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The Liechtenstein family foundation in assets management

Marcus Hutter, attorney-at-law, Vaduz, 1993

1. Introduction

As in the past, the Liechtenstein family foundation continues to enjoy undiminished popularity among private clients in international assets management and with the banks, lawyers, trustees and asset managers advising them. The increasing demand for this excellent instrument in individual successor planning has been especially supported this year by the favourable stock exchange developments in the relevant finance centres throughout the world. Following the growth in clients’ assets which has been significant in some cases, many such persons have expressed the legitimate wish for a safe, flexible and cost-effective instrument which guarantees that their assets are preserved in the long term for future family generations, if possible increased and are used after his decease in accordance with the client’s wishes.

Within the framework of the universal service and all-round counselling now demanded by clients, it is our task, among other things, as the major confidant, to pay the appropriate attention to the question of the legal succession and offer adequate, tailor-made solutions for the specific individual case.

2. The Liechtenstein family foundation

2.7 Concept legal form and nature of the foundation

The foundation can be defined as a legally independent asset which has been donated for a specific object in accordance with the will of the founder. Definitions of such objects are listed by way of example in the Liechtenstein Persons and Companies Act (Art. 552 Para. 1 PGR) whereby in practice it is the family foundation which is far more significant than the charitable and ecclesiastical foundations.

The Family foundation essentially requires that the beneficiaries be members of one or more designated families (Art. 553 Para. 2 PGR). One speaks of a mixed family foundation wnen the donated assets «in addition or supplementally» also serve for objects outside the family. Beneficiary foundations are foundations whose beneficiaries are specifically designated or definable.

As is well known, a foundation is an independent legal entity which as such is bearer of rights and obligations, can hold bank accounts, grant proxies and be a liti-ganf It thus differs from the trust («Treuhdnderschaft»), pursuant to Art. 897 et seq. PGR, where the trustee himself, practically «ad personam», acts as legal but not beneficial owner of the trust property, acts as the holder of accounts at banks, issues proxies or appears as plaintiff or defendant in court actions, etc. With the trust, it has emerged that civil law jurisdictions sometimes have problems in their dealings with this instrument.

The following are considered to be necessary elements in the formation of a foundation:

- the expression of the will of the founder to form a foundation

- the designation of the asset to be dedicated to the foundation

- the definition of the object of the foundation

The fundamental liberality of Liechtenstein law on foundations means that the formal and material requirements for the formation of a (family) foundation are quite modest:

- unilateral legal transaction of the founder (no deed by public notary necessary)

- low minimum capital (SFr. 30,000. — )

- maintenance foundation permissible as intended purpose (i.e., payments to beneficiaries for their general living expenses<=>in contrast to family foundation pursuant to the Swiss Civil Code)

- no entry necessary in a register accessible to the public

- admissibility of the fiduciary formation of a foundation (for example by a Liechtenstein lawyer, a bank, a trust company) at the expense of the beneficial founder.

In the administration of the Liechtenstein family foundation, mention is to be made of the following additional advantages in practice:

a) assignment of any asset rights of monetary value to the foundation (liquidity, shares of companies, noble metals, claims, etc.);

b) the family foundation is not subject to any general supervision by the authorities or any other body;

c) the family foundation is not required to submit a balance sheet or carry out an audit;

d) the formation, existence, administration and dissolution of the family foundation are carried out under the most confidential conditions;

e) the tax burden in Liechtenstein is negligible;

f) a wide measure of freedom in the arrangement of the internal organization of the foundation, the allocation of powers to bodies, the assets management and the protection of family members;

g) decree that the enjoyment of beneficial interest of the foundation obtained without consideration cannot be deprived in the event of distraint concerning the assets of the beneficiary;

h) a possible cancellation takes place by law as soon as there are no longer any assets or the object of the foundation can no longer be achieved.

2.2 Typologies

a) General

Liechtenstein foundation law is largely based — as already mentioned — on the principle of private autonomy, i.e., the possibility of the free arrangement of the internal organization of the foundation (principle of the freedom of the foundation). Admittedly, it is no longer possible since the 1970’s, following a decision by the Liechtenstein Supreme Court (F.L. OGH judgment of 14 December 1973, ELG 1973–1978, 260 et seq., 263), to provide for so-called affiliate founder’s rights in the statutes, which in addition could be assigned or inherited; with agreeable clarity, the OGH has put an end to such distortions of foundations. Furthermore, a continued influence of the founder as a body of the foundation in its operations must be reserved in the statutes.

On the other hand, in a decision of 1988, the Liechtenstein Supreme Court made it clear that the enactment of the so-called beneficiary bylaw is not a stringent necessity for the valid formation of a foundation. The absence of clear provisions concerning the beneficiaries on formation is admittedly a serious deficiency according to the considerations of the Liechtenstein Supreme Court but this can be subsequently corrected and is to be accepted for reasons of legal certainty (LES 1991, 91 (107) and LES 1990, 105 (1 19); this ruling, which primarily takes account of trust practice, is hotly disputed since it certainly touches on the question of the adequacy of the intended object and thus of the valid formation of the foundation.

A result of the unrestricted freedom of arrangement is also the competence to reserve the designation of the beneficiaries and the award of the benefit of the foundation for a special body, the collators as they are known, instead of for the foundation council (561 Para. 2 PGR).

Finally, the beneficiaries and their specific beneficiary shares do not have to be fixed in detail already at the formation of the foundation. It is sufficient when the foundation council is allowed the widest discretion in the designation of the beneficiaries and the award of the benefit of the foundation (e contrario from Art. 567 Para. 2 PGR, § 1 1 1 TRU). This type of foundation is known as a «discretionary foundation» (see lit. с below).

b) The classic arrangement of the foundation

In the classic arrangement of the foundation, the ruling for the designation of the beneficiaries consists in a bylaw or internal regulation in which the founder specifies the beneficiaries and the extent of the beneficial interest when the foundation is formed. On the death of the founder who is usually also the first beneficiary, the prospective beneficiaries accede to the beneficiary rights to the extent provided for in the bylaw.

This rigid beneficiary ruling is often desired when the situation is straightforward but, at the same time, it can also be a disadvantage in some cases:

aa) On the one hand, the «drawing off» of benefits in capital and yield by the beneficiary from time to time in the absence of conditions can have negative consequences and in certain circumstances — despite the disparity of legal personalities in civil law — can lead to an unwanted imputation of the foundation’s assets in the country where the beneficiary is domiciled.

bb) On the other, it is no longer possible to take account of fundamental changes occurring in the family and environment of a beneficiary after the death of the (beneficial) founder. If, for example, the beneficiary on reaching the relevant age for a payment finds himself in a difficult situation or in an unfavourable social environment, the foundation council has usually no possibility from the legal viewpoint of preventing the (unconditional) payment, even if such a prevention would clearly have been in accord with the hypothetical will of the founder.

c) Discretionary foundation

With the discretionary foundation, as the name says, the founder allows the foundation council a more or less large measure of discretion in the designation of beneficiaries and the payments to be made to these. On the formation of the foundation, only a class of beneficiaries, usually all the members of the family of the founder, is named instead of a fixed sequence of beneficiaries and prospective beneficiaries. The nature of the discretionary foundation is that it is not determined from the very start who is named as the beneficiary from the class of the beneficiaries and what his beneficial interest will finally be. The foundation council is given only guidelines by the founder as to how the object of the foundation is to be achieved and how a beneficiary bylaw could be formulated. However, such a «letter of wishes» — and this cannot be stressed often enough — does not have a binding character.

In order to achieve a kind of «checks and balances» in the administration of the foundation, a protector, as he is known, is appointed together with the foundation council and advises the foundation council in all major decisions, whereby the degree of counselling can vary. As a rule, the protector has a detailed knowledge of the family relations and enjoys a position of absolute confidence. He can be a legal entity or a natural person, the family lawyer, the personal assets manager or a friend of the family. Before the foundation council decides a payment to a person from the class of beneficiaries to be designated, the foundation council and the protector form an opinion on the subject.

Any binding whatsoever of the foundation council by reason of a mandate contract is detrimental and contrary to this concept of the foundation.

d) Mixed form

This is a combination of the classic and discretionary foundations. In this form, the benefit of the founder and first beneficiary is fixed for his lifetime while on his death beneficiaries from the class of beneficiaries can be appointed at the discretion of the foundation council together with the protector.

3. The Liechtenstein foundation and assets management 3.1 Fundamentals of assets management

For the object of the foundation to be achieved, the assets dedicated to the foundation must be properly administered, preserved and, if possible, increased. Depending on the composition of the originally dedicated assets, the foundation council is well advised to call in qualified third persons, i.e., professional investment advisers and asset managers.

The memorable stock market crash of 1987 and the destruction of assets associated with this and the appearance on a massive scale of new instruments for investment have led to a fundamental and far-reaching discussion as to whether there are limits to assets management in family foundations and, if so, what limits.

As is well known, the inadmissibility of an intrinsically commercial activity, i.e., of a trade pursued in a commercial manner (e.g. trading with goods), is considered fundamentally as a general legal limit. On the other hand, the investment and management of own assets does not fall under this, irrespective of the number of stock exchange transactions in a portfolio.

Incidentally, the legal basis is very rudimentary since it is succintly stated in Art. 558 Para. 5 PGR that «in case of doubt» the investment of the assets shall «ensue in accordance with the regulations concerning trust investments». Mention is made there of investments in securities of the Liechtensteinische Landesbank. The regulations of the trust company, which are to be applied by analogy, state that the trustees «shall ensure the orderly administration and preservation of the trust assets in their legal and economic volume» (§ 28 Para. 1 TRU) and stipulate the «obligation to preserve, improve and insure the trust assets» (Para. 2). If nothing can be inferred from the object of the trust company or the trust regulations (e.g., from the so-called investment clause), the investment must be made in a «safe» and «profitable» manner (§ 31 Para.1 TRU).

The essence of these provisions is that in the absence of any other ruling by the foundation council a conservative investment policy must be followed.

The foundation statutes normally used in Liechtenstein rarely include rulings on the investment of the assets unless express provision is made for the «free ana unrestricted discretion of the foundation council». It is occasionally stated that consideration is to be paid primarily to «safety» and subsidiarily to «yield». The foundation council can therefore certainly pursue a venturesome investment policy if the statutes provide scope for this and the object of the foundation is not frustrated by it.

Case law in Liechtenstein on this subject is (as yet) practically non-existant.

In general, as the responsible body for the management of the company, the foundation council cannot avoid taking the following fundamental decisions when the management of the assets is to be delegated to third parties:

- the selection of the assets manager and/or the depository bank

- the fixing of the investment strategy/guidelines

- the provision of surveillance mechanisms.

Depending on the situation of the beneficiaries and benefits, the foundation council has a more or less far-reaching duty of care as regards these decisions:

If the founder keeps formally or informally an influence during his lifetime in respect of the three points mentioned above or if effectively the beneficiaries give their consent in the matter, the observance of the duty of care of the foundation council will differ from that when it is a question of beneficiaries of different categories (in some cases minor beneficiaries) with different beneficial interest staggered in respect of time or when an existing and poorly structured portfolio has been dedicated to the foundation. The foundation council will act in a manner appropriate to the situation and in consideration of the object of the foundation, the will of the founder and the interests of the beneficiaries.

In this connection, it is important that an accurate analysis of the situation of the beneficiary be carried out on the death of the founder whereby a completely new orientation of the assets management may possibly have to be adopted (e.g., income-related instead of capital-related).

With the discretionary foundation, the investment of the assets and the definition of the strategy are decided in agreement with the protector.

3.2 Recent developments in assets management

a) General

The area of investments has become more global, more volatile, in short more complex and calls for decisions at increasingly shorter intervals whereby the flood of information which may possibly be relevant for decision-making outstrips the capacity of the individual to absorb it. The present-day financial market is characterized by a great innovative power which is constantly bringing out new products with the most diverse objectives. It is usually the case that the legal coverage and assessment of these new products cannot keep up with the pace of this development. However, the foundation council must also face up to this situation since in the final analysis it bears the responsibility for the management of the assets.

b) Derivative financial instruments

With derivative financial instruments and transactions, it is a question of financial contracts whose value is derived from the price of one or more basic assets (shares, raw materials) or reference rates (interest, indices, currencies). Traditionally, a distinction is drawn between fixed-date bargains, where all conditions are fixed from the start (classic forward transactions), SWAPS (not quoted on the stock exchange), futures (quoted on the stock exchange), and options (on futures, SWAPS, calls and puts).

The financial background for the use of financial instruments may be:

- hedging

- speculation

- mixed form.

Assessment from the viewpoint of the foundation council:

- When such financial instruments are used within the framework of hedging (safeguarding of positions against market-related and unexpectedly marked price movements), there is certainly no objection to be made to them; on the contrary, they conform to the principle of the preservation of the assets, although safeguarding of this nature has its price.

- structured transactions, as they are termed, where synthesized investment instruments are employed (linking of a traditional investment instrument, e.g., of a bond with a derivative) are acceptable as long as

- they are intended as hedging

- guarantee at least the repayment of the capital invested do not have leverage on the portfolio as a whole conform with the investment policy at the bank managing the assets.

As an investment instrument, however, such derivative instruments are of a speculative character and, by reason of the inherent leverage and the unlimited margin requirement by which futures, for example, are secured, are inadmissible from the viewpoint of the foundation since it is making incalculable commitments and the risk potential involved cannot be estimated.

If such speculative transactions are undertaken, certain precautions must be made in that the foundation council decides, for example, a payment to the beneficiary/beneficiaries and the foundation undertakes these transactions on a fiduciary basis at the risk of the beneficiaries without, however, endangering or involving the rest of the foundation’s assets in any way. However, the foundation may not assume any far-reaching margin requirements for the beneficiary.

bb) The problem from the viewpoint of the foundation

The ownership of the securities (including the rights associated with them) or the claims in question to the securities are transferred to the borrower when the securities are lent. The agent (the bank) acquires for the account of the customer, i.e., the foundation, a claim to the return of flawless securities of the same kind and quantity.

The claim of the foundation against the bank or the SEGA (Swiss Securities Clearing Corporation) as the collecting depot for the procurement of ownership of securities is transformed with the lending of the securities into a (merely obligatory) claim for restitution against the bank or the borrower. This can mean a deterioration in the position of the foundation within the framework of separation in distraint and bankruptcy proceedings. The probability of the occurrence of such a case with a top rating bank is certainly slight, however.

с) Securities lending

aa) General

With securities lending (SL), it is a question, in short, of lending securities for a charge against security. Due to delay in the supply of titles, stock-exchange brokers use this procedure to obtain securities for delivery to third parties.

In law, it is a question of a transaction similar to a loan by which the lender undertakes towards the borrower to temporarily transfer ownership of certain papers while the borrower promises the return of securities of the same kind, quantity and quality (category). The restitutory right is secured by the pledging of securities or liquid funds which must be deposited at the depository bank in favour of the foundation or by a bank guarantee. In accordance with the usual agreements, the depository bank is also liable for deficits on the part of the borrower. The sums accruing during the lending of the securities, e.g., dividends, interest and bonuses, are transferred to the lender/grantor. The right of disposition over the securities lent is fundamentally not impaired. The economic motive for the lender is to obtain an additional commission and thus to increase the performance.

The lender (in this case the foundation) provides the securities for the securities lending.

The borrower is the counter party who takes over the securities lent by the foundation. This can be the foundation’s own depository bank which takes over the securities on its own account (as the principal) or which it arranges for another borrower as a trustee with indemnity guarantee (agent) in its own name but for the account of another.

cc) Assessment

As long as the borrower is only the depository bank of the foundation or first-class banks, broker companies and insurance organizations, the cancellation of this transaction is possible at any time and the performance risk is covered by securities to at least the same extent and the depositor/ bank is familiar with the handling of such transactions, an acute danger for the assets of the foundation cannot be identified. Under certain circumstances, it is even the case that the indemnity liability or guarantee of a prime bank can be a better risk than a majority of individual titles.

At any rate, the corresponding standard bank contracts are to be thoroughly examined in respect of risk assessment. The foundation council is well advised to make itself familiar with the relevant guidelines of the Swiss Banking Commission for security investment funds.

4. Other special problems in assets management practice

4.7 The pledging of beneficial interest

The question here is whether a beneficiary right per se, which is provided for in a bylaw, can be assigned or pledged by the beneficiary, e.g., in connection with the securing of a loan to this beneficiary personally:

The provisions of the Liechtenstein law on foundations do not give any lead here. With reference to the footnote of Art. 552 Para. 4 PGR, § 1 22 Para. 1 TRU states «If not provided otherwise the beneficial interest as a whole as well as individual rights and obligations arising from the possession of the beneficial interest including that from the reversionary interest shall be alienable, transferable and inheritable and the beneficial interest as well as individual rights therefrom may be charged with limited material rights in rem…»

When applied to the law on foundations, this means that firstly the provisions in the statutes are authoritative; in many cases, they prohibit the alienation and encumbering of beneficial interest and reversionary rights (i.e., benefits which are not yet due). If the agreement of the foundation council is required, the council must consider that this does not anticipate a payment which is only due at a later dater and that, under certain circumstances, this does not run counter to the will of the founder. In contrast to this, claims which are due, i.e., payments which have already been decided by the foundation council, can be transferred even when the statutes stipulate that they are inalienable (testimony of the witness § 1 22 Para. 2 TRU).

4.2 The pledging of foundation assets

The pledging of foundation assets may be necessary within the framework of assets managment at the depository bank to secure lombard credits or other debit positions.

Fundamentally and by reason of its object, the foundation should not create any major obligations at all or even give sureties or guarantees. In particular, care should be taken with general loan against pledge declarations in favour of banks that such encumbrances of own assets of the foundation should only be granted for claims of the bank against the foundation but not against beneficiaries or persons related to them. For the securing of bank claims against subsidiaries/holdings, caution is likewise advisable and it should be clarified whether they are at least in the interests of the foundation.

At any event, such commitments always call for restrictions appropriate to the sums involved.

5. Summary

The point of departure for our remarks was the fact of the general popularity of the Liechtenstein foundation among international private clients. The analysis of these findings leads us to the principle of the freedom of the foundation and to the minimum requirements in comparison with foreign regulations for the formation of a family foundation in Liechtenstein. In addition to the legal preconditions, we have examined individual forms of foundations in practice. Finally, in the main part, it was a question of identifying the possibilities and limits of assets management in the Liechtenstein foundation. It was shown that the foundation council certainly has an objective duty of diligence in the area of assets management but that it must perform this in a flexible manner according to the situation of the beneficiaries. In this, investments with a speculative element are not fundamentally excluded. New forms appearing in the range of financial instruments can also be usefully employed for the assets management of the foundation but must be examined with care as to the risks. A basic condition is that the institutions entrusted with such transactions are familiar with such investment forms.

Finally, however, I would like to recommend once more the generous use of the family foundation instrument in the assets management and successor planning area of your private clients since the Liechtenstein foundation is to be regarded as a part of the solution and not as a part of the problem!

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