Legal Briefing

Use of trusts for asset protection in the UAE

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UAE | 01 April 2010

Significant legislative changes have taken place in the UAE within the relatively recent past that enable investors and others to use trusts to creatively hold and manage their assets and businesses.

origins

While trusts are normally considered a common law creation, the Islamic world is no stranger to the concept. Indeed there are compelling historical indications to the effect that the trust was in whole or in part an import from Islamic law into English law during the 12th and 13th centuries. In earlier medieval times – in the 7th to 9th centuries – the concept of charitable trusts or waqf was already developed in the Islamic world. Every waqf was required to have a waqif (founder), mutawillis (trustee), qadi (judge) and beneficiaries, fitting essentially the same roles as the settlor, trustees and beneficiary in common law trusts.

As with their common law equivalents, property was placed into the waqf by its founder and that property was reserved for the benefit of specifically designated individuals or for general charitable purposes. One important distinction, however, is that the assets of a waqf must revert to wholly charitable purposes once the object of the trust ceases.

development of the law

By 2005 the federal government of the UAE and the government of Dubai began preparations to re-import the common law trust concept back into local laws, by establishing a trust law within the Dubai International Financial Centre (DIFC). The DIFC itself was already a unique creation. Its establishment required a constitutional change, which in 2004 enabled the federation to enact a Financial Free Zone Law (Federal Law No 8 of 2004), providing the basis for the establishment of financial free zones throughout the UAE. These zones were to be entirely exempt from UAE civil and commercial laws, and, accordingly, free to create their own laws and regulatory framework entirely independent from the laws of mainland UAE.

The DIFC was established under Federal Decree No 35 in 2004. Dubai Law No 9 of 2004 followed, formalising the independence of the DIFC, and providing exemption for the DIFC from the rules and regulations otherwise applicable in Dubai. The DIFC free zone has since developed its own commercial and corporate laws based on common law principles that are enforced by the DIFC’s very own courts or arbitration centre (which it jointly administers with the London Court of International Arbitration). The DIFC has since become a focal point for financial services not just in Dubai and the UAE but for the region as a whole.

The DIFC Trust Law No 11 of 2005 (the Trust Law) was promulgated soon after the establishment of the DIFC itself. It represents a very modern trust law, drawing from the legislative backgrounds of several jurisdictions. The Trust Law enables a trust to be created that provides for the vesting of beneficial ownership rights in land or shares to a defined group, being the beneficiaries, while separating the rights of control, stewardship and legal ownership.

The introduction of the Trust Law provided the legal foundation for the establishment of trust relationships and asset holding arrangements of the type widely available in common law jurisdictions. Enforcement of the trust relationship could be achieved by approaching the DIFC courts. The Trust Law stipulates that trusts constituted under it can specify which governing law will apply to it. Where trusts are stated to be governed by the laws of the DIFC they may be subsequently changed to the laws of another jurisdiction provided that jurisdiction would recognise the validity of the trust, and that all of the powers and provisions of the trust would remain enforceable and capable of being exercised.

A trust constituted under the Trust Law can, through its trustees, hold its property for an indefinite time. Under the Trust Law, the control of the assets of the trust lies with the trustees. However, the Trust Law specifically provides for the appointment of a protector – who may also be the trust settlor – to oversee the actions of the trustees and even to remove trustees if that power is granted under the terms of the trust.

The Trust Law provides several codified obligations of the trustees, essentially general fiduciary duties, such as, for example, the duty not to profit from their position and the duty to act in utmost good faith in the performance of their duties. Unlike the laws of some jurisdictions, the Trust Law permits trustees to be beneficiaries of a trust, a position that might tend to put some strain on their ability to adhere to their fiduciary obligations. The Trust Law is silent as to whether such duties also apply to any protector appointed with respect to the trust. General rules of statutory application, however, would imply that they do not.

The trust can grant the trustees extensive powers to manage the assets under their control as they see fit, subject to the statutory obligation to act as a prudent person and in good faith in dealings. Note, for example, that transactions effected by the trust that enrich others at the expense of the beneficiaries are voidable on application by the beneficiaries that are affected. Otherwise, however, the trustees can:

  • administer the trust assets;
  • acquire, sell and borrow on such assets;
  • vote the shares of companies that are held by the trust;
  • carry on any businesses held by the trust; and
  • in all respects, exercise rights similar to those of an owner of such assets.

in practice

The actual implementation of the Trust Law has raised some issues and questions that are unique to the UAE. For example, would the recognition of trusts and the actual ownership of assets by them be recognised in mainland UAE areas that are outside of the DIFC? There was some preliminary doubt about this. Unlike some jurisdictions the Trust Law does not suggest that the trust itself has legal personality – the ability, for example, to hold assets on its own, or to sue or be sued in its own name – as in some forms of statutory trusts.

To rectify some of the ownership questions that were raised in November 2007, Federal Implementing Regulation No 28 of 2008, regarding Law No 8 of 2004 in relation to financial free zones, was issued. The amendment permitted companies and establishments licensed to do business in the DIFC to found subsidiaries and branches in mainland UAE, and to own the companies operating in the UAE in accordance with the regulations in the state. Further, the changes provided that companies established in the DIFC are considered as national companies, as long as they meet normal ownership requirements under the laws effective in the UAE.

The amendments make it clear that companies incorporated in the DIFC may own branches, subsidiaries and shares in companies operating in the UAE, subject to local ownership requirements, as well as other assets. This amendment in the law permitted UAE-owned corporate trustees established in the DIFC to own assets onshore in the UAE, whereas previously DIFC entities were deemed to be foreign entities for UAE foreign investment law purposes. This change in regulations made it easy to use the Trust Law because any DIFC trust can be readily enforced in the DIFC courts against any DIFC entity holding onshore subsidiaries. For this reason the interjection of a DIFC-incorporated entity into the trust structure, as illustrated in the diagram below, has great benefits.

Of greater concern is whether or not local courts would recognise a distribution under a trust that was contrary to Sharia principles. The term Sharia is often understood to mean ‘Islamic Law’, but it is actually broader than this in that it also encompasses the general body of spiritual and moral obligations and duties in Islam. Compliance with these principles is key to determining whether or not a DIFC trust could be used for succession planning.

The Sharia laws of Faraid or succession are based on principles stipulated in the Qur’an. The rules are elaborate and refined. They create several interests for sharers and residual beneficiaries. On the death of a family member the law mandates the fracturing of the estate into shares, with the percentage interest flowing to the stipulated family member, varying depending on the make up of the family and the lineage surviving at the time of the death. The formulae are complex. A son might be entitled to a share of a sixth of the estate, a living father or brother to a similar amount, with the Sunni and Shia applications of the law differing. In most traditions a person is entitled to deal with a portion but not all of their estate through a will. Gifts given by a person during their lifetime, however, are permissible.

These rules are the basis of succession law in mainland UAE. What, therefore, is the situation with a DIFC trust? What would be the legal effect if the settlor of a trust gives their property as a gift to the trustees on behalf of the trust and the terms of the trust provide for a stipulated distribution – on the death of the trust’s settlor – that might contravene these important rules?

The Trust Law deals with the issue directly. At Article 15 it stipulates that where property is held in trust in this manner, neither the trust nor any disposition by it that is valid under the laws of the DIFC ‘is void, voidable, liable to be set aside or defective in any manner by reference to a foreign law’. ‘Foreign law’ is specifically defined by the legislation as meaning the law of any jurisdiction other than the DIFC. The implication is that neither existing UAE law nor Sharia principles can invalidate the trust or transactions lawfully undertaken by it.

comment

The Trust Law, however, is still very new and has yet to be tested in this regard. It remains to be seen what view the courts may take in the matter. Until a critical mass of jurisprudence develops, careful structuring, sound advice and planning is a necessity.