Switzerland is the world's leading private wealth location and one of the most attractive offshore centres from which to run trusts. Yet the concept of trusts is virtually unknown in Swiss law. As a civil law country, its courts have wrestled with trusts over the years, attempting – with difficulty – to identify the local legal entity they most closely match.

Trust professionals have been crying out for action to ensure that Swiss law recognises trusts as trusts. This has led to a buzz of activity within Swiss legislature and change is now imminent.

The Hague Convention

The buzz began with a Government-commissioned report in 2001 on whether Switzerland should ratify the 1985 Hague Convention on Recognition of Trusts.

Some other European civil law countries have already ratified the Convention, including Italy, Luxembourg, the Netherlands and Liechtenstein.

The problem with the Convention is that it is drafted in such a way that it does not sit well, or in some cases at all, with some of the Swiss legal and tax issues on trusts. This has caused a great deal of problems, but moves have continued and, at the end of 2003, the Swiss Federal Administration began an informal pre-legislation consultation with interested parties.

That process resulted in an initial draft bill, with provisions to enable the Convention to be ratified and for the trust concept to be inserted into the Swiss Private International Law Code. An officially drafted Federal Bill based on that began a formal four-month consultation procedure on 1 October, 2004.

The final draft bill was issued on 5 December, 2005, and is due to be submitted to both chambers of Parliament early this year. Both chambers will be entitled to amend the draft bill, subject to this, and following the expiry of a statutory period during which a referendum can be requested by interested citizens, the bill will become law and the Swiss Confederation will be able to ratify the Convention.

What will the new law be?

The new law will add trusts to Switzerland's 1987 legislation on private international law and amend its 1889 bankruptcy statute.

Importantly, the new law will provide a definition of 'trust domicile'. In the previous draft bill, the concept was borrowed from Swiss company law; now, thankfully, it is specifically defined for trusts as the place where:

. the trust document says the trust is administered (the forum for administration);

. there is other written evidence of such a choice; or

. in the absence of express provision, as a matter of fact. This is a key connecting factor for the recognising of foreign decisions on trusts and jurisdiction generally.

Under the new law, choice of a jurisdiction under a trust will be binding and, subject to any contrary provision in the trust, treated as exclusive. However, this choice will be ineffective under the new law if it improperly deprives an interested party, such as a beneficiary, of access to a Swiss court.

If a Swiss court is selected it may not decline jurisdiction if one of the parties, the trust itself or a trustee is domiciled or habitually resident in the relevant canton of the Swiss court. If there is no valid exclusive selection, the Swiss court will have jurisdiction if the defendant is domiciled or habitually resident in Switzerland, or the trust is domiciled there.

Trust governing law

The new law will incorporate into the Swiss Private International Law Code the Convention's provisions with two modifications. Firstly, it disapplies the Convention's provision that if the governing law indicated by the Convention's provisions does not recognise trusts then the Convention will not apply.

Secondly, the new law disapplies article 13 of the Convention. Article 13 provides that a country need not recognise a trust if its main connecting factors (other than the governing law, location of the trustees' habitual residence or the trust's place of administration) are in a country that does not recognise trusts. This was intended to prevent the back-door introduction of trusts into non-trust jurisdictions. Switzerland felt that this would create uncertainty over trust recognition. This means that trusts which, but for the applicable proper law, are wholly Swiss-based will be recognised under the new law, even though Swiss law has no trust law concept – an important point.

Decisions of non-Swiss courts on trusts

The new law deals with recognising decisions in Switzerland of non-Swiss courts relating to trusts. Decisions of a court designated by a jurisdiction selected in accordance with the Swiss Private International Law Code, or by a court in the country of the defendant's domicile, habitual residence or establishment, or in the country of the trust's domicile, will be recognised by the Swiss courts. The latest version of the bill also provides for recognising decisions by courts in the country of the trust's governing law.

Limited registration

It was proposed initially that all trust property should be subject to a registration system. The idea was dropped – what remains is a provision that applies only to assets subject to a registration requirement in any event; most notably land, but also ships and aircraft. Failure to register means that such trust assets are not protected against a bona fide purchaser.

Changes to bankruptcy law

Switzerland's bankruptcy law also changes to reflect the distinction between trust assets and trustees' assets. The first draft bill envisaged the possibility of legal action under Swiss law against the trust; this would have caused conflicts with the position in jurisdictions where legal action lies against the trustee, with the consequent risk that Swiss judgments would not be recognised there. The new draft bill provides that a debt claim relating to the trust must be brought against the trustee(s) as representative(s) of the trust. It also ensures that in the event of the trustee's bankruptcy the trust assets are ring-fenced and protected.

Tax treatment of trusts

Although, in practice, the Swiss tax authorities already deal with trusts, the tax treatment of trusts by them is anything but standardised. Things are happening here too. A working group of the Conference Fiscale Suisse is currently preparing a paper on the taxation of trusts which is due to be published soon. However, the legislative process will go ahead independently.

Trusts have been run out of Switzerland for many years but against an uncertain legal background. Ratification of the Convention will make for a more favourable environment for setting up and administering trusts from Switzerland. This can only be good news for the Swiss trust industry in a challenging global trusts arena – with the emergence of new trust centres such as Singapore, combined with increasing international pressure on some traditional centres. Stephen Pallister is a partner and Lyndsey West and Philippe Freund lawyers in Charles Russell's private capital group.