"What are the differences between trusts and foundations?"
"Which is better between a foundation and trust?"
These and similar questions are quite commonly asked and the answer is really that it depends on a variety of factors which must be considered for each client. There are many similarities with trusts and foundations. For the purpose of this comparison we will narrow the focus to "private" foundations and trusts. The following is a comparison (if grossly oversimplified) between trusts and foundations covering the similarities as well as the key differences, advantages and disadvantages of each.
The classic definition of a trust is (from Underhill & Hayton, Law of Trusts and Trustees):
"A trust is an equitable obligation, binding a person (called a trustee) to deal with property owned by him (called Trust property, being distinguished from his private property) for the benefit of persons (called Beneficiaries or, in old cases, cestuis que trust), of whom he may himself be one, and any one of whom may enforce the obligation."
A further definition of trusts, which is more in the form of a description, is that in the Hague Convention on the Law Applicable to Trusts and on their Recognition:
"For the purposes of this Convention, the term "trust" refers to the legal relationships created 'inter vivos' or on death by a person, the settlor, when assets have been placed under the control of a trustee for the benefit of a beneficiary or for a specified purpose."
At the very basic level, the concept of the trust is relatively easy: a person (settlor) places assets in the legal custody of another (trustee) held for the benefit of some third party (beneficiary). The trust is not a separate legal entity, but more of a legal "obligation" agreed between two parties: the settlor and the trustee. This sounds simple enough, correct? Trusts are of course much more complicated than this, but this is the basic concept anyway.
There are three minimum certainties for a trust to be valid:
- "Certainty of Intention": the settlor must have clearly intended to settle the trust and confer legal control of assets.
- "Certainty of Subject Matter": the assets that are to form the trust must be clearly stated.
- "Certainty of Objects": it must be clear for whom the trust was created and subsequent assets transferred to the trust are being held.
These are only the bare minimums for the trust to be valid and courts cases throughout the world have provided for many variations and interpretations of these matters. Surprisingly, a fair percentage of trusts being established likely fail at least one of these critical criteria. This could lead to a great deal of money is spent on legal fees trying to defend the validity of the trust at some later date when the settlor is sued by a creditor, family member, someone who slipped and fell on their property, etc.
Two common issues which lead to challenges of validity of a trust are as follows:
- the settlor wants to maintain full control of the trust assets and trust decisions;
- legal title of assets intended to be part of the trust property is never conferred to the trustee;
Failing either of these or a number of others can lead to all sorts of potential legal issues for the settlor. A court could determine that the trust is a "Sham Trust" and order any assets transferred (assuming they ever really were) to be repatriated as part of a settlement. To battle this, many offshore jurisdictions (international financial centres) have enacted specific trust laws which make it difficult to declare a trust "invalid".
Probably the biggest advantage of a trust lies in the fact that it can be used for business purposes whereas most foundation jurisdictions limit the use of a foundation to non-commercial uses. Trusts may be used to purchase property, accrue capital in mutual funds, sign international contracts in order to facilitate exchanges and avoid taxes. In this regard, unit trusts are particularly popular in the real estate and financial fields whereby investors purchase "units" in real estate investment trusts "REITS" and mutual funds or hedge funds.
Perhaps it is best to first start by defining the private foundation. One of the most comprehensive definitions of a private foundation comes from John Goldsworth, founding editor of "Trusts and Trustees" and a renowned expert on trusts and private foundations:
"A private foundation" is an independent self-governing legal entity, set up and registered or recorded by an official body within the jurisdiction of where it is set up, in order to hold an endowment provided by the founder and/or others for a particular purpose for the benefit of beneficiaries and which usually excludes the ability to engage directly in commercial operations, and which exists without shares or other participation."
Just from this definition, even the casual observer should begin to see some differences between foundations and trusts. Looking at this carefully:
1st phrase: "A private foundation is an independent self-governing legal entity"
We can see that, unlike the trust, a private foundation is a separate, self-governing legal entity. It is not an "obligation" as with a trust, but a completely separate legal entity.
2nd phrase: "set up and registered or recorded by an official body within the jurisdiction of where it is set up"
Here we see that a private foundation is registered or recorded (usually publicly) which is not usually the case with a trust.
3rd phrase: "in order to hold an endowment provided by the founder and/or others"
Assets placed into a foundation may come from the founder and/or any other third parties depending on the purpose of the foundation. This is different from a trust whereby the settlor must places assets into the custody of a trustee when establishing the trust to be administered and held on behalf of the beneficiaries named by the settlor.
4th phrase: "for a particular purpose for the benefit of beneficiaries"
Trusts and foundations are similar in this regard.
5th phrase: "and which usually excludes the ability to engage directly in commercial operations"
Trusts may be used for certain commercial purposes where private foundations may not carry out commercial activities.
6th phrase: "and which exists without shares or other participation"
Both trusts and foundations have beneficiaries rather than shareholders.
So it is established that trusts are susceptible to validity issues and can lead to legal issues and adverse consequences in situations whereby the trust is labeled a "sham trust". Unlike a trust, a foundation cannot be deemed a "sham foundation". The main reason is relatively simple: unlike a trust, is a private foundation is are separate legal entity incorporated like a company and thus has separate legal personality. Thus by the very fact that it is incorporated, which is confirmation that the foundation meets the legal requirements of the law that governs foundations, it exists as a separate legal "person" and therefore cannot be set aside as a "sham" by a court of law.
How can a foundation be used when the objects include commercial activities? This is a common question and one that is easily accommodated by inserting one or more underlying offshore companies (such as an international business company) with the shares 100% owned by the foundation. This offers all of the protection and advantages of the foundation while allowing for a wide range of business uses to be carried out through the underlying offshore companies.
This is by no means a thorough comparison of the two structures; however it is a good start and should help clarify some of the major points. A further analysis of the specific trust and/or foundation laws in each jurisdiction would be necessary to make any further distinctions.
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