Bermuda: Bermuda Unit Trust Funds And Derivatives Transactions Under An ISDA Master Agreement

Introduction

A common form of open-ended collective investment vehicle is the Unit Trust. Many such Unit Trusts have been established in Bermuda, and may be regulated under the Investment Funds Act 2006. They may also have Bermuda trustees ("Trustee"). And, typically, Bermuda collective investment vehicles, known also as investment funds or even "hedge funds" enter into SWAPs and derivatives arrangements with a non-Bermuda financial institution, usually based in either London or New York. There are no regulatory restrictions or prohibitions on the types of derivative transactions that are entered into by Trustees of Bermuda trusts, operating as investment unit trusts. The typical form for such transactions is based on the standard documentation promulgated by the International Swaps and Derivatives Association ("ISDA").

Derivatives transactions typically involve, for example, Credit Default/Total Return/Asset Swaps, Credit Linked Notes/Trusts, Interest Rate Swaps/Caps/Floors/Collars, Currency Options or Foreign Exchange Contracts. These derivatives contracts provide risk mitigation techniques for the Unit Trust as an investment fund. The specifics of any individual transaction, from its type to the detailed conditions precedent and subsequent would be set out as Schedules and Confirmations attached to the main agreement with the counterparty ("Counterparty"), establishing the initial basis of the commercial relationship, known as the "ISDA Master Agreement" or "Master Agreement". That is to say, there is a single industry standard master creating the contract, with tailored dependent schedules and confirmations fleshing out the detail relevant to the specific counterparties to the agreement under which "Transactions" may occur. However, there are certain essential Trusts law concepts which affect entry into the Master Agreement and resolution of contractual issues between the Trustee acting in respect of the Unit Trust and the derivatives Counterparty where certain "Events of Default" occur.

This Brief serves as an introduction to the essential pre-contract conditions for Trustees of Unit Trusts entering into an ISDA Master Agreement and also the post-insolvency netting analyses that can apply to Unit Trusts. Thus, various themes are covered in terms of how an ISDA netting agreement should be structured in order to ensure that the anticipated contractual effect of the agreement is given the same practical and commercial effect in the insolvency of the Bermuda Unit Trust Counterparty, to the extent that a trust can be said to be "insolvent".

Formation of a Unit Trust

Unit Trust funds are constituted by a trust deed, usually made between the investment management company which (or whose affiliate) is promoting the vehicle and the Trustee. A Unit Trust fund has no separate legal personality. It is a fiduciary relationship whereby a fund is held by the Trustee that is subject to equitable obligations to deal with the fund under the terms of the trust instrument and in equity for the benefit of the beneficiaries who may enforce such equitable obligations. The Trusts (Special Provisions) Act 1989 is clear in that the assets of a Bermuda Trust constitute a separate fund and are not part of the Trustee's own assets.

The trust deed will provide for the manner in which the Unit Trust fund is to be administered, unit holders' rights, the duties, and appointment and removal of the manager and the Trustee, investment and borrowing powers and restrictions, and the termination and winding up of the affairs of the Unit Trust fund.

Custody of the assets, accounting and calculation of net asset value are usually performed by the Trustee (provided that, if providing the services in Bermuda, the Trustee is also a licensed administrator for the purposes of the Investment Funds Act 2006). The management company is usually responsible for making investments on behalf of the Unit Trust fund. No Bermuda governmental consent or approval is required to form a Unit Trust fund. All that is required is settlement of the terms of the Unit Trust fund deed and execution of the deed by the Trustee and the management company.

Once constituted, however, the Unit Trust fund may not issue units until relevant contracts and offering materials are approved and the consents required under the Foreign Exchange Control Regulations of Bermuda have been obtained. At the time of the application for such consents, information on the Trustee and its investment expertise is usually submitted.

Management

In the case of a Unit Trust fund, the responsibility for the management of the Trust's affairs is shared by the Trustee and the management company.

Fiduciary Duties of Trustees

Trustees act as custodians of the assets of the trust and owe fiduciary duties, under the general law, to unit holders in the Trust. There are usually specific provisions in the trust deed giving the benefit of certain exemptions or indemnities to the Trustees, but the extent of these is a matter for negotiation and agreement on commercial terms according to industry standards.

Legal Nature of Trusts in Bermuda – Entry into an ISDA Master Agreement Part I

The principal statute governing trusts and their administration in Bermuda is the Trustee Act 1975 (the "Trustee Act"), which is largely patterned on the English Trustee Act 1925. Another important statute in Bermuda is the Trusts (Special Provisions) Act 1989 which increased certainty on the conflict of laws rules in relation to the recognition of trusts. This 1989 Act also allows for the incorporation of statutory administrative powers into the trust deed and introduced the concept of the 'purpose trust'. Both Acts have undergone several amendments.

The Perpetuities and Accumulations Act 1989 makes it possible to stipulate a perpetuity period of a fixed term lasting for up to 100 years. This perpetuities Act adopted the 'wait and see' rule whereby if there is a possibility of vesting occurring at too remote a time, the application of the rule against perpetuities is deferred until it becomes apparent that vesting will occur beyond the perpetuity period, if ever. It is possible however to draft an exclusively charitable trust or purpose trust that may last indefinitely. The Perpetuities and Accumulations Act 2009, however, has limited the application of the rule against perpetuities to estates or interests only to the extent that the trust property is land in Bermuda, in relation to instruments taking effect on or after the commencement day of the Act (1 August 2009).

It is possible to apply to the Court in Bermuda for the new general exemption to be applied to trusts created before 1 August 2009.

The Trusts (Regulation of Trust Business) Act 2001 came into effect on 25 January 2002. It replaced the Trust Companies Act 1991 and provides that a company, partnership or individual shall not carry on trust business in or from within Bermuda without the appropriate licence. Trust business is defined in the Act as the provision of the services of a Trustee as a business, trade, profession or vocation. The Bermuda Government is committed to keeping information concerning trust business confidential, except in the event of a criminal investigation. The 2001 Act provides that no person carrying on business in or from Bermuda shall use any name which indicates that it is carrying on trust business, unless it is a licensed Trustee or has received an exemption. This means that a private trust company which seeks to use 'trust' or 'trustee' in its name can only do so if it is licensed or has an exemption order. The Trusts (Regulation of Trust Business) Exemption Order 2002 took effect on 9 August 2002. The exemption order operates to exclude certain persons falling within a specified class from the requirements to hold a licence under the Act. Most private trust companies will be covered by an exemption order¹.

A Bermuda Trust acts through its Trustee, who, save for a breach of trust, is not normally personally liable for the obligations it incurs. When obligations are incurred in that capacity, the Trustee will have a right to discharge those obligations out of the funds of the Bermuda Trust (such indemnity is unlikely to be excluded or limited in the trust deed). Assuming the Trustee's right has not been excluded, where the Bermuda Trust's funds are insufficient to meet the liability in full, the Trustee may be personally liable to the relevant creditor for the balance if fraud or gross negligence is present. It is possible, however, for the Trustee to enter into limited recourse provisions so as to limit liability contractually.

As stated above, the Trusts (Special Provisions) Act 1989 makes clear that a Bermuda Trust has the following characteristics:

• the assets of a Bermuda Trust constitute a separate fund and are not part of the Trustee's own estate;
• title to the Bermuda Trust's assets stands in the name of the Trustee or in the name of another person on behalf of the Trustee; and
• the Trustee has the power and the duty, in respect of which he or it is accountable to manage, employ or dispose of the assets in accordance with the terms of the Bermuda Trust and the special duties imposed upon him by law.

Under the Exchange Control Act 1972 and the regulations promulgated thereunder, Bermuda undertakings are to be regarded as resident or non-resident for exchange control purposes. An undertaking that is regarded as nonresident will be free to trade in any currency other then the Bermuda dollar, and the rules in Bermuda regarding exchange control will not affect their obligations in currencies other than Bermuda dollars. Bermuda Trusts are Bermuda undertakings for the purposes of the Exchange Control Act 1972.

A Bermuda Trust may be designated as non-resident in Bermuda e in those frequent instances where the Trustee itself is resident for exchange control purposes. Any exchange control restrictions operating in relation to the Trustee as resident for exchange control purposes would not affect any accounts held in the name of the Trustee in respect of a Bermuda Trust that is non-resident for exchange control purposes. Accordingly, before entering into an ISDA Master Agreement in respect of a Bermuda Trust, enquiries should be made as to whether or not the Bermuda Trust has received a designation letter (or equivalent documentary evidence) that indicates its designation as resident for Exchange Control purposes. In our experience, it would be unusual if the result of the enquiries that we are recommending in this connection was that a Bermuda Trust that was a unit trust was designated or regarded as "resident" for Exchange Control purposes. Should the mentioned result prove actually to be case, then an appropriate permission would need to be obtained from the Bermuda Monetary Authority, before any Transaction were entered into in respect of the particular Bermuda Trust.

Capacity (see discussion as to capacity in Part II)

In order to determine whether there is capacity or the power for a Trustee to enter into derivative transactions to bind itself in relation to the Bermuda Trust, such capacity or power must be within the provisions or purposes of the Bermuda Trust, as set out in the terms of the Trust deed and settlements etc. and any actions taken by the Trustee must be within its power/capacity or permitted by statute.

Where a Bermuda Company enters into an ISDA Master Agreement and Credit Support Document as Trustee on behalf of a Bermuda Trust (and assuming the Trustee is duly licensed or exempted as aforesaid), the power to enter the ISDA Master Agreement and Credit Support Document must also be within the corporate capacity of the Bermuda Company acting as Trustee. Recommendations:

• Obtain a copy of the trust deed governing the Bermuda Trust and review it to establish the powers conferred on the Trustee.

• Make all investigations as to the capacity required in relation to the Trustee, both in its capacity as Trustee and in its corporate capacity.

Authority

In order to establish the authority of the Trustee to enter into an ISDA Master Agreement (and its underlying Transactions) it must be established that the Master Agreement and the Transactions to be entered into under the Master Agreement (i) are in accordance with the purposes of the Bermuda Trust as set out in the various trust deeds establishing or governing the operation of that trust; (ii) is within the powers of the Trustee granted to it as Trustee of the Bermuda Trust by the various trust deeds establishing or governing the operation of that trust; (iii) has been validly authorised, executed and delivered by the Trustee in its capacity as Trustee of the Bermuda Trust in accordance with the provisions of the various trust deeds establishing or governing the operation of that trust; and (iv) is expressly stated as being entered into by the Trustee in its capacity as Trustee of the Bermuda Trust.

Normally such authority would derive from a typically wide and unrestricted "trustee investment power"

Further, when the Bermuda Counterparty enters into a Transaction pursuant to a Master Agreement, it should be verified that the Master Agreement is valid and binding on the Trustee in relation to the specific assets of the Bermuda Trust which are to be subject to the Master Agreement in accordance with the various trust deeds or other documents establishing or governing the operation of that trust. Accordingly, the trust and also corporate constitution of the Trust and the Trustee itself should be examined to see that the Master Agreement and each transaction entered into thereunder, constitutes a valid and binding agreement of the Trustee both in its capacity as Trustee of the Bermuda Trust in respect of the assets of the Bermuda Trust and in its corporate capacity (and does not exceed its corporate capacity).

Other elements which should be established are that neither the Bermuda Trustee (if there is one – usually a Bermuda Company licensed to provide trust and administration services) nor the Bermuda Trust itself is registered or required to be registered under the National Pension Scheme (Occupational Pensions) Act 1998, Contributory Pensions Acts 1967 and 1970 or the Pension Trust Funds Act 1966.

Finally, and clearly importantly, one should verify that no admission, withdrawal, retirement, dissolution, or bankruptcy of the Trustee will trigger the termination of the Bermuda Trust.

The effort required to establish capacity and authority derives from the fact that the formation and operation of trusts are governed by private documents, namely the trust deed by which they are established. Thus, absent a standardised, regulated format, each Bermuda Trust is unique and thus varied. As already noted the Trustee's (and any manager's) authority to carry out the terms and provisions of the specific trust are dictated largely by the terms of the trust deed.

Where the terms of the trust deed related to, and all relevant legislation applicable to, a Bermuda Trust permit the entry into of derivative transactions to bind the assets of a Bermuda Trust, it is necessary to then determine whether the person/entity that executes the derivative transactions and performs the obligations to bind the Bermuda Trust has the authority to do so as regards both the terms of the trust deed of the Bermuda Trust and in terms of the corporate governance issues that are applicable to the party that purports to act in relation to the Bermuda Trust, in this case a Bermuda Company. This will generally be the Trustee of the trust but, in the case of investment funds established as unit trusts, may also be the manager.

The question of authority of a Trustee (or manager) to bind itself as Trustee of a Bermuda Trust therefore requires an analysis of the constitutional and other arrangements relevant to the Trustee (or manager) itself to establish whether there is authority at that level to bind the Trustee (or manager) and whether the proposed transactions are within the terms of the trust deed applicable to the Bermuda Trust so as to bind the assets of the Bermuda Trust.

Under the Trustee Act it is possible to have a managing Trustee, often with the power of investment. Where a Bermuda Company is appointed as Trustee, it is possible to have just one Trustee which will exercise all powers in its capacity as sole Trustee. In the case of a unit trust where one manager is appointed, that manager will also carry out its duties under the trust deed in its sole capacity and third parties can deal directly with the sole Trustee and/or sole manager.

Recommendations:

• Obtain copy of trust deed relevant to the Bermuda Trust.
• Obtain information to establish the authority of the Trustee (or manager), in terms of its own corporate governance structures.

Netting

Part II

Apart from basic questions as to the ability of a Trustee of a Bermuda Trust to enter into a derivatives transaction, the main concern which Master Agreement counterparties on the other side from a Bermuda Trust will have relates to the consequences for them in the event of an "insolvency" of the Bermuda Trust (or the Trustee) and in particular in relation to a central mechanism of Master Agreements, namely the setting off, or netting, of the parties' debits and credits arising under the likely multiple transactions entered into pursuant to the Master Agreement. The netting of such multiple transactions is sought in order to arrive at a single lump sum which would represent the amount to be settled either way between the two sides, and so bring their relationship to a close. Typically, if the Bermuda Trust owes money to its Counterparty, such Counterparty will have taken security over an account containing cash and securities belonging to the Trust, and the Counterparty will be able to deduct from that secured account any net sums it may be entitled to. Thus, the mechanism for netting and for granting security will need to be confirmed to the counterparties.

It is the case that there are a variety of "Events of Default" which may trigger the closing out of the Master Agreement and trigger the netting of obligations, and counterparties will wish to know both what happens during the solvency of the Bermuda Trust, expecting generally that the Master Agreement will be performed as described by its terms, and then to ensure that in an insolvency they will have equivalent rights and security for their exposure.

In general terms, there being freedom of contract in Bermuda, the Master Agreement will be enforced in accordance with its terms during the solvency of the Bermuda Trust. However, questions may arise in so far as Bermuda Trusts cannot become insolvent, as such, nor can they commit "acts of bankruptcy", as typically defined in an ISDA Master Agreement thereby triggering an "Event of Default". However, the Trustee or the beneficiaries of a Bermuda Trust may become insolvent and commit "acts of bankruptcy". Whereas there is thus no concept of insolvency or bankruptcy for a Bermuda Trust, and therefore no rules in Bermuda regarding the distribution of a Bermuda Trust's assets in the "insolvency" scenario of a Bermuda Trust, which is to say that the assets of the Bermuda Trust exceed its liabilities, Appleby recommends that an additional trigger for termination be included in the Schedule to the ISDA Master Agreement by reference to the financial position of the Bermuda Trust, e.g. a provision that permits the Non-defaulting Party to terminate all transactions in the event that the liabilities of the Bermuda Trust exceed its realisable assets (an "insolvent Bermuda Trust"). A provision of this kind would, in principle, be enforceable.

Capacity in which a Trustee Contracts

Where the Trustees of the Bermuda Trust is itself a Bermuda Company, the following issues may arise in practice in determining liability to the defaulting Counterparty, and the application of statutory set-off under the Companies Act 1981, Section 235 as it applied Section 3705 of the Bankruptcy Act 1989.

For each ISDA Master Agreement to be executed between a Bermuda Company acting as Trustee for a Bermuda Trust, a determination should be made as to the capacity in which the Bermuda Company will execute the ISDA Master Agreement. There are essentially four scenarios:

1. the Bermuda Company executes as Trustee so as to become personally liable because it is acting for its own account or profit and the Counterparty has recourse to the Bermuda Company's separate assets for its claim(s);
2. the Bermuda Company executes as Trustee acting for and on behalf of the Bermuda Trust so as to undertake personal liability for the Counterparty claims, on the basis that the Bermuda Company acquires a right of indemnity against the Bermuda Trust's assets (to the extent of these) that is equal to the amount of any claim(s) paid to the Counterparty, with the result that (as in (i) above) the Counterparty has recourse against the Bermuda Company's separate assets for any balance of its claim(s) that exceed the Bermuda Trust's assets;
3. the Bermuda Company executes as Trustee as in (ii) but has contracted out of its residual personal liability, i.e. for any amount of the Counterparty's claim(s) that exceeds the Bermuda Trust's assets available for the Bermuda Company's indemnity except where there has been fraud or negligence; or
4. the Bermuda Company executes as Trustee so as to limit its liability whether acting for its own account or as Trustee, so the Counterparty has recourse for its claims only as against the Bermuda Trust's assets.

Although extremely unusual for a professionally managed trust, in the situations detailed in (i) and (ii) the Trustee (the Bermuda Company) has personal liability for the Counterparty's claim, and therefore where there are insufficient assets in the Bermuda Trust to discharge the Counterparty's claim under the relevant ISDA Master Agreement, the Trustee will be contractually liable for the shortfall (call the situations described in (i) and (ii) the "Personal Capacity Situations"). On the other hand, in the situations described in (iii) and (iv), the Trustee has contracted out of its personal liability with regard to the Bermuda Trust's assets, so that once the funds of the Bermuda Trust have been exhausted, there will be no further recourse available to the Counterparty under the ISDA Master Agreement (call the situations described in (iii) and (iv) the "Limited Recourse Situations").

The analysis below reviews how contractual and insolvency set-off principles might operate in relation to some of scenarios outlined above.

Pursuant to Section 235 of the Companies Act, the rules that prevail under the law of bankruptcy with respect to the rights of secured and unsecured creditors, debts provable and the valuation of future and contingent liabilities also apply in the winding-up of an insolvent company. The most important of these rules, for the purposes of our analysis of the enforceability of the termination provisions and the netting provisions, is Section 37 of the Bankruptcy Act 1989 which provides:

The general position is that, if insolvency set off applies at all, the mutuality requirement that it entails will be satisfied in any case where the claims sought to be set off arise uniformly under contracts entered into by the Bermuda Trustee in precisely the same capacity. If there is only one ISDA Master Agreement between the Bermuda Trustee and the Non-Bermuda Counterparty, then the Bermuda Trustee must be acting throughout in only one of the four capacities described above and no issues should arise. Even if there are several ISDA Master Agreements between the parties, no issues arise provided that in each case the contract is structured so that the Bermuda Trustee acts in the same capacity (i.e. in the same scenario outlined above) for each. Difficulties may arise, then, only where (a) there are several ISDA Master Agreements between the Counterparty and the Trustee acting in respect of that particular Bermuda Trust and (b) they are structured in such a way that the Trustee acts in different capacities in respect of different contracts. Also pertinent is that generally a Trustee will enter into contracts only in a Limited Recourse Situation, that is to say, very rarely in a personal capacity

Solvent Bermuda Trust, Insolvent Trustee

Where the Trustee is insolvent but the Bermuda Trust is solvent, which is to say that the assets of the Bermuda Trust exceed its liabilities, then the close-out netting provisions of the ISDA Master Agreement should be effective, either as a matter of contract or by operation of insolvency set-off. The result is substantially the same in either case.

In practice, the insolvency of the Trustee would not typically affect the substantive rights of the parties under an ISDA Master Agreement or a Credit Support Document where the Bermuda Trust is itself "solvent": either a liquidator would be appointed and would (by court order) obtain the authority to (a) administer the ISDA Master Agreement and the relevant Credit Support Document or (b) transfer the obligations of the Trustee to a third party; or, a new Trustee may be appointed by the Bermuda Court pursuant to its powers under Section 31 of the Trustee Act 1975. In each case, the rights of the underlying parties (the beneficiaries) would survive.

Further, in these circumstances the assets of a Bermuda Trust constitute a separate fund and are not part of the Trustee's own estate (providing they have not been comingled with the assets in the Trustee's own estate).

Accordingly, Bermuda insolvency rules that apply to the general assets and liabilities of the Trustee should apply (if at all) separately to the Bermuda Trust's assets and liabilities². Any liquidator appointed (under the terms of a court order of the kind described above) to administer both the general assets of the Trustee and the assets of the Bermuda Trust would draw up one set of insolvency set off accounts between the Trustee and each of its creditors at the general account level and another set of insolvency set off accounts between the Trustee acting in respect of the Bermuda Trust and each of its creditors at the Bermuda Trust account level. The Counterparty would be entitled to exercise set-off rights and net its claims under any ISDA Master Agreement because the claims in either direction (i.e. by or against the Trustee and the non-Bermuda Counterparty) satisfy the mutuality requirement in the insolvent liquidation of the Trustee provided that (and as we assume is the case for the purposes of this advice) they all come into being while the Trustee is acting in the same capacity vis-à-vis the non-Bermuda Counterparty. Insolvency setoff under Bermuda law involves disregarding or looking through agencies and trusts and will only apply as between parties having the requisite beneficial entitlements under the relevant agreements.

Apart from, and in addition to, set off rights, the remaining net balance owing by the insolvent Trustee to the creditors of the Bermuda Trust would be satisfied out of the funds in the Bermuda Trust (even if the general creditors of the Trustee cannot be paid in full). These assets would remain available to meet the claims as against the Trustee acting in respect of the Bermuda Trust, notwithstanding the insolvency of the Trustee.

If instead of being administered by a liquidator, the assets of the Bermuda Trust are transferred to a third party Trustee, then insolvency set off would not apply and netting would operate according to the contractual provisions of the ISDA Master Agreement.

Most Master Agreements provide for Automatic Early Termination and thus where this applies (i.e. has been selected to apply in the Schedule) then the ISDA Master Agreement would automatically terminate on the insolvency of the Trustee, which may not be in the Counterparty's interests where there are sufficient assets remaining in the Bermuda Trust to meet its obligations under the relevant ISDA Master Agreement, especially in the Limited Recourse Situations. To avoid or reduce complications in this regard, Counterparties may wish to incorporate a contractual procedure that requires the Trustee to transfer his functions to a new Trustee nominated by the non-Bermuda Counterparty, immediately prior to the onset of insolvency (or as soon as practical thereafter), and to transfer (assign and novate) all documents and assets to the new Trustee and to take all other steps as may be necessary to accomplish this.

Insolvent Bermuda Trust, Solvent Trustee

Aside from the solvency of the Trustee, there is the question of the "solvency" of the Bermuda Trust itself (though, as indicated, a Bermuda Trust does not have legal personality under the law of Bermuda). Where the Trustee is solvent but the Bermuda Trust is insolvent, which is to say that the assets of the Bermuda Trust exceed its liabilities, then we are of the opinion that the close-out netting provisions of the ISDA Master Agreement should be effective simply as a matter of contract. Insolvency set-off cannot apply in these circumstances because, as indicated above, there are no statutory rules regarding the claims of competing unsecured creditors of a Bermuda Trust; this may be determined by the rules set out in the trust deed or such claims may be paid out by the Trustee in the order that they are made.

To the extent the Counterparty has a valid security interest over the Bermuda Trust's assets, then (and on the basis of which no issues of preferences and illegal conveyances prior to insolvency should arise, such a secured creditor should be able to realise his security out of the Bermuda Trust's assets ahead of the other (non-secured) creditors of the Bermuda Trust.

In the Personal Capacity Situations, the Trustee will be contractually liable for any shortfall in the Counterparty's claim against the assets in the Bermuda Trust, and so on the basis that the Trustee is solvent the Counterparty should be able to realise its claim in full.

Insolvent Bermuda Trust, Insolvent Trustee

Where the Trustee is insolvent and the Bermuda Trust is insolvent, which is to say that the assets of the Bermuda Trust exceed its liabilities, then the close-out netting provisions of the ISDA Master Agreement should be effective, in accordance with the analysis set out above under the heading 'Solvent Bermuda Trust, Insolvent Trustee'. Again, this is either as a matter of contract or by application of insolvency set-off.

In a case where both the Bermuda Trust and the Bermuda Trustee are insolvent and the Bermuda Trustee is the subject of insolvent liquidation proceedings, the net balance owing to any creditor of the Bermuda Trust would remain as a valid claim against the Bermuda Trust, as in the case where the Bermuda Trust remained solvent. If the Bermuda Trust is insolvent, however, obviously such claims could not be satisfied in full. In a case where the Bermuda Trust were being administered by a liquidator, creditors of the Bermuda Trust would be entitled to receive a pro rata distribution out of the assets of the Bermuda Trust to the extent of their net claims after applying set off.

Conclusion

Appleby's view as to the enforceability of the ISDA Master Agreements and the Credit Support Documents relating to a Bermuda Trust where the named Counterparty to the ISDA Master Agreement is a Bermuda Company in its capacity as Trustee of the relevant Bermuda Trust is that, inter alia, the provisions of the ISDA Master Agreements providing for the netting of termination values in determining a single lump-sum termination amount upon the insolvency of the Bermuda Trust or the Bermuda Company acting as Trustee of a Bermuda Trust are enforceable under the law of Bermuda.

When advising Counterparties of derivatives transactions with a Bermuda Trust, Appleby generally recommends that an additional trigger for termination be introduced in the ISDA Master Agreement, by reference to the financial position of the Bermuda Trust. The provision would entitle the Counterparty to Early Termination in the event that the liabilities of the Bermuda Trust exceeded its realisable assets (or some such test). Provided the Trustee is solvent at all material times and to the extent that the beneficiaries themselves are solvent, this would enable netting to occur on a solvent basis, which is not problematic. Even if the beneficiaries are not solvent, Bermuda insolvency set off either should not be called into application or produces a result that is generally consistent with the contractual close-out netting provisions of the ISDA Master Agreement.

Typically, a Bermuda Trust Counterparty will execute the ISDA Master Agreement on the basis of one of the Limited Recourse Situations. In each of these typical cases, either: (a) Bermuda insolvency principles will not apply (i.e. where there are no insolvent liquidation proceedings in relation to the Trustee) and close-out netting will operate in accordance with the contractual terms of the ISDA Master Agreement; or (b) if there are insolvent liquidation proceedings in respect of the Trustee, insolvency set-off may apply but will not create difficulties because the mutuality requirement for insolvency set off will be satisfied, and so the insolvency analysis as set out above will apply.

Recommendations

On the basis of the foregoing Appleby generally recommends that:

1. the insolvency of the Bermuda Company is not incorporated into the ISDA Master Agreements as an event that would automatically terminate/entitle the Bank to terminate the relevant ISDA Master Agreement, and instead to introduce an Additional Termination Event; namely, one that is triggered by reference to the financial position of the Bermuda Trust; and
2. parties contracting on an ISDA Master Agreement in relation to a Bermuda Trust take steps to ensure that any trust deed/settlement governing the Bermuda Trust include provisions whereby immediately prior to the onset of insolvency of the Trustee of the Bermuda Trust, a replacement Trustee is appointed as Trustee of the Bermuda Trust and the existing Trustee removed.

Footnotes

1 A Bermuda Company is exempted from the requirement to hold a licence if it is authorised to provide the services of a trustee only to the trusts specified – (a) in its memorandum of association; or (b) in the case of an overseas company, in its permit; and to such other trusts as the Minister may approve from time to time. A Bermuda Company that is exempted from the requirement to hold a licence as aforesaid is required to certify to the Bermuda Monetary Authority that it qualifies for an exemption.

2 There may be potential issues where the Trustee has a contractual right under the trust deed or other agreement against the Bermuda Trust's assets, e.g. an indemnity for expenses. Whilst this should not create significant difficulties, we recommend that specific advice be obtained in such event

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.