Using Trusts to Safeguard the Family Crown Jewels by iff67063



  Using Trusts to Safeguard
  the Family Crown Jewels
  By Christian Stewart,
  Family Legacy Asia (HK) Limited,
  Hong Kong

                                  rusts are often marketed in               2.The type of trust that would most

                          T       Asia as a succession planning
                                  device, and as a tool that can
                                  help keep wealth in a family for
                          more than three generations. The
                          purpose of this article is to consider the
                                                                              typically be used in the Asian context
                                                                              is a discretionary trust, revocable while
                                                                              the settlor is alive and that would
                                                                              become irrevocable upon the death of
                                                                              the settlor. A discretionary trust means
                          pros and cons of a trust structure to hold          that the family members would be
                          and preserve the family “Crown Jewels”. In          named as discretionary beneficiaries.
                          this article, the Crown Jewels refers to the      3.The typical scenario is one in which
                          core asset of the family, often the family          the Crown Jewels are situated in one
                          owned business.<1>                                  or more countries within Asia. The
                               In Chinese, there is a saying that wealth      trust structure however would be set
                          cannot stay in a family for three                   up in one of the traditional offshore
                          generations. In fact, this is a universal           finance centres. The trustee would
                          proverb. So the question then is whether a          hold the shares in one or more
                          trust can be used to hold and to preserve           offshore investment holding
                          the family Crown Jewels for three or more           companies, which will then invest into
                          generations, overcoming this proverb. Are           shares in an onshore holding company
                          trust structures to hold the Crown Jewels           that directly or indirectly holds the
                          really the kind of “total solution” that they       Crown Jewels.
                          are sometimes marketed as being?                  4.Who is the trustee of the trust? Most
                               Clearly there are certain benefits of          likely in an Asian context, the trustee
                          using a trust structure that tax and trust          would either be a bank affiliated
                          advisers can articulate for their clients.          trustee company, or it would be a
                          However, in the world of the family-owned           private trust company (a PTC) set up
                          business there is a different perspective on        specifically for the family. In this article
                          the challenges of sustaining a family               it is assumed that it will be an
                          business or other forms of family wealth. It        independent bank trustee.
                          is suggested that if a trust structure is being   5.Who are the discretionary
                          set up for the purpose of owning and                beneficiaries of the trust? Let us
                          preserving the family Crown Jewels, then            assume that while the settlor of the
                          that structure needs to be examined                 trust is dead, there is a surviving
                          through this specific family business lens.         spouse who is not active in the
                                                                              business. Assume that in the second
                          The Trust to hold the Crown Jewels                  generation, there are three sons who
                              We first need to consider what a                are all active in the business, and two
                          typical trust structure would look like, if         daughters, who are not. Assume also
                          the purpose was to hold and preserve the            that there are nine members in the
                          family Crown Jewels.                                third generation. This would give a
                            1.The settlor of the trust would be the           current family population of 15 people
                              first generation entrepreneur who               excluding spouses of the children and
                              founded the family business. In the             grandchildren (which is the typical
                              following example, let us assume that           Asian way). What is not so obvious
                              the settlor set up the trust, but has           however is that it would be usual to
                              passed away, and that the Crown Jewels          draft the definition of beneficiaries
                              are now being managed by a sibling              under the terms of the trust to also
                              partnership.                                    include any other issue of the settlor

OI 190 • October 2008                                                                                                        19
             born before the expiration of the            forced heirship laws, the trust can allow       increasing number of family members who
             maximum trust period.                        the family substantially greater freedom        are in the ownership circle and a smaller
           6.Who makes the distribution decisions?        than those forced heirship provisions           and smaller number of family members
             Most likely the bank trustee would be        would allow for. The trust structure            who are in the business management
             responsible for making discretionary         provides confidentiality for the family         circle.
             distribution decisions, guided by a non-     members. In many Asian countries, this is            The three circle model, says that
             binding letter of wishes provided by         an important consideration for a wealthy        where a person is located in the three
             the settlor.                                 family. Discretionary trusts of course are      circles has a significant impact on their
           7.Who would act as the custodian,              noted for their flexibility.                    perspective. A family member who is in the
             having the legal ownership of the                Depending on the domicile of the            ownership circle, who is not involved in
             Crown Jewels? This would be the bank         family and the residency or nationality of      the management of the business is going to
             trustee in its capacity as trustee of the    the beneficiaries there may be tax benefits,    have a very different view from a family
             trust.                                       and the trust structure might be helpful in     member who is both a shareholder and
           8.Who makes investment decisions for           avoiding estate taxes. The offshore trust       who is on the inside of the business.
             the trust? If it is a bank trustee, they     structure might even be helpful in                   Therefore, another challenge for the
             will not know how to run the family          providing some degree of protection             family-owned business is managing the
             business, so they will not want to take      against political risk in the home country      divergence that will occur between the
             on that role. In practice, there will be     where the Crown Jewels are located.             views of “inside shareholders” with those
             some form of investment committee                These are all benefits that the family’s    of the “outside shareholders”. A simple
             mechanism created under the terms of         trust lawyers and tax advisers can fully        example of this is that an inside
             the trust instrument. The trust              brief them on.                                  shareholder may see the benefits to the
             instrument will contain lots of language                                                     business of accumulating surplus profits for
             that will say the bank trustee has no        Family Business Theory                          reinvestment, while an outside shareholder
             control over the Crown Jewels and no              There is an often quoted statistic that    in the same family business may only be
             responsibility for them. The bank            only one third of family-owned businesses       interested in maximising dividend
             trustee has to keep its hands off the        will make it into the second generation         payments.
             Crown Jewels, and is not responsible         and something like a 10% chance of                   The family-owned business literature
             for any investment decisions. The flip       survival into the third generation. The         says that in order to successfully sustain a
             side of the coin is that the trust           theory of family-owned businesses helps         family business over the long-term it is
             instrument will be drafted to say that       to explain these statistics by reference to a   important to make sure there are healthy
             the investment committee is fully            “three circle model”, which says that a         boundaries between the family, ownership
             responsible for making all investment        family-owned business is made up of three       and business systems. There need to be
             decisions, including deciding how to         overlapping systems. The first system is the    separate forums created so that ownership
             exercise the voting rights on the            management or business system. The              and family issues can be discussed outside
             shares in the family business; the           second system is the ownership system.          of the boardroom.
             investment committee is responsible          The third system is the family emotional             If we are to determine whether a trust
             for supervising and safeguarding the         system.2                                        structure can be used to keep the Crown
             value of the Crown Jewels. The                    When you look at the overlap               Jewels in the family for three or more
             investment committee exercises its           between the family circle and the business      generations, isn’t it going to be necessary
             powers by giving written directions to       management circle, many times, family           to compare the characteristics offered by
             the bank trustee which the bank              dynamics and family behaviours will be          the typical Crown Jewel trust structure
             trustee must strictly comply with,           inconsistent with sound business                against the three circle model and other
             under the terms of the trust                 management practices. Family values (e.g.       family business theories?
             instrument.                                  all family members are equally valued)
           9.Who is on the investment committee?          often clash with business values (e.g. we       The Three Circles & how a Trust
             Let us assume that the investment            only hire the most capable). Family             can help
             committee is currently comprised of          dynamics (e.g. sibling rivalry) may be played       Clearly there are some ways in which
             the three sons from the second               out in the boardroom and impact                 the kind of trust structure that has been
             generation, who are active in the            negatively on the business system. This is      described is going to be helpful and will fit
             business.                                    one set of reasons why sustaining the           neatly within the three circle model.
                                                          family business across generations is a very      1. An ownership forum is created in the
         The Legal & Tax Benefits of a Trust              significant challenge.                              form of the trust investment
             Clearly, the trust structure will confer          Some families will declare themselves          committee.
         certain benefits. The discretionary nature       as being committed to taking a “business          2. The trust structure can help to create
         of the trust means that none of the              first” philosophy to problem solving,               and maintain a voting block. It helps to
         beneficiaries has a proprietary interest in      whenever there is a conflict between                prevent the family control over the
         the assets comprised in the trust fund.          family values and business values. Other            Crown Jewels from being diluted.
         This means the family members can benefit        families will declare themselves as               3. In practice, the exercise of setting up
         from the trust as beneficiaries without          preferring a “family first” philosophy when         the trust should allow the perfect
         having any legal or beneficial ownership of      faced with such a value conflict. The               opportunity for clear rules to be
         the Crown Jewels. In general terms               important thing is being clear and explicit         written into the trust instrument as to
         therefore, this arrangement will protect         about the approach the family will take             how the investment committee will
         the Crown Jewels from any third party            when problem solving.                               vote and what is the mechanism for
         claims against one of the beneficiaries. The          When you look at the overlap                   dealing with any deadlocks.
         trust may also help to protect the Crown         between the ownership system and the              4. It is also an opportunity to write clear
         Jewels in the event of the divorce of one of     business management system, the trend as            rules into the trust instrument spelling
         the family members. The trust will avoid         a family transitions from the first, then to        out how one qualifies for membership
         probate proceedings should a beneficiary         the second and then to a third generation           to the investment committee, and how
         die. If the family is from a jurisdiction with   family is for there to become an ever               succession to the investment

                                                                                             Financial Duties

    committee is dealt with. As such,           clear which hat, for example, the
    setting up the trust structure is the       father/shareholder/CEO is wearing                 In the context of investment duties
    perfect exercise to draw up a clear         when he talks to his                         under a trust structure the duties are
    ownership succession plan.                  employee/shareholder/son. Family             likely going to be purely financial in
  5. Members can be added and removed           decision-making becomes that much            nature. Accordingly, the investment
    from the investment committee,              harder because of the multiple hats          committee is going to have legal duties to
    without having to change the                involved. Sadly, by creating an              always have to choose the option or
    ownership of the underlying shares,         investment committee under a trust           decision which is going to provide the
    which remain registered in the name         structure, this means there is going to      best financial return to the trust fund.
    of the bank trustee as a custodian.         be one more hat for some family              This legal environment may work
  6. There is an opportunity to spell out       members to wear.                             perfectly well for a family that has a very
    the role of investment committee, vis-           Clearly, it will be important for       clear “business first” philosophy.
    à-vis, the Crown Jewels.                    members who are on the investment            However, this could represent difficulties
  7. The trust structure means that the         committee to be properly advised as to       for a family that would like to take a
    members of the investment committee         their legal duties as members of the         “family first” philosophy. Putting family
    are acting as stewards of the family        investment committee, so that they           interests first may not be an option that a
    assets, rather than owners.                 know what they have to do when they          member of the investment committee is
                                                are wearing this particular hat.             allowed to consider.
The Three Circles & how a Trust                      In our hypothetical example, we
will complicate                                 have an investment committee of three         A Duty to Preserve
     On the other hand, a trust structure       siblings, and a total group of 15 living         Traditionally, trusts are also
will also add some additional                   beneficiaries. As noted however, the         structures set up to preserve and to
complications, as described below. It           class of beneficiaries will typically also   conserve wealth. Trustees are supposed
should be noted that the objective of this      include the future unborn issue of the       to be prudent and conservative investors.
article is to identify potential issues where   settlor. It is clear to see therefore that   The legal starting point therefore must be
there may be a conflict between “trust          the investment committee has                 that the members of an investment
law” and “family business theory”. Families     responsibility for making investment         committee on a trust structure should
can then take these specific issues to their    decisions for a group which goes             find themselves in a similar situation i.e.
trust lawyers who can identify whether          beyond themselves. They are managing         having duties to prudently and
there are any drafting or structural            assets on behalf of others. Most likely      conservatively invest. From a multi-
solutions, or not as the case may be.           the investment committee members             generational perspective, this may be just
                                                will have fiduciary, or trustee like,        what the family wants. But if the family
Creating an Exit Plan                           duties to the beneficiaries as a whole.      members sitting on the investment
     One of the first tasks of a family                                                      committee want to have a more
ownership committee is typically to create      Being Even-Handed                            aggressive risk appetite or they wish to
an exit plan, usually in the form of a family       When it comes to administrative          be more speculative in some of their
shareholders agreement. The idea is to          powers under a trust, like the power to      business ventures, then there may be an
have some mechanism that allows family          control investment decisions, the            inconsistency between their risk appetite
members to gracefully exit if they do not       members of the investment committee          and the trust structure.
like to be tied to the family business any      should be under a duty to act in an
more.3 If you have one trust structure          even-handed manner and to act in the         A Case of Anarchy
that is holding 100% of the shares in the       best interests of all the beneficiaries.         Discretionary trusts are like a form of
family company, and there are several           This means they should not be allowed        anarchy! What this means is that any
different branches of the family                to discriminate between different            adult, discretionary beneficiary would
represented under this one trust                classes of beneficiaries or to give          normally have the right to enforce the
structure, how do you put in place a            certain beneficiaries a preference over      due administration of the trust and would
shareholders agreement or an exit plan?         others. Also, they should be precluded       have rights to receive trust information.
How do you quantify the financial interest      from putting their own self-interest in          In our example, while the investment
of a discretionary beneficiary?                 front of that of the other beneficiaries.    committee may be made up of three
     At a minimum, it would be more                 If a family member from the second       members from the second generation of
prudent to have different trusts for each       generation, who is involved in the           the family, one of the grandchildren from
branch of the family. Different trusts for      management of the family business, was       the third generation and who was not
different beneficiaries might then dictate      to directly own shares in the family         involved in working in the family business
needing to have different trustees – or         company, then they would be free to do       could in theory, question whether the
different investment committees – for           what they like with their shares. They       members of the investment committee
each family trust to prevent conflicts of       could make decisions having regard to        are acting in accordance with their strict
interest from arising should there be any       what they consider to be in their own        legal duties as fiduciaries.
difference between the various branches         personal best interests. They are free if
of the family. It can quickly be seen that      they like to only think about what is        Trust Fund Babies
suddenly it is not that simple any more.        best for their own pockets. On the                Another issue will be access to
                                                other hand, they are also free to make       information.4 Every family will have its
Managing your Hat Collection                    decisions which they believe are in the      own philosophy regarding when and what
    One of the very difficult things            best interests of the family as a group,     it tells its younger family members about
about keeping the Crown Jewels in the           for example, with the goal of                the size of the family wealth. What will
family across several generations is that       preserving family harmony. However, if       the bank trustee do if it receives a
the family and personal relationships           you are a member of the investment           request from one of the 18-year-old
involved become very, very complex.             committee under a trust structure, you       beneficiaries in the third generation,
Family communication becomes that               are not an owner and this has to be          asking to see a copy of the trust
much harder because it's not always             understood.                                  accounts?

OI 190 • October 2008                                                                                                                      21
         Important Tasks that still need to
                                                                 structure, there is no guarantee that          to fall into the trap of thinking of a Crown
         be done                                                 the committee members are going to             Jewels trust as representing a total solution
              When you look at family business                   talk to each other or can get along, or        for all of the family’s succession and
         theory there is a list of critical tasks that a         problem solve in a businesslike manner.        continuity problems, which clearly it is not.
         family concerned about continuity and                4. The three circle model says that the                       
         succession still need to attend to, regardless          health of the family system is a good
         of whether or not there is a trust set up to            indicator of the success of the
         own the Crown Jewels.These are tasks that               ownership and management systems.              END NOTES:
         have to be done and which will not                      The model says that the ideal is to find        1. It can also refer to a family held controlling
         automatically get done just because you                 ways to balance all of the three circles.          stake in a listed company, as well as to the
         have a trust structure. Many of these tasks             The conclusion is that the health of the           liquid financial wealth of a family that has
         (but not all) are about addressing “soft”,              family system is itself a very important           cashed out, and that is perhaps organised
         “emotional” or “relationship” issues.5                  task that is not to be overlooked. This            around a family office.
              The following is not intended to be a              might entail a family mission of helping        2. For example, see ‘Generation to Generation,
         comprehensive checklist, but it is intended             individual family members pursue their             Life Cycles of the Family Business’, Harvard
         to give an example of the kinds of tasks that           own dreams.                                        Business School Press, by Gersick, Davis,
         should be addressed by a family that is                                                                    Hampton and Lansberg. Their three circle
         serious about continuity and succession.            Drawing some Conclusions                               model is in fact a four dimensional model with

           1. The family will need to predict the                 The key conclusion must be that                   time being the fourth perspective.
              areas in which there will be a conflict        families in business together should be             3. See ‘The Eight Practices of Successful Families’,
              between family members who are                 adopting the recommended “best                         by Amy Braden, a JPMorgan Private Bank
              outside the business and those who are         practices” for family-owned businesses                 Advice Paper.
              inside the business and they should            regardless of whether they have a trust or          4. Consider the example of Liesel Pritzker who
              produce written policies addressing            not. You do not need a trust structure in              sued her father and uncle for raiding her trust
              how these conflicts will be approached.        order to set up a “family council”.                    fund. See ‘Knives Drawn for $15 Billion Pie’ –
              One example would be to prepare a                   Clearly trusts are a very useful and              New York Times (11 December 2002).
              dividend policy.                               helpful tool, especially in relation to the         5. For a good example of a case where a family
           2. The family council should ensure that          ownership circle, but it must be realised              trust that held over 90% of the voting control
              there is an employment policy.                 they will also bring an added level of                 in a family business media empire failed to
           3. Work on improving trust and                    complexity.                                            stop a brother and sister from fighting in the
              communication, planning, teamwork and               For the family that likes to take a “family       boardroom with devastating consequences for
              decision-making are all critical tasks. Just   first” philosophy, maybe a trust structure is          the family business, look at the often quoted
              because there is an investment                 not going to be the best solution.                     example of the Bingham Family from Louisville
              committee in place under a trust                    The biggest danger however would be               in Kentucky, USA.

                                                   Family Legacy Asia

                              The goal of Family Legacy Asia is to help families in Asia
                              preserve their family wealth. But this is not an easy task.
                              Only one in three family controlled businesses successfully
                              pass into the second generation and only about 12% last to
                              the third generation. In Chinese there is a saying that wealth
                              only lasts for three generations.

                              While the above statistics are well known, it would still be the
                              exception rather than the norm to see a family in Asia with a
                              written succession plan, a family shareholders agreement or
                              a formal “Family Council”.

                              While ultra high net worth families in Asia are starting to get
                              more exposure to the concept of “Family Governance” and
                              the advantages of having, for example, a written “Mission
                              Statement” or “Family Constitution” getting help to
                              implement these new concepts is still a challenge.

Family Legacy Asia (HK)       Family Legacy Asia was established to provide Asian families
Limited                       with an independent alternative that is focused solely on
                              helping ultra high net worth families plan and then
                              implement best family governance practices.

Clients                       We act for families that control a business or listed company,
                              for family offices, and for private trust companies.

Services                      Our services include structuring complex trusts (e.g.
                              “incentive trusts” and “family banks”) and family
                              foundations; helping to administer private trust company
                              structures; facilitating family meetings; and providing
                              families with advice on Family Governance.

Models Frameworks and Tools   The preservation of family wealth requires families to engage
                              in an ongoing strategic planning process. We can provide
                              families with the models frameworks and tools they need to
                              get organized, to facilitate communication, and to plan ahead
                              in an objective impartial manner.

Examples Of Our Experience    Our experience includes facilitating family meetings, setting
                              up the family council, creating the family foundation,
                              drafting family shareholder agreements, and drafting the
                              family employment policy.

Our Approach                  We believe that ultimate responsibility for long term strategic
                              planning for a family lies with the family itself. Our approach
                              is to advise the family as to the proper process and the key
                              tasks they have to undertake. We play the role of the
                              independent project manager and facilitator.

Our perspective               We aim to bring a wide perspective that is intended to make
                              families think beyond the trust structuring, the asset
                              management decisions and the business management
                                                     Christian Stewart

                              Christian Stewart founded Family Legacy Asia to help Asian
                              families preserve their family wealth for generations, by
                              providing them with independent and objective advice on good
                              family governance.

                              He has eighteen years experience in advising high net worth
                              individuals and families on complex trust structuring, estate
                              planning and succession matters, including fourteen years in

                              Before founding Family Legacy Asia, he was a Managing
                              Director and the head of the Wealth Advisory Team in Asia for
                              JPMorgan Private Bank for six years. In that capacity, he has
                              worked with some of the leading families and Family Offices in
                              Asia on family governance, private trust companies, and cutting
                              edge wealth structuring techniques.

Founder & Managing Director   Family Legacy Asia provides advice on family governance and
Family Legacy Asia (HK) Ltd   advice to business controlling families. It also specializes in trust
                              and estate planning and private trust company (“PTC”) structures.

Managing Director             When he first joined JPMorgan Private Bank in 2002, its Asian
Head of Wealth Advisory,      Wealth Advisory team primarily focused on trust structuring.
Asia Pacific                  Christian transformed the services and skill set of his team by
JPMorgan Private Bank         helping to bring to Asia JPMorgan’s US know how and expertise
                              on charity and philanthropy, family governance and family
                              owned business succession, and applying this expertise for the
                              benefit of JPMorgan’s Asian clients. In his six years with
                              JPMorgan, he grew their Wealth Advisory team in Asia from a
                              team of 3, to a team of 8 professional Wealth Advisors.

Tax Partner                   Prior to joining JPMorgan, Christian was a Tax Partner at
Head of Trusts &              PricewaterhouseCoopers in Hong Kong. In his eight years at
Private Client Group          PwC he helped found and lead its Trust and Private Client Group
PricewaterhouseCoopers        and helped PwC create a reputation as one of Hong Kong’s
Hong Kong                     leading firms in the trust planning area.

Tax & Trust Lawyer            Christian started his career as a Solicitor in private practice in
Private Practice              South Australia. During his 4 years as a Solicitor, he helped
Adelaide                      clients with tax, trusts, wills and estate planning work.
South Australia

Professional Qualifications   He is qualified as a solicitor in the Australian State of South
                              Australia, in England and Wales, and in Hong Kong.

                              In June 2002, he was named one of the top ten tax advisors in
                              Hong Kong by the International Tax Review in its annual survey
                              of leading tax advisors.

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