Business succession and estate administration using trusts
Amendments to the Trust Law
A major amendment to the Trust Act was made on December 15, 2006, and went into effect on September 30, 2007. The revised Trust Act provides various new systems, including self-trust, in which the trustor acts as trustee to manage and dispose of trust assets. This has greatly expanded the scope of use of the Trust Act, for example, making possible business trusts, which were not possible before, and permitting successor bequest-type beneficiary succession trusts. Recently, the Trust Act has been used in connection with gifts of education funds from grandparents to grandchildren. Therefore, we would like to provide an overview of what a trust is and explain how the new Trust Act can be utilized.
Basic Structure of Trusts
A trust is a mechanism whereby a trustee entrusts the management, operation, and disposition of trust assets to a trustee, and the trustee distributes to beneficiaries the income obtained as a result of the management, operation, and disposition of the trust assets. In a trust, the concepts of trustor, trustee, beneficiary, trust property, etc. are used. The establishment of a trust is done by an entrustment from a trustor to a trustee called an act of trust. Since the authority to manage and dispose of the trust property is transferred to the trustee by the trust act, the trustee becomes the owner of the trust property thereafter. When real estate is trust property, the trust is registered and the transfer of ownership is registered from the trustor to the trustee, and it becomes clear in the registration that the trust property is the property of the trustee. The trustee manages, operates, and disposes of the trust property in accordance with the instructions from the trustor, and distributes the profits obtained from the trust property to the beneficiaries.In this way, the act of trust transfers the ownership of the trust property to the trustee, but the economic benefit of the trust property belongs to the beneficiaries, and therefore, for tax purposes, gift tax, etc. is imposed on the beneficiaries in principle as if the economic benefit had been transferred from the trustor to the beneficiaries by the establishment of the trust. Therefore, for tax purposes, gift tax, etc. will be imposed on the beneficiaries in principle as if there was a transfer of economic benefit from the trustor to the beneficiaries upon establishment of the trust (trust taxation on beneficiaries).
How trusts are established
Under the Trust Act, there are three cases in which a trust may be established. The first is by trust agreement, which is the most typical way of establishing a trust (Article 3, Item 1 of the Trust Act). A trust agreement is made by agreement between a trustor and a trustee, and a written trust agreement is usually prepared. The trust agreement stipulates the names of the trustor, trustee, and beneficiaries, trust assets, trust period, and investment method of the trust assets. These details will be registered in the trust registration as set forth above.
The second method is to establish a trust by will (Article 3, Item 2 of the Trust Act). In the will, the trustor specifies the names of the trustee and beneficiaries, the trust property, and the method of managing and operating the trust. A trust by will is called a testamentary trust, and since it is a type of will, it comes into effect upon the death of the testator (trustor). For example, in the case of a testamentary will, the testator is required to write the entire text of the will in his/her own handwriting, date the writing, sign and seal the document, etc. Since a testamentary trust is a type of will, these formalities are required, and a will that lacks these formalities (for example, a will in writing without the date of creation) .If a will lacks form (for example, if a self-written will lacks the date of creation), it is invalid. Also, a testamentary trust can be rewritten by the testator as many times as he or she wishes until his or her death, and can be revoked at any time during his or her lifetime.
The third method is called self-trust (Article 3, Item 3 of the Trust Act), in which the trustor establishes by notarization or other means that he or she will manage and dispose of the trust property himself or herself. In a self-trust, the trustor manages, operates, and disposes of the trust property on his/her own, and thus the relationship between the trustor and the trustee is established. However, since the trust property is an independent asset from the trustor’s assets, it is necessary to make it clear to the outside world that the said property is trust property, and therefore, it is necessary to do so in writing by a certain method such as a notarial deed.
Functions of trusts
Since trust assets are independent of the trustor’s assets, they are not included in the trustor’s bankruptcy estate in the event of the trustor’s bankruptcy, nor do they become inherited property in the event of the trustor’s death. In addition, creditors of the trustor cannot foreclose or otherwise enforce against the trust assets. Similarly, since the trust property is separate and distinct from the trustee’s personal property, the trustee’s creditors cannot seize or enforce against the trust property, and the trust property does not constitute the trustee’s bankruptcy estate in the event of the trustee’s bankruptcy. This function of isolating trust assets from both creditors of the trustor and creditors of the trustee is called the insolvency isolation function of a trust.
The second function of a trust is to freeze the trustor’s intention. Since the trust property is operated, managed, and disposed of by the trustor in accordance with the trustor’s instructions (stipulations of the trust deed), the trust agreement will continue even after the death of the trustor, unless otherwise specified, and the operation, management, and disposition of the property will continue in accordance with the purposes stipulated by the trustor. This ability of the trustor to operate, manage, and dispose of property in accordance with his/her own will even after his/her death is called the intention freezing function of a trust.
Third, by establishing a trust, the trustor can separately determine the right to receive income from the trust property (income beneficiary interest) and the person to whom the principal belongs (principal beneficiary interest). For example, the trustor may, in the trust act, vest the income derived from the investment of the trust property in his or her children and the principal in his or her siblings. This ability to divide and dispose of the beneficial interest in the income and the beneficial interest in the principal of the trust property is called the split-rights function of a trust.
Fourth, it is possible to collectively manage trust assets from multiple trust acts in a lump sum. For example, if 100 trustees collectively manage property entrusted with 1 million yen each, they can manage 100 million yen of property, which enables them to invest in more expensive property (e.g., high-value real estate in the city center such as high-rise buildings) or to increase their bargaining power when investing by collectively managing more expensive investments, which can be more advantageous. By consolidating high value investments, it may be possible to increase the bargaining power at the time of investment and enable investment under more favorable conditions. This ability to manage multiple trust assets collectively is called the collective management function of a trust.
Fraudulent trusts and how to prevent them
As mentioned above, since trusts have a bankruptcy segregation function and trust assets are separated from the trustor’s property, trusts may be used as a way to conceal property owned by a debtor who is strapped for cash. From the standpoint of the trustor’s creditors, the debtor’s assets will be reduced by the trust act, and the assets that can be used to cover his/her claims will be reduced. Under the Civil Code, the right to rescind a fraudulent act exists with respect to such acts of concealing property, and creditors can file a lawsuit with the court to rescind the act of disposing of the property and recover the debtor’s property. Similarly, under the Bankruptcy Code, a trustee in bankruptcy can exercise his/her right of repudiation against a fraudulent disposition of property, rescind the act of disposition, and incorporate the disposed property into the bankruptcy estate.
Therefore, the Trust Act also provides that if a trustee has created a trust knowing that it will harm his/her creditors, the trustee may request the court to rescind such trust act, regardless of whether the trustee knew that it would harm the creditors or not (Article 11, Paragraph 1 of the Trust Act). For example, in a case where a cash-strapped debtor establishes a trust over his/her property, transfers the company property to the trustee, and continues to operate and earn profits while causing the old company to go bankrupt, thereby causing damage to creditors, it is possible to restore the said property to the creditors’ assets by rescinding the fraudulent trust act, which will serve as an allowance for the creditors’ claims. It is possible to restore the property to the debtor’s estate. However, since the Trust Act provides that revocation of a fraudulent trust cannot be performed if the beneficiaries of the trust did not know at the time of creation of the trust that they would harm the creditors of the trustor, there is room for the trustor to attempt to conceal the property by having a bona fide beneficiary intervene. Recently, the act of concealing property through fraudulent corporate divestiture has often been a problem in court cases, and it is conceivable that the same standard of judgment could be applied to fraudulent trusts.
Liability for trust assets
What is transferred from the trustor to the trustee by the establishment of a trust is the trust property, and in principle, debts owed by the trustor are not transferred to the trustee (the trustee is not liable for them). However, the trustee is obligated to pay for the obligations to bear the burden of responsibility for trust property as defined in the Trust Act. Article 21(1) of the Trust Act defines the types of liabilities for which the trustee is liable. Article 21(1)(iii) of the Trust Act defines “claims against the trustee that arose prior to the trust and for which the trust deed stipulates that the obligation pertaining to such claims shall be an obligation to incur trust property liabilities” as an obligation to incur trust property liabilities. In other words, even if the claim arose prior to the trust, the trustee will assume the debt for which the trustee has agreed to the terms of the claim and the debt has been assumed. There are two types of debt assumption methods: exemptive debt assumption (where the trustor is exempted from liability for the debt and only the trustee becomes the debtor) and superimposed debt assumption (where both the trustee and the trustee are jointly and severally liable for the debt). Of the two, the superimposed assumption of debt can be established only with the consent of the trustee, while the assumption of indemnified debt requires the consent of creditors because it has a significant impact on their interests. If the holders of trust claims consent, in addition to having the trustee be exempted from liability (dischargeable assumption of liabilities), the liability for performance can also be limited to the extent of the trust property (Article 21, Paragraph 2, Item 4 of the Trust Act). In other words, in the case of assumption of indemnified liabilities, while the trustor is exempted from liability, the trustee is liable for his/her own property as well, but with the consent of the creditors, it is possible to stipulate that the trustee is also liable only within the scope of the trust property. Therefore, if the trust property is lost, the scope of liability is limited in that the trustee is not liable any more, which is advantageous to the trustee.
Limited liability trusts
A limited liability trust is a trust in which the trust deed stipulates that the trustee shall be liable for the performance of the trust property liability obligations solely from the property belonging to the trust property and registers to that effect. Since creditors of obligations to bear the burden of responsibility for trust property are only entitled to receive payment from the trust property, they are not allowed to seize or otherwise enforce against the trustee’s own property (Article 217, Paragraph 1). Therefore, creditors of trust property liability obligations may suffer damages because they will not be able to receive payment of their obligations if the trust property becomes insolvent. Therefore, the Trust Act requires a limited liability trust to be registered as a limited liability trust (Article 232 and following), mandates the use of the words “limited liability trust” in its name (Article 218, paragraph 1), and requires the trustee to clearly indicate to the counterparty of the transaction that the trust is a limited liability trust when conducting the transaction (Article 219). Although limited liability trust is a system newly permitted by the amendment of the Trust Act, it is a very effective system for both the trustor and the trustee in that it allows the scope of liability to be limited. In other words, a stock company under the Companies Act has limited liability, and in principle, shareholders are not liable for the company’s debts. This system of limited liability makes it clear to investors that they will not suffer losses beyond the scope of their investment, allowing them to make investments with peace of mind (shareholder limited liability). The system of shareholders’ limited liability is a system that limits the liability of investors by creating a legal entity separate from investors, and it is a system that can be said to be the foundation of capitalist society. In particular, in the case of business trusts, which will be discussed below, the scope of liability will be clarified. In particular, the principle of limited liability is essential for business trusts, as discussed below (the limited liability trust system can be used for business trusts).
Business trusts
It is possible for a corporation to separate one of its business units from the main body of the corporation and transfer it to a trustee, who then continues the business. This is similar to the system of corporate separation in that a company separates its assets and liabilities related to a particular business. As mentioned above, the trust assets are in principle positive assets, but if the trustor and trustee agree, the trustee can assume certain debts. In addition, if the creditors agree, the trustee can not only be exempted from the liability of the trustor (exemptive assumption of liabilities), but also the scope of liability can be limited to the extent of the trust assets, so that the trustee is not obligated to make repayments from its own assets. Similarly, when utilizing the limited liability trust described above, it is now possible to stipulate that the trustee shall be liable only to the extent of the trust property for any subsequent obligations arising thereafter. Although the trust property does not have juridical personality, the ability to separate assets and liabilities from both the trustor’s property and the trustee’s property has created a kind of juridical personality-like status. Such a trust is called a business trust.
Business trusts can be created by taking advantage of the system permitted under the new trust law, and it is not expected that there will be a large number of use of such trusts. However, as described below, it is an effective system and may be considered for use in fundraising situations. For example, a company (pachinko chain “X”) needs 6 billion yen (2 billion yen per store) to open three new stores, and although it is conceivable that X itself could borrow from a bank or other institution as a debtor, if X goes bankrupt, the lender would likely be unable to receive repayment. In this case, there is a high possibility that the lender will not be able to receive repayment. Of course, when borrowing funds, collateral is usually required, but Company X may already have pledged all of its assets to other creditors and may not have sufficient assets to serve as collateral. Pachinko machines often do not provide sufficient collateral because the disposal price is extremely low compared to the purchase price, and if leases are used, collateral cannot be provided in the first place. Even if there is real estate that can serve as collateral and a mortgage or other security interest is obtained on it, if Company X files for corporate reorganization, the security interest held by the lender will become a security interest in the reorganization and may well be reduced in accordance with the reorganization plan.
To begin with, the most valuable business asset in the above case would be the daily sales that come in from the operation of the pachinko parlor. From the lender’s perspective, even if Company X should go bankrupt, it would be most desirable for Company X to continue its business after the bankruptcy and continue to make repayments from the daily receipts. It is also considered that the lender provides loans focusing on the business value of the three stores that Company X will open in the future, and does not recognize the collateral value of the other business values of Company X (which in many cases are secured by security interests held by other creditors). In light of the above, the most appropriate method would be for Company X to transfer the three stores to a specific trustee in trust, and then transfer the beneficial interest in the trust acquired by Company X to the lender as security for the lender. Since the three newly opened stores are transferred to the trust, even if Company X goes bankrupt, the assets of the three stores will not be included in the bankruptcy estate of Company X due to the bankruptcy isolation function of the trust, and the business of the three stores can continue(In some cases, the lender may be able to manage the daily deposits by itself by maintaining a deposit book for the transfer account designated by the lender). If it is necessary to distribute the ongoing earnings of the business to Company X, a contract for the operation and management of the business could be concluded between the trustee and Company X, with a monthly payment to Company X for management fees. Then, upon completion of the ¥6 billion payment, the lender could transfer the beneficial interest in the trust to Company X or terminate the trust agreement, so that the income thereafter belongs to Company X. If a business trust is effectively utilized in this way, a new form of financing may become possible, and it may be well worth considering for new businesses in the future.
Trust in lieu of will
Since a testamentary trust is a type of will, it requires the formalities of a will and becomes effective upon the death of the trustor. On the other hand, a testamentary trust is a trust in which the trustor establishes a trust with himself/herself as the beneficiary while he/she is alive (a trust in which the trustor = beneficiary is called a beneficiary trust), and when the trustor dies, the beneficiary rights are transferred to the person previously designated in the trust. Therefore, after the death of the trustor, the beneficiary designated in the trust act becomes the beneficiary. For example, a trustor may establish a trust with his own house as the trust property and himself as the beneficiary, and then designate his wife (or his children) as the beneficiary after his death.
Since a testamentary substitute trust is established during one’s lifetime through a trust agreement, revocation by the trustee is restricted and the status of the beneficiary is stabilized. Also, as mentioned above, it avoids the formality of a will, and avoids the risk of invalidation due to lack of formality. Establishing a trust during one’s lifetime may also have the advantage that the said property is excluded from the scope of the estate, thus avoiding disputes by heirs. However, it should be noted that the provision for claiming the reduction of the residuary estate is also applicable to a testamentary trust in lieu of a will, so if the trust infringes on the residuary estate of other heirs, it may be subject to a claim for reduction of the residuary estate.
Successor bequest type beneficiary succession trust of the estate.
Article 91 of the Trust Act allows for the establishment of a trust that stipulates that upon the death of a beneficiary, the beneficiary rights held by the said beneficiary shall be extinguished and another person shall acquire new beneficiary rights. For example, it is now possible for a trustee to establish a trust in which his home is the trust property and the trustee is the trustee during his own lifetime (the above beneficiary trust), but after his death, his wife becomes the beneficiary and after his wife’s death, his children become the beneficiaries. Such a trust is called a successor bequest-type beneficiary succession trust.
If the trustor can determine the beneficiary right after his death as described above, it would be very beneficial for the trustor to be able to determine the ownership of the property after his death according to his own will. On the other hand, however, since the ultimate owner of the beneficiary or ownership of the trust property is not determined until the termination of the trust, it may result in the creation of uncertain property, and in some cases, it may harm the safety of transactions. Therefore, the Trust Act provides that a successor bequest-type trust for successive beneficiaries as described above shall remain in effect until the death of the beneficiary or until the extinguishment of the beneficiary right, even if the beneficiary who currently exists after 30 years from the time when the trust was created acquires the beneficiary right under such provision (Article 91). In other words, the beneficiary right shall remain in effect for 30 years after the establishment of the trust (Article 91). In other words, after 30 years have passed since the establishment of the trust, the trust will terminate upon the death of the person who newly acquired the trust beneficiary right. For example, if Mr. A has the trust beneficiary right as of the 30th year, and Mr. A dies in the 40th year and Mr. B acquires the trust beneficiary right, the trust will terminate when Mr. B dies(If Mr. B survives 50 years after acquiring the trust beneficiary right, the trust will continue to exist for 90 years from the time of establishment)。
Under the Civil Code’s provisions on inheritance, heirs are defined by law, and even when a will is prepared, it is often not always possible to pass on property according to the wishes of the trustor. Successor bequest-type beneficiary succession trusts are often used in the U.S. and other countries, and it is of great value that this system has been approved in Japan through the recent amendment of the Trust Act.
For example, suppose that Ichiro Tanaka had a child, Jiro Tanaka, by his former wife (deceased) and later married his second wife, Hanako (maiden name Takahashi). According to the statutory inheritance, Jiro Tanaka and his future wife Hanako will inherit half of the property, but Ichiro Tanaka wants his future wife to live in his home at least during her lifetime because he is worried about her livelihood. On the other hand, since Ichiro Tanaka’s home is property that has been passed down from generation to generation from the Tanaka family, he would like Jiro Tanaka to inherit that property after his future wife’s death. If Ichiro Tanaka wrote a will and had Hanako, his future wife, inherit the property, Hanako would be able to dispose of the property during her lifetime, and if Hanako died without writing a will, the property would be inherited by someone in the Takahashi family who is Hanako’s legal heir (e.g., parents or brothers). In such a case, the successor will not be able to fulfill Ichiro Tanaka’s wishes. In such a case, Ichiro’s purpose can be achieved by establishing a successor bequest-type trust with the home as the trust property and Hanako as the beneficiary after Ichiro Tanaka’s death and Jiro Tanaka as the beneficiary after Hanako’s death. If you wish to terminate the trust upon Hanako’s death, you can also set Hanako’s death as the event for termination of the trust and Jiro Tanaka as the principal beneficiary, so that Jiro Tanaka will become the owner of the relevant property after Hanako’s death.
A similar case would arise in the case where a wife has a stepson. For example, if Ichiro Tanaka married Hanako and died without having any children, Hanako would receive two-thirds (if Hanako and Ichiro’s parents are heirs) or three-quarters (if Hanako and Ichiro’s brothers are heirs) of the legal inheritance, and after Hanako’s death, the property inherited by Hanako Hanako’s relatives would inherit the property. If the property was inherited by Ichiro Tanaka from the Tanaka family, then Ichiro Tanaka may wish to have it inherited by his own brother or others who are from the Tanaka family. In such a case, by utilizing a successor bequest-type beneficiary succession trust, Hanako can be given the benefits arising from Ichiro’s property (e.g., rent from a rental apartment) during Hanako’s lifetime to ensure her livelihood, and after her death, the ownership of the property can be passed to Ichiro Tanaka’s brothers to ultimately vest the ownership of the said property in the Tanaka. After Hanako’s death, the property can be passed to Ichiro Tanaka’s siblings so that ownership of the property will ultimately belong to the Tanaka family. In this way, the successor bequest-type beneficiary succession trust is a system that allows the beneficiaries of the property after the death of the trustor to be determined for many generations, and its use in inheritance is expected to pave the way for new methods of passing on property that were not possible before.