The history of private foundations is as long as that of the trust system in Britain. Rooted in a continental legal system, private foundationshavealso absorbed some concepts from trust laws and modern corporate lawsunder the common law system, and have acquired some aspects of trusts too. However, running in a similar corporate pattern, private foundationsare a legal subject with independent corporate capacity. Therefore, the private foundation system is regarded as the trust system under civil law.
- I. Advantages of Private Foundations
Compared with trusts, private foundations have the following advantages in terms of family wealth management:
- Perpetual Existence
Traditionally, the perpetual existence of trusts is forbidden in British trust law. Upon maturity, trust assets should either be distributed or transferred to another trust. However, the inheritance of family wealth and the governance of family businesses require long-term running. To meet such requirements, some offshore territories prolong the duration of trusts by legislation. The British Virgin Islands, among others,has extended the duration of trusts to 360 years, and the Cayman Islands and the Bahamas have extended the duration to 150 years. The usual way to achieve the perpetual existence of a trust is by establishing an offshore private trust company and then entrusting the stock rights of the private trust company to a licensed trust company through a special purpose trust. However, under continental law, such a structure is too complicated to be accepted and understood by the trustor.In contrast, private foundations (as independent legal entities) can last as long as the registration status is maintained.
(2) Ultimate Ownership of Family Wealth
Private foundations inherit the principle of “One Property, One Right of Ownership” under continental law. Once the founder donates his/her properties to a private foundation, such properties will no longer belong to the founder, and the private foundation will enjoy the full ownership of such properties. Unlike a company, a private foundation has no shareholders or any ultimate owner other than the foundation itself.This eliminates the private foundation founder’sanxiety overloss of family wealth in the continental legal system. Therefore, the management of family wealth through private foundations can be easily understood and accepted by founders in the continental law system. However, to set up a trust, the transfer of ownership of properties to the trustee is required, which makes founders in the continental law system worry about their safety. Offshore private trust companies (PTC) may eliminate such a worry to a certain degree, but stability of their existence is still threatened by the birth, senility, death, and illness of the shareholders of the private trust company, among others. Making a private foundation a shareholder of a private trust company is a legitimate legal aspect of family wealth management.
(3) Ultimate Control and Management of Family Wealth
A private foundation is an independent legal entity. Once a founder transfers or donates family wealth to a private foundation, the ownership of such assets belongs to the private foundation. Private foundations have no shareholders or owner other than the foundation. In the same way that a person can, a private foundation can control family wealth by possessing shares and assets of a private company as the ultimate owner of family wealth.
Each private foundation has specific responsibilities and functions. All of a private foundation’s legal duties (limited to those specified in the Articles of Foundation) shall be borne by the council or committee of the foundation. Families with greater financial capacity can set up a private foundation as the unique family office to manage family affairs, thus avoiding the legal risks caused by information asymmetry arising from the entrusting of the management rights of family affairs to others.
- II.Limitations of Private Foundations
Compared with trusts, private foundations have certain limitations in terms of the management of family wealth.
- Private foundations have less flexibility and freedom
Normally, private foundations can only be established in conformity with a country or special jurisdiction’s legislations. A private foundation is a person, legally speaking, viewed as independent in the eyes of the law. Countries specify the conditions for setting up private foundations with accompanying legislation. For example, according to the Private Foundation Law of the Republic of Panama, the Articles of Foundationare required to be registered with the public registry and the original capital value of a private foundation cannot be less than 10,000 US dollars.In Liechtenstein, the Human and Company Law (amended in 2008) requires that mixed foundations founded mainly for public benefits are supervised by the government. However, trustsare only designed as a management system for family wealth and family affairs and do not have an independent corporate capacity.The trustor may set up several trust plans according to his/her personal and family demands. Such plans are not normally required to be registered with or supervised by the government, except when specified by countries that are governed under continental law. China,for example, has some special requirements regarding trusts.
When a private foundation (especially a mixed foundation) cannot be validly set up, or the initial reason for its establishment is no longer valid, private funds cannot be withdrawn. The court will not dispose of such assets. Normally, the assets will be used for social welfare and public benefits, rather than being returned to the founders or their relatives.
(2) Private foundations are not as widely-accepted as trusts
Although the private foundation system originates from the continental legal system – and countries and regions that are governed by continental law, such as Liechtenstein, Panama, Austria, Italy, the Netherlands, Switzerland, and Antilles have already implemented corresponding legislation –they are not generally accepted under continental law. For example, China has only formulated the Regulations on Funds specifically for public welfare foundations. The Federation of Saint Kitts and Nevis and the Bahamas – both of which belong to the British Commonwealth – along with Jersey and Guernsey, among others, have all formulated laws on private foundations. However, the private foundation system has not been recognized by countries led by Britain and the US. In contrast, the trust system has already been recognized by most countries in the world, including those within the continental legal family. As for the management of family wealth, more countries accept trusts than private foundations.
(3) Trustsare more beneficial for tax planning and the protection of privacy
Since private foundations are an independent legal entity and an independent tax payer (while trusts are not), trusts have advantages over private foundations in terms of tax planning. For example, the TaxLaw amended by Liechtenstein in 2010 made the trust more competitive than the private foundation in terms of tax payments. Trustsare not required to file tax statements. In spite of the form and value of trusted properties, they are only required to pay a small amount of tax (1,200 Swiss francs). In contrast, as an independent legal entity, private foundations have to submit a statement of Private Property Structure (PVS) to the government if they want to be exempted from the obligation of filing tax statements or paying the minimum profit tax. Such requirements don’t apply to trusts.
Compared with trusts, private foundations needs to be registered. As to the privacy management of family properties, offshore trusts are also slightly better because they doesn’t need to be registered.
- III. Governance of Private Foundations
Theoretically, private foundations may exist forever. However, because private foundations don’t have a complete ternary governance structure consisting of owner, performer and supervisor, the founder has no power after the establishment of a foundation if he/she doesn’t stipulate the reserved right to revoke the articles of foundation.Unlike the beneficiary of a trust,the beneficiary of a foundation doesn’t have equitable ownership. The beneficiary is not the creditor of the foundation either. Unless permitted by the Articles of Foundation, the beneficiary cannot claim rights against the foundation. As a matter of fact, the private foundation has a binary governance structure consisting of the council and the protector of a foundation. The natural defects within the foundation tend to result in moral hazards, so the founder needs to thoroughly think over the regulations and planning of the governance structure of a foundation through articles and corresponding rules of the foundation before setting one up.
- Governance Documents for Foundations
Normally, the foundation’s governance documents include the articles of foundation and various rules and regulations.
The Articles of Foundation refers to the written document which needs to be publicized with the registration authorities and to provide basic information about the establishment of the foundation, as required by law. As to the governance of foundations, the Articles of Foundation normally includes the name list and addresses of the members of the council, and specifies whether the founder has the right to amend the Articles of Foundation in due course.
Rules and regulations of the foundation refer to the unregistered documents which are confidential and privately agreed upon. Any information which is not required by law to be disclosed in the Articles of Foundation and considered by the founder as confidential can be recorded in the rules and regulations. As to the governance of the foundation, the rules and regulations of the foundation normally specify in detail the duties, tenure, remuneration and process of selecting new candidates as members of the council and protectors of the foundation.
(2) Council of Foundations
Sometimes called the committee of foundations, the council of foundations is a permanent body with the right to control and govern the foundation. According to the regulations of the Human and Company Law of Liechtenstein, the council of foundations consists of at least two natural persons or legal entities. Generally, the council of foundation has the following powers: 1.)to execute the Articles of Foundations and amend the articles according to the authorization; 2). to appoint and replace the beneficiaries according to the articles and regulations; 3.)to distribute, operate and dispose of the foundation’s properties; 4.)to sign relevant external contracts on behalf of the foundation. The Articles of Foundation may restrict or expand the rights and stipulate the voting procedure of the council of the foundation. The founder may reserve his/her or others’ rights to dismiss and replace members of the council of the foundation.
(3) Foundation Protector
The foundation protector refers to the natural person or legal person who accepts the commission or appointment of the founder to supervise the council of the foundation and protect the interests of the beneficiaries.
The protector has the following powers:
1) To authorize the behavior of the council of the foundation beyond the Articles;
2) To add and replace beneficiaries;
3) To supervise the council of the foundation and request information about the foundation’s accounts and finances.
The foundation protector can supervise the behavior of the council of the foundation together with auditors or other supervising entities.
Like the offshore trust system, the system of many private foundations is still developing. In order to enhance competitiveness, offshore trusts and private foundations learn from and combine with one other to satisfy high net-worth clients’ demand for wealth management.
By Liang Han
Mr. Liang Han Professor at Nankai University Law School, Doctorial Tutor, Director at King & Capital Law Firm Family Trust Law Center
