A wealth planning tool in Luxembourg: the fiduciary contract
Whilst Luxembourg has no specific trust law already existing for several centuries in Anglo-Saxon countries, since 1983 the arrangement of fiduciary contract had been used by financial institutions established in the Grand-Duchy.
Apart from some cases which dealt with the recognition of foreign trusts, until the Law of 27th July 2003 on the fiduciary contract (the “Law”) has been passed, there was no real legal certainty concerning the subject as to how it fits to the definition of trusts mentioned in the Hague Convention on the law applicable to trusts and on their recognition (the “Hague Convention”). The Law has provided for a new regulation on the fiduciary contracts and also ratified the Hague Convention.
According to the definition provided by the Law, a fiduciary contract is a contract by which a person, the principal (the “fiduciant”), agrees with another person, the fiduciary (the “fiduciaire”), that, subject to the obligations determined by the parties, the fiduciary becomes the owner of assets which shall form a fiduciary property.
The fiduciary assets are transferred to the fiduciary without any consideration and according to the obligations laid down in the written contract entered into by the principal and the fiduciary, the fiduciary shall manage such assets as fiduciary estate in a fiduciary capacity. The fiduciary concept complies with the definition of trusts set-out in the Hague Convention, according to which a trust has the following characteristics:
a)the assets constitute a separate fund and are not a part of the trustee’s own estate;
b) title to the trust assets stands in the name of the trustee or in the name of another person on behalf of the trustee;
c) the trustee has the power and the duty, in respect of which he is accountable, to manage, employ or dispose of the assets in accordance with the terms of the trust and the special duties imposed upon him by law.
The reservation by the settlor of certain rights and powers, and the fact that the trustee may himself have rights as a beneficiary, are not necessarily inconsistent with the existence of a trust.
As such, the fiduciary of a fiduciary contract shall record the trust assets transferred to it as off-balance sheet items in its own account and this is where the protection comes in. As the fiduciary assets are not booked in the accounts of the fiduciary as its own assets, they are not available to the creditors of the fiduciary in case of its bankruptcy during an insolvency process.
However, there is a condition which is required to qualify for the protection provided by the Law: the role of the fiduciary is reserved to certain professionals of the financial sector, i.e. to credit institutions, investment firms, investment companies with variable or fixed share capital, securitisation companies, fiduciary representatives acting in the context of a securitisation transaction, management companies of common funds or of securitisation funds, pension funds, insurance or reinsurance undertakings or national or international public bodies operating in the financial sector.
In practice, this does not mean that others than the mentioned professionals are not entitled to act as nominees, trustees (e.g. lawyers, trusted advisors), however, such arrangements and relationships are not governed by the Law but by the Civil Code and the provisions of a mandate. More importantly, the trust assets transferred to such trustees are not entirely ring-fenced and separated from the non-fiduciary assets of the trustee which can have some adverse consequences in case of the insolvency of the trustee as the trustee’s creditors can attach these assets.
There are some basic differences between the Luxembourg fiduciary contracts (the “contrat fiduciare”) which derive their origin from the civil law and the Anglo-Saxon trusts which come from the English common law. The fiduciary contracts are contractual in nature, based on a bilateral agreement entered into by and between the principal and the fiduciary in writing, in which the fiduciary shall honour the obligations set-out in the contract, whereas the trustee of an Anglo-Saxon trust providing discretionary powers to the trustee shall act in a fiduciary duty in the best interest of the beneficiaries named in the trust instruments. The powers of the settlor, his instructions may be disregarded in case the trustee does not deem them fit or he thinks they are not proper and they do not fit the purpose why the trust was set-up.
Furthermore, Anglo-Saxon trusts can simply be set-up (in addition to bilateral deeds, trust instruments) also in the form of declarations of trust, where the settlor is in fact not actively involved at the time the fiduciary obligations are created.
It should be noted that fiduciary contracts may also be established as irrevocable and discretionary, as such limitations on the trustees’ powers may be regulated in the written contract.
As regards confidentiality, there is no public registry in Luxembourg where the fiduciary contract should be registered, unless the fiduciary assets consist of Luxembourg real estate property, ships or aircrafts.
Fiduciary contracts may be used to hold shares in investment holding companies as nominees in a confidential way, to pool fractions of shares, minority shareholdings in order to provide a better representation as one group of shareholders; furthermore, they may be used for bank guarantees, securitisation and also for inheritance, estate planning.
Mr. “X” is a wealthy entrepreneur owning a successful company active in the industrial sector. The business is prospering well, he has accumulated profits on his bank accounts managed by his bankers due to successful years in the recent years. He is married with two children who are at the age of 12 and 16.
Mr “X” creates a Luxembourg fiduciary contract and transfers the amount of USD 10,000,000 to the fiduciary being a bank to hold such assets based on the terms and conditions of the fiduciary contract. Mr “X” reserves rights for him in the management of the assets whereby the bank as fiduciary shall provide asset management services on an advisory basis, the bank shall consult with Mr. “X” prior to investments being made. He instructs the trustee that 70% of the investments should be made in fixed income products (AAA rated corporate bonds in the US and Europe) to generate income, 20% in equity to provide growth and 10% to be kept in cash to provide liquidity.
He makes provisions in the contract towards the fiduciary whereby upon his death the fiduciary contract be terminated and 30% of the fiduciary assets should be paid out to his wife and 70% of the assets should be held for his children in 35-35% proportions. He instructs the trustee that his children should receive 50% of their capital entitlement (17.5%) at the age of 25 and the remaining balance should be paid out when they attain the age of 30.
Mr. “X” instructs the trustee in the trust agreement that the education of his children should be paid out from the income generated by the fixed income investments.
Years later Mr. “X” faces financial difficulties and he goes into bankruptcy. As he set-up a fiduciary contract, he has made arrangements to secure the future of his family with “ring-fenced” assets which are not available to his creditors and can provide security for his family’s financial well-being.
Dr. Gabor Mocskonyi, TEP
Member of the Society of Trust and Estate Practitioners