Malaysia: Building Legacy On A Foundation - Part II

Last Updated: 6 March 2018
Article by Millie Chan

This paper is written against the backdrop of my previous article entitled "Building Legacy on a Foundation, Part I" published in InsightPlus issue of October 2017. Part II seeks to contrast key features of a private foundation with those of a common law trust. While both structures are similar in many respects, it is their differences that can distinguish them as the suitable vehicle of choice in a particular estate plan.

Differences between Foundations and Trusts

It is helpful to bear in mind that the differences in the characteristics and functionalities between a private foundation and a common law trust arise chiefly from two fundamental distinctions, namely, the legal traditions that birthed the respective concepts (civil law vs. common law), and the status of the structures (legal personality vs. legally recognised relationship).

(i) Ownership of Assets

As a legal personality, a foundation owns its assets absolutely and indivisibly. In general, the civil law tradition does not countenance split ownership of assets. A trustee, on the other hand, only claims legal ownership of the trust assets while the beneficial ownership rests in the beneficiaries. The split in legal and beneficial ownership means that these properties do not form part of the trustees' own estate. They must be accounted for as a segregated fund.

(ii) Duration 

A foundation can exist indefinitely as a legal entity, unless the applicable legislation or its constituent document limits its duration. The original common law position vis-à-vis trusts on the other hand imposes a rule against perpetuity in respect of the ownership of trust assets. Nevertheless, several jurisdictions have taken the step to abolish this rule against perpetuity. For example, a trust established pursuant to the Labuan Trusts Act 1996 (LTA 1996) can exist for unlimited period.

(iii) Contracting

A foundation contracts in its own name and can sue or be sued in its own name. A trust, not being a legal entity, is represented by the trustee for all intents and purpose. Hence, the trustee contracts personally. The unfortunate consequence is that the trustee will be personally liable for any breach of contract to the extent of the trustee's own estate. In some jurisdictions, special legislations have been introduced to limit the trustee's liability. In practice, it is also common to negotiate with the other contracting party to accept a restricted liability, for example, confining it to the extent of the trust funds.

Another disadvantage arising from a trustee having to contract in trustee's own right is that, in the event of a change of trustee, the contracts must be assigned or novated.

(iv) Mobility

A foundation owes its existence to the enabling legislation in its country of establishment. In principle, it cannot be relocated. In order to move ownership of its assets to another country, the assets have to be transferred by the foundation to another foundation established in the other country. And in that circumstance, there is no continuation of ownership. Most foundation legislations overcome this problem by allowing redomiciliation of a foundation. For example, the Labuan Foundations Act 2010 (LFA 2010) permits redomiciliation of a foundation established thereunder.

A trust on the other hand is inherently mobile. If the trustee is an individual, he is capable of moving to the designated new jurisdiction and continues running the trust. The trust document can also provide for the continuation of the trust in spite of change of country of ownership by the old trustees transferring the trust property to the newly appointed trustee in another jurisdiction to take over the operation of the trust, and changing the governing law, provided of course that the initial trust is not invalidated.

(v) Operational and Structural Framework

As a statutory entity, the operational and structural framework of a foundation is subject to the provisions of the relevant statute. In this respect, the general trend in foundation legislations is to provide a bare-bone structure for its operation consisting of a few mandatory rules while leaving a wide berth for the founder to flesh out the details. The founder is given much discretion in determining how he/she wishes the foundation to be structured and to operate.

On the other hand, being a brainchild of the common law, the concept of trust is governed by an abundance of case law that determines and guides how a trust is to operate, subject to any statutory provisions which may have varied the common law position. Lawyers and judges are guided by these judicial decisions in their approach to, and interaction with, the trust. This also means that any interstices in the provisions of the trust deed can be fleshed out by the case law.

(vi) Position of Founder vs. Settlor

The founder of a foundation and the settlor of a trust may be said to be in a position to retain similar extent of influence after the establishment of their intended structure. Both can reserve certain powers, such as the power of revocation, the power to amend the structure, or the power to replace members of governing body or trustees.

It may justifiably be observed however that the reservation of powers by a settlor requires more care and attention. If the effect of the reserved powers leads to a conclusion that the trustee is merely holding the trust assets to the order of the settlor, and that the settlor in reality remains the full beneficial owner of the trust assets, the trust will be held to be a sham as far as the ostensible beneficiaries or purposes are concerned. No similar outcome exists in the case of a foundation. The founder may give very specific instructions to the governing body without concern over affecting the validity of its establishment. This is because a foundation derives its validity from its incorporation.

(vii) Position of Beneficiary

As noted above, a beneficiary of a trust has equitable interest in the trust assets. On the other hand, generally, a beneficiary of a foundation does not have any interest in the foundation assets or any preferred obligation binding the foundation if it becomes insolvent or is liquidated. This crucial difference gives rise to other important ramifications. For example:
  • Trust beneficiaries can, via the tracing process, make proprietary claims against assets found in the hands of third parties, subject to certain exceptions. Trust beneficiaries also have the right to see trust accounts with supporting documents. The position of foundation beneficiaries stands in stark contrast. Unless a founder provides in the constituent documents specific rights upon the beneficiaries vis-a-vis the foundation and the governing body, foundation legislations are usually meagre in conferring meaningful rights upon the beneficiaries.
  • If all trust beneficiaries are ascertained, of full capacity and of one mind, they can require the termination of the trust and the distribution of the assets to them. This is the traditional position of a proprietary trust (Saunders v. Vautier) although many jurisdictions have abolished this right so as to facilitate the fulfillment of the settlor's intention. Foundation beneficiaries on the other hand do not enjoy similar right.

(viii) Position of Governing Body and Trustee

The governing body of a foundation may be given a wide a range of powers and duties by the constituent documents. These duties are owed only to the foundation and not the beneficiaries. To counterbalance the power of the governing body, most foundation laws give the founder the option to set up other internal entities to "police" the conduct of the governing body. In some instances, the foundation legislation itself implants safeguards such as requiring the governing body to have as its members a specified number of local licensed trust officers.

As the governing body of a foundation owes its duties to the foundation, it cannot seek relief from liability from the beneficiaries or the court. It is however not unusual for a foundation's constituent documents to be drafted so as to exempt the governing body from liability for a breach of standard care other than one resulting from wilful misconduct or dishonesty. The foundation's regulations may also provide for the granting of relief by a specified person, for example, the supervisory person. Further, the relevant foundation legislation may permit relief to be granted by the court, as in case of the LFA 2010.

In the case of a trust, the common law also confers on the trustees a wide range of duties and powers, subject to such restrictions or enlargement specifically provided for by the trust instrument. The duties are owed to the beneficiaries and this provides the beneficiaries with the standing to monitor or "police" the trustee's conduct, including seeking intervention by the courts where appropriate. In turn, the trustees may be relieved or indemnified for breach of trust by the beneficiaries. In addition, trustees may also be excused by the court if certain conditions are met, for example, if they had acted honestly and reasonably and ought fairly to be excused for the breach and for omitting to have earlier sought advice from the court.

(ix) Validity of Structure

The question of validity/effectiveness of each structure is dealt with differently. As mentioned above, if the construction of a trust evidences an arrangement to act as a smokescreen for the trustee to hold the trust assets to the order of the settlor, the trust will be considered a sham. The court will find that there is a true bare trust for the settlor as he has in fact not divested his beneficial interest in the property.

A foundation, on the other hand, comes into existence as a "legal person" by virtue of its incorporation in accordance with the registration formalities. The apparent or secret agenda of the founder concerning the use of the foundation does not affect its validity. However, if a foundation is created as a façade to hide or dissipate the founder's assets, there may be a piercing of the veil of legal personality to enable the court to treat the assets of the foundation as the assets of the founder.

Concluding remarks:

In deciding on the choice between foundation and trust, the following are some of the practical considerations which should also be born in mind: 

(i) The common law trust has a long history of development and is steeped in established jurisprudence. On the other hand, the available case law affecting foundations is minimal and there is little guidance available to practitioners on the effective structuring of a private foundation.

(ii) Similarly, there is a grave scarcity of tax rulings and case law on the tax treatment of foundations. The fact that a foundation has characteristics like a company on the one hand and operates like a trust on the other opens wide possibilities as to how they may be treated by common law tax authorities.

(iii) The ability of the founder to effectively control the assets owned by the foundation must be resorted to carefully when designing the founder's role. Unintended and undesirable legal and tax consequences may arise from the indiscriminate retention of control by the founder.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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