Establishment, Creation, and Termination of a Trust Fund and Related Documentation

04 \ 04 \ 2023

In the next part of our series for Právní prostor, we will focus on the topic of the establishment, creation, and subsequent termination of a trust fund. The process of setting up and creating a trust fund will be gradually analyzed, including the distinction between a trust fund established inter vivos and mortis causa.

n this context, we will focus on the mandatory and optional documentation associated with the establishment and creation of a trust fund, with special attention given to the trust fund’s statute, which represents the fundamental cornerstone of the trust fund. In conclusion, we will address the termination of the trust fund.

Further information about trust funds can be found in the individual parts of this series — The Concept and Definition of a Trust FundThe Origin and Development of the Trust FundParties Involved in the Trust Fund. 

Establishment and Creation of a Trust Fund

The legal framework does not grant a trust fund legal personality, and as discussed in more detail in the first part of this series, it is not a legal entity. However, since 2018, the creation of trust funds can be viewed as a two-phase process. The key factor in defining these phases is the legal basis on which the trust fund is established.Section 1448, paragraph 1 of the Civil Code states that a trust fund is established by “setting aside assets from the founder’s ownership so that the founder entrusts the assets to a trustee for a specific purpose (i) by contract or (ii) by a disposition upon death.” Thus, we distinguish between trust funds established during the founder’s lifetime (inter vivos) based on a founding contract, and trust funds established in the event of death (mortis causa) based on a disposition upon death.

A trust fund established during the founder’s lifetime, according to Section 1451, paragraph 1 of the Civil Code, is created as soon as the trustee accepts the mandate to manage the assets that the founder has set aside from their ownership. If the trust fund has multiple trustees, it is sufficient for at least one of them to accept the mandate. A trust fund established for the event of death is created by a disposition upon death, typically a will, but it can also be based on a hereditary contract or a codicil.

The creation of a trust fund also differs depending on its type. The establishment of an inter vivos trust fund is linked to the moment the trust fund is entered into the trust fund registry. In this case, the registration has a constitutive effect. This approach is relatively rare in an international context, as foreign legal systems that require the registration of trust-like structures typically do not condition the creation of the entity on its registration. For example, in the Principality of Liechtenstein, the creation of a Treuhänderschaft (trust-like structure) requires only a written agreement. Registration is mandatory for structures established for a period longer than twelve months, but it has only a declaratory effect.

A trust fund established mortis causa (upon death) comes into existence at the moment of the founder’s death. Unlike an inter vivos trust fund, the registration of a mortis causa trust fund in the trust fund registry has a declaratory effect.

A key difference with mortis causa trust funds is that at the moment of their creation and existence, it may not be clear whether the intended trustee will assume their role. Therefore, the trust fund can come into being even if none of the trustees designated by the founder take on the position.

For such cases, the legislator established a backup rule in Section 1455(2) of the Civil Code, according to which the court appoints a trustee upon the proposal of a person who has a legal interest in the matter. Following this, a legal fiction applies, and the trustee is considered to have exercised the function from the moment the trust fund was created. In these situations, the trustee assumes the role with retroactive effect.

Based on the above, it can be summarized that three following conditions are necessary for the proper establishment of a trust fund:

  • a legal act of the founder, which may be either inter vivos or mortis causa,

  • acceptance of the obligation to hold and manage the given assets by the trustee

  • the death of the founder in the case of a mortis causa trust fund, or, in the case of an inter vivos trust fund, its subsequent registration in the trust fund registry.

Documentation related to the establishment, creation, and operation of the trust fund

Trust funds represent a highly flexible instrument, a fact that is also reflected in the documentation, which can generally be divided into mandatory documentation—without which it is impossible to ensure the establishment, creation, or ongoing operation of the trust fund—and optional documentation, without which the trust fund can still be created.

Mandatory documentation includes the founding legal act and the trust fund statute. Optional documentation mainly includes additional documents that specify the founder’s will and are not required by law. Typically, this refers to a list of wishes or a wish list of the founder. Certain formal and content requirements are usually attached to selected documents, especially those that are mandatory.

Mandatory documentation

Before the trust fund is created, assets are entrusted for management based on a contractual relationship between the founder and the trustee, referred to as the establishment agreement. The establishment agreement contains the expression of the founder’s will on one side and the acceptance of the mandate for management on the other side, which may also be the subject of a unilateral declaration. Typically, the agreement also specifies the separated assets and the trustee’s obligation to manage them with the care of a prudent manager. Except for trust funds under the ZISIF Act and the separation of real estate and related rights through the establishment agreement, there is no specific form requirement for the establishment agreement. Therefore, the agreement may also be concluded implicitly; in most cases, it is part of a notarial deed.

The basic document of a trust fund is the statute, which is a sort of equivalent to the founding legal act, but it must not be confused with the establishment agreement described above. The statute regulates the distribution of rights and obligations of persons involved in the trust fund, its organization, the setup of its operation, and its functioning. The statute is adopted by the founder and generally takes the form of a unilateral legal act. The statute must be in the form of a public deed, i.e., it must be drawn up in a notarial deed.

The mandatory requirements of the statute are set out in Section 1452(2) of the Civil Code. The founder is granted considerable flexibility when drafting the statute. In addition to the mandatory requirements, the founder may, at their discretion, define additional optional provisions. Some of these optional provisions are anticipated by the law itself, while others result from the founder’s own creative will. In practice, the statute often includes the establishment of the role of a protector, a family council, or another optional governing body of the trust fund. It is also common for the statute to specify further rights of the founder beyond what is provided by law. However, it is essential to respect the boundaries of the trust fund’s administration, as it is not permissible for the founder to assume a role that replaces the trustee’s function.

The statute of a mortis causa trust fund has certain specific features. In this case, the statute is included in the testamentary disposition, with the appropriate application of the legal provisions on the establishment of a foundation upon death. Thanks to the concept of appropriate application, the statute contained in the testamentary disposition will include the mandatory elements just like the statute of an inter vivos trust fund.

The issue of possible amendments to the trust fund statute is inherently connected with defining the content of the statute. Given the scope of this issue and the focus of this part, we refer to a detailed analysis of this topic contained in the publication Trust Funds for Practice. Briefly, however, we hold the view that amendments to the statute are possible, provided that other conditions are met.

Additional documentation required for the establishment of a trust fund includes consents to the registration of persons in the register of trust funds pursuant to Section 12 of the Act on Public Registers of Legal Entities and Natural Persons and on the Register of Trust Funds.

Optional Documentation

Besides the mandatory documentation, there are also so-called optional documents, which are not required by law but regulate or specify particular aspects of the trust fund’s operation. A typical example is the founder’s so-called wish list, which is written by the founder of the trust fund and usually has a confidential nature. In this document, the founder provides an interpretation of their will, expands or clarifies their thoughts and wishes regarding the management and functioning of the trust fund. It thus serves as an implementing document that concretizes the provisions of the trust fund statute. Other documents that are directly or indirectly related to the trust fund’s operation may include the family constitution, wish lists of beneficiaries, or other documents.

Optional documents also include other contracts, such as the trust fund management agreement, which contains more detailed information regarding the exercise of management, the position of the trustee including their remuneration, etc., or agreements between the founder and optionally established bodies.

Termination of a Trust Fund

The termination of a trust fund is not synonymous with the termination of the trust fund’s administration, which by itself does not lead to the termination of the trust fund due to the need to settle obligations towards entitled parties. For these purposes, Section 1472 of the Civil Code provides that upon termination of the administration, the trustee shall transfer the assets to the person entitled to them.

The termination of a trust fund can be divided into four phases: the termination of the administration, the settlement of the managed property, the termination of the trust fund itself, and its removal from the register of trust funds, which has declaratory effect.

The termination of the administration may occur either at the will of the involved parties or without it, including by a court decision. The reasons for the termination of the administration of a trust fund may include:

  • the expiration of the period for which the trust fund was established,

  • fulfillment of a resolutory condition,

  • the achievement of the purpose for which the trust fund was established,

  • a decision by the founder or another authorized person based on a reservation in the statute,

  • a court decision,

  • waiver of the right to benefits by all beneficiaries,

  • the depletion of all property in the trust fund.

Once the reason for the termination of the administration arises, the trustee is obligated to settle the property managed in the trust fund. In this context, the trustee has the following main duties:

  • to settle debts, including public law liabilities,

  • to transfer the remaining property to the entitled persons, and

  • to present a final accounting to the beneficiaries.

To transfer the remaining property from the trust fund to the entitled persons, it is necessary to determine who shall become the owner of such property. Primarily, the right belongs to the person designated by the founder in the trust fund statute. If no such person exists, the right to the property passes to the beneficiary. If there is no beneficiary, the founder has the right. In practice, a situation may arise where neither the beneficiary nor the founder exists. The legislator has taken such an eventuality into account and established a subsidiary rule, according to which the property passes to the state.

After all assets of the trust fund have been settled, the trust fund itself ceases to exist. The final step is the removal of the trust fund from the register of trust funds. The trustee is obliged to submit an application for removal from the register within thirty days of its termination. The removal from the register has only a declaratory effect.

Exit Clause

In addition to the "standard" ways of terminating the administration of a trust fund and the subsequent termination of the trust fund itself, there is another option that does not lead to the termination of the trust fund but rather to the transfer of assets or the structure itself—either to another trust fund established in the Czech Republic or, more commonly, abroad. This is done through a so-called exit clause, which is triggered upon fulfillment of conditions anticipated in the statute. The main reason for the growing popularity of these clauses is the current socio-political crisis, global conflicts, and the public’s fear of the future and its unpredictability. The typical destinations for asset transfers are jurisdictions known for their long-standing experience in asset management and economic and banking stability. These include, in particular, the Principality of Liechtenstein and the United Kingdom.

This section discussed the establishment and creation of a trust fund, including the distinction between trust funds created by inter vivos and mortis causa legal acts. In this context, we also focused on the mandatory and optional documentation associated with the formation and existence of a trust fund. Finally, we examined the process of terminating a trust fund, including the reasons for the termination of administration, the related duties of the trustee, and a brief discussion of exit clauses. In the next section, we will focus on property as the main attribute of a trust fund, specifically analyzing the contribution and increase of assets, distributions made from the trust fund, and the related tax implications.

 

Author: Jakub Hollmann

Written for Právníprostor.cz 4. 4. 2023

JUDr. Jakub Hollmann, Ph.D.
Owner and Attorney