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Foundations: Ready, Steady, Go

A Practical Perspective

Presentation to ICSAIsle of Man

Annemarie Hughes & Tom Maher

6 March 2012

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Overview of Presentation

• Brief Summary of Legislative Regime

• What is a Foundation: Trust v Foundation

• Review of Competitor Jurisdictions

• Why introduce them and possible uses

• AML issues

• Establishing a Foundation/Content of Instrument and Rules

• Administration (e.g. minutes, open bank accounts, borrowing)

• Case Study highlighting practical issues, risks and liability

• Questions

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Who do we thank?

• Working partnership between Public/Private Sector

• Gillian Prestwich, IOM Treasury*

• John Wilkinson, Companies Registry

• The Queen for eventually signing the Bill

* Note to Treasury Minister – Eddie, if you’re listening, Gill deserves a very big bonus!

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Legislative Regime

• Permissive not prescriptive (similar to NMV)

• Foundations Act 2011 in force 15 November 2011

• Financial Services Rule Book effective 1 January 2012

• Regulated Activities Order

• Foundations Regulations

- Foundations (Winding Up) Regulations

- Foundations (Continuance) Regulations

- No Merger Regulations (compare Jersey)

• AML Handbook

• Under review – Treasury needs your input

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Isle of Man Foundations

• Incorporated, self-owning, legal entity

• Capable of holding assets, suing and being sued

• Cannot directly engage in commercial trading not incidental to its objects

• Taxed as a company in the Isle of Man

• Two Foundations established in the Isle of Man since 1 January 2012

• Slow take up in Jersey (only 22 after 6 months), so don’t panic

• Wealth planning a slow and careful process

• Quality not quantity

• Global economic uncertainty

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Trust v Foundation

Trust Foundation

No legal personality Separate legal personality

Settlor should not “meddle” Founder can “meddle” away

Must have initial trust fund Not necessary

Extensive duties to beneficiaries No duties to beneficiaries

Beneficiaries “right” to information No right to information if excluded in Rules (s.31)

Preserve/enhance value of trust property

No such duty. Skill and care duty but can hold wasting or volatile assets

Beneficiaries can force trust termination

Beneficiaries cannot force dissolution without Court Order

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So who is the competition?

• Liechtenstein (1926) – less attractive now

• Panama (1995)

• St Kitts & Nevis (2003)

• Bahamas (2004)

• Jersey (2009)

• Labuan (2010)

• Guernsey (pushed back to Q3 2012)

• Major competitors likely to be Channel Islands

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• 154 foundations incorporated to date

• Must have a licenceholder (“qualified member”) as council member

• Must have an enforcer (“guardian”)

• No fiduciary duty on Council Members? (s.22 Jersey Law -v- s.24(3) IOM)

• Two migrations of foreign law Foundations to Jersey (Liechtenstein)

• No migrations out yet

• No mergers yet

Jersey Foundations

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• Expected to be effective Q3 2012

• Drafted with civil law advisors in mind

• Three major differences compared to Jersey Law according to Guernsey

lawyers:-

- allows the Founder to decide what rights beneficiaries should have

- does not “negate any fiduciary duty within the structure” (arguable)

- establishment of an initial endowment required

Guernsey Foundations

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Why choose the Isle of Man?

• Registered Agent does not have to be Council Member

• No requirement for Enforcer in all cases

• Can hold land

• Fiduciary nature of Council’s duty to act honestly and in best interests of

Foundation

• Protection for “clients”: Court can order compliance and take action

• No requirement for initial dedication

• Isle of Man white list, reputable jurisdiction

• High quality professional services industry

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Why introduce Foundations?

• Treasury Minister said:-

- “The Manx Foundation will be a bespoke product that will provide our

financial services industry with an additional tool to open up new business

opportunities. The world of wealth management is highly competitive so it is

vitally important that Government keeps working in partnership with the

private sector to enhance the Island’s offering to international clients.”

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Why introduce Foundations?

• According to some commentators, the real reason:

“I was talking to someone of considerable expertise on tax haven / secrecyjurisdiction issues about Jersey and Guernsey foundations. He pointed out thereal reason for them, and I quote:-

‘I read your piece about foundations. A point you might consider – the main reason for the foundation law was to avoid fiduciary responsibility. A number of court decisions in Jersey held trustees responsible for the activities of the corporations they controlled. Obviously this increased trustee risk to a very high level. When a foundation is involved the new foundation law absolves the agents creating and managing them from responsibility.’

Now it makes sense! Foundations are about screwing the client as well as the rest of the world.”

• Source of the above commentary?

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Tax Research UK

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Why introduce Foundations?

• John Christensen, Jersey’s former economic adviser-turned-dissident, said:

- “It is worrying that Guernsey is expanding its services in this direction since

potential users of Guernsey foundations, especially those originating from

Latin America, China and the Middle East are very likely to be attracted to

using foundations precisely because their secrecy will provide cover for

criminal activity.”

• Beware of this perception

• Island must work hard to counter this and avoid PR disasters

• Despite these extreme views, there are valid legitimate reasons for offering

Foundations

• Myriad of uses which add to our existing offering

• Appeal to civil law clients

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Possible uses• ‘Shelf’ Foundations

• Wealth planning - exclusion of foreign law / forced heirship (s.38 of the Act)

• Trust alternative for civil law clients (e.g. where trusts cannot hold assets)

• Wasting assets (jet or yacht) – no duty to preserve / enhance value

• Orphan structures (e.g. securitisation or distressed finance, off balance sheet)

• Unlimited duration structures (contrast trust perpetuity period)

• Charitable (note registration issues)

• Purpose Trust alternative (e.g. holding shares in PTC) – must have Enforcer if non-charitable purpose

• Sharia compliant structure

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Sharia compliant structure

• Growing area of business

• Standard & Poor’s introduced Sharia compliant stock index in 2006

• Generally forced heirship rules do not apply to lifetime transfers

• Avoid ‘family empire’ being fragmented

• Draft Instrument and Rules to comply with Sharia:

- obligation/recommendation for Council to consult with Sharia scholar

- restrict investments to Sharia compliant investments

- ensure distributions made in accordance with Sharia

- may contain founder’s Zakat obligation

- Enforcer could be Sharia scholar

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AML & KYC

• AML Handbook – now updated for Foundations

• Liaise with your RM at the FSC for your first few

• Must carry out AML/KYC checks:-

- on establishing the Foundation

- when receiving a dedication

- when making a distribution

• Critical to get this right given the perception about Foundations

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Establishing a Foundation

• Draft Instrument and Rules

• File Application Form with Instrument and fee £195

• Forms and fees on Companies Registry website

• Registrar – not too prescriptive or restrictive

• Client agreement / terms of business with Founder and Foundation

• Regulated Activities Order

- Class 4 (Registered Agent and Council Member)

- Class 5 (Enforcer) – de minimis exemption

• Consent to act from each Council Member and Enforcer

• Shelf Foundations

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Instrument

• Standard Form on Companies Registry website

• Beware client confidentiality. Council Members’ names and addresses

filed in the Instrument and any changes must be filed

• Use Registered Agent as Council Member or a client SPV

• Make sure you get the objects clause correct

• Can you have commercial trading as your sole object?

• Note s.36(3) which states:

“A foundation may not directly engage in commercial trading that is not

incidental to the attainment of its objects.”

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Rules

• Model Rules s. 20(1) – none yet

• Large degree of freedom for draftsman

• Almost infinite flexibility

• Similar freedom to drafting a trust deed

• Likely to be many differences between Rules of different fiduciaries

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Rules

• Act prescribes what Rules must contain but is still permissive:-

- appointment, retirement, removal and remuneration of the Council Members,

Registered Agent, Enforcer

- decision making

- Enforcer’s name and address

- all dedications

- winding up provisions (e.g. can someone trigger it, what happens to assets)

- charitable – cannot permit amendment to specify a non-charitable object

• Advisable to include Rules on indemnities, exclusion clauses, wasting assets

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Duties of Council Members

• Conduct Foundation's affairs in accordance with Instrument, Rules, Act

• Act honestly and in good faith (fiduciary in nature)

• Act in best interests of Foundation (fiduciary in nature)

• Exercise the care, diligence and skill that reasonably prudent persons

would exercise in comparable circumstances

• Any insurance purchased by the Foundation itself cannot cover Council

Member, Registered Agent or Enforcer for any liability to the Foundation,

any fine in respect of an offence, costs of certain civil/criminal proceedings

• Ensure your D&O and PI insurance policies cover you

• Terms of business/Rules cannot exclude liability for fraud, wilful

misconduct or gross negligence

• CODA applies

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What is gross negligence?

• Spread Trustee v Hutcheson (2011 Privy Council, majority decision)

• English (and Guernsey) common law permitted a trustee to exclude

liability for gross negligence

• Difference between ordinary and gross negligence is only one of degree

• Jersey Court (1995) “a serious or flagrant degree of negligence”

• English Court (1997) non exhaustive list of relevant factors:-

- existence of a high degree of risk of loss or damage

- foreseeability of that high degree of risk

- seriousness of the loss which ought to be foreseen

- extent to which defendant took any steps to prevent the loss

• Important to include a wasting/speculative assets Rule but still note gross

negligence issues

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Wasting assets etc – DQ Rules Subject to Section 36(3) to (5) of the Act, in administering the assets of the Foundation, the Council shall have all powers of a natural person acting as an absolute beneficial owner of the assets of the Foundation and, in particular, the Council may cause the Foundation to acquire and hold:

(a) investments of a speculative nature;

(b) reversionary or limited interests in property and/or assets of a wasting nature; and

(c) partly paid shares in any company and other investments capable of giving rise to any liability for the Foundation including hedges, swaps, options, contracts for differences and other derivative obligations capable of giving rise to a potentially unlimited liability,

and the Council shall be authorised to permit the assets of the Foundation to consist of a single asset or the securities of a single company and shall be under no duty to cause the assets of the Foundation to be diversified or to procure that a certain or any level of income is generated from the assets of the Foundation.

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Administration

• Filings

- simple annual return (note no strike off / restoration procedure)

- changes to Instrument

- changes to Council Members (name and address): publicly available

- late filing fees

• Dedications (s.15)

- Rules must specify all dedications including further additions

- use schedule or appendix to rules (is this an “amendment” to Rules?)

• Letterhead s.40 (name, business address, registered number)

• Electronic communications must also include above (email footer?)

• Business address must be Registered Agent address

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Administration

• Record keeping (s.41) & accounts (s.42)

• No requirement for audit

• Registered charity – file Rules with General Registry (publicly available)

• If a registered charity, may need audit or independent accountant report

• Private Charitable Foundation with no IOM fund raising or beneficiaries

– must it register as an Isle of Man charity? On the AG’s agenda

• Open bank accounts – provide full copy of Rules to bank?

• Foundation can borrow, grant security and guarantee

• Borrowing more likely to be done at “subsidiary” level due to commercial

trading restrictions (s.36) and banks’ reluctance. Full copy Rules

• See case study

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Case study

• Prestwich Foundation (“F”), established by founder Roy Castle in Jan

2012

• Object is to benefit beneficiaries who are not named in Rules but enforcer

consent needed before any distribution

• Enforcer is Norris McWhirter, Roy’s close friend

• No dedication of assets on establishment, but Roy now wants to make an

initial dedication of £15m, having sold his valuable trumpet collection

• F owns ‘subsidiary’ Record Breakers Limited (“RBL”)

• Roy Castle wants a new Council Member appointed and a Picasso bought

• F wants to buy the Calf of Man Lighthouse and, if it gets planning

permission, to redevelop it into a 5 star hotel and casino, with helipad. This

will be done via RBL

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Case study• The directors of RBL think this project is very risky and want the F’s

consent and instruction in the form of a members written resolution

• RBL will buy the Calf of Man Lighthouse for £10m and spend another

£25m applying for planning permission and developing it

• Icelandic Outlandish Ventures Bank willing to provide a £30m loan but

requires the F to lend £5m to RBL as “equity injection”

• Land without planning is worth £50,000

• Land with planning is worth £15m

• Land is zoned as an area of national importance for heritage and wildlife

• Note Rules permit speculative investments and contain an exclusion clause

for negligence (it doesn’t specify what type of negligence)

• See Minutes in separate document

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Case study

• 12 months later, planning permission was refused and all appeals

exhausted

• RBL spent £10m on the Land, £5m on planning expenses, now owes the

Bank £10m plus interest

• The Bank calls in the loans due from RBL, repossesses ‘the Calf’ and sells

it for £500k to Donald Trump. Leaving an outstanding balance of £9.5m

• The Foundation writes off its £5m loan to RBL

• Is the Foundation liable for the £9.5m loan to the Bank?

• Are the Council Members liable for the £9.5m loan to the Bank?

• Are the Council Members liable to the Foundation for the £5m loss?

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Risk Management for Fiduciary

• Registered Agent terms of business with Foundation and Founder – include

appropriate indemnities and exclusion of liability clauses (note Rule Book)

• Ditto if you act as Council Member or Enforcer

• If terms of business are not signed by Founder, bring exclusion clauses to

his attention

• Remember s.26(2) cannot exclude liability for fraud, wilful misconduct,

gross negligence

• Ensure your D&O and PI insurance policies cover you

• Avoid Founder having too many reserved powers – tax planning issues

• Manage who has power to amend Instrument, Rules or make decisions

• Insist on being Council Member?

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Applications to Court

• IOM Court likely to look to other Foundation jurisdictions for caselaw

• S.51 “person with sufficient interest” can apply to Court (see s3 definition)

• S.52 order compliance with Instrument, Rules or Act

• S.53 amend Instrument or Rules

• S.54 directions

• S.55 Court appointed “protector” (to protect interests of unborn or

incapable beneficiaries)

• S.56 appoint or remove Registered Agent

• S.57 Court itself can act and “sign the cheques” – novel power

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Offences

s10 - RA must retain English translation copy Rules

s29 - RA must retain copy of assignment of rights

s40 - Foundation name, address and number in written communications,

including email

s41 - Documents and records to be kept at place of business

ss42-43 - Accounting records and financial statements

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s44 - Foundation must make Annual Return

- Late filing fees

- who is responsible?

s45 - Amendments to Instrument must be notified

- RA must keep copy

- Late filing fees

s59 - False information to Registrar

s60 - Liable on summary conviction to a fine not exceeding £5,000

NB - Council or RA authorisation / permission / participation / failure to take

all reasonable steps to prevent foundation’s commission of an

offence – Council Member or RA also liable

Offences

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Management & Control

• Establishment provides certainty without sham trust issues – or does it?

• Reserved powers

• Tax implications

• How will HMRC / other tax authorities view IOM Foundation?

• Sommerer v HM The Queen 2011 TCC 212

• Importance of minutes / resolutions – who has control?

• TIEAs

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• Insolvency and Winding Up

• Continuance

• Charity Registration Issues

• Management & Control

• Tax

For another day

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Conclusion

• Foundation is a flexible and useful vehicle

• Large degree of drafting freedom in Rules – get it right

• IOM has some distinct advantages but competitive market place

• Use appropriate vehicle in each case

• Don’t abandon the trust just yet

• Note other jurisdictions introducing trust law

• It will be a “slow burn”

• Please give your feedback to Treasury

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Questions?

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Contact details:

Tom Maher tom@dq.im +44 1624 632950

Director

Annemarie Hughes annemarie@dq.im +44 1624 632965

Director

Dougherty Quinn Limited is an incorporated practice in the Isle of Man, company number 119175C. Registered Office: The Chambers, 5 Mount Pleasant, Douglas, Isle of Man, IM1 2PU.  Directors: Paul Dougherty, Tom Maher, Walter Wannenburgh, Mark Dougherty, Giles Hill, Annemarie Hughes.