Fight or flight? Flee clauses and offshore trusts in the time of Covid-19

A global emergency?

Much of Europe has followed the US in declaring a state of emergency, as has New Zealand and certain provinces in Canada. While the UK has yet to take similar measures, some jurisdictions which many trust practitioners will be familiar with have followed the US’s example. On 18 March 2020, the Bahamas, in which many trusts are resident and administered, declared a state of emergency.

How does this affect trusts?

The effect of a state of emergency declaration is that certain government powers are unlocked in order to deal with the challenge faced by the nation. In general, this works by freeing the government from abiding by some of its usual legal constraints.

A state of emergency is a situation which is commonly provided for in older offshore trust instruments. Regardless of the root cause of the designated emergency, the declaration of a state of emergency can trigger what is known as a flee clause.

What is a flee clause?

A flee clause is a clause in a trust instrument which, once "triggered", purports to automatically transfer the trusteeship and the administration of the trust out of the current jurisdiction and into a different jurisdiction. This is often effected by the automatic retirement of a corporate trustee in favour of a sister company resident and administered in the alternative "safe" jurisdiction.

Classic examples of trigger events include a change of regime, a breakdown of law and order, a natural disaster or a declaration of a state of emergency in the jurisdiction in which the trust is resident and/or administered.

Flee clauses today

The flee clause, once a popular tool of the trust draftsman, is rarely seen in modern trusts. A leading authority on trust drafting, Kessler, Drafting Trusts and Will Trusts: A Modern Approach (Sweet & Maxwell, 14th edition, 2019), does not contain any examples of a flee clause, taking the view that they are no longer justifiable in a standard trust instrument. In an era of increased cross-border reporting and transparency and changing geopolitical circumstances, a flee clause can seem outdated and obsolete.

However, these provisions remain in many older, often offshore, trust instruments and the current global situation therefore highlights potential problems linked to their operation.

Firstly, under a flee clause, it is often the case that the existing trustee is retired automatically on the declaration of a state of emergency, regardless of the reason behind the declaration. This leaves no room for the trustee to consider whether the situation demands such a drastic course of action, and it is easy to see how a trustee might be retired unnecessarily, contrary to the interests of the beneficiaries of the trust. This may result in the unplanned crystallisation of tax liabilities and a host of unnecessary expenses, as well as the disruption of what may have been a well-crafted structure. An example that is often cited is the assassination of the Governor of Bermuda, Sir Richard Sharples, in 1973, which resulted in a declaration of a state of emergency and led to the unnecessary (and expensive) flight of many Bermudian trusts to alternative jurisdictions.

Secondly, a large proportion of the common trigger events are events which would typically be limited to one country, or at least a small number of neighbouring nations. By contrast, Covid-19 has resulted in nations the world over declaring states of emergency in a manner unprecedented in modern times. Trustees may find that the alternative "safe" jurisdiction designated in the trust deed has also declared a state of emergency as a result of the pandemic, a situation which the trust deed may not cater for and in which the course of action to be taken by the trustee may therefore be unclear.

Advice for practitioners

The first step is to identify the trusts which may be affected by the current crisis. Depending on the situation in the jurisdiction in which a trust containing a flee clause is resident, it may be prudent to consider amending the trust instrument to provide the trustee with some discretion in a situation in which the activation of a flee clause may be undesirable.

Further steps may include bringing the problem to the attention of legislators responsible for the emergency legislation in relation to Covid-19, which may be drafted to avoid triggering flee clauses in relevant trust instruments. This has been the case in the Bahamas, where the government specifically amended the legislation to provide that the state of emergency declared as a result of Covid-19 will not trigger flee clauses in Bahamian resident trusts.