September 12, 2018 Matthew Smith

KEEPING ON TOP OF THE TRUST – A CASE STUDY – PART 1

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BY MATTHEW SMITH

Legal Counsel

So, you’ve finally set up that trust you always planned to get around to. Your assets are protected, the estate plan is locked in. You can just forget all about it and let it run itself now, right? Wrong! In Part 1 of an ongoing series, we look at what you need to keep doing – and why you need to keep doing it – to ensure the trust you have established works best for you.

Picture the scene: you’ve spent months setting up that Cook Islands trust you always talked about, the final piece of your asset protection and estate planning jigsaw that was going to keep everything you’d worked for out of the hands of speculative litigators and retain it for the benefit of yourself, your wife, your kids and their families. No more conference calls! No more due diligence! No more attorney fees!

You just need to keep paying that annual renewal fee to the trustee and you’re home and dry! Job done….

And then let’s jump forward 20 years.

A lot can happen in 20 years. Let’s take my last 20 years. I’ve lived in 13 different homes in three different countries. I’ve completed two university degrees, had six full-time jobs across three careers and qualified as an attorney in two jurisdictions on opposite sides of the world. There have been births, marriages and deaths amongst my nearest and dearest and friendships have been made, lost and maintained. Suffice to say, life is very different to what it was 20 years ago.

Now let’s go back to our opening and put some names to that scene. In the box below, you’ll meet the Fletcher family, find out about the terms of the offshore family trust, and see what changes have happened in the lives of family members since it was established. Then, in this and each of the next few issues of INsight, we’ll look in more detail at some of the practical pitfalls faced by the trust and what could have been done to avoid them.

Meet the Fletchers

It’s 1998. Nate Fletcher, an entrepreneur from California, has finally got around to setting up an offshore trust for the benefit of his family, the Fletcher Family Trust (the ‘Trust’). Nate is married to Lisa and they have two children, Claire and Maya, who are both at college and have long term partners called Federico and Gabe, whom Nate regards very fondly as his own sons. Nate has a brother, David, but they had an acrimonious fallout a few years back after a business they set up folded. As a result, Nate decided not to make David a beneficiary of the Trust. The Trust Protector is Brenda, a close friend whom Nate has known since college, and the Trustee is a Trust company in the Cook Islands.

The Trust Deed

The Trust Deed identifies five classes of beneficiaries, a to e, as follows: a) Nate Fletcher b) Lisa Fletcher c) The children of Nate and Lisa Fletcher d) The husbands of the children of Nate and Lisa Fletcher e) Any natural-born descendants of the children of Nate and Lisa Fletcher and the natural-born descendants of such children.

None of the beneficiaries except for Nate and Lisa are aware of the trust.

Under the Trust Deed, the Protector alone has the power to remove and replace the Trustee but the Protector cannot be removed against their will – they may only resign, and have the power to designate a successor on their resignation. Any amendments to the Trust Deed, including theaddition and removal of beneficiaries, must be made by the Trustee, but need the consent of the Protector. Any discretionary beneficiary distributions made by the Trustee also require the Protector’s consent. The Deed provides, on Nate’s death, for the Trust Fund to be distributed among the beneficiaries in full with 80% to be shared between the surviving class b) and c) beneficiaries and the remainder to be shared equally between any surviving class d) and e) beneficiaries. The Trust Fund holds real estate and an investment account with a combined value of $5m. 20 years later.

Back to 2018, and a whole lot has happened over the last 20 years. Nate and Lisa divorced, albeit amicably, and Lisa married Nikolai, a millionaire. Nate and David buried the hatchet and they had a good relationship again for several years, during which time David married Brenda, and Nate and David set up a few successful businesses together. However, they turned out once again to be lousy business partners and their relationship deteriorated over a number of years until David – and Brenda – cut off all contact with Nate 18 months ago. Last year, David issued a number of lawsuits against Nate, whom he accused of stealing and profiting from his business startup ideas. As a result, Nate decided to place additional assets worth $12m into the Trust’s investment account to ensure David could not get his hands on them. He did not tell the Trustee about these additions to the Trust Fund.

Claire and Federico never married – instead, Claire now finds herself in an unhappy marriage to Keith, who she tolerates for the sake of their children, but who is manipulative and controls all the family finances to feed his gambling habit. Kevin, the eldest of their two children, is 15 and has got into a lot of trouble at school and with the police in the last year as a result of which Nate has publicly washed his hands of his grandson.

Maya and Gabe didn’t work out either, but Maya is at least happily married – to Ruth. They have two adopted children, and Nate is very close to the four of them.

Nate did not tell the Trustee about any of the events of the last 20 years. While he was happy to have the trust, he did not feel the need to do anything with it as it only held property and long-term investments, which were only added to in the last year. He was happy to pay the annual Trustee fees, but ignored requests from the Trustee for updated information to be provided or to make time to discuss the terms of the trust.

Where Nate went wrong.

The Protector issue Setting Brenda up as the Protector probably seemed a good idea to Nate at the time. After all, they were friends from college, and Brenda was someone that Nate trusted completely, who would always act in his best interests and do the right thing. Or so he believed…

Brenda is in a very powerful position in relation to the Trust, and Nate is unable to do much about it. Brenda cannot be removed as Protector under the terms of the Trust Deed, and the Trust Deed cannot be amended to allow for her removal unless she consents to any such amendment. In addition, any beneficiary distribution can only be made if she consents to it. Worst of all, as she has the power to remove and replace the Trustee, there is a risk that she could forcibly remove the offshore Trustee and appoint an additional trustee who she knows would follow all her recommendations. She could then request that trustee to add David as a beneficiary and distribute the Trust Fund to him – to which she would, of course, consent. So the entire integrity of the trust is severely threatened.

Where did Nate go wrong?

Firstly, in appointing Brenda in the first place. This is an object lesson in how a good idea at the time does not always stay a good idea. In an ideal world, and to ensure maximum asset protection, it is advisable to select a protector who lives or is domiciled in a different country from the settlor and isnot subject to the jurisdiction of the same courts. Where this is not an option, the next best thing is to appoint a trusted professional advisor, such as an attorney or CPA, in the role.

Appointing a family friend may seem sensible, but it is important to remember that relationships can change over time. The entire integrity of a trust can rely on the settlor and protector maintaining a good relationship, and, sad as it may be, a professional relationship can be more durable than a personal one.

Secondly, as soon as he sensed a shift in the quality of their relationship but before it soured completely, Nate should have taken steps to get Brenda to agree to her own replacement as Protector. As soon as Brenda and David started their relationship, Nate should have been alive to the possibility that this could have caused significant problems further down the line. However, Nate probably did not even consider this – having set up the Trust, he did nothing to ensure that it still worked for him and did not give the matter any thought. Nate should have reviewed the Trust periodically and read the annual reports from the Trustee. This would have placed him in a better position to request changes to be made.

It is worth noting that, had an independent corporate protector been used, then the fact that they were very difficult to remove would be much less of a problem. In fact, having a protector who cannot be replaced against their will can be highly beneficial from an asset protection perspective, even if it can still cause administrative problems. To counteract these, it will often be preferable to empower the settlor tore move and replace a protector, provided that any such action is void if there is an event of duress.

The Solution

Unfortunately, the Trust Deed does not provide a solution to the Protector issue. Brenda cannot be replaced as Protector unless she agrees to her own replacement, or consents to amendments to the Trust Deed which will make this possible. Nate will have to reach some sort of agreement with her to retire as Protector, which is likely to require substantial financial concessions on his part. In the probably unlikely event that he is able to secure her voluntary retirement, he could then appoint a corporate protector in her place and request the Trustee and Protector work together to insert provisions into the Trust Deed which allow for the Protector’s replacement in certain circumstances.

This example shows the importance of (1) ensuring appropriate trust officers are selected from the outset; (2) being satisfied that the trust deed does not give too much, or too little, power to trust officers; (3) periodically reviewing the structure, terms and officers of the trust to ensure it can still function as originally intended; (4) taking note of information provided by the trustee, as this can serve as a vital reminder of how the trust is set up.

If you would like to discuss this topic further or have an interest in setting up a trust please contact Southpac at www.enquiries@southpacgroup.com

Matthew Smith

Matthew Smith joined Southpac in March 2017 and works as Legal Counsel based in the New Zealand head office. Matthew is a dual-qualified attorney, having been admitted as a Solicitor of the Senior Courts of England and Wales in 2008 and as a Barrister and Solicitor of the High Court of New Zealand in 2017
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