03 October 2016

Commercialisation of trusts heightens risk of insolvency

Trusts have their origin in private family arrangements but they are increasingly being used to hold commercial and often complex business assets. This has heightened the risk of trust structures effectively becoming insolvent, according to Carey Olsen trusts and private wealth partner Elaine Gray.

“The move towards commercialisation of trusts has led to them becoming much more dynamic and we are seeing a marked increase in those that hold commercial enterprises or complicated investment assets instead of looking after a family’s wealth,” Advocate Gray told fiduciary professionals at Carey Olsen’s well-attended 2016 Autumn Trusts Conference.

Another contributory cause of insolvency in trusts was the financial crisis of 2008 when many trustees found that the value of their portfolio of trust assets had dropped, resulting in cases being referred to the courts where the trust assets were financed through any kind of lending.

While in legal terms a trust cannot be insolvent, due to it not being a separate legal entity, in practice that is the result where on a cash flow test the trustee is unable to meet the debts of the trust as they fall due.

Where there is cash flow insolvency (i.e. not enough cash to pay the trust's debts), this results in a shift in interests so that the trustee's duties are not purely to the beneficiaries of the trust but shift towards the creditors' interests.

Although there are historically relatively few precedents for trust insolvency, the issue has come before the courts several times in recent years and several of these cases were outlined at the conference by Carey Olsen Jersey partner Keith Dixon.  

Given the current uncertainty in the financial sector, Ms Gray considered that there was a high likelihood of further cases going to court in the future. One of the concerns for trustees may be that they are not even aware that a trust has become insolvent.

“It’s fairly common for trusts to hold assets such as commercial property with complex financial instruments underlying them. It’s not difficult to foresee a situation where a trustee has to rely on expert advice as to the values of those assets and the attractiveness of commercial terms applicable to any lending on the assets.  Bearing that in mind, trustees need to keep a careful eye on valuations to ensure that the trust is operating satisfactorily and is not at risk of being cash flow or balance sheet insolvent,” she said.

Also speaking at the half-day conference were Carey Olsen partners Alexa Saunders and Keith Dixon and counsel Laila Arstall and Richard Holden, who covered tax issues for trustees. Partners Karen Le Cras and Natasha Kapp and associate Will Burnell gave a review of recent trust decisions in offshore jurisdictions.