The most common tool used in the management and inheritance of family wealth in common law countries is the trust. For high-net-worth customers in mainland China, due to the lack of trust culture and the corresponding legal environment, there are certain obstacles in the understanding and application of the trust function. The foundation originated from the civil law system, and it is more in line both with China’s legal tradition, and the needs of private entrepreneurs and high-net-worth customers in the management and inheritance of family wealth. It has unique advantages.
The biggest difference between a foundation and a trust is that the foundation has an independent legal personality and no “shareholders”. There is no need for a “trustee” as a prerequisite for survival and operation, and no need for legislative innovation in order to make a trade-off between the trustee’s responsibility and the settlor’s rights.[1] On the other hand, the trust needs to rely on the trust company or the private trust company established by the settlor who is acting as a trustee for management purposes.
The trustee’s strict loyalty obligations, duty of care, and property segregation requirements need to be met. There may be a risk of the creditor initiating revocation proceedings. Therefore, the foundation has a more complete independence than the trust, which can better avoid the responsibility and risk affecting the related parties. Impermanence is the basic principle of UK Trust Law. After a certain duration, trust assets are either allocated or placed in another trust. But the foundation is an independent legal entity, and as long as there are no restrictions in the foundation’s charter and it remains registered, it can continue to exist indefinitely. Although it is virtually impossible, high-net-worth clients in mainland China generally have the perception that family wealth can be forever passed onto their offspring. However, this concept of eternal inheritance is contrary to trusts’ impermanent nature.
In the design of the trust system, the trustee is in the center. If the settlor passes over the trustee and directly manages the property, it may be considered a “false trust” in the United States and United Kingdom, and become invalid.
Equity trusts generally face several of the following dilemmas. Trustees usually do not have the professional knowledge required to operate a business, while the settlor and his family members are not willing to let the trustee actually participate in the management of the family business. In the case that the trustee has not fulfilled his fiduciary obligation to make a decision, which ultimately fails, he may be liable for compensation. Transferring equity to a private foundation can successfully solve the above dilemma because the foundation is centered on the promoter and operates according to the “charter” established by the promoter. The promoter can also serve as the director of the foundation council and continue to manage and operate the property.
Since the laws of mainland China belong to the civil law system and implement the principle of “one thing and one right”, there is no system in which the common law system has common law ownership and equity ownership. High-net-worth clients in mainland China generally have problems with understanding the trust system. More importantly, due to the lack of trust culture in China, it is difficult for the settlor to hand over the property to the trustee for management. Even if it is handed over to the trustee for management, it is often necessary to attach a lot of control and supervision provisions in line with the “fake trusts” of the Anglo-American legal system, which means the trust faces the risk of being revoked or penetrated in the future.
However, the foundation originated from the civil law system. There is no legal barrier for settlors in mainland China. The foundation is centered on the promoter’s willingness to set it up. It can meet the interests of entrepreneurs’ public welfare and private interests. It is more suitable for China’s national conditions and is conducive to family business inheritance and wealth management, and therefore has a wide range of application for customers in mainland China.
Influenced by traditional Chinese Confucian “gentlemen culture”, both mainland China and the Taiwan region of China define the foundation as an organization with the nature of single public welfare, separating the family charity from inheritance.
Mr. Wang Yongqing, an entrepreneur in Taiwan, once tried to set up a family business held by a charity foundation, and established the Chang Gung Hospital Public Welfare Foundation to deliver all the shares of Formosa Plastics Group at home and abroad to the Foundation. The Foundation became the controlling shareholder of Formosa Plastics Group. However, due to the very large restrictions on the governance structure and beneficiary arrangements of the charitable foundation, it is impossible to solve the problem of family business inheritance and tax planning. Compared to a single charitable foundation, a hybrid foundation that takes into account public and private interests is more humane and in line with the needs of high-net-worth clients.
A hybrid foundation is a foundation that has both a public interest and a private interest as its purpose. The hybrid foundation is a legal person without shareholders. It is a simplification of the complex corporate relationship of the company, avoiding the risk of splitting the family due to a dispute over property rights between family members, and greatly improving the competitiveness and cohesion of the family business. The hybrid foundation is suitable for the ultimate controller of the inheritance of a family business and charity.
In Europe, many well-known companies have adopted the hybrid foundation as the ultimate owner of a corporate group, playing the role of a holding company and also fulfilling the charity function of the family business. In the design of the trust structure, there is a secondary trust relationship between the equity trust of private trust companies and the purpose trust of licensed trust companies. The structure of the purpose trust in achieving permanence is too complicated, and is often not understood by the high-net-worth clients in mainland China. For the inheritance of family wealth, the most economical (and relatively simple) structure is to make the hybrid foundation become the shareholder of the industrial company, without it needing to carry out the secondary structure design of the purpose trust.
Now Monaco, Liechtenstein, Austria, Panama, Belgium, Germany, Switzerland, the Netherlands and other countries allow foundations to serve both public and private interests. For example, in 1847, J.C. Jacobson established the Carlsberg Brewery, and in 1876 the Carlsberg Foundation was established. The Foundation holds 30.3% of the convertible shares of the Carlsberg Group and enjoys 75% of the voting rights. The objectives of the Carlsberg Foundation are: (1) possessing a controlling stake in the Carlsberg Group to ensure a decisive impact on the Carlsberg Group strategy; and (2) supporting basic scientific research through donations to social welfare projects. The Carlsberg Foundation not only guarantees the development of family businesses, but also serves social welfare.
In the private foundation, the family member is designated as the beneficiary of the foundation to achieve personal or business goals. The foundation allocates benefits to its family members in accordance with the provisions of the Charter, and meets the needs of family members for survival, education, and development. Once the private foundation is established and the legal property is transferred to the foundation, the property is independent of the other assets of the promoter. The debts owed by the promoter and even bankruptcy are isolated from the property of the foundation.
Property assets in private foundations are more independent than trusts. In mainland China, private enterprises earn non-monopoly profits without the advantages of policies and resources, and also face unequal treatment of industry access, along with the financing and tax environments. In order to survive, private enterprises must innovate in areas such as their business model and financing model. Such innovation is full of various kinds of uncertain potentially criminal risks. Even in order to obtain industry access qualifications, some private entrepreneurs are forced to pay bribes to government public officials with approval authority. It can be said that many private entrepreneurs face being found guilty of imprisonment. Therefore, many private entrepreneurs in mainland China have the need to protect family wealth and family members through the establishment of private foundations.
Since the private foundation has the characteristics of being promoter-centered rather than trustee-centered, the management of the private foundation relies on the provisions of the foundation charter, and the promoter can also serve as the director of the foundation council and continue to manage and operate the property. The operation of the private foundation can be carried out in full accordance with the wishes of the promoter, without the need to worry about the trustor having control over the trust and penetrating it or making it invalid. Therefore, family businesses can use private foundations for family wealth management as they wish.
The advantages of private foundations in the protection and management of family wealth have been recognized by more and more offshore countries and European countries. On June 7, 2015, the European Foundation Centre released the “Essentials of Foundation Law: The Operating Environment of the European Foundation”. Among 40 countries studied comparatively, 22 countries including Austria, Belgium, Bulgaria, Finland, Germany, Hungary, Greece, Italy, the Netherlands, Sweden, Liechtenstein, Switzerland, Norway, and Turkey allow the establishment of private foundations. It should be said that in the civil law system, the establishment of a private foundation or a hybrid foundation has entered the mainstream
[1] For example, the VISTA Act of the British Virgin Islands and the STAR Act of the Cayman Islands limit the trustee’s responsibility and protect the settlor’s control rights.
