When it comes to managing and protecting wealth, the choice between a trust and a foundation can significantly impact the effectiveness and efficiency of your estate planning strategy. Trusts and foundations, though similar in some respects, are distinct legal structures with unique advantages and disadvantages, especially for individuals with assets in civil law countries. This article explores the fundamental differences between trusts and foundations, highlighting the benefits of each, and provides guidance on choosing the appropriate structure for your needs
- Trust
A trust is a fiduciary arrangement where the legal owner of assets, known as the settlor, transfers legal ownership of those assets to another party, referred to as the trustee. The trustee, who can be an individual or a corporation, holds and manages the trust property on behalf of the beneficiaries, who are the individuals or entities designated to benefit from the trust. This transfer effectively splits the ownership of the assets into two parts: legal ownership and beneficial ownership.
Upon the establishment of a trust, the trustee assumes legal ownership of the trust property. This means that the trustee has the authority to manage and make decisions regarding the assets within the trust. However, this control is exercised in accordance with the terms set forth in the trust deed and in the best interest of the beneficiaries. The beneficiaries, on the other hand, retain beneficial ownership, meaning they are entitled to the benefits generated by the trust property, such as income, capital gains, or use of the assets, depending on the specific terms of the trust.
Trusts are versatile structures that can be tailored to meet various needs and objectives. The most common type of trust is one that is created for the benefit of specific beneficiaries. These can include family members, loved ones, or other designated individuals. Such trusts are often used in estate planning to ensure that assets are managed and distributed according to the settlor’s wishes, providing financial security and stability for the beneficiaries.
However, trusts are not limited to benefiting individuals. They can also be established for broader purposes. Charitable trusts are a prime example, where the trust is created to support philanthropic goals. These trusts can fund charitable organizations, educational institutions, or public works. Non-charitable purpose trusts are another type, designed to achieve specific non-charitable objectives, such as maintaining family gravesites or supporting non-profit activities.
The flexibility of trusts allows for significant customization based on the settlor’s intentions. Trusts can be structured to address various scenarios, including:
- Discretionary Trusts: The trustee has the discretion to decide how and when to distribute the trust income or capital to the beneficiaries.
- Fixed Trusts: The distribution of trust assets and income is fixed and predetermined in the trust deed.
- Revocable Trusts: The settlor retains the right to alter or revoke the trust during their lifetime.
- Irrevocable Trusts: Once established, the trust cannot be altered or revoked by the settlor.
- Foundation
A foundation is a distinctive legal entity that combines elements of both a trust and a company, making it a versatile tool for wealth management and asset protection. This hybrid nature allows a foundation to leverage the strengths of both structures while minimizing their individual limitations.
One of the defining characteristics of a foundation is its status as a body corporate. Unlike a trust, which is a fiduciary relationship, a foundation possesses its own legal personality. This means that the foundation itself, rather than any individual or group of individuals, owns the property and assets transferred to it. This setup is similar to a company, which owns assets and conducts business in its own name. However, a key difference is that a foundation does not have shareholders or members. Instead, it is an independent entity governed by its own set of constitutional documents, including a charter and regulations.
The management structure of a foundation closely mirrors that of a company. It is typically overseen by a council, which functions similarly to a company’s board of directors. The council is responsible for administering the foundation’s assets and ensuring that its objectives, as outlined in the charter and regulations, are met. These objectives can range from charitable purposes to specific non-charitable goals, providing flexibility in how the foundation operates and achieves its mission.
Despite its corporate characteristics, a foundation shares several similarities with a trust. Like a trust, a foundation is established by a founder who contributes property or assets to it. This founder acts in a role akin to that of a settlor in a trust. The foundation’s property is managed according to the founder’s instructions and for the benefit of designated beneficiaries or to fulfill specified purposes.
Just as a trust must have one or more purposes or beneficiaries, a foundation is required to have clearly defined objects. These objects can be either charitable, non-charitable, or a combination of both. For example, a foundation might be set up to provide scholarships, support scientific research, or maintain a family legacy. This flexibility allows founders to tailor the foundation to their specific intentions and goals.
A unique feature of foundations is their “ownerless” structure. Unlike companies, which are owned by shareholders, foundations have no beneficial owners. This means that once the assets are transferred to the foundation, they no longer belong to the founder or any other individual. Instead, the assets are held by the foundation in perpetuity (or for the duration specified) to fulfill its stated objectives. This ownerless nature can offer significant advantages in terms of asset protection and privacy, as the foundation’s assets are legally separated from the founder’s personal estate.
- Benefits and advantages of the Foundation
As mentioned above, foundation constitutes a legal entity which can be understood as assets endowed by a natural or legal persons, who is/are called the “founder(s)” for specific purposes, whereby said assets are rendered legally independent and are accorded their own legal personality. The fund endowed for certain specific purposes becomes autonomous and acquires the status of a legal person. The autonomous fund is separated from the founder’s personal assets and then forms the assets of an independent legal entity, namely the foundation.
The main advantages of the Foundation include but are not limited to:
- The founder may be an individual, a corporation or a nominee.
- The foundation may be established for an unlimited period of time.
- The assets may consist of any kind of property, real and personal, cash etc… wherever situated including securities of commercial enterprises.
- Vested beneficiaries must be notified of their interest and will be entitled to request information from the bodies of the Foundation.
- Anonymous ownership and control except for disclosure of beneficial ownership in cases of money laundering.
- The public may not gain information on existence or beneficial ownership from the Register or other means.
- The foundation may engage in commercial activities (to a limited extent).
- Minimum Taxation.
- There are no requirements concerning bookkeeping.
- There are no auditing requirements.
- Professional secrecy: lawyers, trustees, banks, investment and asset management companies and their employees are subject to prosecution and prison up to three years, in case of disclosure or breach of secrecy.
Finally, a key feature of a foundation (as compared to a common law trust) is the ability of the founder to retain more control over the foundation.
In contrast, the settlor has a more limited role and, once assets are settled on trust, the duties of trustees are towards the beneficiaries, rather than the settlor.
- Disadvantages of the Trust in civil law countries
Since the Trust is a legal institution established and regulated according to the Common Law, and creates legal relationships regulating transfers of property on good faith basis, the question of its ratification by Civil Law countries, has proven to be a difficult one to answer – and rarely in a positive manner.
The difficulty appears when Civil Law countries – (such as UAE, Lebanon, France, Luxembourg, Russia,…) – attempt to introduce the Common Law principles governing the Trust in their legal systems, and are, in result, faced with many legal and fiscal controversies that necessitated intellectual maneuvering in interpreting and applying said institution, and comparing it to some similar – not identical – Civil Law institutions in order to attempt to limit the incompatibilities between the Trust and Civil Law governing principles.
Said maneuvering, has proven to have resulted in a “destructive” requalification of the institution of Trust.
As a matter of fact, before the ratification of The Hague Convention of July 1st 1985, the French judges (as all civil law judges will still do) facing foreign Trusts, had a duty to retain the characteristic traits of the Trust in question, then to transpose them in a legal frame/institution similar and/or better known to the French law (Civil Law), which had undoubtedly distorted the Trust in question: it is the traditional way of adaptation.
Indeed, the main obstacles for the ratification of the Trust in Civil Law countries are the following:
- The principle of the undividable patrimony (the sum of one’s wealth, assets…):
According to this principle, each individual has only one undividable patrimony which constitutes a general guarantee to the benefit of its creditors. One is not allowed to subtract a part of his assets to this general guarantee. This principle has long refrained the recognition of the Trust in the countries of Civil Law tradition.
And so, the principle of an allocated patrimony (Patrimoine d’Affectation) known to the Trust and of which the assets transferred to the trustee make part and are subtracted from the personal mass of the personal assets of the trustee which can be seized by the creditors of the latter, derogates to the principle of an undividable patrimony.
- The distinction between law and equity:
Since unity of one’s patrimony is fundamental in Civil Law, the distinction between legal ownership and beneficial ownership of an asset – pillar of the Trust – is inconceivable.
Indeed, in Romano-Germanic law (Civil Law), one cannot be owner of assets for the sole sake of management – as in the case of a trustee – without being able to receive the gains from such assets.
- Real title and personal title:
Real titles, which in Civil Law confer to their owner absolute prerogatives on the asset in question, are strictly enumerated in the real estate law.
Based on the dispositions of the Trust, the real title over the assets of the Trust is entrusted to the trustee in law, and to the beneficiary in equity.
The real title conferred to the beneficiary over the assets of the Trust allowing him to “follow” this asset and to claim it from whoever, could not have the required effects (especially if it is a real estate property right) unless the legislation of the civil law country acknowledges such a right.
As for the personal right in Civil Law, it is a right which confers to its owner the right to claim the accomplishment of an obligation. This right is only opposable to the debtor of this obligation and not to everyone.
And so, the personal right conferred to the beneficiary via the Trust is distinguished from the traditional personal right in Civil Law, in the meaning that the former is general and that it assures a certain priority to its holder with the right of tracing on the assets in Trust.
- Simulation and apparent ownership:
It is undeniable, in Civil Law, to say that the person who detains the ownership of a movable or real estate asset based on the state registers is the effective owner of this asset and any contradicting side-letter can only prevail among the parties of said document and cannot be considered as opposable erga-omnes (with regards to all third parties).
And so, the duplication of ownership between the trustee and the beneficiary and the right of tracing (droit de suite) conferred to the latter will put again in cause the well-established principles in Civil Law in the matter, and cannot be rightfully operated in such systems.
So, when a trustee does not mention on the ownership title his quality of trustee and sells the asset of the Trust to a third party, the beneficiary cannot recuperate his rights facing the purchaser in good faith and the right of tracing shall totally be ineffective. Similarly, he shall be a simple creditor of the trustee in case of his bankruptcy.
Finally, in the first system (Trust), the priority is given to the beneficiaries in case of insolvency of the trustee, but in the countries of Civil Law, the mass of creditors is protected.
Therefore, the institution of Trust is far from being easily admitted in Civil Law countries such as the United Arab Emirates, and aside from the foreign legal notions that the Trust necessitates to apply, it is mandatory that a Romano-Germanic judge (Civil Law) places himself in the shoes of the Anglo-Saxon judge (Common Law) in deciding on a conflict relevant to a Trust for this institution to function correctly: a quasi-impossible mission.
- What to choose: Foundation or Trust? And Where?
Based on all of the above, we recommend the incorporation of a Foundation for the Clients who have the majority of their wealth in civil law countries.
As for the jurisdiction where the Foundation shall be incorporated, there are many options.
The most common jurisdictions are: Liechtenstein, Panama, Cayman Islands, Isle of Man…
Moreover, there are some free zones in the UAE that have introduced the Foundations, such as DIFC and ADGM. While these two free zones are based on the common law systems, they amended the regime of the foundations in order to get the advantages of both trusts and foundations.
Zeina Azzi
CSP Director
04/1/2024
For personalized guidance regarding Trusts and Foundations, please do not hesitate to contact our team by sending an email to: assiss@assiss.com.
DISCLAIMER: This blog post does not constitute professional advice. Additional facts or future developments may affect the content of this blog post. Before acting or relying upon any information within this document, please seek the advice of a member of our team.