Both are useful for investment vehicles, however, based on your business needs and objectives, one might prove to be the better choice. However, under varying economic conditions or a different time frame, you may find the other to be preferable. Do not automatically default to one over the other.
In Part One of this series, we consider the structural differences between the two trusts.
In our follow up article, we will compare the trusts from an operational perspective.
In this article, we aim to provide you with points to consider and discuss with your legal or fiduciary advisors when beginning the trust selection process. It is not actionable nor legal advice on its own.
Many of us already know some details about plain-vanilla, discretionary trusts. In general, a trust is a common law, legal structure. A settlor cedes legal ownership of certain assets to a trustee, which are transferred and settled into the trust. In turn, the trustee, as a fiduciary, manages the trust assets on behalf of the beneficiaries, who, under specific terms and conditions, are determined by the settlor upon creating the trust.
Trusts, as a common law concept, have been around for centuries. Evolving over time, there is a large amount of case law and legal precedents that guide trustees and other involved parties in creating and managing the trust. This provides a great sense of clarity and comfort for all participants, including settlors, beneficiaries and trustees.
To be valid, a trust requires identifiable beneficiaries (i.e., persons). Duties imposed upon trustees are owed to the beneficiaries and the trustee manages the trust for the sole benefit of these beneficiaries. A lack of ascertainable beneficiaries to enforce these duties, could mean that a trust will not be upheld.
In addition to the trust deed, there is normally a Letter of Wishes. This is not binding on the trustee, however, these are “wishes” from the settlor that the trustee may consider when making its fiduciary decisions concerning the trust.
There may also be a Protector, though this is not necessary. Protectors provide oversight of specific functions within the trust. These are finite and focused in nature, and the Protector tends not to take on a fiduciary role itself. In these defined areas, the Protector ensures that the trustee properly exercises its administrative and dispositive powers in accordance with the trust deed.
Charitable Trusts are “normal” trusts. Guided by the same trust principles and common law that has grown over hundreds of years. There is, however, an exception to the rule that requires actual persons as beneficiaries. Charitable Trusts are, instead, created for the benefit of an abstract purpose, rather than individual beneficiaries.
Under Cayman Islands’ law, a Charitable Trust may be established to create a charitable fund or to make provision for existing charitable institutions or purposes. There must also be an element of public benefit. What constitutes a “Qualified Charity” is defined under Cayman Islands’ trust law.
A key aspect when using a Charitable Trust to hold investment vehicles, is to ensure that there is a charitable remainder once the trust’s business purposes are achieved. That charitable remainder must be distributed to a recognized charity, qualified under the laws of the Cayman Islands.
In practice, shares in the investment vehicle are settled into the Charitable Trust. These are typically, management shares that hold the voting rights in the investment company, but have no participation rights. Another class (or classes), with the participating, non-voting shares, is issued to investors.
As the management shares are non-participating in the entity’s profits, fair market value should always be at par value. When the structure is wound down, the shares can be sold or redeemed at that par value. It may make sense to issue the management shares at a minimal par value. For example, 100 shares at USD 1.00 per share. This allows for a minimal redemption cost to the initial issuer. If issued at USD 100,000.00 in total, then that amount will be needed when the shares are redeemed.
In addition to settling the management shares, a relatively small amount of liquid assets is settled within the trust. These funds cover any government fees at trust termination, with the residual cash contributed to a qualified charity. This step is important to ensure that the trust falls under the definition of a Charitable Trust.
In typical offshore personal trusts, the trust assets are held within an underlying company. While a trust is a separate structure, it is not considered a legal entity. As such, the trust cannot engage in business transactions, such as contracts for example. As a result of this, an underlying company is utilized.
When a Charitable Trust is used for investment funds and similar, an underlying company may be used. However, as the transferred-in investment vehicle is usually a legal entity itself (e.g., limited liability company), that entity can engage in legally recognized business transactions. The entity’s authorized signatories, often the Directors, are then eligible to enter into contracts on its behalf. Additionally, the structure should be bankruptcy remote from the settling entity’s other business activities.
Charitable Trusts are typically created via a Declaration of Trust. As the trust objectives are finite and clear when holding investment companies, there tends not to be a Letter of Wishes nor Protector. With the beneficiaries being charitable organizations, the enforcement or protection of the trust is conducted by the jurisdiction’s Attorney General (or similar public official). Protectors are therefore redundant and not required.
STAR Trusts are unique to the Cayman Islands. However, there are different forms of non-charitable purpose trusts in other jurisdictions, such as the British Virgin Islands, Guernsey and Jersey.
While Charitable Trust law has been around for centuries, STAR Trusts are a more recent concept. They are governed by the Special Trusts (Alternative Regime) Law, which came into existence in 1997. Although relatively new, there has been adequate case law around the world, demonstrating that STAR Trusts are considered valid trust structures within the legal and fiduciary community. As the years pass, additional case law will develop that will continue to solidify STAR Trusts and guide practitioners.
It is a requirement that at least one trustee of a STAR Trust be a trust corporation licensed in the Cayman Islands or a controlled subsidiary or a private trust company registered as such in the Cayman Islands. An individual or corporate trustee not qualifying as a ‘trust corporation’ can be a co-trustee of a STAR Trust, provided that there is at least one trustee who qualifies as a trust corporation.
STAR Trusts can be established for charitable or non-charitable, or even a mix of purposes, provided they are lawful and not contrary to public policy in the Cayman Islands. In addition, STAR Trusts may be for the benefit of specific beneficiaries or no beneficiaries at all.
This flexibility makes STAR Trusts highly versatile. While many financial institutions may not require enhanced versatility to simply hold shares in an investment vehicle, this is something to consider when comparing with the more limited, in scope Charitable Trust.
In practice, the set-up of a Charitable Trust is very similar to a STAR Trust. However, as the “purpose” of the trust need not be charitable in nature, there is no need to earmark assets for charitable contributions.
A STAR Trust may choose to utilize a Protector, though this is not commonplace. A STAR Trust is, however, required to have an Enforcer. The Enforcer literally “enforces” the terms of the trust deed. This is another administrative step in the process and possibly involves increased costs if having to pay for an Enforcer’s services.
Finally, as with Charitable Trusts, STARs help with bankruptcy protection and in creating Orphan Trust structures for Special Purpose Vehicles.
Next steps
Having completed a brief overview, setting out the differences in structure between STAR and Charitable Trusts, we can now compare them from an operational perspective. In Part Two of this series, we will focus on what considerations are required when setting up either of these trusts in order to hold an investment vehicle.