Trusts were originally used as an estate-planning tool to preserve family capital and look after the interests of the young, the incapacitated and the foolhardy.

However, due to their flexibility and varied uses, trusts have now become widely used in commercial transactions, too. Unlike a company, a trust is not a separate legal entity, but a legal relationship created by the person creating the trust (the “settlor”) and the persons who act as trustee (the “trustees”) for the benefit of certain parties (the “beneficiaries”).

The key to the importance of a trust is the separation of legal and equitable title.

Once the assets are transferred to the trustee, the settlor loses all ownership rights to those assets. At the same time, the assets held within the trust do not form any part of the estate of the trustee, either, and are therefore not available to any creditors of the trustee.

It is this feature that makes trusts more suitable than any other structure for commercial transactions.

Commercial trust structures often involve a purpose trust. Bermuda was one of the first jurisdictions to introduce the non-charitable purpose trust concept with the passing of the Trusts (Special Provisions) Act 1989. Until then, the only form of purpose trust permitted in Bermuda was the charitable purpose trust.

A purpose trust must have a purpose that is specific, reasonable and possible and the purpose must not be immoral, contrary to public policy or unlawful. While trusts that are non-charitable must not last for more than 100 years, trusts that are charitable can continue indefinitely.

Some of the commercial uses of trusts are:

* Asset holding — A purpose trust can be created for the sole purpose of holding shares in a private limited company. The company, in turn, holds a particular asset. Alternatively, the trust can own the asset directly and not through an underlying company.

* Corporate financing schemes — A purpose trust can be used to own a company that is to enter into a particular contract, such as for the building of a ship or the leasing of an aircraft. The company creates the trust and the trustees borrow funds from a lending institution that are secured against the assets of the underlying company. This structure provides protection for both the lender and the parent company because the ownership of the assets does not change (because of the ownership by the trustees). The trust also offers protection against future creditors of the parent company.

* Pension Trusts — Pension trusts are used to ensure that a pension fund is entirely separate from the funds of the employer, which establishes the trust so that if the employer becomes insolvent, the pension funds are not available to the employer’s creditors. The advantages of establishing a trust of this nature include the ability to pay benefits in any currency and free of taxes in Bermuda.

* Credit Protection — This type of trust has been very popular with individuals from onshore jurisdictions. An asset protection trust is designed to protect a settlor’s assets from future claims by creditors and from claims that may arise on future bankruptcy. If a settlor creates a trust in an onshore centre it might be set aside if a creditor comes along in the future, makes a successful claim against the settlor and the settlor does not have sufficient assets outside of the trust to meet the claim. In this situation the trust would probably be set aside and the creditor paid out of property held by the trust. Asset protection trusts have become popular in the offshore world (Cayman Islands, The Cook Islands, the Bahamas).

The protection is provided by specific legislation that those jurisdictions have put in place that protects local trusts (and the property which those trusts hold) from attacks by future creditors. Generally, the burden of proof is on the claimant and the courts in those jurisdictions are generally reluctant to make a judgement against trustees.

Bermuda has taken a conservative position with respect to such legislation. Unlike other jurisdictions, Bermuda has not foreclosed on all future creditors, but has adopted the concept of the ‘eligible creditor’. Such a creditor is entitled, within two years of the disposition, to challenge a transfer to a trust of an asset that may be below market value with the main intention of defrauding creditors.

The flexibility of a purpose trust makes it an ideal vehicle for various kinds of business transactions, and Bermuda is well placed to assist commercial clients in establishing structures using trusts. The future development of new and innovative uses of trusts in commercial applications is limited only by the imagination of the specialist attorney designing the commercial or tax structure.

Attorney Leah K. Scott is a member of the Trusts Practice Group of Appleby. A copy of this column is available on the firm’s web site at www.applebyglobal.com.

This column should not be used as a substitute for professional legal advice. Before proceeding with any matters discussed here, persons are advised to consult with a lawyer.