Protecting your legacy: understanding the power of governing law in trusts

When establishing a trust, many focus on the specific terms and beneficiaries. However, the often-overlooked 'governing law' is the unseen force that controls its operation. This legal framework dictates how your trust is interpreted, administered and protected, impacting every aspect from its formation to its eventual distribution. Understanding its significance is crucial for any settlor, trustee, or beneficiary.

In this article Leevyn Isabel, Commercial Director, and Kenny Curpen, Unit Head, delve into the intricacies of governing law, exploring its profound influence on trust administration and dispute resolution.

Defining governing law

The governing law of a trust acts as its legal foundation, dictating everything from its creation and interpretation to its day-to-day administration and eventual termination. It definitely establishes which jurisdiction's laws apply and which courts hold authority over disputes. This crucial choice has profound and lasting implications for all parties involved: settlors, trustees, and beneficiaries. Understanding the governing law is essential, as it directly shapes the trust's management, dispute resolution processes and the allocation of rights and responsibilities.

Trust administration and the governing law

The governing law of a trust acts as the cornerstone for its administration, significantly influencing various critical aspects:

• Formation and validity: It dictates the precise legal requirements for establishing a trust, encompassing necessary parties, documentation, and procedural formalities. Furthermore, it determines the settlor's capacity to create the trust and the legal validity of its provisions.
• Interpretation: The governing law provides the framework for interpreting the trust's terms. Jurisdictional differences in legal construction can lead to varying interpretations and applications of trust provisions.
• Trustee duties and powers: It defines the scope of a trustee's responsibilities and authorities, including the standard of care expected, fiduciary obligations, and remedies available to beneficiaries for breaches of trust.
• Reporting obligations: Trustees must adhere to the governing law's disclosure requirements to avoid potential legal repercussions and costly investigations.
• Investment policy: The governing law can influence the trust's investment strategy, ensuring alignment with the risk profile and objectives.
• Tax implications: While not the sole determinant, the governing law plays a significant role in shaping the trust's tax consequences, including income, estate, and gift tax. Other factors, such as trustee residency and the location of trust property, must also be considered.
• Asset protection: The selection of governing law can contribute to the trust's effectiveness as an asset protection tool. Certain jurisdictions offer enhanced creditor protection measures, but the location of trust assets remains a significant consideration.
• Succession planning: The governing law governs the distribution of trust assets to beneficiaries upon the settlor's death or other specified events, defining the rules of succession and beneficiary rights. Some jurisdictions also provide "firewall" rules to safeguard trust property from foreign forced heirship claims.
• Flexibility and control: The governing law can influence the settlor's or family's ability to retain flexibility and control, including the capacity to amend the trust. For instance, jurisdictions like the BVI and the Cayman Islands offer "reserved powers" legislation, allowing settlors to retain powers or grant them to protectors without compromising trust validity.
• Trustee's response to loss: In the event of a loss, the governing law dictates the trustee's expected approach to recovery and the allocation of costs.

Dispute resolution and the governing law

The governing law plays a critical role in how trust-related disputes are resolved, influencing jurisdiction, applicable laws, and enforcement mechanisms.

• Jurisdictional authority:
  • The governing law establishes the jurisdiction where trust disputes are adjudicated, determining applicable procedural rules and available remedies.
  • While trust deeds typically include a governing law clause, courts retain the power to override this choice if deemed inappropriate or motivated by ulterior purposes.
  • In the absence of a clear governing law clause, courts determine jurisdiction based on the "closest and most real connection" to the trust, considering factors such as:
    • Place of administration
    • Location of assets
    • Residence of trustees
    • Trust purpose
• Enforcement of judgments:
  • The governing law dictates the enforceability of trust-related judgments and awards.
  • Jurisdictions with robust legal systems ensure effective dispute resolution.
  • "Firewall" provisions, as seen in some jurisdictions, protect trusts from foreign court orders arising from personal relationships, enhancing asset protection.
• Recognition of foreign trusts:
  • Jurisdictions like the DIFC and Mauritius recognise foreign trusts, facilitating cross-border trust recognition and transfers.
• Dispute resolution mechanisms:
  • Jurisdictions with established and efficient dispute resolution mechanisms, such as the DIFC courts, offer parties confidence in trust enforcement and interpretation.
• Alternative dispute resolution:
  • Mediation and other alternative dispute resolution (ADR) services may be available, providing options to avoid costly litigation.
• Court intervention:
  • In all jurisdictions, trustees can seek court guidance on trust deed interpretation and appropriate actions.

Key considerations for governing law selection

Choosing the appropriate governing law for a trust requires careful consideration of several critical factors:

• Settlor's intent and judicial oversight:
  • While the settlor's chosen governing law is generally respected, it is not absolute.
  • Courts retain the authority to override this choice if it is deemed inappropriate or intended to circumvent specific legal provisions.
• Public policy concerns:
  • A court may invalidate a settlor's chosen governing law if it contravenes the "strong public policy" of the jurisdiction with the most substantial connection to the trust.
• Mandatory legal provisions:
  • Certain jurisdictions enforce mandatory rules that supersede the settlor's intentions, ensuring specific protections and obligations are upheld regardless of the chosen governing law.
• Trust flexibility:
  • The selected governing law should be evaluated for its impact on the trust's flexibility, particularly concerning the ability to amend or modify its terms.
• Tax implications:
  • A thorough assessment of the tax consequences associated with the governing law is essential, as it directly affects beneficiaries and trust administration.
• Cross-border considerations:
  • For families with international interests, the governing law must be carefully chosen to facilitate cross-border transactions and provide flexibility in managing assets and beneficiaries across multiple jurisdictions.

How can Ocorian help?

The governing law, in its essence, is the enduring legal foundation upon which a trust is built and operated, shaping both its administration and dispute resolution processes. As such, the selection of this law is a critical, long-term decision. It requires a meticulous assessment of the settlor's desires, the geographic distribution of assets, the residences of trustees and beneficiaries, and the overarching vision for the trust's future. As your trust administrator, Ocorian is committed to providing practical guidance in this crucial area.