Building Legacy on a Foundation - Part I - Featured Articles

PART I

In the estate planning arena, there has been a flurry of activities in various common law jurisdictions in legislating and promoting the concept of private foundation as an alternative to trust. These legislative efforts are reminiscent of the development in which common law trust or trust-like arrangements found their way into some civil law countries.

A key driver of these initiatives to adopt a concept which is indigenous to civil law traditions is likely to be the evolving profile of high-net-worth families. As these families become more international and the size of their wealth grows exponentially, they demand a multitude of legal solutions to accommodate the diversity and complexity of their needs. For jurisdictions who wish to maintain a competitive edge in attracting clients to come onboard, the ability to offer a tool box showcasing a wide range of structures is crucial.

Labuan International Business and Financial Centre, Malaysia (Labuan IBFC) was the first common law jurisdiction in Asia to adopt the civil law concept of private foundation. The Malaysian legislature passed the Labuan Foundations Act, 2010 (LFA 2010), which was a brilliant legislative innovation aimed at providing multiple legal tools for families seeking to structure their estate planning.

The geographical location of Labuan IBFC is also likely to beckon families in Asia who may, for a variety of reasons, such as the situs of their main assets or operating businesses, find situating their estate planning structure outside of Asia not entirely desirable or practical.

While foundations and trusts in the estate planning space are now often mentioned in the same breath as almost serving the same purpose, there are nevertheless fundamental differences which must be born in mind. In addition, for common law practitioners and service providers advising their clients on the use of foundations, it is important to resist the natural tendency of viewing this entity through the “common law” lens.

This article “Building Legacy on a Foundation” is contributed with the hope of promoting a more meaningful interaction with the foundations. It comes in 2 parts:

• Part I seeks to understand the statutory creature of private foundation by examining its legislative characteristics in general; and

• Part II adopts a comparative approach to consider how the foundation functions similarly or dissimilarly in comparison with the common law concept of trust. It further ventures to weigh various practical considerations in determining whether foundation is the structure of choice.

This article however does not enter into a polemic as to which structure, foundation or trust, is a better option for estate planning purposes.

Key Features of Private Foundations

The concept of foundation traces its origin to the civil law traditions. The scholarship on foundations points to Germany as the location where the use of foundations for setting aside assets for the benefit of the members of a specified family first started to sprout.

In 1926, the first codification of the concept of family foundation (as opposed to foundation for religious or charitable purposes) took place in the Principality of Liechtenstein.

Liechtenstein’s adoption of private purpose foundation was followed by several other civil law countries such as Austria (1993), Panama (1995), and the Netherlands Antilles (1998). Many other civil law countries, however, remain resistant to the concept of private foundations and the use of foundations continues to be confined mainly to charitable, religious, or similar purposes.

Just as the concept of trust has evolved with variations in each country in response to local requirements and demands, one may also observe a similar trend in the development of private foundations in countries offering this vehicle. Nevertheless they do share some fundamental characteristics.

In Part I of this article, the distinct characteristics of private foundations are being discussed against the backdrop of the LFA 2010, and for emphasis, these characteristics may be contrasted with those of other structures, such as corporations and trusts.

(i) Distinct Legal Personality

A foundation, whether established for charitable or private purposes, is recognized as a distinct legal person. It can sue and be sued in its own right, contracts and trades in its own name, is liable for breach of contract etc. In other words, it has the same rights as a natural person to the extent provided or curtailed by the statute of its creation. In that sense, it is similar to a corporation as known in the common law tradition.

(ii) No Shareholders

The ultimate authority of a foundation rests with itself. There are no shareholders who may liquidate the foundation to release the underlying value of its assets. This is where the foundation differs from a corporation.

(iii) Absolute Ownership of Assets

In traditional civil law, the ownership of assets is absolute and indivisible. This is translated to mean that all rights and obligations associated with the assets are vested in one person. The tenet of split ownership as found in trust laws (where the right of management and disposition in property may rest in one person while the right to its enjoyment rests in another) is alien and offensive to the civil law system.

Following from the above premise, the foundation owns its assets absolutely and indivisibly. Hence, when a founder transfers specific assets to a foundation, he no longer has ownership to these assets and they are protected from the founder’s creditors. If the foundation has beneficiaries, they similarly do not have any interest in its assets. This is contrary to the concept of trust which imputes a beneficial interest in the trust property to the beneficiaries.

A foundation however has to deal with its assets as determined by its stated purposes. This is unlike a natural person who can deal with assets in whatever manner he/she wishes.

(iv) Limited Liability

A foundation’s liability is limited to its assets. No founder, beneficiary, governing body or any subsequent contributor of assets is accountable for the foundation’s liability.

(v) Founder’s Reservation of Rights and Control

The founder establishes the foundation and can continue to exert great influence over it by reserving a range of powers in the constituent documents and may assign or transfer such rights. Power may be reserved to amend the constituent documents or to give instructions to the governing body. This reservation of powers to a founder is generally allowed pursuant to private foundation legislations and may be achieved without affecting the validity of the foundation.

The founder can be a member of the governing body of the foundation and sets his own policies. He can be the sole beneficiary. The governing statute may place confines on the degree of identification between the foundation and the founder but conceptually there is no difficulty for the founder to structure the foundation as his alter-ego.

The degree of flexibility accorded to a founder must however be considered carefully against the possibility of triggering undesirable tax consequences and estate planning implications. Further, the greater the retention of control in the founder, the less effective the foundation may be as a solution to planning needs that necessitate a break between the founder and his control of assets.

(vi) Management and Control

A foundation is managed by a governing body (the nomenclature of the governing body differs in different jurisdictions) in accordance to the purposes expressed in the constituent documents. The governing body is an agent of the foundation.

A founder may also reserve power to give instructions to the governing body or establish an entity within the foundation to play a supervisory role over the governing body.

(vii) Beneficiary

A beneficiary of a foundation does not have any beneficial interest in the assets of the foundation, even if the beneficiary is always intended by the founder as a recipient. And generally, a beneficiary has no right of action against the foundation itself and consequently no right against its management.

This position is in sharp contrast to the more entrenched status enjoyed by a beneficiary of a trust. It may not be too far-fetched to observe that a foundation beneficiary is of peripheral importance, and that the central players in the foundation landscape are the founder, the foundation itself and its governing body.

(viii) Indefinite duration

As a juridical person, a foundation can have indefinite duration but this can be limited by the constituent documents.

Observation

The foundation has been “nicknamed” the “incorporated trust”. Indeed the incorporated status of a foundation facilitates an easier grasp of its functionality than the concept of trust. However by coining the foundation in light of trust may give a false sense that they are similar and, in turn, mask their underlying differences. Often, the suitability of a legal solution becomes most apparent when its distinctive features are differentiated from other options.

Part II of this article Building Legacy on a Foundation will explore the manner in which foundations and trusts function similarly and dissimilarly.