Preserve Your Wealth, Ring-Fence Them with Trust

India has witnessed a manifold increase in both the number and the wealth of High Net-Worth Individuals (HNIs). Forbes’ rich list for India of March 2020 named 102 billionaires—individuals or families with a combined wealth of more than $300 billion. On the other hand, research statistics and empirical evidence all suggest that a business run by a family seldom lasts for more than three generations, with a survival ratio of only 3 per cent by the third generation. This manifests into the need for a more intense focus that HNIs should devote towards wealth preservation and succession planning. HNIs need to transform the way they hold wealth and make investments and leverage on modern-day ecosystem enablers such as family offices while setting up family charters or constitutions along with trusts. 

Family trusts are one of the prominent options being exercised by HNIs with the objective of wealth preservation and succession planning. Family trusts are effectively private trusts which are registered under the Indian Trust Act, 1882. In general, the parties to the trust are the settlor, trustee, and beneficiaries. As the names suggest, a settlor is a person who contributes the assets or income to the trust. In the case of a family trust, the settlor would effectively be the promoter of the family business or the current head of the family managing the family business. Beneficiaries are the persons for whose benefit the trust is being formed. In the case of a family trust, the beneficiaries would be the next generation including the future generations. A trustee is someone who has been entrusted with the responsibility of managing the trust assets and ensuring that the benefits of the trust accrue to the beneficiaries as envisaged in the trust deed. 

The necessity or importance of trust is prominent in scenarios where there are multiple legal heirs in the next generation of family members. HNIs usually transfer their assets to the trust including the shares in the family business. Some of the basic operational benefits of a trust are:

• The family assets can be preserved for the benefit of the future generations with covenants such that the next generations can only enjoy the benefits of the property and the property cannot be mortgaged or sold

• Avoiding family disputes by ensuring that the benefits from all the assets are shared among all the beneficiaries or legal heirs, instead of distributing the assets among the beneficiaries

• Bypassing probate process in case of succession

In addition to these obvious benefits, the most important advantage of floating a family trust is to protect the family assets from contingent liabilities or unforeseen losses on the business front. Though the degree of risk varies from sector to sector, there is an inherent risk of huge financial loss in any business and the same is even higher in the case of the next generation of HNIs venturing into new and upcoming sectors with big bang investments. The investor money raised generally is not entirely on equity terms and there ought to be some portion of the debt. Further, debt funds would also be raised frequently from financial institutions with the personal guarantee of promoters being mandatory. In these scenarios, the failure of the business would put the personal assets of the promoter at risk. However, transferring personal properties to a family trust would ensure that assets are ring-fenced from the personal contingent liabilities including the guarantees provided and other business losses. The protection from the attachment of personal assets transferred to a trust is not always guaranteed and the following caveats are to be considered before transferring the assets:

• A family trust that is formed can be either a revocable trust or irrevocable trust. A revocable trust is one where the settlor has the power to undo the transfer of the assets to the trust. Whereas, in an irrevocable trust, the settlor shall have no such rights. In case of insolvency or personal guarantee being enforced, the assets transferred to a trust under revocable trust can still be attached.

• The assets should be transferred and not only the income. The settlor can form a family trust by just transferring the income for the benefit of the Beneficiary. However, in such cases, ring-fencing of assets shall not be possible since the assets would still be in the personal name. 

• The trust deed shall not permit the mortgaging of the properties of the Trust even for the benefit of the Beneficiaries. In the event of trust property being mortgaged for any loan, the property of the Trust would be attached in case of default.

• The ring-fencing of assets under a family trust is available only in cases where the transfer of assets has been done without any malafide intention. In the case of both liquidation of the company or personal insolvency, the transactional audit would be conducted to identify transactions that are not at arm’s length and transactions entered into with such malafide intentions. In the event of it being established that the assets have been transferred to a family trust just before the unfortunate event of liquidation or insolvency, then the courts may not grant the protection to the assets.

Trusts are increasingly becoming popular among the HNIs for succession planning and wealth preservation. If managed professionally, the benefits could be reaped. Considering the extent of risk involved in business and the uncertainty of the ability and passion of the next generation in managing the family business, trusts can be the optimum solution wherein the assets can be ring-fenced from all the uncertainties. 

The author is Founder & Managing Partner of DVS Advisors LLP