The protectorate in Liechtenstein foundation and trust law and its impact on asset protection
The formation documents of foundations drawn up by Liechtenstein professional trustees often contain provisions on protectorates. A protectorate may be established if, at the time the foundation is formed, there is not yet a sufficient relationship of trust between the client and the professional trustee. In such cases, clients want to make sure that the assets they transfer to the foundation and separated from their personal assets will be used for the purposes they intend. As a founder, the client therefore wants to reserve the right to exert influence on the management and use of these assets. For this purpose, certain rights may be assigned to the protectorate.
Foreign persons who set up a foundation in Liechtenstein often pursue two different interests: Firstly, they want to protect asset components from heirs who would be entitled to a compulsory portion or from creditors by transferring those components to the foundation and separating them from their overall assets (asset protection). Secondly, they may wish to limit or at least monitor the unrestricted rights of the Liechtenstein professional trustee – in whose custody the founders transfer their assets but with whom they have not (yet) built up a firm relationship of trust – to dispose of the foundation assets.
There is a tension between these two interests, given that effective asset protection can work only if the professional trustee of the foundation is not subject to any influence on the part of the founder. One solution to this dilemma is to implement a protector or protectorate within the organisation of the foundation. The concept of the protector or protectorate originates from Anglo-American trust law and was adopted by Liechtenstein practitioners at the end of the 20th century. You can find out more about the Liechtenstein trust here.
Concept of the protector or protectorate
With a protector or protectorate, one or more natural or legal persons are integrated into the foundation under the name of protector (one person), protectorate (several persons) or another designation such as advisory board or advisor, to which certain rights are granted that are parallel or superordinate to the rights of the foundation council. The founder, a person of trust of the founder, or beneficiaries may be appointed as protectors. The founder is free to determine the role of the protectors. The protectors may play a purely passive role and supervise the foundation council and/or serve as a link between the foundation council and the beneficiaries. However, it is also possible to assign the protectors an active role and have them, in lieu of the foundation council, decide on distributions to beneficiaries and the management of the foundation assets. It can also be stipulated that protectors may amend certain foundation documents. These rights may also be structured as rights to issue instructions to the foundation council. It is also conceivable that the execution of the decisions of the foundation council may be made subject to the approval or veto of the protectors. The founder determines which rights the protectors are granted in individual cases. For the balancing act between effective asset protection and the implementation of protectors to succeed, certain rules must be observed.
Conceptual comparability of foundations and trusts
In practice, a protector or protectorate is often also integrated into trusts. Due to the conceptual comparability of foundations and trusts, the following considerations apply analogously to protectors and protectorates of trusts.
The founder as protector
Founders are free to appoint themselves as protectors. However, this may be dangerous for reasons of effective asset protection where the founder, in the role of protector, continues to be able to exert influence on the assets contributed. Depending on the scope of the ability to influence the foundation, a court may take the view that merely formal changes have been made to the ownership structure of the assets contributed by the founder, and that there has been no effective separation from the personal assets of the founder, so that the contributed assets must continue to be economically attributable to the founder. In foundation law, the Liechtenstein Supreme Court finds that in an overall consideration of the founder's rights of influence, any initial or subsequent contributions of assets by the founder may be challenged if the founder continues to reserve the right of disposal and management over the foundation assets and thus is not deemed to have made a financial sacrifice. In the view of the authors, this case law is also applicable to the transfer of assets to the trustee of a trust. If, in a given case, no financial sacrifice has been made, the statutory periods do not apply within which transfers of assets to the foundation may be reversed by unsatisfied creditors or heirs entitled to compulsory portions. Where, however, the asset contribution is deemed to be a financial sacrifice, heirs entitled to compulsory portions may contest asset contributions only if they have been made within a period of two years preceding the death of the founder. Creditors may reverse only asset transfers made within a period of one year before the compulsory execution granted against the founder.
There are concerns that a court may not recognise a financial sacrifice of the founder if the founder appointed as protector is able to exercise certain rights. These include the right (of instruction) relating to determination of the type, amount, and/or time of the benefit, where the founder belongs to the group of beneficiaries. Granting this right to founders serving as protectors would allow founders to distribute the foundation assets in their entirety back to themselves. Caution must also be exercised when granting a right (of instruction) relating to the amendment of the foundation documents, in particular amendment of rules governing benefits. Granting the right of amendment would enable founders in their function as protectors to name themselves as the sole entitled beneficiary of the foundation assets. This would de facto amount to a right of revocation of the founder. In their role as protectors, founders would thus continue to have access to the assets of the foundation.
With regard to trusts, a further consideration must be made under the aspect of asset protection. Trust law prohibits the trustee from being bound by the continuous instructions of the settlor. For this reason, settlors appointing themselves as protectors should refrain from reserving the right to issue instructions to the trustee via this indirect route. Otherwise, a court may conclude that the prohibition of continuous instruction has been circumvented and that no fiduciary relationship exists. These concerns also exist if any exercise of the trustee's rights is made subject to the prior approval or subsequent veto of the settlor-protector.
Beneficiaries as protectors
The founder has the option of appointing beneficiaries to the protectorate. In this case, there may be a gateway for unsatisfied creditors of beneficiaries appointed as protectors to access the assets of the foundation. Where beneficiaries are appointed as protectors, they should not – on grounds of asset protection – be granted rights to determine the type, amount, and/or time of the benefit. Otherwise, there is a risk that creditors with enforceable claims against the beneficiaries appointed to the protectorate may seek attachment of such rights by way of compulsory execution or bankruptcy proceedings. These concerns arise from the case law of the Austrian Supreme Court of Justice on the Austrian Act on the Enforcement of Judgments, which is used as the basis for Liechtenstein jurisprudence and from which the Liechtenstein courts may in principle not deviate. The Austrian Supreme Court of Justice has held that the right to determine beneficiaries constitutes property subject to execution. If the attached right to an asset does not itself constitute an asset, a two-stage exploitation procedure is provided. The rights of the plaintiff-creditor are determined by the scope of the rights of the obligor (defendant-debtor). The court of enforcement accordingly must grant the plaintiff-creditor judicial authorisation to exercise the right to determine the beneficiaries in the place of the obligor, in order to be able to subsequently claim any conceivable proceeds.
Conclusion
With the appointment of a protector or protectorate, founders may – indirectly by way of one or more persons of trust or directly by appointing themselves as protectors – exercise certain possibilities of influencing the management of the foundation. It is the founder's decision which rights in particular cases are assigned to the protector. Where founders appoint themselves or beneficiaries as protectors, it must be considered under the aspect of asset protection that certain rights should not be granted to the protector or protectorate, given the risk that third parties may access the assets contributed to the foundation.
It goes without saying that the various ways in which a protector or protectorate can influence the management of the foundation must also be analysed from the perspective of tax law.
Dr. Marco Felder and Dr. Vladimir Good are happy to answer any questions you may have relating to protectorates.
*) Dr. Vladimir Good wrote his doctoral thesis in law at the Private University in the Principality of Liechtenstein on "The Protectorate in Liechtenstein Foundation and Trust Law". The thesis was published in 2018 and is available here.