The possibilities and limitations of trusts and Private Foundations to protect capital

Publication

29 July 2013

On 12 April 2013, Rogier van den Heuvel lectured for STEP (Society of Trust and Equity Practitioners) Curaçao about separation of capital by means of a trust or Private Foundation. He addressed how they work, and what the limitations are. This article is an excerpt of this lecture, as published in Antilliaans Dagblad on 12 July 2013.

Trusts and Private Foundations often serve the same purposes. One transfers goods (money, real estate, shares, etc.) to an Private Foundation or trustee to be managed for the benefit of one or more others. Those “others” can be the ones who have transferred the goods to the trustee or the Private Foundation, but not necessarily so. It is also possible, for instance, that goods are placed in a trust or Private Foundation to pursue a good cause, to keep real estate in (use of) the family, or to provide for financial needs of relatives, whether or not after the death of the person who places these goods in the trust or Private Foundation.

However, I also noticed a website of a more adventurous-minded service provider that mentions under the heading “When is a trust interesting to you?”, inter alia:

•    You run a great risk of being held liable or facing claims for compensation in the practice of your profession or conduct of your business.
•    You run a considerable chance of personally being held liable in your private capacity.
•    You run the risk of personally being declared bankrupt.
•    You are about to get a divorce and do not feel like paying unjustified alimony or assets. You can arrange through the trust that for instance only your children benefit.”

The first two examples are risky cases. The latter two are absolutely misuse, in which separation of capital does not work.

Why does separation of capital work?
How can it be that the trust and Private Foundation legally work to separate capital for bona fide purposes but not in case of misuse?

To answer this question it is important that according to the law (except for some restrictions), everyone has to vouch for his debts with his entire capital. In other words: creditors can recover their claims from their debtor’s entire capital. If I do not pay my debts, my creditors can for instance attach my car, my house and my bank balances and recover their claims from same.

The reason why placing goods in a trust or Private Foundation works well to protect capital is that these goods are consequently no longer the goods of the person who places them there. If goods are placed in a trust, they are legally transferred to a trustee. If they are placed in a Private Foundation, they are transferred to the Private Foundation. The goods then leave the capital of the person who transfers them and become part of the capital of the trustee or the Private Foundation that have their own rights, obligations, assets and debts.

The consequence hereof is that the person who places goods in a trust or Private Foundation is no longer the owner of these goods himself. And as my creditors cannot recover their claims on me from the capital of my neighbor (for instance car, house, or bank account), they also cannot recover their claim from the capital of the trustee or Private Foundation to which I transferred goods. That is why separation of capital works against creditors (as long as it is done properly).

Practical example
Let’s assume that a creditor (A) has a claim on a debtor (B), who is the beneficiary of a trust or Private Foundation (C) from which he receives payments now and then, and that (B), as often happens in practice, cannot influence himself whether and when he receives these payments (the Private Foundation director or trustee determines this). (B) himself consequently does not have a claim on (C). Can the creditor then recover its claim from the trust or Private Foundation (C)?

Even if creditor (A) would know that debtor (B) receives a payment from trust or Private Foundation (C) from time to time – which is not always easy, for this is not public information – then there is the legal obstacle that it still has nothing to claim from trust or Private Foundation (C) and consequently still cannot recover its claim from the capital in the trust or Private Foundation. As stated: the debtor is not the same as the trustee or the Private Foundation and one does not have to vouch for the other’s debt with its capital.

Sometimes one attempts to “pierce” such a difference in identity in court, and still hold one party liable for the debts of another party. This phenomenon is called “piercing the corporate veil”, because one “pierces” the differences in (legal) personality with the liability claim, so to speak. Creditor (A) then argues before the court that for all kinds of reasons his debtor (B) is actually the same party as (and should consequently be equated with) trust or Private Foundation (C), and that (C) is consequently also liable or the debts of (B) towards (A). But this is never successful. The highest court in the Kingdom, the Supreme Court, consistently dismisses equation in that sense, because it goes against the principle that every natural person and legal person bears his/its own rights and obligations and not those of others.

Something similar does occur and is called “indirect piercing of the corporate veil”. This is a confusing term, as one actually doesn’t pierce anything with it. In case of indirect piercing, creditor (A) accuses trust or Private Foundation (C) of unlawful act, which has led to creating the claim of (A) on (B) or to (B) not being able to pay this claim. So in that case (C) is not liable for a debt of (B), but for its own debt, arising from its own unlawful act. Therefore, there is no equation or piercing. Examples of liability based on indirect piercing are the situation that the director of a corporation refuses to let the corporation pay its debts and the situation that the sole shareholder withdraws all the money and goods from the corporation as “dividend”, whereas he knows that the corporation consequently cannot pay its creditors anymore.

A trust or Private Foundation can prevent such indirect piercing claims in a simple way. For if trust or Private Foundation (C) only minds its own business (and not that of (B)), it will not give rise to the accusation that it is involved in creating the claim on (B). The trust’s or Private Foundation’s “own business” is usually restricted to administering or investing money and (other) goods with due care and making payments, and this in conformity with the general provisions in the law and the special provisions, if any, in the trust deed or letter of wishes (in case of the Private Foundation).

In principle, it is consequently not possible for a creditor (A) to “pierce” the capital of a trust or Private Foundation (C) to recover claims on a debtor (B).

When doesn’t separation of capital work?
There are also cases in which placing capital in a trust or Private Foundation does not work against recovery from creditors. The most important category is: cases of misuse. Undue acts of which the foreseeable consequence is that creditors are prejudiced in their recovery options are not permitted. When facing bankruptcy, one cannot transfer goods to a trust or Private Foundation to keep them out of reach of the creditors. These transactions can be annulled. Let alone whether this category of misuse also includes the transfer of capital facing divorce by the spouse who “does not feel like paying unjustified alimony”, spouses living in my jurisdiction can annul major donations (such as the transfer) by the other spouse if they have not given permission for same. This transfer is also unlawful towards the soon to be former spouse, and the court can ignore it when calculating the alimony obligations. The service provider I quoted at the beginning of this article consequently gives the wrong advice if it recommends using a trust when facing bankruptcy or to evade alimony obligations when facing divorce.

In order to prevent accusations of misuse, there is one simple solution: who wants to protect his capital has to do so when he is doing well and he is not (yet) led by the wish to protect the capital from expected recovery or an expected claim from others.

Another case in which creditor (A) can recover its claim from capital in trust or Private Foundation (C) is the case in which debtor (B), contrary to in the above example, does have a claim on trust or Private Foundation (C), for instance when he can determine himself that he receives a fixed payment periodically. In that case, (B) has a claim on (C). That claim falls under the capital of (B) and consequently (A) can recover by attaching this claim. This can be prevented by determining in the trust deed or letter of wishes (in case of the Private Foundation) that debtor (B) as beneficiary never has control over the question whether the trust or Private Foundation pays him or that the beneficiary loses this control at the time his capital is attached.

To summarize: separation of capital by means of a trust or Private Foundation is a legitimate way to protect goods from recovery by creditors, but one has to do so when one is doing well, viz. when this does not prejudice creditors. If the trustee or Private Foundation does not get involved with the business of the beneficiary – and why would it? – the chance that the trustee or Private Foundation is ever successfully called on in connection with debts of the beneficiary is minimal. However, the trust and the Private Foundation are not meant to prejudice for instance soon to be former spouses or (other) creditors. In such cases separation of capital does not work.