By Nigel Rotheroe

Most people will have heard of Trusts or Foundations which they can establish or benefit from.  But even if they are in the legal or financial services professions, they do not necessarily understand the differences between both, or which may be best suited in particular circumstances.

Trusts are not a Civil Law concept and so in Civil Law jurisdictions foundations are more commonly used. Whereas in Common Law jurisdictions Trusts, whose origins go back to the era of the Crusades in the Middle East, are the favoured option and whose Muslim Law equivalent is the “Waqf”.  Evidence of the popularity of the use of foundations in the Middle East can be seen, for instance, by the introduction by the Dubai International Finance Centre (“DIFC”) of the Foundation Law DIFC Law No. 3, for the establishment of foundations in the DIFC.

What is a foundation?

The term foundation can mean different things, to different people, in different contexts.  In practice a foundation will be a body corporate, a trust, or possibly an unincorporated association¹.  An Isle of Man foundation is an incorporated legal person that whilst having much in common with limited companies and trusts, has its own unique attributes.  As a separate legal entity it is capable of holding assets, entering into contract and can sue and be sued in its own right.

The key differences between a limited company and a foundation are that a foundation:

1. Is governed by a council and a company by a board of directors;
2. Unlike a company, it cannot directly engage in commercial trading that is not incidental to its objects;
3. Does not issue shares or any legal title of ownership like a company; and
4. Is governed by the provisions set out in its “Objects and Rules” whereas with a company it is subject to the provisions within its Memorandum and Articles of Association (“Constitution”);

The key differences between a foundation and a trust, are that a foundation:

1. Is both the legal and beneficial owner of its assets, whereas with a trust the legal ownership of a trust’s assets lies with the trustee(s) who holds the beneficial interest in those assets for its beneficiaries; and
2. Is liable for its own debts whereas with a trust, such a liability falls on its trustee(s).

A foundation has no “owner” and so the person establishing the foundation, the “Founder”, cannot be held liable for its debts.

Fiduciary and other roles associated with an Isle of Man foundation

The parties typically associated with an Isle of Man Foundation are:

• Registered Agent – Every foundation must have a registered agent. The registered agent may be a natural person or a corporate entity; however, they must hold a Class 4 licence, which permits them to provide administration services to a company, issued by the Isle of Man Financial Services Authority. The registered agent, when instructed by a founder, is the person that applies to the Isle of Man Companies Registry to establish a foundation. The registered agent may be, but is not required to be, a member of the council.
• Founder – The founder is the person who instructs the registered agent to apply for the establishment of the foundation. The founder may provide initial assets to the foundation, through a dedication (gift), but this is not always the case.
• Council – A foundation must have a council to administer the assets of the foundation and carry out its objects. The council is similar to the board of directors of a company or the trustees of a trust. The council members have a fiduciary duty to act honestly and in good faith with a view to acting in the best interests of the foundation. The founder may be a member of the council.
• Enforcer – A foundation may have an enforcer, but this is not mandatory. An enforcer, whose role is similar to a protector of a trust, is only required for foundations whose objects [activities] are to carry out a specified non-charitable object. The enforcer will oversee the activities and actions of the foundation’s council to ensure that they act in accordance with the foundation objects. The enforcer may have the power to sanction or authorise acts of the council which might not otherwise be permitted within the rules of the foundation. Other than the founder and the registered agent, no person may be a member of the council and the enforcer.
• Beneficiaries – In a trust a beneficiary has an equitable interest in the assets held by the trustees. Whereas in a foundation the beneficiaries have no interest in the assets that it holds. It may be the case that a foundation has no beneficiaries, for example if the foundation’s sole object is to hold assets. The procedures regarding the appointment and removal of beneficiaries will be contained within the foundation rules. Even when beneficiaries are named, they do not necessarily have a right to receive distributions from a foundation and they do not have the right to information or documents relating to the foundation.

The formation, constitution and documents associated with a foundation

A foundation’s activities and formal statutory provisions are contained within:

• A Foundation Instrument; and
• A Foundation’s Rules.

A foundation is formed by the registered agent submitting an application to the Isle of Man Registrar of Companies accompanied by a copy of the Foundation Instrument which states:

• The name of the Foundation, which ends with the word “Foundation”;
• The objects for which the foundation is established which have to be certain, reasonable and possible, and to benefit a person or class of persons or undertake a specified purpose;
• The names and addresses of the members of the council; and
• The name of the foundations registered agent.

A Foundation’s Rules, which can be looked at as a combination of a company’s Articles of Association and the administrative provisions of a trust deed, contain the substantive provisions regarding the management and administration of the foundation, such as:

• The establishment of the council, the appointment, retirement, removal and remuneration of council members, the functions of the council and its decision-making process;
• The appointment, retirement, removal, and remuneration of the registered agent;
• The appointment, retirement, removal, and remuneration of the enforcer, if applicable;
• The addition and removal of beneficiaries;
• Records of all dedications (gifts) to the foundation;
• How changes may be made to the foundation instrument; if applicable;
• How any assets of the foundation should be applied upon its winding-up; and
• Any automatic winding-up provisions, such as following a specified time period or upon the occurrence of an event.

Once established the foundation will be included on the Isle of Man Register of Foundations and the Foundation Instrument will be available as a public document.

The Foundation Rules are not a public document, and these do not need to be filed with the Registrar. The rules need not be provided to anyone other than the council members, the registered agent, the enforcer, and the founder.

What are non-charitable foundations typically used for?

The most common uses of a foundation are:

1. Business succession planning – A foundation can protect against conflict and competing interests amongst family members.
2. Wealth management and family provision– A foundation can hold investments, interests in trading subsidiaries and other assets separate from other assets of the founder to create a specific ‘pot’ of value for specific beneficiaries.
3. Legal separation of assets from the founder’s personal estate – The foundation can be used to protect assets against any personal liability issues of the founder.
4. Holding shares in a private trust company – The foundation can hold shares in a private trust company that acts as a trustee in family office arrangements.
5. “Orphan”’ or off-balance sheet structures – A foundation can be used where there are securitisation issues or distressed asset re-financing.
6. Holding wasting assets – Foundations are commonly used to hold aircraft and superyachts.
7. Alternatives to trusts – Foundations may be attractive to clients based in non-common law jurisdictions.
8. Confidentiality – Foundations can be used to protect the confidentiality of individuals by separating the legal ownership of assets from the benefits being received.
9. Probate avoidance – Assets and companies held within a foundation can continue to operate upon the death of an individual as the foundation assets will not be tied up in the process of probate.