Shooting star

One of the great benefits of trusts is that they can enable family businesses to remain within the family long after the lifetime of the founder and, with careful planning, help the family avoid the typical story of rags to riches to rags in three generations. As a result, many trusts around the world hold a significant amount of their value in undiversified business interests.

Why should this be a cause for concern? The potential tension arises as a result of the trustees’ duties to invest prudently and to diversify. While such duties should obviously take the overall circumstances of the trust into account, those trustees with very significant value tied to the fortunes of just one or two businesses can find themselves at risk of a few sleepless nights. This is particularly acute in the current turbulent economic climate. However, there are a few things that trustees can do to ensure they sleep more soundly.

Best wishes

It is often presumed when the shares are being transferred that the settlor intends to create a legacy and ensure the company can remain in family control for generations to come. However, it is important to consider whether the settlor’s wishes actually relate to the best interests of the beneficiaries, or are simply for sentimental reasons that are entirely the settlor’s own.

Where there are grounds for retaining the shares, what is the best way to achieve this while removing as much of the dilemma as possible? The first option might be to delegate the investment decisions to the settlor. This implies that shares should be treated as investments and may overlook any broader beneficial purpose. If these powers then expire at the death of the settlor, the trustees may well feel uncomfortable retaining the same investments, particularly if a professional investment adviser would recommend ?a more diversified approach.

If the whole ethos of the trust centres on the retention of certain shares, arguably the better approach is to build provisions into the trust deed itself, identifying the relevant shares and creating a presumption that they will be retained indefinitely. Carefully drafted wording tends to accompany these sorts of provisions, removing any obligation to follow the performance of the company too closely (often referred to as an ‘anti-Bartlett’ clause) and attempting to exculpate the trustees if the shares are retained and subsequently drop in value.

Diversity dilemma

Relying on these type of clauses can be something of a grey area. This is particularly apparent where their effectiveness is dependent upon the trustees not receiving information about the underlying assets. Putting aside the fact that any prudent trustee is likely to require at least some understanding of how the business is performing, in these days of greater regulation it is highly likely that this will not be acceptable from a business perspective.

So what might the alternatives be? Many trustees and advisers in this position are turning to Cayman STAR trusts, the legislation for which was, after all, inspired by exactly this dilemma. The resultant regime encapsulates both non-charitable purposes and beneficiaries within the same trust. By enabling the maintenance of the business to be included as a purpose of the trust means that this can legitimately be considered by the trustees alongside the beneficiaries interests, rather than solely as a means of furthering them. A similar effect can also be achieved with a foundation if structured appropriately. For settlors who wish to take a very long-term view of the business and believe that it should remain within the family, these can be powerful ways of achieving their goal.

Although this area can be difficult to navigate, with sufficient knowledge, careful structuring and forward planning, a safe course can be steered. As with most matters, time and effort spent during the set-up period in this difficult area will reap dividends in the future. In the words of Warren Buffett: “Wide diversification is only required when investors do not understand what they are doing.” n