The most common mistakes when setting up a trust fund

Establishing a trust fund can be an excellent tool for protecting family assets and planning the intergenerational transfer of wealth. However, this is precisely an area where mistakes are often made – and the consequences can be fatal. Ambiguous statutes, a lack of control mechanisms, an unsuitable administrator, or formal shortcomings can lead to the fund becoming paralyzed, protracted disputes, or even its invalidity. In this article, we provide a clear summary of the most common mistakes that every founder should avoid so that their fund fulfills its purpose and does not jeopardize what it was intended to protect.

Author of the article: ​ARROWS (JUDr. Kateřina Müllerová, office@arws.cz, +420 245 007 740)

Even with the best intentions, mistakes can occur that later jeopardize the functioning of the fund. Here are the most common mistakes that founders should avoid:

• Unclear definition of conditions and entitlements of beneficiaries. Typical mistakes include vague or even unfulfillable conditions under which beneficiaries are to receive payments from the fund. If, for example, the statutes stipulate a condition such as “graduation from a prestigious university” or “leading a law-abiding life” for the payment of a share, disputes over interpretation may arise. Conditions must be formulated clearly, realistically, and verifiably, otherwise there is a risk of paralysis of the fund and conflict within the family.
• Lack of dispute resolution and oversight mechanisms. Many statutes fail to specify how to proceed in the event of a dispute between the administrator and the beneficiaries or between multiple beneficiaries. Similarly, there is no independent supervision of the administrator. Weak or non-existent conflict resolution mechanisms can then lead to protracted legal battles that jeopardize the purpose of the fund. The solution is to appoint a protector (supervisor) or arbitrator to intervene in the event of a dispute, or to negotiate an arbitration clause for disputes arising from the fund.
• Inappropriate selection or insufficient control of the administrator. It happens that the founder chooses a person who does not have sufficient expertise or reliability as administrator. In the worst case, it may even be someone with ulterior motives. An example of a mistake is entrusting all power to a single administrator without setting up safeguards—if the administrator fails or begins to act in their own interest, the fund will suffer great damage. It is therefore a mistake not to include in the statutes the possibility of dismissing the administrator (e.g., by joint decision of the beneficiaries) or to leave them without an obligation to report on their activities. Trust, but verify applies doubly here.
• Omission of clauses protecting the fund's assets. Some funds do not contain provisions to prevent waste or misuse of assets. For example, there is no protective clause against reckless behavior by beneficiaries who could demand early payment from the administrator. Similarly, there is no provision that the beneficiary loses their claim if they attempt to challenge the fund in court, etc. It is also a mistake not to address the replenishment of assets in a timely manner – the fund may then cease to exist if all beneficiaries exhaust their share and no other rules are in place.
• Violation of formal legal requirements. Even a minor formal deficiency can cause the establishment of a fund to be considered invalid. For example, if the founding agreement does not contain all the necessary elements, the statutes are not in the form of a notarial deed, the fund does not have its own name with the designation “trust fund,” etc., you run the risk of the fund being declared absolutely invalid. Unintentional disclosure of sensitive documents (e.g., by establishing a collection of documents in another register) may in turn void the fund's confidentiality. Therefore, always follow the law and the notary's advice precisely—the notary will check the form, requirements, and timely submission to the Register. If someone still questions the validity of the fund, a court would have to decide, which means additional costs.
• Establishing a fund at the last minute due to debts. As already mentioned, trying to “quickly” hide assets in a fund from creditors is a recipe for trouble. Creditors or insolvency administrators may challenge such a transfer as purposeful and contrary to good morals, and the court may decide that it is ineffective or invalid. This would render the entire fund worthless. The tax authorities also monitor these situations for possible abuse, which could result in tax penalties. Establish a fund with pure intentions and as a long-term preventive solution, not as a last-minute rescue.

Risks of insufficient preparation of the fund

If a trust fund is established without thorough preparation or in violation of the law, serious consequences may arise. The main risks include, in particular:

• Legal invalidity of the fund: The ultimate risk is that a court will retroactively find the fund's founding legal act invalid (e.g., for being contrary to good morals or the law) and declare that the fund was not validly established. In such a case, the assets would have to be returned to the founder or to the estate, and all payments to the beneficiaries could be challenged.
• Loss of control over assets: A poorly structured fund may result in the founder or family effectively losing control over their assets without adequate compensation. A cautionary example is a situation where the administrator abuses the freedom granted by the statutes and begins to use the managed assets inappropriately or for their own benefit. If the statutes do not allow for the easy replacement of the administrator, the beneficiaries or the founder may struggle for years to remedy the situation. In extreme cases, the founder may even end up in a worse situation than before the fund was established—for example, losing their home or income from property they put into the fund because they did not reserve the right to continue using it. That is why it is so important to include minimum guarantees in the statute (e.g., that the founder may use the property they put into the fund for life, etc.).
• Financial and tax risks: Inadequate preparation may result in the fund and its beneficiaries bearing an unnecessarily high tax burden or receiving penalties for non-compliance. For example, failure to register the fund for income tax or VAT may result in penalties. A poorly structured fund may be taxed less favorably than other forms of asset management. If the founder does not discuss the situation with a tax advisor, they may be surprised that certain transfers have triggered a tax liability (gift tax, real estate acquisition tax – which existed until 2020 but no longer does, etc.). There is also a financial risk in terms of costs – the fund must pay a notary, administrator, accountant, and possibly an auditor, which can erode returns on smaller assets. Without a proper plan, the costs and taxes may outweigh the benefits of the fund.
• Risk of disputes and paralysis of the fund: If the preparation is underestimated and the fund's rules are ambiguous, it is almost certain that a dispute will arise sooner or later. This may be a dispute between family members over the interpretation of the statutes (who is entitled to what and when), or a dispute with the administrator over how the assets are managed. Such disputes often end up in court and, until they are resolved, the fund's assets may be frozen. The beneficiaries then do not receive their payments on time and the fund loses its purpose. There is also a risk that a new administrator cannot be appointed if the original one resigns – again due to insufficient provisions in the statutes. The result can be a frozen fund with no one to make decisions, and the only way out is court intervention.
• Reputational and legal risk of misuse of the fund: Last but not least, if the fund is not transparent and compliant with anti-money laundering regulations, it may come under the scrutiny of the authorities. Current legislation already requires trust funds to register their beneficial owners (typically the founder or beneficiaries) in a central register. If the fund is established solely for the purpose of covering up illegal activities or hiding assets, those involved in such a fund may face criminal prosecution. For honest founders, the risk therefore lies more in ensuring that their fund complies with all registration requirements and cannot be associated with any wrongdoing, even by mistake.

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Practical examples

• Finally, let's look at two real-life stories that illustrate how setting up a trust fund can work in practice – once positively, once negatively. These examples show what a well-set-up fund can achieve and, conversely, what problems can arise if the process is not followed correctly.
• Inspirational example – a family business in safe hands: Mr. Novák built a successful family business, but found that his children had no interest (or the necessary skills) to continue running it. He did not want to sell the company to strangers, but at the same time he could not hand it over to his descendants, who would not run it. He therefore decided to set up a trust fund and place his shares in the company in it. He appointed an experienced manager from outside the family as the administrator, with the understanding that this professional would continue to manage and develop the company. The fund's statutes stipulated that the administrator would regularly pay the net profits from the business to Novák's children and grandchildren as beneficiaries. This arrangement separated the ownership and management of the company—the company can continue under professional management and carry on the family name without the children having to be actively involved in the business. At the same time, the family will not lose the financial benefits of the family business. The fund also stipulated that if any descendant began to harm the company or interfere with its operations, they would lose their entitlement to profit payments. This secures the family inheritance: the company prospers and the family is guaranteed benefits without internal disputes or the company going bankrupt due to incompetent management.
• A cautionary example – the risks of fund abuse: In 2015, the Supreme Court (24 Cdo 1754/2022) dealt with the case of Mrs. Anna, a senior citizen suffering from a mild mental disorder who was abused by a fraudster. This man gained her trust, even moved in with her and her family, and persuaded her to set up a trust fund into which she placed her two properties. The statutes discreetly stipulated that the man would be the beneficiary of last resort, meaning that the property would fall to him if the fund ceased to exist. The fraudster benefited from the real estate. When the whole thing came to light, he was convicted of attempted fraud, but the problem arose of how to get the property back from the fund. The courts had to resolve the issue of the validity of the establishment of the fund and the allocation of the property. The Supreme Court ultimately confirmed that if the fund was established fraudulently and contrary to good morals, its establishment could be declared invalid and the property returned to its original owner. After many years, Anna finally got justice, but the case serves as a warning – never establish a fund under pressure or at the instigation of another person without independent oversight. This unfortunate story shows that a poorly set up trust fund (especially one established for dishonest motives) can seriously endanger the founder and deprive them of their assets instead of protecting them. Therefore, always act cautiously, involve trusted advisors, and act in your best interests.

Conclusion

Establishing a trust fund is a powerful tool for protecting assets, managing them, and ensuring long-term security for beneficiaries. However, for the fund to be effective and problem-free, it is essential to carefully set the terms and conditions, select the administrator, and establish mechanisms for resolving any disputes. Mistakes in these areas can lead to legal problems, disputes, or even the invalidity of the fund. It is always important to approach the establishment of a fund with long-term intentions and with the help of experts who will ensure that the fund operates in accordance with the law and the wishes of the founder.

When establishing a trust fund, the founder should consider all potential risks and avoid rushing. A properly set up fund can be an excellent tool for protecting family assets, but its preparation and implementation require maximum attention to detail and careful legal supervision. Compliance with legal requirements, transparency, and protective measures are key to ensuring that the fund serves its purpose without any problems.

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