A mistrust of trusts? | In Principle

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A mistrust of trusts?

In common-law jurisdictions, the trust is a popular form for achieving various aims: managing assets, inheritance, building corporate structures, and tax planning. But countries from the Continental legal tradition, like Poland, typically do not have any institution directly corresponding to a trust. Polish doesn’t even have a word for it. This has raised doubts over the years and sometimes even suspicion on the part of courts and lawyers when they need to determine the consequences exerted by a trust in actual or potential disputes in jurisdictions unfamiliar with this form. Are their suspicions well-founded?

What is a trust?

To answer this question, we must examine the notion of a trust within its native legal environment, i.e. the law of England and Wales and state law in the US.

In the simplest terms, a trust is an arrangement where certain assets are held by a trustee who is their formal legal owner, but for the interest and benefit of another person, the beneficiary of the trust. The trustee is required to handle the trust assets with due care and loyalty toward the beneficiary, i.e. property of another entrusted for safekeeping. This is why ownership of the assets in a trust is divided: “bare” title is held by the trustee, while the ownership of the ultimate benefits generated by the trust (beneficial ownership) is vested in the beneficiary. Moreover, the assets are held by the trustee in a separate trust fund which is not subject to execution by the trustee’s own creditors.

Beyond this basic outline of the structure of a trust, its features may differ significantly, as one of the key advantages of trusts is their flexibility.

Thus a trust can be established by a third party (known as the grantor or settlor), or by the trustee or even the beneficiary. Interestingly, the beneficiary may even in certain configurations also be simultaneously the trustee, but only in a temporary sense (for example in “living trusts” used among other things as a method of inheritance).

The beneficiary may be indicated by name, or may be a person or institution not existing at the date the trust is established (e.g. future children), or a certain category of persons with characteristics defined by the grantor (where the specific beneficiaries are then chosen by the trustee). In the case of charitable trusts there is no beneficiary as such, but only a defined aim which the funds in the trust are to be used to pursue.

Distinctions can also be made in the rights of the beneficiary. Traditionally, a fundamental right of the beneficiary is to demand transfer by the trustee of ownership of the assets in the trust. But the terms of the trust may provide that for a certain period, or indefinitely, the beneficiary will have a right only to the income on the property, for example receiving regular payments from the trust, or may only have a right to make present use of the assets. The scope of the beneficiary’s rights assumes additional importance as it determines the extent to which the trust assets are protected against the beneficiary’s own creditors, who can execute only against any rights the beneficiary has under the trust. If these rights do not include a claim for transfer of ownership of the property in the trust, then as a rule the assets of the trust will be protected against execution (in particular, execution against the trust by the trustee’s creditors is excluded). Indeed, this is one of the reasons for establishing trusts designed to protect beneficiaries against their own profligacy (known as “spendthrift trusts”) or more generally against the consequences of poor life choices.

An important feature of the beneficiary’s rights is that as a rule, they lie against the trustee. I say “as a rule” because in certain circumstances the beneficiary may also have a claim against third parties, for example if they have come into possession of trust property or interfered with the property in some other way.

How is a trust created?

The basic method for creating a trust is a declaration by the grantor. In practice, this typically is made in the solemn form of a deed, a document made under seal, signed by the grantor and two witnesses—a form used in common-law countries comparable to the notarial deed used in the Continent. The document is usually signed also by the trustee, but this is not strictly required.

A trust may also arise by implication, i.e. when the overall behaviour of the person demonstrates that the true intent was to create a legal relationship in the nature of a trust—known as a “resulting trust”—even if this is not what the grantor expressly stated.

Finally, a trust may arise by operation of law or pursuant to a judgment (although de facto in either case this will only be confirmed when a judgment has been issued) in a situation where it is required by broad principles of equity. This is known in English as a constructive trust. This happens when the court finds that other available legal instruments will not adequately secure the legitimate interests of the parties. This category of trusts may seem the most “alien” to Continental law, and may be described as a specific gap-filling instrument in common-law systems. Nonetheless, an examination of the judgments from courts in those systems suggests that a constructive trust plays a role analogous to the notion of unjust enrichment, which is well-known in Continental legal systems.

What’s the problem?

The foregoing description refers to how a trust is treated in countries expressly providing for such an institution in their own law. The problem arises when the consequences exerted by a trust must be examined by a court or state authority in a country whose law does not contain the notion of a trust—for example Poland.

One way this might arise is if a creditor attempts to execute against trust assets located in a jurisdiction that does not have trusts. To this end, the trustee, or less often the beneficiary whose rights derive from the deed establishing the trust, will appear before the court or administrative authority. Then the judge or public official must answer a number of questions to determine whether the petitioner has a right to commence the proceeding, and then whether the rights arising under the trust are subject to protection in Poland, and if so, to what extent and under what conditions.

The legal issues that arise in this area are numerous and some of them are quite complex in their details, and thus I present here only an outline of the most important issues.

Which law applies?

The first question is the applicable law, which always arises when the court must assess a situation containing a foreign element. The rules for selecting which country’s laws apply, containing conflict of law standards, are used to assess the situation. In Poland these rules are found primarily in the Private International Law of 4 February 2011 and in a number of EU regulations and international conventions binding on Poland.

Unfortunately, none of the legal acts in force in Poland contain rules directly addressing the law governing trusts. In particular, Poland is not a signatory of the 1985 Hague Convention on the Law Applicable to Trusts and on Their Recognition, which is in force in many European countries. This is doubly unfortunate, as Art. 6 of the convention gives the settlor of a trust the freedom to select the law governing the trust, and in most instances this solves the problem.

Consequently, under Polish law there are two paths for seeking the law applicable to a trust. The first is based on the conflict of law rules covering similar legal relationships (by analogy), and the second is to apply the stopgap rule under Art. 67 of the Private International Law, which provides that if there are no standards in force in Poland (including EU regulations) covering the situation, the law of the state most closely connected with the legal relationship in question will apply. Each of these methods can lead to equivocal and unpredictable results.

Seeking conflict of law rules governing “similar” relationships can lead to various conclusions, because a trust may combine characteristics and functions realised in Polish law by institutions of the law of obligations (particularly contract law), as well as property law, inheritance law, and even corporate law. Generally, it is desirable to apply conflict of law rules for obligations (not necessarily contractual obligations), because this opens a path to recognition of the choice of law for the trust under the EU regulations governing contractual obligations (Rome I, 593/2008) and non-contractual obligations (Rome II, 864/2007).

But if instead of analogy, we try to identify the state with which the trust is most closely connected, we are inevitably faced with the vagueness of this formulation. Even if we are familiar with the detailed circumstances of the trust, it is hard to guess in advance how the court will decide, unless all or nearly all of the facts point to a single state.

Without entering into the details of the process of seeking the governing law for a trust, it can generally be stated out that the greatest risk tied to this issue is the possibility that the court may decide to apply Polish law or the law of another country that does not have trusts. Such a conclusion cannot be ruled out, particularly when most of the assets covered by the trust, as well as the trustee or beneficiary, are located in that country.

In the worst-case scenario, this will lead to a finding that the act of establishing the trust was invalid, thus treating the relations between the persons and property as if there were no trust. It may be assumed—and it would be desirable—for the court to attempt in that case to try to achieve results consistent with the intent or at least the interests of the participants in the trust by applying institutions of Polish law serving analogous functions (e.g. unjust enrichment, or administering the affairs of another person without a mandate) relevant to the given state of facts.

In a better scenario, there may be an attempt to validate the act establishing the trust in its entirety as a contract. This is problematic, as a trust is generally established unilaterally. To rescue the consequences intended to be achieved by the trust, it should therefore be demonstrated that the persons mentioned in the document establishing the trust (the trustee and the beneficiary, at least) consented to the provisions of the document, i.e. accepted their roles as provided in the structure of the trust, which can enable the court to find that a contract was concluded under the terms provided for in the deed establishing the trust.

Will the trust be recognised?

Even if the law which was supposed to govern the trust can be found to be applicable (or at least some other law providing for trusts), the problems don’t necessarily end there. The consequences arising under foreign governing law are recognised and enforced by the courts only as a rule—so long as they do not violate the public policy of the state before whose courts the case is heard.

It would be an obvious overstatement to claim that a trust as such is contrary to Polish public policy simply because Polish law does not have trusts, and thus in the eyes of the court they exert no effects—although unfortunately statements to that effect can be encountered even in the contemporary case law. In Continental countries with a longer and more extensive history of contacts with common-law systems, the courts and the legal commentators quite correctly rejected such an approach decades ago.

It cannot be concluded from any general principles of Polish law or constitutional standards that trust relationships are prohibited. To the contrary, many instruments of Polish law assume (or may assume) such a character, such as a contract of mandate, administration of the affairs of another without a mandate, or the functions of receivers and administrators in bankruptcy and restructuring proceedings. Assumption of title for security also has a specifically trust-like character.

So it should rather be accepted that as a rule, trusts and the legal relationships arising out of them are consistent with Polish public policy. Possible inconsistency might apply at most to specific consequences generated by trusts, or only the effects with respect to certain assets of the trust, e.g. real estate in Poland (as trading in real estate and establishment of rights to real estate are subject to special requirements).

Moreover, not all the potential conflicts that might arise can be predicted in advance, due to the flexibility of the trust structure on one hand and the vagueness of the notion of public policy on the other. It may generally be said that doubts should not be raised by the status of the trustee as the legal owner of the assets of the trust, and thus authorised to act in the role of owner in all types of proceedings and contracts. The position of the beneficiary may prove more problematic. While the beneficiary’s claims against the trustee should generally be recognised and enforced, problems may arise in the event of claims by the beneficiary against third parties with whom the beneficiary has no legal relationship. This may run up against a barrier in the form of one of the fundamental principles of Polish civil law, under which in rem property rights (i.e. those effective erga omnes—against all the world) may be established only pursuant to statute.

Doubts as to consistency with public policy may also be raised for example by the segregation of trust assets from the general assets of the trustee as a separate pool (including for purposes of execution), as well as certain consequences of the use of trusts as a vehicle for inheritance (e.g. connected with the right to a forced statutory share of the decedent’s estate).

How to manage these issues?

Obviously, the simplest method for avoiding these difficulties would be not to bring about a situation where it would be necessary to rely on the structure of a trust before Polish courts or authorities. Thus it would be safest to exclude property from the trust that is actually or probably located in Poland. But this point is generally addressed to the settlor at the planning stage, and provides little help to the beneficiary or trustee facing an existing state of affairs.

Moreover, in some situations the location of trust assets in Poland may be accidental and unforeseeable, or may be secondary to other considerations deciding on the use of the trust structure, e.g. when most of the assets are located in a state that does have trusts, or the use of trusts in a integral part of a broader strategy of the given enterprise.

If it is necessary to pursue rights under a trust in Poland, it is important to carefully consider the situation and tailor the strategy accordingly. Given the array of situations that may arise in practice, due among other things to the flexibility of the trust, there is no single approach, but only certain general guidelines can be indicated.

When it comes to acting against third parties (i.e. not bound by the trust), it may be optimal for the trustee to act, first and foremost holding documents proving the trustee’s legal title (or other rights) to the specific assets of the trust. Unless it is necessary for some reason, it may be better not to disclose or emphasise the existence of the trust, or at any rate create the impression that the trustee is acting for another person.

If the beneficiary must pursue rights against the trustee, apart from the deed establishing the trust it is also important to hold evidence of the trustee’s consent to take on that role. In that case, it will be hard to avoid an examination of the rights and obligations arising out of the trust relationship and the issue of the governing law. Given the complexity of these issues and the still relatively low familiarity with them under Polish conditions, it is essential for the litigants to explain them thoroughly to the Polish court or authority, ideally using excerpts from the law governing the trust. If possible, efforts should be made to apply that law, stressing the connections between the trust and the legal system in question.

As a precaution, it should be considered whether the claims could be based on any institutions of Polish law. If so, that can be indicated as an alternative ground for the relief sought. It cannot be ruled out that in some instances, it will be possible and more advantageous to base claims solely on Polish law, ignoring the trust relationship.

Maciej Zych, adwokat, Dispute Resolution & Arbitration practice, Wardyński & Partners