Offshore Creditor Protection Trusts
All trusts provide asset protection but some are aimed specifically at protecting assets from future unknown creditors or from claims which may arise on the bankruptcy of the settlor. They are a popular device, particularly with professionals who have a high risk of litigation, such as doctors, dentists and surgeons in the USA.

Choice of Centre
Creditor protection trusts should only be created in a centre which has introduced specific legislation aimed at offering protection from creditors. Examples include the Cayman Islands, the Bahamas, the Cook Islands and Gibraltar.

Features of a creditor protection trust
The actual provisions will, of course, vary between centres but this type of trust generally provides the following features and possible benefits:

· Most onshore centres have legislation in place which enables transfers into trusts to be made void or voidable if a claim is made against the settlor by a creditor or if the settlor is declared bankrupt within a certain period of time, which can be up to ten years from the date of the transfer.
· Those offshore centres which have implemented legislation will refuse to accept claims which are received within a much shorter time frame and the onus will be on the creditor to prove his case.

The Cook Islands: This was the first centre to introduce creditor protection legislation in September, 1989 and its laws provide that a local trust will not be void or voidable in the event of the settlor's bankruptcy or as a result of claims received from creditors. There are exceptions in the case of fraud but the onus is on the creditor to show that the international trust was established with the intent to defraud the creditor and that as a result of the transfer into trust, the settlor became insolvent. These points must be proved beyond a reasonable doubt and are, as a result, a major hurdle to those with a claim, but if the claim is successful the creditor will receive funds from the trust to cover his debt but the trust itself will not be void or voidable.

A transfer is deemed not to be fraudulent if it is made more than two years after the creditor's cause of action arose or where the creditor fails to bring an action within one year of the transfer. In addition, any action must be commenced in the Cook Islands within two years of the transfer.

The local law also refuses to recognise any foreign judgement which may be made against the settlor, trustee or protector.

However, the recent case of 515 South Orange Grove Owners Association and Others v. Orange Grove Partners and Others (1995) has cast some doubt on the use of the Cook Islands as a creditor protection centre. In that case the presiding judge was very critical of the use of such trusts in the Cook Islands and found in favour of the creditors on the basis that the two year limitation period should begin, not from the date the trust was created, but from the date of the judgement in California which led to the action which was heard in the Cook Islands.

As a result of this case the laws in the Cook Islands were altered to clarify the cause of action date.

The Cayman Islands: This was the second centre to introduce specific legislation and the provisions are similar in many ways to the laws of the Cook Islands. However, in Cayman the limitation period is 6 years (as opposed to two in the Cook Islands) and if a claim is successful the creditor will have first charge over the trust property in its entirety, which could make the trust void or void-able (compare this with the situation in the previous centre).

§ Transfers to defeat the claims of existing creditors will most certainly be considered to be fraudulent and will not be protected under offshore provisions. It is only claims' arising after the transfer of property has taken place which creates the planning opportunities.

Matters service providers should consider
In view of the purpose of this type of trust, service providers who have been approached to act as trustees of a creditor protection trust should proceed with caution. Here are some areas which they may wish to consider prior to agreeing to act as trustees:

i) Full 'know your client' procedures should be followed because if it is later found that the client was attempting to defraud known and current creditors, the trust would not only be illegal (under the laws of all the offshore centres) but the adviser and the trustee might be criminally liable for their involvement in the fraudulent operation and perhaps charged with conspiracy.

ii) The client should be asked to execute a declaration or affidavit confirming that he has no pending (or current) creditors, claims or legal actions against him.

iii) A declaration or affidavit of solvency should also be obtained.

iv) The client should be advised to retain sufficient funds outside the trust to meet personal expenses or cash requirements. This could be used as a defence that the trust did not contain all his assets and that he had personal funds available.

v) The source of funds should be verified and perhaps the client asked to confirm (again by declaration or affidavit) that they were not received as the result of money laundering or other criminal activities.

vi) The service provider may wish to consider arranging separate indemnity insurance in respect of this type of business.

vii) Finally, and perhaps most importantly, exercise common sense and if you suspect that the trust is an attempt to defraud existing creditors, do not take on the business.

Offshore Forced Heirship Protection Trusts
Forced heirship is a means by which a State imposes control over an individual's power to make testamentary dispositions. In such cases an individual's spouse and children will usually be entitled, by law, to at least a fixed share of his estate on death. Some offshore centres have introduced legislation which is designed to protect local trusts and trust property from the claims of 'forced heirs' as the family members are usually referred to.

Choice of centre
A number of offshore centres, such as the Cayman Islands, the Bahamas, Bermuda, Cyprus, Guernsey, Jersey and the Isle of Man have introduced legislation.

Features and potential benefits
We should start by looking at what succession rights are applied in some onshore areas;

i) Strict Forced Heirship Succession Rights
The individual has testamentary power over only part of his estate (such as in France, Italy, Spain, Scotland, Sweden, Denmark, Eastern Europe, South America and the Islamic states).

ii) Forced Heirship in Indefeasible Shares
The individual has full testamentary power over his entire estate but certain family members must receive at least a minimum share as prescribed by local law. (Several of the states in the USA have this restriction.)

iii) Judicial Adjustment
The individual has full testamentary power but certain family members have the right to apply to the court for financial provision which the court can grant at its discretion. (This is the situation in, for example, England and China).

Making lifetime transfers will not necessarily avoid heirship rights as the value of any gifts made will usually be added to the value of a deceased person's estate and the shares of the 'forced heirs' will be calculated on this combined value. Gifts which have been made might be clawed back from the donees under court orders and the funds recovered paid to the heirs who have the enforceable rights.

Matters the service provider should consider
Those who are approached to act as trustees of such a trust must not only follow the usual 'know your client' policies and procedures but should also consider other factors which may affect the protection afforded by the trust.

i) The statutory protection does not extend to the lex situs of property and as a result, assets transferred into a trust designed to offer forced heirship protection should not be held or located in a country or region which has or recognises forced heirship laws.

ii) Any distributions which are made by the trustees to beneficiaries who reside in a country which has or recognises forced heirship laws might be seized by the court in that country in the vent of a dispute. Those funds might then be transferred to the persons who are entitled under the forced heirship rules in the settlor's country.

iii) If the trustees has an office or branch in a country which recognises the claims of forced heirs, there is a possibility that the court in the country where the office or branch is located might initiate proceedings against that office or branch in an attempt to recover funds or receive compensation which could not be obtained against the trustee or trust property in the offshore centre.

Sham Trusts - What They Are and How to Avoid Them

Definition of a 'Sham Trust'
There are three possible definitions of a sham trust.

§ Firstly, a sham trust could be one where the provisions in the trust deed do not create a valid trust, either because the powers which are retained by the settlor are too wide giving him what amounts to an absolute interest, or the 'trust' contravenes the local legal requirements for a valid trust.

§ Secondly, a sham trust could be one where the settlor and trustee agree that the trust will be administered in a manner which differs from the provisions contained in the trust deed.

§ Thirdly, a sham trust could arise were the settlor lacked the necessary intention to create a trust. This could be through incapacity or duress although a lack of intention could also be proved if the settlor failed to understand the terms and effects of the trust which he executed. When you consider the length and complexity of many trust deeds, perhaps the trust salesman should stop and ask himself whether the client sitting in front of him really understands what it is he has been asked to sign. If he does not, the trust could be attached as a sham because of his failure to take time to explain the terms and effects of the trust deed.

Example of a Sham Trust Situation
The following is a simple example of a situation which could be attacked as being a sham trust.

A settlor and trustee execute a trust deed under which the trustee has a number of wide discretionary powers, including the power to distribute capital and income. However, the settlor has issued a letter of wishes which sets out how he would like the trustees act. The settlor confirms that it was never his intention that the trustees would exercise any power without his authority and that they were only to make distributions in accordance with the provisions of the letter of wishes. The trustees in turn confirm that they will refer to the settlor on all matters and in particular that they will follow the contents of the letter of wishes.

The settlor never intended to have the powers which the deed gave them and the trustees never intended to exercise any of those powers.

If attacked: The trust would, in all likelihood, be set aside as a sham.

Avoiding Sham Trusts
The list which follows contains areas of advice which all service providers who offer trustee services should consider if they wish to avoid creating a sham trust situation.

a) The Trustees and the settlor should both accept the reality of the trust and have an intention to be bound by the terms of the trust deed. Perhaps this could be achieved by the settlor confirming in writing his intentions to create a binding trust, and that he accepts and understands the powers which will be given to the trustees. The trustees could then countersign this.

b) The trustees must control, and be seen to control, the trust property.

c) Settlors should not be given powers which give them elements of management and control.

d) Trustees should be seen to have exercised their discretionary powers by using an active mental process. Trustee meetings and the preparation of minutes of those meetings will help but are not the sole solution to this issue.

e) Avoid the use of phrases in letters of wishes or letters to the trustees which can be seen as instructing or directing the trustees.

f) Discourage the settlor from calling the trust "my trust" or referring to the trust property as "my property". If he does refer to the trust or the trust property in this manner, correct him (preferably in writing).

g) Avoid the use of dummy settlors.

h) Avoid giving the protector wide powers which could affect or reduce the powers and discretions of the trustees (especially if the settlor is also the protector).

i) Avoid creating blind trusts or at the very least, obtain from the settlor full details of why such a trust is requested. If you proceed, consider making a token distribution to the named charity to show that there was an intention to benefit it.

j) Be aware of the additional risks and liabilities associated with creditor protection and forced heirship protection trusts and remember that the could also be attacked as a sham unless they are correctly administered. Remember that the local trust provisions in place in an offshore centre might not always offer the protection which the client requires.

k) Keep indemnity provisions in trust deeds reasonable. Too many wide exculpation clauses which fully indemnify the trustees for all actions could create a sham situation.

Trust Litigation in Offshore Centres

Offshore trusts can provide a number of planning opportunities which cannot be offered by onshore trusts. They are also often used in complex financial and taxation planning arrangements which can involve substantial amounts of assets. In addition, offshore trusts may not be recognised as being valid under the laws of the settlor or the beneficiaries. It is no wonder that offshore trust litigation is on the increase.

Litigation can arise from the actions, or inactions, of the trustees. Such an attack would usually manifest itself as a claim against the trustees for breach of trust or perhaps for negligence.

The following examples outline the steps that should be taken to minimise the risk of a trust having dealings with the subject of litigation.

i) Make sure that any 'standard' trust documentation has recently been reviewed by a law firm in the centre concerned and that the terms and powers are valid.

ii) Understand the pitfalls which can be associated with discretionary trusts and take appropriate action to ensure that these are avoided.

iii) If you suspect that a beneficiary or a third party is considering attacking the trust, obtain legal advice as quickly as possible. Remember that the advice which you receive may be information which the beneficiary has a right to have a copy of.

The Regulation of Offshore Trusts and Trustees
The reader must understand that, many offshore centres have introduced legislation which prevents persons, and particularly corporations, from conducting trustee business unless they are licensed to act in this capacity. Here are just a few examples of centres which have this restriction include the Bahamas, Bermuda, BVI, the Cayman Islands, Gibraltar, Madeira, Malta, Mauritius, the Turks and Caicos Islands and Vanuatu.

Those centres which have licensing requirements will usually expect professional corporate trustees to meet certain minimum capital requirements as well as proof that they have sufficient expertise. Often there will also be different categories of licenses, such as unrestricted (where they can act as trustees of any trust) or restricted (where they can only act as trustees for those cases which are recorded on the license).

As trust litigation, or the risk of such litigation, increases so too no doubt will the number of offshore centres which implement regulatory controls over their trust (and also managed company) providers.