MYKOLAS ROMERIS UNIVERSITY

LAW FACULTY
INSTITUTE OF PRIVATE LAW

EVALDAS CERKESAS

TRUSTS AND FOUNDATIONS AS THE ASSET PROTECTION

AND
TAX MITIGATION VEHICLES

Master Thesis

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1.5. Creditors of Settlor

On this subsection of Master Thesis, the author will analyse the chances by the settlor
creditors to bring a claim regarding the assets transferred to PT.
It is worth to mention that asset protection, in its correct understanding, should not be
intended to frustrate the rights of the settlor’s creditors. Hence as the general principle, a legal
device should not be abused to the extent of causing an undue detriment to the rights of third
parties.1
According to the general rule, the settlor’s creditors no longer have access to the trust
property since upon creation of trust when the property has been transferred to the trustees and
thereby separated from the settlor’s assets. However, a possibility to reach this asset exists. In
general, two ways could be considered to dispute the transfers to PT. First one, when a trust is
considered as a “sham” and second one when illegal actions were made in connection with the
intentions to fraud the creditors of settlor.
Therefore in next subsection, author of this Master Thesis will analyse the cases when
the assets of PT are not secured from the creditors of settlor.

1.5.1. Trust as the ‘Sham’

Firstly creditors could challenge the transfers to PT by claiming that it was the ‘sham’.
English judge and Law Lord Diplock LJ described the shams as: “the acts done or the
documents executed by the parties to a ‘sham’ which are intended by them to give to the third
parties or to the court the appearance of creating between the parties the legal rights and
obligations different from the actual rights and obligations (if any) which the parties intended
to create”.2
Another example when in relations to the trusts, the ‘sham’ could arise when the settlor
appears to have divested himself <…> of beneficial ownership of the trust assets and
beneficiaries seem to have acquired the equitable interests in that property and the rights
enforceable against the trustees, but in reality <...> the intention and substance of the
transaction is that these are retained by the settlor.3

1
P. Pusceddu, ‘International Trusts and Assets Protection’, Trusts & Trustees, 20.7 (2014), p. 739
2
UK Court of Appeal case Snook v London and West Riding Investments Ltd [1967] 2 QB 786, 802
3
G. Thomas, “Shams, Revocable Trusts and Retention of Control”, Glasson and Thomas, The International Trust
2nd edition (2006) p. 590

2
 Whereas, T. Graham and J. Poole indicate that a ‘sham’ is applicable to the trusts where
is an intention that a trust should not take effect in accordance with its provisions and an
intention to mislead third parties.4
Whereas, the Royal Court of Jersey in famous case Rahman held that the settlement PT
was wholly invalid, and in doing so found that: “<…> the settlor retained the dominion and
control over the trust fund throughout his lifetime. The settlement was the ‘sham’ in the sense
that it was made to appear what it was not <...>. The trustee was never made the master of the
assets <...>”.5
Another leading example of sham trust is Jersey Royal Court case Minwalla v.
Minwalla6, in which a husband set up a Jersey trust to hold his shares in offshore companies
and other properties. An application by his wife, on divorce, for ancillary relief was objected
to on the grounds that the husband did not have the assets in which the wife claimed a share as
he had placed the assets in a trust. It was held that the trust was void as a ‘sham’ and that the
husband was the ‘true and sole owner’ of the pretended trust fund. According to the court, the
husband as a settlor: “Never had the slightest intention of respecting even the formalities of the
trust deed <...> his purpose was only to set up a screen to shield his resources<...>. His intention
was that the resources were his and would continue to be his <...> and the trustees went along
with his intentions”.
On purpose to make the ‘sham’ trust peculiarities more clear, the Swiss court decision
in the case OD-Bank in Liquidation v. the Bankrupt Estate of WKR7 should be mentioned. In
this case, the court considered the arguments of defendant in relation to the Guernsey trust
settled by Mr. Werner K. Rey, a Swiss national, who was also one of the beneficiaries of trust.
PT called the “WKR Trust” owned more than 100 companies, including a bank called the “OD-
Bank” that went into liquidation in the context of the collapse of the entire company group (the
“Omni Group”) held by the trust. The Zurich court first determined that the trust had been
validly settled under Guernsey law. The court then moved on to determining whether the trust
was the ‘sham’. On the basis of the principles in the Rahman case, the Zurich court found that
Mr. Rey had repeatedly interfered with the trustee’s management of the assets. Among other
things, Mr. Rey had personally executed the proxies for shareholders’ meetings in some of the

4
T. Graham, J. Poole “Switching assets from one shadowy hand to another: piercing the veil of company and
trust”, Trusts & Trustees, (2010) 16.9, p. 716
5
Jersey Royal Court case Rahman v Chase Bank (CI) Trust Co Ltd [1991] JLR 103
6
Jersey Royal Court case Minwalla v Minwalla [2004] EWHC 2823
7
District Court of Zurich case OD-Bank in Liquidation v. the Bankrupt Estate of WKR [1999] ZR 1999 225

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companies held on trust without the trustee’s prior approval. The proxies furthermore stated
that the settlor personally owned the shares. The settlor also used the shares as collateral in
relation to negotiating the bank credits. In addition, the companies owned by the trust asked
Mr. Rey to take care of the trust matters when the trustee was unavailable. On this basis, the
Zurich court unsurprisingly held the WKR trust to be the ‘sham’.
If a trust is successfully challenged and held to be the ‘sham’, the legal effect is that all
it’s property, or a part of it, legally belongs to a settlor. The role of trustee is reduced to that of
an agent or nominee, who has no legal ownership of the trust property and assets are exposed
to the enforcement claims from the settlor’s heirs and creditors.8 However, a high threshold
exists in a practice that an allegation of the ‘sham’ trust would succeed. This is compounded
by the nature of ‘sham’ trust conspirators to conceal their dishonest arrangement.
When taking into consideration three PT jurisdictions, which are analysed more
detailed in this Master Thesis it is necessary to mention that except common law country
Guernsey, in respect Panama and Cyprus do not have the ‘sham’ concept. As a result in other
PTs civil law countries (incl. Switzerland, Monaco, Malta, etc.) the ‘sham’ doctrine is an alien
either.

1.5.2. The Fraudulent Transfers

Seeking to have the transfers of assets set aside on the basis that they were made at an
undervalue with the intention to defraud the creditors, the Romans developed civil law remedy
Actio Pauliana could be used. Whereas, in the United Kingdom this concept could be traced
through the Statute of Elizabeth and is called the fraudulent conveyances.9
Actio Pauliana (Acción Pauliana) remedy regarding the fraudulent transactions in the
Panamanian PTs is established under TLP Art. 15. The mentioned article states that PT loses
immunity from the creditor’s claims when assets have been fraudulently transferred or damages
caused in the execution of purposes of PT. However, the creditors right to sue shall lapse three
(3) years from the date of the endowment or transfer of assets to PT.
Therefore, a creditor must convince a court that a settlor (or a trustee) committed the
fraud, as well as a damage as a result of the transfer of assets into PT, must be proven.

8
J. Jørgensen "Sham Trust", p. 5. Available at: <http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2758245>,
[seen: 23/09/2016]
9
UK Fraudulent Conveyances Act of 1571

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Alternatively, a creditor must show that an intent of settlor was to defraud him by creating PT
or that the transferring assets’ into PT was the reason of settlor’s insolvency. Above all things,
in order for a creditor to file an action against a fraudulent transfer, it is necessary to provide
enough evidence to convince the judge that his right actually existed prior to the transfer of
assets into the trust. However, claims regarding fraudulent transfers to the trusts in Panama are
very rare. The author of this Master Thesis unaware of any such action having been filed.
Whereas, looking at the Guernsey legislation regarding the fraudulent transfers,
according to TLG Art. 11(2)(d) that an asset protection of PT would be challenged by the
creditors in the Guernsey courts, its necessary to prove that as the result of the transfer:
(i) the settlor was or became insolvent or otherwise did not have the assets to meet
legitimate claims against him or
(ii) his estate and the transfer was made or can reasonably be inferred as being made to
prejudice or defraud the claims of creditors.
A fraudulent disposition claim in Guernsey as same as in Jersey may be brought by way
of the Actio Pauliana (Pauline Action). The essential elements of a Pauline Action are set out
in the Royal Court of Jersey judgment Re Esteem Settlement.10 Whereas, the Guernsey Court
of Appeal in Flightlease Holdings Guernsey Limited et al v International Lease Finance
Corporation11 held that the elements set out in Jersey case Re Esteem Settlement summarised
the relevant Guernsey and Jersey law provisions regarding fraudulent transfers. The main
elements formulated in aforementioned cases could be distinguished as follow:
(i) the person bringing the Pauline Action must have been a creditor at the time of the
transaction under attack;
(ii) for the purposes of a Pauline Action, a person is properly described as a ‘creditor’
if the facts giving rise to the claim pre-date the transaction under attack;
(iii) the creditor seeking to set aside a transaction must show that the settlor was
insolvent at the time of the transaction under attack, or became insolvent by that transaction;
(iv) the debtor’s insolvency is measured on the balance sheet test;
(v) in order to succeed in an action to set aside a transaction, the creditor must show
that the debtor carried out the transaction (e.g. a settlor settled the trust) with the intention of
defrauding his creditors; and

10
Jersey Royal Court case Private Trust Corp. v Grupo Torras S.A., [2002] JLR 53
11
Guernsey Royal Court case Flightlease Holdings (Guernsey) Limited et al v International Lease Finance
Corporation [2005] 55/2005

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 (vi) if the debtor carried out the transaction for more than one purpose, it suffices that
the intention to defraud was a substantial purpose.
The Pauline Action in Jersey and Guernsey is the action personnelle mobilière
(regarding personal estate or movable property), and that for this type of action the limitation
period for bringing a claim is 10 years. A shorter limitation period of 6 years is applied for the
droits personnelles (rights to demand performance or payment).
Whereas, according to the Cyprus legislator, a claim may be brought in respect of the
assets that have been transferred to PT if only its proved to the satisfaction of the court that PT
was created with the intent to defraud the creditors of settlor. An onus of proof for the
fraudulent intentions lies on the part of the creditors.12 Although, in Cyprus as well as in
Panama there is no case law regarding this issue, under the general rule, the Cypriot PT shall
be declared an invalid only if current or pending claims exists against the settlor at the time he
sets up PT.
Under ITL, an action regarding the fraudulent conveyances to PT must be brought
within a period of two years from the date on which a transfer or a disposal of assets was made
to a trust.13
Currently the majority of the offshore jurisdictions have substantially modified their
legislation in order to make them rather pro-debtor friendly than pro-creditor. Usually, in order
to constitute a trust settlement voidable, it must be made with:
(i) the principal intent to defraud14 or
(ii) intention wilfully to defeat an obligation owed to a creditor, which would seem to
require dishonesty.15
It’s worth to mention that the fraudulent transfer (a conveyance) laws protect just
present creditors but not future since such laws explicitly protect only those creditors that exist
at the time of establishing PT.16 Moreover, the burden of proof for the fraudulent intents
transferring assets to PT almost invariably rests on a creditor. Some jurisdictions even imposing
a criminal standard of proof “beyond reasonable doubt”.17 Finally, there may be the limitation

12
Art. 3(2) of the ITC
13
Art. 3(3) of the ITC
14
Channel Islands, Cook Islands, Dominica, Nevis
15
Barbados, Cayman Islands, Bahamas
16
Panama, Cyprus, Channel Islands, Cook Islands, Dominica, Barbados, Nevis, Cayman Islands, Bahamas
17
Cook Islands, Dominica, Nevis

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periods imposed as short as one or two years from the date of the relevant conveyance or
disposition within which the creditors may bring the claims in an effort to have the disposition
set aside.18
In the next section of this Master Thesis, PT taxation peculiarities and the aspects of
the foreign origin assets favourable treatment is going to be analysed.

18
Cook Islands (1 year), Dominica (1 year), Nevis(1 year), Bahamas (2 years), Barbados (3 years), Cayman
Islands (6 years)