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Separating the goats from the sheep

(Article published in the Feb 8, 2006 issue of Manila Standard Today)

                  It would be most productive of an end-product acceptable to both the trust industry and Bangko Sentral, for purposes of achieving the objectives of the recent discussion on the new rules on living trusts, if they were to together conduct a scan of the current legal and business environment to identify the major uses people make of living trusts.  The regulator and the regulated can then determine which of the kinds of living trusts are obviously disguised deposit arrangements, which ones may be but are not necessarily so, and which ones are definitely true trusts.  The terrain thus properly mapped, it would be a simple matter to fence off the “No Entry” areas, the “Danger” zones, and the Safe Harbors.

 Trusts are resorted to when it is in the legitimate interest of the trustor (who as such normally steps out of the picture after making the transfer in trust of the property) to separate legal title from beneficial title, or, in layman terms, to give one person, called the beneficiary, the benefits of ownership and to another, called the trustee, its burdens. 

 Thus, a parent who wants to set aside, during his lifetime, substantial property to assure the education a minor child but does not want to through the process of securing judicial guardianship over the property as required by law,  may wish to set up a trust in the child’s favor. That is called an educational trust. If such a trust is over property which is big enough, in addition, to answer also for the child’s personal maintenance and comfort during minority, the trust is called a “support trust.”

 When the trustee is directed to give out benefits from the trust, irrespective of the child’s needs but instead depending on whether the child, in school or in a chosen activity, meets an objective standard or bench mark, such as graduating with honors or being admitted to a top quality school, then the trust is called an “incentive trust.”

 For parents who are afraid that their children may dissipate the property as soon as they reach majority age of 18, the common solution is for the trust to specify a desired term of years (extending beyond 18 years of age) with a prohibition on the right of the child beneficiary to alienate or encumber his interest prior to the distribution of the trust estate to him.  This is called a “spendthrift trust.”

 Clearly, when trusts are created for legitimate life-condition reasons, such as for education, support and maintenance or as incentive or protection against profligacy of the beneficiary, the arrangements are true trusts (assuming other essential elements are present) so long as they are designed to last until the disability or need of the beneficiary exists.  The mandate to fulfill the life-related purpose acts as the control that prevents them from becoming mere deposit relationship with banks.  The green light in my view ought to be given to these trusts as a matter of course.

 The orange light ought to start flashing, however, when the trustor keeps himself in the picture.  A trustor can continue being involved in the trust in three major ways, namely (a) by retaining the right to revoke the trust (and when he does he gets back the trust property); (b) by making himself a beneficiary among other beneficiaries; and (c) by reserving for himself substantial powers of the trustee.  The light is orange because in some cases the trustor’s involvement is justified and in others not so.  Here are some examples to show the difference.

 A trust where the trustor retains the right to get back the property is called a “revocable trust” as distinguished from an “irrevocable trust” the trustor could not, even if he wanted to, get back the property.  The latter naturally is considered by tax law as a taxable gift; the forever, non-taxable.  A trustor may wish to retain the right to revoke a trust for the legitimate reason that his business (which feeds the entire family) is vulnerable to unexpected reversals requiring the infusion of capital from him.  Thus, he needs the property in trust as fall back.  On the other hand, a trustor is making a mockery of the trust device if he sets up sets up a revocable trust and revokes it after 30-days, only to repeat the process with another trust. 

 The trustor may also remain in the picture by making himself a beneficiary together with others. The so-called “living trusts” in American trust usage is actually one where the first to benefit is trustor, for life, and then the trust property, if any is left at that time, go to his named successors upon his death.  A trust can also be the other way around.  A trustor may want to set up a trust for the support and medical expenses of his elderly parents after whose deaths the property goes back to him automatically.  This is called a “reversionary trust”.  Far East Bank and Trust Company called it at one time, rather inaccurately, as a “revertible trust.”   In living trusts, the trustor is referred to as the “life tenant” and his successor beneficiaries as the “residuary”.  In the reversionary trust, the trustor is the “residuary” and his parents are the “life tenants”.

 Obviously, a “living trust” that is essentially terminable at the option of the current beneficiary could very well be a disguised deposit arrangement if the sole beneficiary (who would terminate the trust by agreement with the trustee) is the trustor.  But it could be a legitimate device for a professional, say a doctor or ballet dancer, who wants someone to manage his or her investible funds for so he could focus his energies for the meantime in meeting the demands of his or her science or art.  But, when the spirit fails to inspire him, he wants to be able to go back managing his property himself.

 The third method by which a trustor continues to be involved in the trust is by being a co-trustee thereby being co-responsible for the performance of the trust as a whole, or by reserving the right to over-ride the trustee’s function, particularly, his power to invest.

 In some cases, this arrangement is above board.  For instance, a person who strongly believes in the future of a new endeavor, such as stem cell research, may want to direct a portion of the property in trust to be invested in the future in some promising companies that may arise in the near future.  Trust entities, which are called to meet the standard of the prudent investor, are normally conservative and may hesitate to take their chances on such a new thing.  As a compromise, the trustor retains the right to direct the trustee to make investments of his choice.  This is called a “directory trust”, or sometimes, again inaccurately, “directional trust.”

 But then, the arrangement can also be easily debased when the trustor is given the power to take complete charge of the investment powers of the trustee and the trustor so empowered simply behaves as a money-market client directing each and every investment.

 It is important for the rules to distinguish the trust from the false one.  But the problem is that bogus trusts, like dirty money, do not have identifying labels at the time they come out of the production line.

           Nevertheless, in my view (undoubtedly through lenses tinted, not tainted, by the belief that human nature though fallen has in fact been risen), the trust regulator and the trust industry can easily come to an agreement giving the green light to trusts with documentation and behavior consistent with stated life-condition purposes.   Trusts where the trustor remains in the picture should be initially considered legitimate unless examination reveals that the involvement of the trustor in any other the three ways outlined above impugns the integrity of the trust arrangement.

 And the red light should glaringly focus only on trusts, which on examination of document and/or operation permit the trustor to intervene,  in such as manner as to disregard the life-condition purpose for which the trust is established  where the trustor, as beneficiary or holder of trustee powers,  has in effect merely transferred ownership in these types are what are usually called “illusory trusts.”

 I realize the foregoing suggestion would demand exercise of judgment on the part of the examiners of the BSP and of patience and transparency on the part of the trust industry particularly in the process of segrating the true trust from the deposits and deposit substitutes.  But I have no doubts that the BSP examiners are capable and understanding and that the trust  industry is honestly desirous of doing legitimate fiduciary business, and serious in policing its own ranks.