Recent Decision – Settlement of Assets in Underlying LLC

A recent case in the Cook Islands High Court is of interest to legal advisers establishing asset protection trusts in the Cook Islands.

In brief the facts are as follows. In 2020 X transferred cash (Funds) to an account opened in the US by a US LLC. A Cook Islands trust was then established and the membership interests in the US LLC were transferred to the Cook Islands trust. An account was then opened for the US LLC with CSB and the funds were transferred to that CSB account.

IN 2022 X was arrested on criminal charges of defrauding a group of investors. Freeze orders were issued by a US court over the proceeds of the alleged fraud as well as over X’s personal assets. Following receipt of a Suspicious Transaction Report, the Cook Islands regulatory body (FIU) also froze the Funds held by the LLC in the CSB account.

The liquidators appointed for the investors entity then issued civil proceedings in the Cook Islands Court. The proceedings were issued against the US LLC based on a cause of action for moneys had and received, a personal restitutionary remedy relying on the concept of unjust enrichment. This cause of action normally applies to stolen property and requires only receipt of money by a defendant who has no right to retain it or who has improperly disposed of it. The only defence to this cause of action is that of a change of position. A holder of stolen money is personally liable to the one whose money is stolen unless a bona fide purchaser without notice.

The plaintiff joined the trustee of the trust as a defendant but argued that while the Funds were assigned to the LLC, there was no assignment of the Funds to the trust. For this reason the plaintiff argued that the trustee had no standing to defend the action against the LLC and that the protective provisions of the International Trusts Act did not apply.

The Court issued a number of preliminary judgments, in one of which it set out the issues to be addressed for the trustee to establish standing to defend the action against the LLC. Senior legal advice determined the trustee’s interest was limited to membership of the LLC and that it lacked standing to defend the action against the LLC. The trustee was required to take a neutral position in the proceedings against the LLC and abide by the decision of the Court.

The Court issued a judgment in favour of the plaintiffs for the Funds held to the credit of the LLC in the CSB account.

The important issues to be taken from this case are;

a) The time limits and other protective provisions of the ITA apply to protect a transfer of assets to a trust. They may not apply to protect a transfer of assets to an intermediary entity such as a LLC.

b) Where assets are held by a LLC, a trustee may not have standing to defend an action brought against the LLC, even though the LLC is owned by the trust.

c) Likewise, unless the assets are distributed by the LLC to the trust before freezing orders are issued, the provisions of the ITA protecting trust assets against freezing orders may not apply.

d) If a freezing order is issued against funds held by a LLC then the trustee may not have standing to apply to the Court for orders to release funds to the trustee’s costs of defending the claim or to maintain the settlors financial obligations.

T&F recognises that for various reasons it is often impractical to transfer assets direct to a trust and then on to an intermediary entity. In these situations, therefore T&F advises clients;

1. to have the trustee form a special purpose LLC to hold the assets, (rather than use an existing LLC or an LLC formed by the settlor)

2. to have the trustee, the settlor and the LLC enter into a 3-way agreement deeming the transfer of assets to the LLC to be;

(a) a transfer by way of a gift to the trust, and

(b) a transfer by way of either loan or subscription for membership interests from the trust to the LLC.

3. alternatively, the LLC can be formally appointed as a nominee for the trustee.

4. where litigation is anticipated, if it is not practical to liquidate the LLC and distribute its assets to the trust, then it is important to ensure that at least sufficient funds to mount a defence are distributed by the LLC to the trustee for this purpose.

© 2023 Reuben Tylor BA.LLB,
Director, Trustees & Fiduciaries (Cook Islands) Ltd