Sep 2024
Background on Purpose Trusts
The private discretionary trust is the most widely known form of trust where trustees are given a fund of money to manage and distribute amongst certain named or described beneficiaries who are typically individuals, often in a family context. Bermuda does however also recognise that a trust may be established in circumstances where assets are held by a trustee to manage and expend solely in the fulfilment of a certain purpose rather than for the benefit of named beneficiaries. These trusts are known as purpose trusts. Bermuda was the first offshore jurisdiction to provide for these trusts by statute over 30 years ago with the introduction of the Trusts (Special Provisions) Act 1989 (the “Act”). The purposes can be charitable or non-charitable. The criteria to be met is that the purpose(s) must be sufficiently certain to allow the trust to be carried out, lawful and not contrary to public policy. The concept has been developed since inception and the Act has been updated several times in response to the practical experience of using purpose trusts including in commercial structures.
Commercial Purpose Trusts – Insurance
One of the areas where a number of such trusts have been used is with the establishment of certain special purpose insurance vehicles. This is most commonly seen with cat bond structures and certain limited purpose sidecars. In the typical cat bond structure, for example, a Bermuda exempted company is incorporated and registered as a special purpose insurer in order to facilitate an underlying fully-collateralised reinsurance transaction with a cedant.
The issue that then arises is how the shares of the Bermuda exempted company should be held. It is often the case that it is not possible or desirable for any of the parties to the transaction to own the company or include the company as a balance sheet asset. In the past one solution was to use a charitable trust as the shareholder. The purpose trust, however, provides certain distinct advantages.
Advantage of a Purpose Trust
The main advantage of the purpose trust is that the duties of the trustees of a purpose trust are clearly defined, focusing on fulfilling the stated purposes as stated in the trust deed, and which accord with the intentions of the parties. These purposes are normally to (a) promote the incorporation of the Bermuda exempted company; (b) subscribe for the shares of the company; (c) hold those shares; (d) support the company in pursuing the activity of the particular transaction in question; and (e) enter into any agreements that may be appropriate in connection with the transaction. The trustee may also charge the shares of the Bermuda exempted company by way of security.
The use of a purpose trust therefore avoids any potential conflict that may arise as with an exclusively charitable trust, where the duties of the trustees are to maximise the benefits for the charity or charitable purposes. In that case and depending on circumstances, a conflict of interest may arise whereby it is in the interests of the party establishing the structure to minimise the profit of the trust’s assets. With commercial insurance transactions it is usually desired that the company declare enough dividend to the purpose trust shareholder to fund its ongoing expenses if needed. The use of a purpose trust where the stated purposes are to promote the use of Bermuda exempted companies to meet the needs of the arrangements by subscribing for the shares of one or more such companies, holding those shares and supporting the efficient operation of the company or companies avoids such a conflict.
The Trust Fund
A purpose trust will have a trust fund comprising an initial fund together with any assets that are added to the trust fund from time to time. The initial fund is typically US$10.00. The trustee will then use one dollar of the initial fund to subscribe for the underlying share of the Bermuda special purpose insurer.
It should be noted that special purpose insurers, the insurers used most commonly for cat bonds and other limited purpose sidecars require only one dollar of share capital. Collateralised Insurers and other classes of insurers require significantly more capital. In that case more complex arrangements will need to be put in place. This is often addressed on a case by case basis, but may include, amongst other options a loan or gift from the sponsor to the purpose trust sufficient to cover the required capital.
Role of the Protector with a Purpose Trust
For most purpose trusts used in commercial insurance structures it is often the case, although not mandatory, that a protector will be appointed. Typically the protector will be the insurance manager of the underlying Bermuda insurance company. The protector has a specific role and the scope of their duties is set out under the terms of the trust deed. Typically the trustee must obtain certain written confirmations from the protector before the trustee is able to take certain actions. For example, on termination of the structure the trustee must receive a confirmation from the protector that all of the obligations of the underlying company under the key reinsurance transaction documents have been completed before the trustee can vote to dissolve the company. The idea is that this acts as a check on the powers of the trustee and provides comfort to the underlying sponsor. It is fairly common in these structures for the trustee to be a Bermuda licensed trust company. Such a trustee will have great expertise in trust management but will be less familiar with the intricacies of a specific insurance transaction than the insurance manager. Having the role of protector performed by a party with first-hand knowledge of the transaction aides the trustee.
Where a protector is not specifically appointed, the trust deed will generally require the insurance manager or another third party familiar with the transaction to provide the trustee with certain confirmations before it can take certain actions.
Examples of Uses for Special Purposes Insurance Vehicles
As noted above, the purpose trust structure features in a number of commercial insurance structures. Some of these include:
1. Cat Bonds
The purpose trust structure is now used for all cat bond transactions in Bermuda. For these vehicles, the trustee on behalf of the purpose trust holds the one (1) voting share of the underlying Bermuda company which is registered a special purpose insurer to carry out restricted special purpose business.
2. Limited Purpose Sidecars
The purpose trust structure is also often used with limited purpose sidecars. As with a cat bond, for these vehicles the trustee on behalf of the purpose trust typically holds the one (1) voting share of the underlying Bermuda company which is registered as a special purpose insurer (restricted or unrestricted) and may also be registered as a segregated accounts company. The company then raises funds through the offer of notes and/or non-voting preference shares to investors.
In the event that tailored arrangements are to be agreed with the investors, the terms of the purpose trust may need to take those into account.
3. Joint Ventures
On occasion parties may join together and seek to enter into a joint venture arrangement. In that case it may be useful to get the underlying Bermuda company up and running early both to arrange for it to be registered as an insurer and to allow for other administrative tasks to be completed (such as the opening of bank accounts). For these joint ventures a purpose trust may act as the temporary shareholder before the parties enter into final arrangements.
4. More Complex Insurance Structures
There may be circumstances where a purpose trust may be useful as part of a larger, more complex insurance structure. For example, we have seen them used on occasion for collateralised insurers as well as some general business commercial insurers. These structures will be considered on a case by case basis as they require careful tailoring to ensure both the client’s needs as well as the capital and solvency requirements of the Insurance Act 1978 can be satisfied.
Please feel free to contact Conyers or the authors of this article should you have any further questions about purpose trusts and their possible use in special purpose insurance vehicles.