Asset isolation failed! Why was Zhang Lan's overseas family trust broken down?

Recently, a judgment released by the US Federal District Court showed that Zhang Lan still owed the CVC fund US$142 million (about 980 million yuan) and its interest. Zhang Lan's overseas family trust was broken down, and a New York apartment purchased with it was about to be repaid, and the relevant news caused heated discussions.

Family trusts are a great wealth management tool that is favored by high net worth individuals for its features such as risk isolation. Why was the family trust set up by Zhang Lan broken? Is there also a possibility that domestic family trusts may be broken? How should high-net-worth individuals properly set up a family trust?

Zhang Lan's overseas family trust was broken down

According to media reports, the U.S. District Court announced the civil lawsuit ruling of La Dolce Vita Fine Dining Company Limited and Zhang Lan, ruling that the proceeds from the sale of apartment 39A at 20 West 53rd Street in New York, owned by Zhang Lan and her company, belonged to Dolce Vita. Sweet Life Gourmet Co., Ltd. was actually established by European private equity firm CVC Capital Partners (CVC) to acquire Qiujiangnan, and the judgment also revealed that Zhang Lan lost a lawsuit with CVC in 2019, owing the other party a total of US$142 million (about 980 million yuan) and its interest.

In addition to obtaining funds to sell the New York apartment, CVC also targeted two bank accounts opened by Zhang Lan's family trust and family trust shell company Success Elegant Trading Limited (SETL) at Credit Suisse and Deutsche Bank in order to recover the arrears.

In 2014, Zhang Lan established a family trust shell company SETL and transferred all the shares of SETL to the offshore trust The Success Elegant Trust, the beneficiaries of Wang Xiaofei and her children, and the custodian of Asia Trust Limited.

In November last year, a judge in Singapore's High Court found that Teo Lan was the beneficial owner of the assets in the bank account where the trust was located, and granted CVC's application to appoint a receiver. In other words, the family trust property is recognized as Zhang Lan's personal property, so Zhang Lan's creditor CVC can apply for corresponding enforcement measures against the funds.

It stems from Zhang Lan's excessive actual control

Offshore family trusts simply mean that residents of a country set up family trusts in other countries or regions outside the country, such as the British Virgin Islands and the Cayman Islands. Offshore family trusts can avoid the problem of wealth division due to business operation risks and marriage risks, and its core function lies in risk isolation.

In order to achieve risk isolation and realize the inheritance of family wealth, the basis for offshore family trusts to be achieved is also "isolation", that is, the independence of trust property, and the rights boundary of the settlor needs to be set carefully.

This is also the core reason why the offshore family trust set up by Zhang Lan was broken: the actual owner of the property under the family trust is the settlor, not the custodian. Whether it is transferring assets or buying real estate, Zhang Lan's control over the so-called family trust is too great, exceeding the power of a settlor.

In an effective family trust with the function of asset isolation, after the settlor converts his property into trust property, the trust property will be independent of the settlor, the beneficiary and the respective inherent property of the beneficiaries. Only in this case, even if the settlor or trustee has debts, the trust assets are not liability assets, and the creditor has no right to apply to the court to directly take property preservation measures or other enforcement measures. From the current situation, Zhang Lan's offshore family trust was recognized as her personal property, thus losing its property preservation function.

The judgment of the Singapore High Court also published a number of Zhang Lan's direct interference in trust assets. For example, before the Singapore High Court issued an asset freeze order, Zhang Lan was eager to transfer the assets in the trust account. Specifically, in September 2014 and February 2015, Zhang Lan directly asked Credit Suisse to transfer US$3 million twice without specifying the reason; A transfer of funds from a Deutsche bank account in November 2014 was eventually traced back to the purchase of the apartment in New York.

How to set up a family trust correctly?

With the accumulation of wealth by domestic residents, the wealth management needs of high-net-worth individuals are increasing, the available financial investment tools are becoming increasingly abundant, and the service capabilities of financial institutions continue to improve, which has accelerated the development of family trust business in China.

According to data released by China Trust Registration, in January 2023, 9.207 billion yuan of new family trusts were added in China, an increase of 40.44% month-on-month. As of the end of the third quarter of 2022, the scale of domestic family trusts has increased to about 470 billion yuan. During the "14th Five-Year Plan" period, the scale of family trusts is expected to exceed one trillion yuan.

The breakdown of overseas family trusts cannot help but make high-net-worth individuals worry: Is there a possibility that domestic family trusts may fail in asset isolation?

Article 2 of the Mainland Trust Law stipulates that the trustee manages and disposes of the trust property in his own name, according to the wishes of the settlor, for the benefit of the beneficiaries and for specific trust purposes. In other words, in a domestic trust relationship, the trustee must obey the wishes of the settlor. According to this, some people in the industry believe that the protection of the settlor's will is one of the biggest differences between offshore trust and domestic trust, in domestic trust, although the trustee obeys the will of the settlor, they are still a legal trust relationship, which cannot deny the validity of the trust, and then conclude that the domestic trust is less likely to be penetrated.

In fact, up to now, there have been no judicial cases in mainland China that directly adjudicate on the independence of family trusts, but although the trial practice in China in terms of the settlor's control over the trust is still unclear, this does not mean that family trusts in China are completely impossible to be breached. Industry experts suggest that due to differences in cultural and legal systems, the function of domestic family trusts is more reflected in inheritance. Although the legal background is different, the establishment of a family trust must comply with the law in order to better realize its role and function.

At the same time, high-net-worth individuals should correctly understand the asset protection function of family trusts. The essence of a family trust is to hold, protect and inherit family wealth, rather than evading debts, avoiding tax obligations and hiding illegal gains.

In addition, the true intention to establish a trust should not only be clearly reflected in the trust document, but also truly implemented in the daily management of the trust after its establishment. If the settlor ignores the trust deed and still arbitrarily dispatches and uses the assets in the trust like he dispatches and uses his own assets, then, like Zhang Lan, it may be considered that he never really wanted to surrender the ownership of the assets to establish a trust, thus making the trust lose its due asset protection and risk isolation functions.

From Zhang Lan's case, we can also see that if you want to maintain the independence of the trust property, you must properly restrict your rights as a settlor and give up controlling the trust property anytime and anywhere, in order to truly realize the function of the family trust without being broken.