Singapore Trusts: the increasing risks of reserved powers for trust settlors

Trusts can be one of the most effective ways of protecting assets. Assets transferred to a properly constituted trust no longer form part of the property of the person creating the trust – the settlor – and therefore should be protected from any potential future threat from creditors, lawsuits, family disputes or divorces.

The practical advantages of a trust are gained from the distinction that is drawn between the formal or legal owner of property, the trustee, and those people that have the use or benefit of the property, the beneficiaries.

But many settlors are not comfortable with the idea of handing over complete control over their assets to a third party, and this has led them to seek to ‘reserve’ for themselves certain powers or grants that would usually sit with the trustee.

As a result, a number of trust jurisdictions, including Singapore, have legislated to accommodate the demand of settlors by relaxing the extent to which such reservations or grants can be carved out of powers generally given to the trustee – for example to appoint or remove trustees, or to veto distributions.

Perhaps the most common reserved power a settlor looks to reserve when establishing a trust, particularly in Asia, is the power to give binding direction to the trustee in relation to the purchase, holding or sale of trust property – often referred to as the ‘reserved power over investments’.

Historically, a trustee was solely responsible for the investment of the trust fund of the trust. But with the introduction of the reserved powers legislation, the trustee’s role in investing the trust fund can be completely divested to the settlor or another third party.

In Singapore, for example, Section 90(5) of the Trustees Act focuses on the reservation of “any or all powers of investment or asset management functions” and further provides that “no trust or settlement of any property shall be invalid only by (this) reason”.

The vesting of this investment function in a non-trustee party may seem to be a practical solution to a situation where a settlor is more knowledgeable or experienced in managing their investments and wants to continue to do so even after they cease to be the legal owner of the trust assets.

It is, however, an essential part of the trust concept that the trustee should always remain independent and exercise proper control over the trust property. Reserved powers can therefore raise concerns if proper parameters are not set to ensure that the fundamental concept of the trust and the trustees’ strict fiduciary duties towards the beneficiaries are not prejudiced.

If the powers retained by a settlor are so extensive and of such a nature that they amount to an uncontrolled power to recover the trust property, then the settlor’s rights are ‘tantamount to ownership’ and he or she cannot be said successfully to have alienated his or her beneficial interest.

In recent years, courts have shown an increasing willingness to scrutinise how trusts are operated and to invalidate trusts in which the settlor has retained such a level of effective control that the trust has lost the essential features that make a trust a trust.

Two recent decisions stand out. Firstly, in the case of Mezhprom v Pugachev, the liquidator of Mezhprom bank sought to recover USD95 million assets that Pugachev had settled in five New Zealand discretionary trusts for the benefit of his family after he had fled Russia. Pugachev was also a beneficiary and protector of the trusts. The liquidator attacked the validity of the trusts, arguing that Pugachev had effectively retained control of the trust assets through the powers he had reserved in the trusts.

The English High Court concluded that the terms of the trusts and the amount of powers held by Pugachev did not ‘divest’ him of his beneficial interests and effectively allowed him to retain his beneficial ownership of the trust assets. It therefore ruled that the trusts were invalid, and the assets were therefore available to his creditors. It also made findings on the evidence that the trustees were not sufficiently independent of Pugachev and followed his directions, and that the transfers into trust were made for ‘asset protection’ purposes.

Secondly, in the case of Webb v Webb, the settlor had established two family trusts in the Cook Islands of which and his two children were the discretionary beneficiaries. The settlor was also the sole trustee and protector of the trusts. His estranged wife challenged the validity of the trusts and contended that the assets settled under them were matrimonial property.

The Privy Council ruled in 2020 that the trust deeds failed to record an effective alienation by Webb of any of the trust property and that “the bundle of rights which he retained is indistinguishable from ownership”. He had the power at any time to secure the benefit of all the trust property to himself and to do so regardless of the interests of the other beneficiaries. As a result of the ruling, the trust funds were fully exposed to a matrimonial property claim against the settlor.

Although both these cases are extreme examples of reserved powers, they serve to demonstrate the risk that, even in jurisdictions where reserved powers are permitted by statute, if such powers combine with the factual circumstances to produce the ‘true effect’ that the settlor still retains effective control of the trust property, then the courts may find that the trust is not valid.

Settlors looking at the menu of reserved power options offered by some jurisdictions should exercise restraint. If their aim is to use a trust as an effective asset protection structure, they need to have a fully independent trustee in place or they may find that the structure they have paid to set up and maintain will not withstand judicial scrutiny and no longer offers effective protection.

The courts regard a trust as creating a special relationship that places the most serious and onerous obligations on the trustee Trustees must follow the trust deed and are subject to very strict rules governing the way in which their powers and discretion may be exercised. They must always exercise their powers in the best interests of the beneficiaries of the trust and must act prudently in the management of trust property. In the case of a professional trustee, the standard of care that the law imposes is even higher.

This can be of even greater significance in cases where a settlor with reserved powers develops capacity issues such that they can no longer exercise their powers, or can no longer exercise them for a proper purpose, or they become subject to pressure or undue influence. Trustees can protect the interests of the beneficiaries by implementing practical steps to assist.

Finally, there can be compelling tax reasons for settlors with reserved power over investments of Qualifying Foreign Trusts (QFTs) in Singapore to consider giving up this power to their professional trustee. But that is a whole new subject and one which I will go on to address in the second part of this article.

For further information or to discuss the establishment or management of a trust, please contact Andy Galway by telephone at +65 6222 3209 or at [email protected].