Milestone in trust litigation

Read our article in the Cayman Financial Review Magazine, eversion 

There is a growing volume of litigation involving offshore trusts. The Cayman Islands case of TMSF v Merrill Lynch1 decided recently by the Privy Council made waves in the law of receivership and represented a potential turning point in the creation of reserved powers trusts.  

Evolution of reserved power trusts

Over the centuries the trust has constantly evolved as a flexible way of holding assets. This trend (particularly offshore) has shown no signs of letting up, and trusts are now regularly used as a wealth-structuring tool by individuals and families all over the globe, many from civil law jurisdictions where the trust concept is truly alien.

However, with this flexibility come fundamental restrictions on what a trust can achieve. These restrictions are often most keenly felt by those from non-common law backgrounds, who have increasingly fuelled the demand for more sophisticated and user-friendly trust solutions.

This demand has been addressed by leading offshore jurisdictions, with Cayman frequently setting the pace via innovative statutory amendments to classic trust principles such as the Special Trusts (Alternative Regime) (STAR) law, the introduction of unlicensed Private Trust Companies (PTCs) and legislation concerning reserved powers.

At the heart of such legislation is the desire to give settlors an element of continuing control over the administration, investment and management of the underlying trust assets. Cayman’s thoughtful and flexible retention of control legislation has proved very popular to clients for whom the concept of transferring their wealth to independent trustees was too great a leap of faith, especially when the trustees would owe duties to the beneficiaries rather than to the settlor.

However, the recent decision of the Privy Council in Tasarruf Mevduati Sigorta Fonu v Merrill Lynch Bank and Trust Co (Cayman) Ltd [2011] UKPC 17 (“TMSF”) will impact directly on the continuing use of reserved powers trusts.

The decision

In 1999, a Mr Demirel settled circa US$24m in two Cayman-law discretionary trusts. TMSF, the Turkish banking regulator, obtained a judgment in Turkey against Mr Demirel in the sum of circa US$30m for damage caused by allegedly fraudulent loan transactions.

Mr Demirel had reserved to himself full power of revocation over the Cayman trusts. Such powers can be viewed as the ultimate retention of control by the settlor, as he can exercise them at any time to completely undo the trust structure.

TMSF wanted to enforce its judgment debt against Mr Demirel, but could only enforce the judgment against the trust assets if they first came back to Mr Demirel by him exercising his powers of revocation.

As a means of achieving this, TMSF issued a claim in Cayman for assignment of Mr Demirel’s power of revocation to a receiver and for authority to allow the receiver to revoke the trusts.

However, the case-law suggested that a receiver could only be appointed over ‘property’. So, was Mr Demirel’s power of revocation a form of property?

Neither the Grand Court nor the Court of Appeal in Cayman thought so. However, the Privy Council ruled that there were no absolute rules as to the distinction between powers and property and, in the circumstances of the case, the power to revoke the trust could be regarded as a right “tantamount to ownership” of the underlying trust assets. The Privy Council therefore ordered that Mr Demirel should delegate his powers of revocation to TMSF’s receiver.

The consequences for reserved powers

The TMSF decision has sent tremors around the offshore trust world by rendering trusts with extensive reserved powers potentially vulnerable to attack by a settlor’s creditors. Certainly, the merits of structuring any trust as revocable must now be seriously questioned, and the general approach should now be to make trusts irrevocable unless there is a very good reason against doing so.

However, what remains to be seen is the extent to which the decision in TMSF may apply to other settlor-reserved powers, such as a general power of appointment in a discretionary trust.  
TMSF will have repercussions for both existing trusts and new trusts.

For existing trusts, practitioners will need to review trust provisions to consider the extent of settlor control over the administration of the trust. One option may be for the settlor to release reserved powers, but each case will need to be evaluated on its merits in terms of the risk of retaining the power in light of TMSF as against the importance to the settlor of retaining a measure of control over trust assets.

For new trusts, it is likely that the extent of settlor-reserved powers will now be considered much more carefully, and only those powers which are real “deal-breakers” to the settlor (ie without which he is not comfortable with establishing the trust) should be reserved.

Receivers of powers

While the real significance of TMSF remains its impact on trusts containing extensive settlor-reserved powers, the decision is also important for plaintiffs or judgment creditors who are seeking effective ways to enforce their claims.

In the TMSF decision, the Privy Council decided that a receiver could be appointed over a power of revocation conferred on Mr Demirel as a means of enabling the plaintiff to enforce its judgment against him. In doing so, the Court effectively expanded the scope of ‘property’ over which a receiver could be appointed.

Now it seems that a receiver could be appointed over powers that enable the defendant to control or access property, as the power of revocation did in the TMSF decision.

Other examples of powers that might be caught by the appointment of a receiver include other trust powers such as powers of appointment over assets, or in the corporate context the rights of shareholders to vote shares in a company.

When one considers that a receiver can also be appointed before trial as a way of preventing defendants from putting their assets beyond the plaintiff’s reach, this potential new jurisdiction to appoint a receiver of powers creates some intriguing possibilities for the enforcement of claims.

The insolvency angle

Finally, TMSF was an interesting case of an individual creditor pursuing an enforcement remedy even though the defendant had already been made bankrupt. A trustee in bankruptcy had been appointed in Turkey, but Mr Demirel’s power of revocation did not vest in the trustee – it was not “property” under Turkish law.

However, because TMSF gave an express undertaking to make the proceeds of its claim in Cayman available to Mr Demirel’s creditors as a whole, the Privy Council was prepared to exercise its discretion to appoint a receiver in favour of TMSF.

This aspect of the Privy Council’s judgment is a good example of how the rights of an individual creditor in bankruptcy can sometimes be better than those of the trustee. In this case the power of revocation was not part of the bankrupt’s estate per se, and the trustee had no basis for appointing receivers itself: it took the intervention of TMSF as a creditor with an enforceable judgment debt to appoint a receiver.

By undertaking to share the proceeds of its claim with all creditors – presumably by paying the sums recovered to the trustee in bankruptcy – TMSF effectively extended the scope of the bankruptcy to ‘catch’ Mr Demirel’s powers of revocation.

Conclusion

The TMSF decision demonstrates just how pragmatic the courts are willing to be, looking through the form of trust structuring and getting to the real substance of control. In this new landscape, the effectiveness of provisions designed to allow the settlor to retain control of trust assets is likely to come under ever increasing scrutiny.

Endnote:

1 .Tasarruf Mevduati Sigorta Fonu v Merrill Lynch Bank and Trust Co (Cayman) Ltd [2011] UKPC 17

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David Herbert

David heads Harneys’ Cayman litigation and insolvency department. His main areas of experience and expertise include insolvency and restructuring, trust advice and litigation, and company and business disputes. David is recommended by Legal 500 as a leading junior barrister in the areas of both fraud and professional negligence.

David Herbert
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Henry Mander

Henry is a member of the banking and finance and private client departments and advises international clients on a wide range of Cayman and BVI trust matters. Henry has a broad range of trust and estate planning experience, including the creation, administration and termination of complex international trusts.

Henry Mander
Associate
Harneys
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Harney Westwood & Riegels is a leading international offshore law firm. We provide the world’s top law firms, financial institutions and corporations with legal services relating to British Virgin Islands, Cayman Islands, Cyprus and Anguilla law.

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