Settlor reserved powers vs settlor appointed as protector – what are the considerations?

13 August 2021

As we see an increasing demand for Jersey law trusts from Asian clients, so too do we see an increasing demand for trusts under which settlors reserve certain powers in favour of themselves.

Trusts that contain reserved powers have long been utilised by Asian clients to cater for their desire to retain an element of control over the trust. Of course, this desire to retain an element of control is not unique to Asian clients. It is simply that the western trust industry adopted a different approach to catering for this desire, favouring the appointment of protectors and the incorporation of provisions that effectively allow settlors to maintain control of the investment of trust funds held in underlying entities.

The Jersey trust industry is well equipped to offer both trusts that reserve powers and trusts with protectors.

Article 9A of the Trusts (Jersey) Law 1984 (the "Law") expressly states that the reservation of a prescribed, but broad, list of powers by a settlor "shall not affect the validity of the trust". And, whilst the Law does not make specific reference to protectors, Article 24(3) states that the "terms of a trust may require a trustee to obtain the consent of some other person before exercising a power or a discretion". It is accepted that a protector may perform the role of that "some other person".

With both options available, advisors should be giving the matter some consideration when taking instruction on the terms of a new trust. Do these two different approaches to control produce the same result? Or is one preferable to the other? Indeed, are they mutually exclusive options?
We have taken some time to consider these questions to assist advisors when advising clients on these issues.

Does the desire for control increase the risk?

As the saying goes, you cannot have your cake and eat it. Put in the context of trusts, you cannot benefit from all the advantages that trusts have to offer, such as asset protection and confidentiality, and retain too much control of the trust and assets with no strings attached. The nature of the strings that attach depends on the nature of the powers that are retained by a settlor, or conferred on a protector.

Personal or fiduciary

Any power that a settlor has in respect of a trust will either be "personal" or "fiduciary" in nature. A personal power can be exercised by the settlor for his own benefit without restriction, whereas a fiduciary power must be exercised in the best interest of the beneficiaries and the settlor is required to consider whether or not to exercise the power.

Powers retained by a settlor are very likely to be personal powers. The position in respect of powers conferred upon a protector is less straightforward. A trust deed may expressly state that the protector's powers are held in a fiduciary capacity. Where this is not the case, it will depend on the construction of each trust deed, as demonstrated in the case of Jasmine Trustees Limited 2015 (2) JLR 52, [2015] JRC 196.

For the purposes of this briefing, we have assumed the general position that powers reserved by a settlor are personal, and those conferred upon a settlor by virtue of an appointment as protector are fiduciary in nature.

Why does the distinction matter?

An important reason for distinguishing between the two types of powers is to be able to determine who has the power to challenge the exercise of those powers.

Personal powers are, by definition, personal to the holder. This opens those powers up to being exercised by insolvency practitioners, such as trustees in bankruptcy or receivers. This can have unintended consequences in respect of asset protection.

The Cayman Islands case of Tasarruf Mevduati Sigorta Fonu v Merrill Lynch Bank and Trust Company [2012] 1 WLR 1721, [2011] UKPC 17 concerned a trust under which the settlor had reserved the power to revoke the trust. A foreign judgment for damages had been awarded against the settlor and a receiver sought to enforce the action against the settlor to gain access to the trust funds.

The court in Cayman held that the reserved power of revocation was a personal power and not a fiduciary power, and further that a personal power is the property of the holder of that power. As such, on appointment of the receiver, the receiver effectively stepped into the settlor's shoes with the right to exercise the power of revocation, triggering the return of the trust funds to the settlor and making them available to meet the damages settlement.

Whilst this case relates to a Cayman law trust, we must draw on the experience of other offshore trust jurisdictions.

Consideration must therefore be given to the specific powers that a settlor wishes to retain and how such powers could be forcibly exercised to affect the asset protection benefit of the trust. A reserved power to direct advancements from the trust would certainly raise a red flag. However, not all reserved powers will give rise to such a risk. For example, it is difficult to conceive how a reserved power to direct the investment of the trust fund could be exercised by an insolvency practitioner in a manner that would secure the extraction of funds from the trust.

By contrast, a protector cannot be obliged to exercise a fiduciary power in a manner that benefits himself if there are additional beneficiaries whose interests must be taken into account. The fiduciary nature of these powers requires that they be exercised for the benefit of the beneficiaries. In any event, protectors' consent in relation to the powers of appointment of trust assets and the termination of the trust are generally negative powers of veto rather than positive powers and are, therefore, of little value in the hands of an insolvency practitioner. Whilst a settlor (as protector) could veto all proposed appointments of funds other than those in his favour, he has no power to require the trustees to exercise that dispositive power of appointment in the first place, nor can he be forced to exercise his power to consent to any proposed distribution if there are other beneficiaries to consider.

It is a double-edged sword however. Whilst the fiduciary nature of protectors' powers may help protect against creditor claims, that very fiduciary nature of the power opens up the possibility of claims for breach of trust from the disgruntled beneficiary who may not stand a chance of benefiting from the trust if the protector uses his power to effectively veto all proposed appointments in the beneficiary's favour by withholding consent.

Case law has evidenced that the court has the power to remove a protector from office if their continuance would be detrimental to the execution of the trust(s). This power was exercised in the case of A Trust 2012 (2) JLR 253, [2012] JRC 169A where relations between the protector and the beneficiaries had broken down irretrievably.

Advisors must be alert to the potential for discontent in the future and the risk of claims for breach of trust that this brings. Risks of such claims do not arise when the settlor is entitled to exercise such powers for his own benefit without restriction, as is the case with personal rights.
Overall, the cost of control is either a risk of creditor claims or a risk of claims for breach of trust. For the most part, the settlor will determine that these risks will be greatly outweighed by the benefits that will be gained by the control retained. The decision will, therefore, depend on which type of risk they are prepared to accept.

Other considerations

Other considerations will also be relevant when considering which approach will best deliver a settlor's wish to retain an element of control. For example, reporting requirements under the Common Reporting Standard ("CRS") may be a relevant factor.

The Organisation for Economic Co-operation and Development has confirmed that, where a trust is a Reporting Financial Institution, a protector "must be treated as an Account Holder irrespective of whether it has effective control over the trust". By contrast, there is no such blanket application of the control test in respect of those who have reserved powers. For "power holders", as such individuals are commonly defined, the test of whether or not they have effective control over the trust can truly be applied. A power holder's powers may not give rise to effective control. This issue is not of immediate relevance when the settlor is the power holder, as the settlor is reportable under CRS in any event. However, it will be of relevance if and when another individual is appointed as a successor to the settlor's role as protector or power holder (as the case may be) in the future. A successor protector will always be reportable under CRS, whereas a successor power holder will only be reportable if the nature of their powers give rise to control.

Thinking to the future gives rise to another consideration. Whilst a settlor may wish to be entitled to exercise reserved powers for his own benefit and without restriction, he is unlikely to wish that any successor power holder be able to exercise the powers in that manner. It is, therefore, very possible that the personal powers of the settlor migrate to fiduciary powers, with the relevant strings attached, in the hands of another.

So which approach?

There is no "right" approach. As with all client matters, the "best" approach will be the approach that is most appropriate for each individual client, in light of their particular circumstances.

One option may be a clear winner, or the best answer may be a combination of both approaches, providing the settlor with a combination of personal and fiduciary powers through the use of reserved powers alongside an appointment as protector.

From an advisor's perspective, their duty is fulfilled by providing the settlor with the information and advice they need in order to be able to make an informed decision.