A look at the use of trusts for business and trading
May 21st, 2021 06:49
Bankruptcies in South Africa averaged 229 companies per month from 1980 until 2020. In August 2000, an all-time high of 511 companies declared bankruptcy, compared to the record low of 63 companies in May of 1988. Projected bankruptcies for 2021 is 220 companies per month and 240 companies per month for 2022. It is a known fact that more than 90% of business owners close their doors within five to seven years of opening them. Up to 90% of these business owners were likely stripped of their personal assets, resulting from sureties and guarantees that they signed as business owners. This could have been avoided had the business owner set up a trust to protect their assets from SARS, the banks, and other creditors.
The “newer type of trust”
A trust which carries on business activities is often referred to as a ‘business trust’ or ‘trading trust’. Similar to any other type of trust, in layman’s terms a business trust can be described as a legal arrangement or instrument which is created to hold and manage assets for the benefit of certain individuals and/or entities – its beneficiaries. A trust is not regarded as an independent entity or juristic person that can be owned, sold, or transferred as would be the case with a company or a close corporation in terms of the common law, nor in terms of the Trust Property Control Act. A business trust was referred to by the court in the Vrystaat Mielies case of 2004 as “a newer type of trust”.
Without legal personality a trust cannot own property. Any property held in trust is held by the trustees in their capacity as trustees. Section 12 of the Trust Property Control Act requires trust property to be held separately from the trustees’ personal estates.
An alternative to a company, regulated by the Companies Act
The introduction of the Companies Act of 2008 brought about a fundamental shift to the left in company law. As an example, Section 76 of the Act states that a director must act with care, skill and diligence. Section 218(2) of the Act states that any person who contravenes any provision of the Act is liable to any other person for any loss or damage suffered by that person as a result of that contravention. Section 20(9) of the Act states that if there is an unreasonably excessive abuse of the company as a separate entity, the Court may declare that the company is to be deemed not to be a juristic person in respect of any right, obligation or liability of the company or make any further order the court considers appropriate. Such a declaration may leave assets at risk. The Court even held in the Stephen Malcolm Gore case of 2013 that the Section 20(9) remedy should not be regarded as exceptional, or ‘drastic’ – therefore totally acceptable. It may therefore be prudent to consider other types of business forms.
A trading or business trust can therefore be structured to resemble a company or close corporation, whereby trustees can be compared to the directors of a company and beneficiaries can have the rights similar to shareholders. If structured correctly, a trading trust can provide a limited liability form of trading without the complexities or expense inherent in trading through companies and close corporations. These trusts are inter vivos trusts, formed to ensure the continued operation of a business that has a profit incentive.
Trusts can be used for trading purposes
A trading trust can be used as an alternative to other business structures such as a company, close corporation, partnership or sole proprietorship. It may be a good strategy to let the trust own the assets, which are leased to an operating company, to protect the assets from operating risks. The Magnum Financial Holdings (Pty) Ltd (in liquidation) v Summerly case of 1984 confirmed that a trust can be used for trading purposes by acquiring assets and incurring debt and can therefore be sequestrated. Trust creditors can therefore look to the trust’s assets for settlement of their claims and not to the founder, trustees or beneficiaries. Trustees will only be liable for trust debt if they have personally bound themselves to be responsible for trust debt or if they have acted in a way to be held personally liable.
Lack of regulation
The main statute that governs South African Trust Law is the Trust Property Control Act 57 of 1988, which only regulates certain administrative aspects relating to trusts. In 1987, the South African Law Commission recommended that the law of trusts should not be codified (arranged into a systematic code) and that only certain administrative aspects relating to trusts should be regulated.
Although the Act does regulate certain aspects of trusts, it gives no guidance as to trustees’ powers, which must derive from the trust deed itself. As a result trust deeds may contain very different provisions, with only a few court cases as guidance. Although most trust deeds have certain standard clauses, a trust deed is a mere contract in which the founder can express their unique wishes and terms.
Trading trusts also need not be audited, except when required by the Master of the High Court or the trust deed. Although this may make a trading trust cheaper and easier to run than other business forms, this lack of oversight may be detrimental to an outsider contracting with the trust.
~ Written by Phia van der Spuy ~