of dealing with settlors who do not have adequate legal advice.

   In due course, most of the major common law countries adopted measures reducing or eliminating the opportunities for avoiding tax through offshore trusts. In the United States, the opportunities were largely eliminated in the early 1970s; Australia and Canada were not far behind; the United Kingdom moved more gradually, but always in the same direction. The result was a substantial decline in the traditional market for offshore trust services. Paradoxically, this untoward development paved the way for the eventual transformation of the offshore trust industry.

3. BASIC INGREDIENTS

   The basic ingredients required to make a successful offshore trust center are predictable enough. There must be an adequate legal system, an adequate judicial system, political stability, adequate professional services, good communications, and an absence of significant taxation, exchange controls, or excessive regulation. Looking at the legal system, it is obviously fundamental that it should embrace the trust concept and provide a sufficient body of trust rules. Many of the offshore centers were in the happy position of being British colonies, or former colonies, acquired by settlement. They had simply inherited the entire body of English law, common law, equity, and statute in force at the time of settlement, insofar as applicable to the situation of the colonists and the conditions of an infant colony. In most cases, this reception of English law was confirmed by statute in due course.(3) Subsequent English case law is highly persuasive, and decisions of the Privy Council may be binding. As in England, the law of trusts remains uncodified though, as in England, legislation has been enacted for supplementary purposes. Centers in this category include Bermuda, the Bahamas, and the Cayman Islands.

   Other centers, such as Cyprus, Mauritius and Nauru, which have had the good fortune to come under British rule or administration, but already had an established system of law, have acquired the trust concept by osmosis, legislation, or both. In some cases, the "trust" may not be exactly the same as the English conception, but the general approach seems to have been to track England as closely as established local laws permitted.

   The Channel Islands are in this category, though it may be noted that they are a constitutional anomaly--certainly not colonies, nor yet part of the United Kingdom. They were part of Normandy when its ruler acquired the English crown in 1066; so perhaps one should regard the United Kingdom as an appendage of the Channel Islands, not vice versa. Curious as the constitutional position may be, even more curious is the fact that from the outset the Channel Islands thrived as offshore trust centers despite lacking what I have described as a basic ingredient--a legal system that embraces the trust concept and provides an adequate body of trust rules.

   There is no doubt that the Channel Islands had acquired a "trust" concept by osmosis through long association with England and the English, but the nature and effect of this "trust" had not been defined by the courts. Given the fundamental differences between Norman customary law and English law, particularly in relation to property, it was plain that this "trust" was not the same as that of England. Trust rules were equally undefined, though it was generally expected that the local courts would try to follow English practice insofar as that was consistent with local law and procedure. This may seem to be a rather shaky foundation upon which to build a trust center, but apparently it caused little concern among the London lawyers who helped their clients to choose a trust domicile. Eventually, in 1984, Jersey did adopt comprehensive trust legislation, and five years later Guernsey followed suit.(4)

   The Jersey legislation is well worth examination. Not only does it provide a comprehensive system of rules, largely derived from English judge-made principles, it also manages to emulate the effects of equitable ownership; in other words, it provides essentially the same proprietary rights and remedies, including the...