Trusts are usually seen as an estate or tax-planning tool. However, in certain circumstances they can also provide an element of protection against the claims of both present and future creditors.

A trust is created when the legal and beneficial ownership of an asset are separated, the beneficial ownership either remaining with the original owner or shared amongst a group of beneficiaries, one of whom may or may not be the original owner. This separation of legal and beneficial ownership is what provides a trust with asset protection features. However, the fact that the transfer of property to the trust is usually gratuitous makes it vulnerable to subsequent attack if the contributor is unable to satisfy the claims of his creditors.

Some offshore jurisdictions have exploited the concept of "asset protection trusts" by enacting legislation, which severely restricts the rights of creditors to lay claims to assets that have been transferred to a trust by a debtor. Bermuda, however, conscious of its international reputation has deliberately avoided taking such a step; instead, it has tried to strike a balance between the rights of the individual to take reasonable steps to protect his or her property and the rights of creditors with legitimate claims.

In 1994 Bermuda adopted legislation which created the concept of the "eligible creditor". As a general rule, the legislation provides for a window of two years during which persons can qualify as creditors of the person who has contributed assets (to a trust). In this context, "creditor" includes not only a person to whom the contributor was liable under a contract, but also someone in respect of whom the contributor is in breach of a duty of care owed to that person; for example, a person injured as the result of negligent driving by the contributor. An "eligible creditor" has six years to begin legal proceedings against the contributor, the point in time from which the period runs depending on the type of creditor.

In order to succeed in having the transfer to the trust set aside, the creditor must prove, on what is called "a balance of probabilities", that the main purpose of the contributor in making the transfer was to put assets beyond the reach of his or her "eligible creditors".

These rules apply whether or not bankruptcy proceedings have been started against the contributor. However, bankruptcy law also permits transfers of property, including the creation of trusts, to be set aside under certain circumstances. For example, if the contributor becomes bankrupt within two years after the date of transfer to the trust, the transfer is void against the trustee in bankruptcy. Furthermore, a transfer made within the period of five years preceding the bankruptcy order is also void, unless the trustees can prove that the contributor was, at the date of the transfer, able to pay all his debts without having to resort to the property contributed to the trust, and that the contributor's interest in the property passed to the trustees at the moment when the trust came into being.

It is clear, therefore, that the intention of the person transferring assets to a trust is the crucial factor when it comes to a court deciding whether or not to set aside the transfer. Only if the circumstances surrounding the transfer show that the main purpose in establishing the trust was to put assets out of the reach of creditors will a court allow the trust to be unwound. However, if the contributor can show that the trust was created principally to minimise taxes or to provide for the orderly passing of the family wealth or business to the next generation, for example, the trust, is likely to remain intact.

On a final and very practical note, persons who establish trusts in the more "aggressive" jurisdictions may yet find themselves at the mercy of the courts of the jurisdictions in which they are resident or where they have property. In one notorious case involving a trust established in the Cook Islands, a US court incarcerated the contributors of property to the trust until they had signed documents effectively assigning control of the trust to the US Federal Trade Commission.

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Attorney Katharina A. Byrne is a member of the Trusts and Financial Structures Department of Appleby Spurling & Kempe. Copies of Ms. Byrne's columns can be obtained on the Appleby Spurling & Kempe website at www.ask.bm.

This column should not be used as a substitute for professional legal advice. Before proceeding with any matters discussed here, persons are advised to consult with a lawyer.