Some states have modified their trust laws to either abolish the Rule Against Perpetuities, or to increased the period to into the hundreds of years so that a trust could theoretically span many generations before terminating. Trusts that take advantage of these laws are commonly known as "Dynasty Trusts".
For family planning, there may be significant advantages to the use of Dynasty Trusts to avoid estate taxes, and also to protect future heirs from creditor claims by way of the spendthrift provisions of such trusts. With so-called "Family Banks", by which no or few gifts are made to beneficiaries, but instead low interest loans are made available to family members, which must be paid back as a condition of being extended further loans. Because the beneficiaries continually repay the loans, the trust corpus is kept in tact for future generations. Additionally, the problems associated with beneficiaries gratuitously receiving large amounts of cash can be mitigated.
Note that "Family Bank" is a common nickname for a strategy which typically utilizes Dynasty Trusts, and does not involve the formation or licensing of any actual bank.
The laws of some Commonwealth jurisdictions recognize a type of trust known as a "Purpose Trust". A purpose trust is one which does not have ascertainable beneficiaries, but rather exists to facilitate the achievement of a particular purpose. The charitable trust is a form of purpose trust with a long history in English law. However, new forms of purpose trusts have evolved in the last several years.
Bermuda was the first common law jurisdiction to permit the purpose trusts. Because there are no beneficiaries, i.e. people who could legally enforce the terms of the trust, a trust "enforcer" must be appointed to ensure that the trustees carry out their obligations in fulfilling the trust's purpose. Purpose trust legislation in Bermuda, the Cayman Islands and the handful of other Commonwealth jurisdictions which permit purpose trusts also provide for a hybrid purpose trust that is a purpose trust during the settlor's lifetime, but a more traditional trust for the benefit of individual beneficiaries afterwards. The Cook Islands and Cyprus go even farther, allowing purpose trusts with no enforcer, and making no provisions for the courts to appoint an enforcer.
A Purpose Trust can exist for a specific purpose, such as to own a corporation, or for a general purpose such as to further the creation and preservation of fine art. Purpose trusts are developing uses in a commercial context to take transactions off a company's balance sheet or to provide a means for asset securitization. Another popular use has been to own shares in private trust companies.
Because of doubts regarding the U.S. tax treatment of purpose trusts, they have yet to become popular with U.S. planners. However, this is good because it means purpose trusts have not been over-marketed or identified as having a specific anti-creditor purpose, as have foreign asset protection trusts.
Of course, our focus is what use purpose trusts can serve in an asset protection context. Purpose trusts are created in a similar fashion to other trusts. A purpose trust is simply an agreement between a settlor and a trustee, memorialized in a trust instrument. As mentioned above, some purpose trust statutes require that an "enforcer" be appointed, who protects the trust assets to ensure that they are used for the purpose the settlor intended.
Purpose Trust Structure
A particularly good use of a purpose trusts is as the owner of an offshore management company. A typical arrangement is to first create the Purpose Trust, and then have the offshore trustee of the Purpose Trust create an International Business Company ("IBC"). The IBC then enters into a contract to act as the manager of one or more LLCs, or as the general partner of a one or more limited partnerships, etc., all of which contain valuable assets.
If the Purpose Trust has been settled by a foreign person who is resident outside the U.S., it likely will be difficult for a creditor to prove a connection between the Purpose Trust and the U.S. person whose assets are being managed. The fact that the Purpose Trust has no identifiable individual beneficiaries will make it difficult for a creditor to pierce the corporate veil; after all, if the veil is lifted, who is under it?
Purpose Trust/Private Trust Company
Control over the Purpose Trust is maintained by having a trusted person as the Enforcer. Also, the management company IBC owned by the purpose trust can hire and appoint some trusted person to be responsible for its day-to-day affairs in managing assets. The purpose trust can be an excellent vehicle in an effective offshore management company structure without the U.S. owner of the asset being directly involved, and without implications that the trust's assets and the assets of the companies managed by the IBC really belong to the settlor because the beneficiaries of the purpose trust are the endless number of charitable organizations that might further the trust's purpose and also, after the settlor's death, his heirs, but not the settlor.
By way of contrast with Foreign Asset Protection Trusts, which only personally benefit the settlor and his designated beneficiaries, the Purpose Trust has other legitimate commercial uses other than tax avoidance and asset protection. Purpose Trusts are sometimes used, for example, to hold corporate stock where the shareholders desire that no one person, or group of persons, be in control of the stock. This is useful in situations involving the sale of the corporation, or where the shareholders have a deadlock that cannot be resolved by conventional means, and thus the shares or voting rights are thus temporarily conveyed to the Purpose Trust so that the appointed Trustee can make the necessary decisions. Because of these commercials uses, it will be difficult for a creditor to argue that a purpose trusts is ipso facto an asset protection device, as is fairly easy to do with a FAPT. Furthermore, a settlor must go offshore to settle a purpose trust. They simply are not provided for under the laws of any U.S. jurisdiction. Indeed, a number of commercial purpose trusts have been created in Bermuda, in particular, by U.S. companies.
U.S. Tax Treatment of Civil Law Entities and Purpose Trusts
The detailed tax treatment of exotic civil law organizations and purpose trusts is beyond the scope of this article. There are very complex and unresolved issues as to how an individual entity will be treated for U.S. tax purposes. Nevertheless, some offshore promoters claim that because these entities are not corporations, partnerships or trusts under U.S. business and trust laws, and are not specifically mentioned in the Internal Revenue Code and Regulations that, therefore, they live some sort of unique tax-free existence.
Don't be fooled by such claims. IRS Revenue Ruling 73-254 makes it clear that the tax treatment of an entity will be determined by its classification under U.S. tax law, and not by reference to state or foreign law. In other words, under U.S. tax law, each entity fits into a particular pigeonhole, even if it doesn't really fit all that well. There are only four such pigeonholes: trust; a corporation; a partnership; or a disregarded entity.
Just exactly which pigeonhole one of these entities will be crammed into will depend upon the facts and circumstances of that particular case. If the entity is not structured correctly that there could be very adverse tax consequences much worse than with a domestic entity owing to the great number of tax landmines that exist for foreign entities in the U.S. tax law. Tax uncertainty is another reason that militates in favor of restricting the use of these entities to holding only shares in another corporation that is used as a management company for valuable assets, as opposed to placing the valuable assets in these entities themselves.
While there are a number of civil law entities that could be utilized for asset protection purposes, the most popular structures for U.S. planners are two trust-like entities, the Stiftung and the Anstalt, created under the law of Lichtenstein (a small country located between Switzerland and Austria) and foundations created in Panama. We will examine these entities, and how they might fit into an overall asset protection plan.
The Stiftung, is basically a fund for a particular purpose that has by statute been given the status as a legal entity. The Stiftung is created by a "Founder" and has a separate legal identity from the Founder. The assets of the Stiftung must be segregated from any personal assets, and are typically not available to creditors of the Founder.
The Stiftung can have some commercial activities, but it cannot be utilized solely for commercial purposes. Instead, the Stiftung is designed to act basically as a private foundation, and it may be formed purely as a family foundation. For asset protection purposes, however, it is better if the Stiftung is formed for the promotion of some important interest (such as to further education or medical research) because there may be less chance that the Stiftung will be considered an "insider" for purposes of evaluating whether the contributions to the Stiftung were fraudulent.
A Stiftung has no shareholders. However, a Stiftung may be drafted to have beneficiaries, including the Founder as a beneficiary. Neither of these features is suggested as the Stiftung then starts looking like a foreign asset protection trust. Instead, the Stiftung should be limited by its terms to supporting the purpose for which it was created and used in that fashion. This does not mean, however, that there are not methods to utilize assets of the Stiftung to endow private scholarships, etc.
The Stiftung is managed by a Council of Members, which most often is originally appointed by the Founder. At least one person on the Council must be resident in Liechtenstein. Assuming that none of the persons on the Council are named as beneficiaries of the Stiftung, it likely will be very difficult for a creditor to pierce the Stiftung. Similarly, since the Stiftung has no "owner," neither the Stiftung itself nor its assets should be available to any creditors of the persons sitting on the Council.
It is very difficult to get information about a Stiftung in Liechtenstein. The by-laws of the entity, which control things such as to whom and under what conditions distributions can be made, are typically not filed in any public registry. If they are kept in Liechtenstein, this means that a litigant seeking the information may have to bring legal action in Liechtenstein.
The Liechtenstein Anstalt is an entity, which has no members, participants or shareholders, and is a sort of hybrid between a corporation and a Stiftung. An Anstalt can have beneficiaries. The principal practical difference between an Anstalt and a Stiftung is that an Anstalt can conduct all kinds of business activities. Liechtenstein also recognizes a form of registered trust, called an "Eingetragenes Treuunternehmen" and an unregistered trust that simply may be filed confidentially with the Public Register Office, called a "Treuhanderschaft". The former operates as a separate entity, somewhat similar to a U.K. "unit trust", while the latter is very similar to a common law trust, having no legal identity separate from its components. Neither, however, carries the legal background (and baggage) of restrictive common law interpretations, meaning that they offer somewhat better flexibility that common-law trusts.
Where these entities and the Stiftung probably have their greatest use is not in holding significant assets, but rather as acting as the holder of stock in traditional domestic or offshore entities that are used as management companies. The civil law basis of these entities, and the fact that they usually do not have identifiable beneficiaries, make them very difficult for creditors' attorneys to conceptualize, and thus attack. But note that a U.S. judge could also miss the subtle differences, and simply treat them as Foreign Asset Protection Trusts and order that their assets be repatriated. Also, Liechtenstein law may not protect the settlor from a U.S. court's finding of contempt.
Panamanian Foundations
Liechtenstein entities are relatively expensive to form and maintain. And although the time difference between the U.S. and Liechtenstein may prove frustrating to creditors in communicating with their local counsel, it more immediately will be frustrating to the U.S. client and planner attempting to form and then administer the entity from this side of the Atlantic. For this and other reasons, Panama copied much of Liechtenstein's Stiftung legislation, giving us the option of the Panamanian Foundation.
The Panamanian Foundation is modeled after the Stiftung, with some important differences, however. The Foundation is formed by the filing of a Charter, and is treated as a separate legal entity. As an entity, it can hold title to assets in its own name like a corporation. However, it can also make discretionary payments to the Founder or beneficiaries, like a trust. When used for this latter function, the entity is sometimes referred to as a "Family Foundation".
Panamanian law permits the appointment of one or more protectors to oversee the three or more members of the Foundation Council. The members of the Council are required to apply the Foundation's assets for the benefit of its beneficiaries or some beneficial purpose as set out in the Charter. As with the Stiftung, the Foundation is mostly controlled by its Regulations (bylaws) which are not required to be registered or publicly disclosed.
Panama has a three-year statute of limitation for fraudulent transfer challenges to contributions to the Foundation. If gifting is utilized to fund the Foundation, there will be a three-year window available for creditors to attempt to void the gifts. For this reason, the Foundation should be initially funded with a small gift, but if it is desired that the Foundation hold significant assets, then the Foundation should be funded by some alternative for-value transfer method, such as an installment note sale or private annuity.
Once past the three-year limitation, however, the assets are probably safe from creditors. Panamanian law specifically provides that the Foundation assets may not be applied towards the debts of either the Founder or any beneficiary. But perhaps the greatest advantage of the Panamanian Foundation over the Stiftung is that the Panamanian version is relatively inexpensive to form and maintain. Another advantage is that Panama is in the same time zone, making administration of the Foundation from the United States easier.
As with the Stiftung, probably the best use of the Panamanian Foundation is not to hold assets but rather to own an entity that is used as a management company. From a creditor's viewpoint, the management company will be owned by a Panamanian charity with three Panamanian residents as members of the Foundation's Council. The creditor will likely not see that the U.S. settlor has appointed one or more protectors to make sure that the Council members carry out the purposes of the Foundation as set forth in the charter. It will thus be very difficult for a creditor to claim that the U.S. owner of the asset being managed has any ties to or control over the Foundation.
Thus far, we have limited our discussion to entities that are recognized under what could be called Anglo-American jurisprudence, i.e., those entities that were creatures of the well-established statutory law and common law of England and the United States. Even the relatively recent U.S. limited liability company, an entity which does not exist in the same form under English law, is little more than a hybrid, combining traits of U.S. corporations and U.S. partnerships.
Most of the popular offshore havens are decidedly English in character, including Bermuda, the British Virgin Islands, the Cayman Islands, the Isle of Man, the Bahamas, Nevis, the Channel Islands, Gibraltar, and the Cook Islands. Although certain laws of these jurisdictions are decidedly debtor-friendly, their laws are still quite fundamentally English in character and thus an easy fit for usage by the former Thirteen Colonies and their progeny.
Nonetheless, Anglo-American Jurisprudence is quite limited in geographic scope. Though Britain may exercise influence over the most popular offshore centers and the U.S. may dominate international commerce, many countries have adopted other legal systems, the most prevalent being civil law jurisprudence based largely on the Napoleonic Code. Most continental European countries, for instance, have civil law systems as do the numerous former colonies of France, Spain, and the Netherlands.
While civil law jurisdictions authorize certain entities that are very similar in structure and organization to common law entities, they also create entities that are quite alien to Anglo-American jurisprudence. Some U.S. planners have taken an interest in these strange (to us, that is) entities, primarily for tax motivated reasons. Some believe that the IRS may struggle with how these entities should be characterized for tax purposes, thus leading to more favorable tax treatment than that received by traditional U.S. entities. The tax treatment of these entities is beyond the scope of this book; however, the hopes of favorable tax treatment may be overly optimistic. To the contrary, the IRS might characterize such an entity in a much worse way than if the entity were of a well-recognized domestic variety.
Nonetheless, however the IRS might treat these civil law creations, they do raise some interesting possibilities from the asset protection perspective based on the similar notion that U.S. courts and creditors may have difficulty grasping the operations and implications of unfamiliar civil law entities. Some of these entities are not required to have individual persons or entities as owners or beneficiaries. Rather, like U.S. non-profit corporations, they are created for some defined (or better -- vaguely defined) purpose. At the end of this Chapter, we will also examine the "purpose trust" which is a common law trust without specific beneficiaries.
Remember, one goal of asset protection planning is to create doubt in the mind of a creditor about whether recovery is possible. If a creditor has trouble in understanding a particular type of entity and in formulating a plan of attack against the entity, the creditor will be more likely to settle. If an entity has no specific beneficiaries, it may be difficult for a creditor to argue that a transfer to the entity had a fraudulent purpose as opposed to being a completely altruistic endowment. Also, the absence of specific beneficiaries means that there are no creditors of beneficiaries with which to contend. So long as the original contribution to the entity was not a fraudulent transfer, the assets will be protected from creditors. For these reasons, some of these "exotic" civil law entities may play a useful role in asset protection planning.
The trust laws of nearly all U.S. states authorize the formation of a trust with so-called "spendthrift" provisions, which protect the trust assets from creditor and spouses of the beneficiaries to one degree or another. A typical spendthrift trust statute is Oklahoma §60-175.25.
A. Any instrument creating a trust may provide by specific words that the interest of any beneficiary in the income of the trust shall not be subject to voluntary or involuntary alienation by such beneficiary. Subject to the following provisions of this section, a direction to this effect shall be valid and enforceable.
B. Notwithstanding a provision in the terms of a trust restraining the alienation of the interest of a beneficiary, such interest shall be entitled to be reached in the satisfaction of claims to the following extent:
1. All income due or to accrue in the future to the beneficiary shall be subject to enforceable claims under the laws of this state for:
a. support of a husband, wife, or child of the beneficiary,
b. necessary services rendered or necessary supplies furnished to the beneficiary, or
c. a judgment based on any such claim under subparagraph a or b; and
2. In all cases not mentioned in paragraph 1 of this subsection, all income due or to accrue in the future to the beneficiary in excess of Twenty-five Thousand Dollars ($25,000.00) per calendar year shall be subject to garnishment by creditors of the beneficiary and shall be fully alienable by the beneficiary.
C. Where two or more creditors undertake to reach the interest of any beneficiary of a trust, pursuant to the provisions of this section, they shall be subject to priority of payment in the order of the service of a notice of garnishment on the trustee. The pendency of any attachment or garnishment shall not prevent the filing of a further attachment or garnishment by the same or any other creditor.
D. Where the beneficiary of any spendthrift trust is also the beneficiary under any other spendthrift trust created or administered either within or without this state, the aggregate income payable under all such trusts to the beneficiary shall be considered together for the purpose of determining the rights of creditors and assignees under this section.
E. The right of any beneficiary of a trust to receive the principal of the trust or any part of it, presently or in the future, shall not be alienable and shall not be subject to the claims of his creditors.
F. Where the interest of the beneficiary of a trust is subject to the exercise of discretion by the trustee or by another, the provisions of this act as to the rights of creditors and assignees shall apply with respect to any sums which the trustee or such other person determines shall be paid to or for the beneficiary.
G. A trust in which the interest of the beneficiary is subject to restraints on alienation as provided in this act may be called a "spendthrift trust" and a direction in any instrument creating a trust that the interest of any beneficiary shall be held on or subject to a spendthrift trust shall be sufficient to restrain the alienation of such interest to the extent provided in this act.
H. Nothing in this act shall authorize a person to create a spendthrift trust or other inalienable interest for his own benefit. The interest of the trustor as a beneficiary of any trust shall be freely alienable and subject to the claims of his creditors. [Editor's Note: This paragraph is discussed further in relation to Self-Settled Trusts a/k/a Asset Protection Trusts.
I. The provisions of this section may be enforced only by an action in a court of competent jurisdiction and the obligor beneficiary shall be a party defendant in such action. The trustee shall not be required to recognize any of the obligations provided for in this section or to withhold any income from the beneficiary until said trustee has been served with summons or garnishment summons. Such action shall be governed by the rules of civil procedure under the laws of this state.
The upshot is that once assets have been properly placed into a spendthrift trust, they will be unavailable to creditors and spouses. Thus, a great deal of everyday asset protection planning concerns the formation and funding of trusts with spendthrift provisions. This is considered on our Funding Methods page.
ALICE KAMOKILA CAMPBELL, AND JAMES L. COKE, ALAN S. DAVIS AND FREDERICK OHRT,
TRUSTEES UNDER THE WILL AND OF THE ESTATE OF JAMES CAMPBELL, DECEASED.
NO. 2991.
Argued March 30, 1955.
Decided June 23, 1955.
RESERVED QUESTION FROM CIRCUIT COURT FIRST CIRCUIT, HON. H. R. HEWITT, JUDGE.
F. D. Padgett (Robertson, Castle & Anthony with him on the briefs), for garnishees-appellants.
R. D. Welsh (B. Kanbara with him on the brief), for plaintiff-appellee.
TOWSE, C. J., STAINBACK AND RICE, JJ.
OPINION OF THE COURT BY STAINBACK, J.
Plaintiff filed an action in assumpsit against the defendant, joining the trustees of the Estate of James Campbell as garnishees. The trustees filed their disclosure and moved for an order discharging them by reason of the spendthrift trust provisions of the will of James Campbell. The defendant filed no answer and an order of default was entered against her. On plaintiff's motion the circuit court reserved to this court for determination the question raised by the motion of the trustees to discharge them by reason of the spendthrift trust.
There is no dispute that James Campbell intended to place the income from his trust estate beyond the reach of creditors of the beneficiaries. The sole question is whether this provision is contrary to law or public policy.
A trust may be defined as the right, enforceable solely in equity, to the beneficial enjoyment of property the legal title to which is vested in another.
A spendthrift trust is defined as one created to provide a fund for a beneficiary and at the same time secure it against his improvidence or incapacity. It is an active trust with provisions against alienation of the fund or property by the voluntary act of the beneficiary or through legal process by creditors.
The modern trust had its counterpart in a device in the early days of the Roman Empire where the legal rule was that a testator could not direct the devolution of his property beyond the first taker who was held to receive an absolute fee in the subject matter of the gift. If a testator desired that a second person should receive a benefit from his property he was obliged to place his confidence or trust in the good faith of the primary beneficiary who, however, could not be held legally accountable though the third person might have a moral claim upon him. The Emperor Augustus directed that the consuls use their power to enforce these moral rights, "and these powers later devolved upon a special officer known as fidei commisarius." (In re Coutts' Will, 249 N. Y. Supp. 788; 4 Kent Comm. 290; Perry, Trusts, 6th ed., § 2.)
*2 This device under the doctrine of "uses" was apparently first introduced into England by the clergy for the purpose of evading the statutes of mortmain. However, there were so many abuses of the system of uses that finally the Statute of Uses (27 Henry VIII c) was enacted to make the owner of the use the owner at law as well as in equity. As is well known, this statute did not accomplish what was intended and courts of equity enforced a use upon a use under the name of a trust so that a trust was a use not executed by the statute, or what a use had been before the statute.
As the early restraints on alienability, particularly of lands, were gradually being removed, the system of restraints on alienation grew up under trusts and statute.
In the earliest days of feudal times no transfer of lands could be made without the license of the overlord. (1 Pollock and Maitland, History of English Law, 310-330.) Then by estates tail (arising after the Statute of De Donis 1285) lands were limited to the descendents in such a way that the family would be perpetuated and no individual could dispose of the entailed lands. However, the reaction to this situation found expression in the courts in Taltarum's Case, Y. B. 12 Ed. IV 19, whereby a tenant in tail could bar the interests of his descendents.
To counteract this the landowners developed a new device known as the strict settlement, but this was defeated when the courts invented the rule of perpetuities which rendered it impossible for one to make his property inalienable beyond the time of life or lives in being and 21 years thereafter.
Again, as the early English rule of common law that land could not be subjected to execution by creditors in satisfaction of their claims was abolished, in lieu thereof there grew up (particularly in America) homestead exemptions, insurance, tools of one's trade and other statutory exemptions from execution by creditors.
In more modern times the doctrine of married women's equitable estates and discretionary and spendthrift trusts acted as restrictions over alienation but the various statutes enlarging the rights of married women have rendered unnecessary the creation of women's equitable estates. Finally, the legislatures in some States have enacted statutes providing for the legality of spendthrift trusts and in some cases limiting the amount of income that may be received free from the claim of creditors and certain types of claims such as alimony, torts, etc.
Thus the struggle between attempted restraints upon alienation for the preservation of family fortunes and the doctrine that he who has the beneficial rights of property should have the responsibilities and liabilities of the owners thereof continues. By a strange quirk the decisions in England, home of the aristocrats and landed gentry, have departed more and more from the doctrine of protecting the family fortune while America, home of democracy and rugged individualism, has gone further and further toward the preservation of family fortunes.
*3 While the great weight of authority in America upholds the validity of spendthrift trusts, there are some States where the contrary is held.
"Although there is some dissent from this view, the validity of spendthrift trusts, at least those protective of the income of trust estates against the creditors or grantees of the beneficiary, is upheld by the great weight of authority in this country * * *. The tendency has been away from the minority view denying the validity of such trusts and toward the adoption, either by statute or judicial decision, of the view upholding their validity. * * *" (54 Am. Jur., Trusts, § 152, pp. 126, 127.) (See also 1 Restatement, Trusts, § 152; Griswold, Spendthrift Trusts, § 58; 1 Scott, Trusts, § 152.)
The reasoning of those upholding and those declaring spendthrift trusts invalid range all the way from the Pennsylvania cases -- one of which makes the sweeping assertion that "Whoever has the right to give, has the right to dispose of the same as he pleases. Cujus est dare ejus est disponere, is the maxim which governs in such case." (Ashhurst v. Given, 5 W. & S. 323, 330); and another which states "It is always to be remembered that consideration for the beneficiary does not even in the remotest way enter into the policy of the law; it has regard solely to the rights of the donor." (Morgan's Estate, 223 Pa. 228, 230, 72 Atl. 498, 499) -- to the statement of Fairman in "Mr. Justice Miller and the Supreme Court," (pp. 321-323) that a spendthrift trust is a "contrivance for the protection of wastrels."
Griswold, in his book Spendthrift Trusts, has reviewed most exhaustively the decisions and status of spendthrift trusts in all jurisdictions. While he has criticised very severely what he calls the confusion and ignorance that gave rise to the growth of such trusts in the last eighty years, in the second edition he repeats the statement in the preface of the first edition that "A large proportion of all trusts today are spendthrift trusts." He recognizes that since Nichols v. Eaton, 91 U. S. 716, 23 L. Ed. 254, decided in 1875, there has been a trend in most jurisdictions in the United States favorable to the validity of spendthrift trusts, which trend has been the result partly of judicial decision and partly of statutes.
In his book on spendthrift trusts Griswold points out that the doctrine holding spendthrift trusts valid was first announced in Nichols v. Eaton, 91 U. S. 716, 23 L. Ed. 254, decided in 1875. Griswold sets forth that the "dictum" in Nichols v. Eaton arose because of a confusion arising from the lack of equity courts, and any lack of equity powers in the law courts, in Pennsylvania in the early part of the nineteenth century. He also attributes the growth of spendthrift trusts to the influence of statements made by Perry, Trusts.
*4 As showing the growth of spendthrift trusts subsequent to the case of Nichols v. Eaton, supra, Griswold quotes from Perry's work on Trusts from the first edition (1872) as follows: "Trusts cannot be created with a proviso, that the equitable estate, or interest of the cestui que trust, shall not be alienated or charged with his debts." The second edition (1874) states: "If an absolute equitable interest is given to a cestui que trust, no restraints upon alienation can be imposed. But a trust may be so created that no interest vests in the cestui que trust; consequently, such interest cannot be alienated, as where property is given to trustees to be applied in their discretion to the use of a third person, no interest goes to the third person until the trustees have exercised this discretion." The third edition (1882) six years after the decision in Nichols v. Eaton, supra, states "there is eminent authority in the Federal and State courts for the proposition, that the power of alienation is not a necessary incident to an equitable estate for life, and that the owner of property may, in the free exercise of his bounty, so dispose of it as to secure its enjoyment to the objects of his bounty without making it alienable by them or liable for their debts, and that this intention, clearly expressed by the founder of a trust, must be carried out by the courts."
The gist of the basis for the legality of spendthrift trusts is thus stated in the leading case of Nichols v. Eaton, 91 U. S. 716, 725, which has been cited and quoted in practically all the spendthrift trust decisions since it was rendered:
"But, while we have thus attempted to show that Mrs. Eaton's will is valid in all parts upon the extremest doctrine of the English Chancery Court, we do not wish to have it understood that we accept the limitations which that court has placed upon the power of testamentary disposition of property by its owner. We do not see, as implied in the remark of Lord Eldon, that the power of alienation is a necessary incident to a life-estate in real property, or that the rents and profits of real property and the interest and dividends of personal property may not be enjoyed by an individual without liability for his debts being attached as a necessary incident to such enjoyment. This doctrine is one which the English Chancery Court has ingrafted upon the common law for the benefit of creditors, and is comparatively of modern origin. We concede that there are limitations which public policy or general statutes impose upon all dispositions of property, such as those designed to prevent perpetuities and accumulations of real estate in corporations and ecclesiastical bodies. We also admit that there is a just and sound policy peculiarly appropriate to the jurisdiction of courts of equity to protect creditors against frauds upon their rights, whether they be actual or constructive frauds. But the doctrine, that the owner of property, in the free exercise of his will in disposing of it, cannot so dispose of it, but that the object of his bounty, who parts with nothing in return, must hold it subject to the debts due his creditors, though that may soon deprive him of all the benefits sought to be conferred by the testator's affection or generosity, is one which we are not prepared to announce as the doctrine of this court.
*5 "If the doctrine is to be sustained at all, it must rest exclusively on the rights of creditors. Whatever may be the extent of those rights in England, the policy of the States of the Union, as expressed both by their statutes and the decisions of their courts, has not been carried so far in that direction.
"It is believed that every State in the Union has passed statutes by which a part of the property of the debtor is exempt from seizure on execution or other process of the courts; * * * This has come to be considered in this country as a wise, as it certainly may be called a settled, policy in all the States. * * *
"Nor do we see any reason, in the recognized nature and tenure of property and its transfer by will, why a testator who gives, who gives without any pecuniary return, who gets nothing of property value from the donee, may not attach to that gift the incident of continued use, of uninterrupted benefit of the gift, during the life of the donee. Why a parent, or one who loves another, and wishes to use his own property in securing the object of his affection, as far as property can do it, from the ills of life, the vicissitudes of fortune, and even his own improvidence, or incapacity for self-protection, should not be permitted to do so, is not readily perceived.
"These views are well supported by adjudged cases in the State courts of the highest character."
Spindle v. Shreve, 111 U. S. 542, 547, states as follows: "It cannot be doubted, that it is competent for testators and grantors, by will or deed, to construct and establish trusts, both of real and personal property, and of the rents, issues, profits and produce of the same, by appropriate limitations and powers to trustees, which shall secure the application of such bounty to the personal and family uses during the life of the beneficiary, so that it shall not be subject to alienation, either by voluntary act on his part, or in invitum, by his creditors. The limits, within which such provisions may be made and administered, of course, must be found in the law of that jurisdiction which is the situs of the property, in case of real estate, and in cases of personalty, where the trust was created or is to be administered according to circumstances."
In Shelton v. King, 229 U. S. 90, portions of the syllabus read:
"While one may not by his own act preserve to himself the enjoyment of his own property in such manner that it shall not be subject to claims of creditors or to his own power of alienation, a testator may bestow his own property in that manner upon one to whom he wishes to secure beneficial enjoyment without being subject to the claims of assignees or creditors. Claflin v. Claflin, 149 Massachusetts, 19, approved.
"The courts of this country have rejected the English doctrine that liability to creditors and freedom of alienation are necessary incidents to enjoying the rents and profits from the property by the object of bounty of a testator."
*6 In this case (Shelton v. King, supra) the statement of Mr. Justice Miller in the leading case of Nichols v. Eaton is quoted with approval, also a number of cases sustaining the same view such as Hyde v. Woods, 94 U. S. 523; Broadway National Bank v. Adams, 133 Mass. 170; Mason v. Rhode Island Hospital Trust Co., 78 Conn. 81; Jourolman v. Massengill, 86 Tenn. 81; Henson v. Wright, 88 Tenn. 501; Brooks v. Raynolds, 59 Fed. Rep. 923; Smith v. Towers, 69 Md. 77; Keyser v. Mitchell, 67 Pa. St. 473; Seymour v. McAvoy, 121 Cal. 438; Steib v. Whitehead, 111 Ill. 247; Wallace v. Campbell & Maxey, 53 Tex. 229; Garland v. Garland, 87 Va. 758; Lampert v. Haydel, 96 Mo. 439.
In presenting the arguments for and against spendthrift trusts Bogert, Trusts and Trustees, 1A, section 222, pages 470, 471, states as follows:
"The position of the spendthrift trust in the United States is fairly well fixed. Therefore it may seem somewhat academic to discuss the reasons urged for and against such trusts when their validity was being determined in the nineteenth century. However, such a presentation has some practical aspects, since in a few states there are no decisions on the subject and since Legislatures may well liberalize or restrict the doctrines of the spendthrift trust in the coming years. (Emphasis added.)
"Probably the strongest argument for the spendthrift trust is that of freedom of disposition on the part of the donor. Many courts have felt that a property owner ought to be able to give on such conditions and limitations as he chooses, provided no principle of public policy be violated. And they have not felt that there was anything anti-social in the spendthrift trust."
Next, Bogert quotes from the Pennsylvania case of In re Morgan's Estate, supra, which bases its decision on the theory that a donor should be allowed to condition his bounty to suit himself so long as he violates no law in so doing; that when a spendthrift trust has been created the law holds the donor has an individual right of the property in the execution of the trust and to deprive him of it would be a fraud on his generosity.
Bogert then presents the argument of the antagonists of the spendthrift trusts as to its unjust effects upon the creditors of the cestui, the injurious consequences to the beneficiaries themselves, and to the repugnant character of the restrictive clause.
*7 Bogert also discusses the desirability of statutory regulations, quoting the model statute on spendthrift trusts which has been prepared by Griswold and will be discussed hereinafter.
Although there may be no decisions squarely upon the point, all the Hawaiian decisions indicate that a spendthrift trust is valid.
In the case of Harris v. Judd, 3 Haw. 421, 430, the majority of the court took the view that an assignment of income from a trust was valid and right to the income was complete and absolute and no words were used to restrain its alienation. In other words, there was no intent to create a spendthrift trust; but in the dissenting opinion of Allen, C. J., taking the view that it was the intent of the testator to create a spendthrift trust for his son, occurs the following statement:
"By the language used in the will, when the income is to be paid over for use and support, a discretionary power is vested in the trustee. It is not a payment only, but a payment for the use and support of the beneficiary. * * *
"When the father gave to the trustee authority to apply the income to the use and support of his son, was it not for the very purpose of preventing the possibility of his squandering it? Had it been a life estate, without limitation, over which the beneficiary had the entire control, no such language would have been used. * * *
"This interest in his father's estate was a matter of public record, and every one inclined to give credit to the son, could decide for himself his interest in the estate, or wait till the Court had given a construction to the will. There can be no fraud where there is no concealment, and if any one has given credit to the son, he had the means, by which he could judge, whether it was safe to give credit, or not. To save improvident persons from squandering their interest in property, is often a reason for a trust like this. But no creditor can properly complain who had the means of knowing the precise pecuniary situation of the son, as in this case, so far at least, as it was affected by the will of the father. * * *"
Likewise, Harrison v. Davis, 22 Haw. 465, affirmed 240 Fed. 97, while not actually deciding that a spendthrift trust in Hawaii was valid, held so in substance as the court stated that the object of the trust was to provide and secure for the defendant a home and an opportunity to make a living out of the land as he might elect to take, and that such right to occupy and use the land was personal to Davis. The following quotation from the decision is pertinent: "The clear weight of authority in the United States is to the effect that a trust may be created under which the beneficiary may be entitled to receive an income which he cannot anticipate by assignment and which is free from the claims of creditors, and it is held that the right of alienation is not a necessary incident to an equitable interest to income or support for the life of the beneficiary. It is also held that the right of alienation of such an interest does not exist where it would be destructive of the trust and incompatible with its purposes though there be no express prohibition. [Then follow citations.] We hold that under the deed of trust here involved the right of Davis to occupy and use the land for certain purposes was personal to Davis and did not extend to his assigns. This was the intention of the donor as we gather it from the deed. The object was to provide and secure for the defendant either a home and an opportunity to make a living out of the land, or an income, as he might elect to take. A right to assign the right of occupancy would be incompatible with that object and we must give effect to the apparent intention of the donor in this respect even though the right to assign the income was not restricted."
*8 Also, the case of Crescent City Motors v. Nalaielua, 31 Haw. 418, 426, held "That property may be transferred by will or by deed upon such terms as to keep it beyond the reach of creditors of the donee may for the purposes of this opinion be assumed to be true." However, the court held that under the language of the trust instrument there was no indication of an intent to place or maintain the property beyond the reach of creditors.
Attention is called by plaintiff to section 1, Revised Laws of Hawaii 1945, which states "The common law of England, as ascertained by English and American decisions, is declared to be the common law of the Territory of Hawaii * * *" and he argues that spendthrift trusts were not and are not recognized by the English common law and, therefore, should not be recognized in Hawaii.
For that matter, equitable interests could not be attached under the English common law as "This doctrine is one which the English Chancery Court has ingrafted upon the common law for the benefit of creditors, and is comparatively of modern origin." (Nichols v. Eaton, 91 U. S. 716, 725.) (Emphasis added.)
Though the present proceeding is an equitable one, the case of Dole v. Gear, 14 Haw. 554, held that equity is included in the common law within the meaning of this statute (R. L. H. 1945, § 1) and further pointed out that the common law consists of fundamental principles and reasons and is a system of legal logic rather than a fixed and inflexible set of rules. This case has been quoted with approval in a number of Hawaiian cases, the latest of which is Territory v. Alford, 39 Haw. 460.
In Dole v. Gear, as well as in Territory v. Alford, supra, the following quotation from Morgan v. King, 30 Barb. 9, appears: "* * * 'when it is said that we have in this country adopted the common law of England, it is not meant that we have adopted any mere formal rules, or any written code, or the mere verbiage in which the common law is expressed. It is aptly termed the unwritten law of England; and we have adopted it as a constantly improving science, rather than as an art; as a system of legal logic, rather than as a code of rules. In short, in adopting the common law, we have adopted its fundamental principles and modes of reasoning, and the substance of its rules as illustrated by the reasons on which they are based, rather than by the mere words in which they are expressed."' (Dole v. Gear, supra, pp. 561, 562.)
*9 In Territory v. Alford, supra, the court held that a wife might testify against her husband where she was the victim of the husband in a white slave case even though at common law and the Hawaiian statute embodying the common law that provides one spouse cannot testify for or against another in a criminal prosecution except in case of an offense of physical violence committed by one against the person of the other. The court held that it was not restricted by the actual decisions at common law, stating that the common law interpreted in the light of modern experience, reason and the furtherance of justice, this prohibition does not apply; it permits a wife to testify against her husband in a prosecution for a crime committed by the husband which corrupts the wife's morality; that this is an offense "against the person of his wife"; that the same reasons apply to the one as to the other.
Again, as stated in the case of Macaulay v. Schurmann, 22 Haw. 140, 144, "And, as pointed out in Dole v. Gear, 14 Haw. 554, 561, the common law consists of principles and not of set rules and admits of different applications under different conditions * * *."
Some other cases dealing with the nature of common law are:
The People v. Randolph, 2 Parker's Cr. R. 174, 176, which states: "The common law consists of those principles and maxims, usages and rules of action which observation and experience of the nature of man, the constitution of society and the affairs of life have commended to enlightened reason, as best calculated for the government and security of persons and property. Its principles are developed by judicial decisions as necessities arise from time to time demanding the application of those principles to particular cases in the administration of justice." (Emphasis added.)
"The common law is but the crystallized conclusions of the judges arrived at from applying the principles of natural right and justice to facts actually experienced in cases before them." (Scott v. Kirtley, 113 Fla. 637, 152 So. 721, 722 fn.)
"The common law does not consist of absolute, fixed, and inflexible rules, but rather of broad and comprehensive principles based on justice, reason, and common sense. It is of judicial origin and promulgation. Its principles have been determined by the social needs of the community and have changed with changes in such needs. These principles are susceptible of adaptation to new conditions, interests, relations, and usages as the progress of society may require." (Miller v. Monsen, 228 Minn. 400, 37 N. W. [2d] 543, 547.)
That the common law is not arrived at by simply following the English decisions is shown in Sayward v. Carlson, 1 Wash. St. 29, 40, where in construing a statute similar to the Hawaii statute it was stated: "But we do not subscribe to the next proposition, that resort can be had only to the decisions of English courts, or to those of American courts which have followed them * * *. * * * since courts have had an existence in America they have never hesitated to take upon themselves the responsibility of saying what is the common law, notwithstanding current English decisions, especially upon questions involving new conditions. Therefore, we have the 'common law' as declared by the highest courts of this, that and the other state, and by the courts of the United States, sometimes varying in each. And we understand, by § 1 of the code, that where there are no governing principles of the written laws, the courts of the late territory, and of this state, are, in all matters coming before them, to endeavor to administer justice according to the promptings of reason and common sense, which are the cardinal principles of the common law; but not that the decisions of the English courts are to be taken blindly and without inquiry as to their reasoning or application to the circumstances." (Emphasis added.)
*10 Where there are no governing provisions of the written law, the courts in all matters coming before them endeavor to administer justice "according to the promptings of reason and common sense." The common law is declared by the highest courts of each State and varies in the several States, and the courts of Hawaii can continue to declare, as they have in the past, the common law of Hawaii based upon justice and sound reason and not inconsistent with settled authorities.
It is interesting to note that not only is the common law of judicial origin and promulgation but also admiralty law. "Since there is no controlling statute the question must be decided as a part of the judicially created admiralty law." (William A. Bisso, Jr., Receiver, New Orleans Coal and Bisso Towboat Co. v. Inland Waterways Corporation, No. 50, October Term 1954, Supreme Court of the United States, decided May 16, 1955.)
As stated before, the overwhelming weight of authority in America is that spendthrift trusts are valid. The Hawaiian courts have intimated that the American rule is sound and at present it is practically regarded as a rule of property in Hawaii, especially by draftsmen of trust instruments. At this late date it would not seem desirable to upset the validity of such trusts.
Finally, the plaintiff argues that if the present spendthrift trust is not invalid in toto, it should at least be limited as to the amount of income which the spendthrift beneficiaries would receive.
Undoubtedly there are certain unsatisfactory results that may flow from unrestricted spendthrift trusts. One of them is where a person with a very large income refuses to pay ordinary debts. However, the limitation of any amount of income which the beneficiary of a spendthrift trust should receive free from execution by creditors is, we deem it, a question for the legislature and not for the judiciary.
Bogert, Trusts, in his argument for and against the desirability of spendthrift trusts points out that a model statute has been drafted by Griswold which has been adopted in Louisiana and Oklahoma. The statutes do not exempt income from a spendthrift trust where the claim is for the support of a husband, wife or child of the beneficiary, or for alimony or for tort, or necessary services rendered or supplies furnished to the beneficiary, or income due or to accrue in the future to the beneficiary in excess of $5,000 per annum.
In a number of States even without statute the right of a wife to reach the interests of a beneficiary of a spendthrift trust has been upheld to satisfy a judgment for alimony though the authorities are divided upon this point. (Griswold, Spendthrift Trusts, §§ 338, 339, pp. 395-398; Hollinrake v. Hollinrake, 40 Haw. 397, 406, 407.) As stated, trusts are the creature of equity and should be administered in a way which is consistent with true equity. "Equity will not feed the husband and starve the wife. Neither will it favor the wife to the detriment of the husband." (Wetmore v. Wetmore, 149 N. Y. 520, 529.)
*11 Likewise, the beneficiary's interest may be reached for the payment of taxes and similar claims. There are a number of decisions to this effect. (Griswold, Spendthrift Trusts, § 345, p. 407, citing cases.)
Undoubtedly a limitation upon the amount of income that might be received by a cestui, as well as the claims of creditors for necessary services rendered or supplies furnished to the cestui, or claims for torts committed by such cestui are proper subjects for legislation.
There is much to be said for the invalidity of a spendthrift trust, as well as to the contrary. On the one hand a donor cannot give a legal estate to a donee so as to deprive creditors of the rights of execution against the same, so it may well be asked why permit him to do with an equitable interest what he could not do with a legal interest. On the other hand a donor can support an insolvent donee in luxury and no one can complain because a creditor of the donee has no legal claim against the donor, so why not permit a donor to do through another (trustee) what he could do directly himself with his own property. This would permit a settlor to provide for the donee (widow, son, daughter or other object of the settlor's solicitude) after the settlor has passed away.
Considering the overwhelming weight of authority in the United States, the balancing of conveniences, the long-continued assumption by the Hawaiian courts and draftsmen of trust instruments in the Territory of the validity of spendthrift trusts, and the Hawaiian courts being free to choose, we believe this court should follow the United States Supreme Court's decision in Nichols v. Eaton, supra, wherein, as repeated supra, it is stated:
"Nor do we see any reason, in the recognized nature and tenure of property and its transfer by will, why a testator who gives, who gives without any pecuniary return, who gets nothing of property value from the donee, may not attach to that gift the incident of continued use, of uninterrupted benefit of the gift, during the life of the donee. Why a parent, or one who loves another, and wishes to use his own property in securing the object of his affection, as far as property can do it, from the ills of life, the vicissitudes of fortune, and even his own improvidence, or incapacity for self-protection, should not be permitted to do so, is not readily perceived.
"These views are well supported by adjudged cases in the State courts of the highest character."
The intent of the testator being clear to create a spendthrift trust, we hold that the spendthrift provision is not contrary to law or public policy in Hawaii and the garnishees should be discharged.
Haw.Terr. 1955.
RICHARD D. WELSH v. ALICE KAMOKILA CAMPBELL, AND JAMES L. COKE, ALAN S. DAVIS AND FREDERICK OHRT, TRUSTEES UNDER THE WILL AND OF THE ESTATE OF JAMES CAMPBELL, DECEASED.
Domestic Asset Protection Trusts Neutered by Bankruptcy Reform
The 2005 changes to the Bankruptcy Code have created a new 10-year limitations period for transfers to self-settled trusts which are meant to hinder, delay or defraud creditors. This effectively means that all transfers to domestic asset protection trusts will be suspect for the 10 years prior to the date that a bankruptcy petition is filed. Because of this, domestic asset protection trusts should not be considered for asset protection planning and, indeed, in most circumstances it might be malpractice per se for an advisor to form a DAPT for his client if asset protection is a concern.
Introduction
The so-called Domestic Asset Protection Trust (DAPT) is a trust with a trust document that has basically the same anti-creditor features as an offshore trust, and is formed in one of the several states that have anti-creditor trust acts and now allow Self-Settled Spendthrift Trusts (i.e., trusts that allow you to establish a trust for yourself which protect you from creditors). Alaska was the first state to enact an anti-creditor trust act, followed quickly by Delaware, and then later by Nevada. A couple of other states have since enacted nearly identical legislation, but when you think of DAPTs you typically think of these three states. Thus, sometimes these trusts are called, almost interchangeably, "Alaska Trusts", or "Delaware Trusts", or " Nevada Trusts".
Cutting through the marketing whoopla, what you essentially end up with are state trust laws that allow the following:
Self-Settled Spendthrift Trusts -- These states allow you to form a trust for your own benefit that protects you against creditors, something expressly disallowed as against public policy of the other 40+ states.
Shortened Statute of Limitations -- There is a shortened time period for a creditor to challenge a transfer to one of these trusts.
Conservative Fraudulent Transfer Standards -- It is more difficult for a creditor to prove that a transfer to the trust was a fraudulent transfer.
The DAPT was created largely as a marketing tool to attempt to exploit the growing market for the Foreign Asset Protection Trust ("FAPT"). After the Anderson and Lawrence cases, the FAPT went out of vogue, and many planners are now advocating the use of DAPTs as a primary asset protection planning vehicle for clients. However, as with the FAPT before it, the benefits of the DAPT are largely theoretical, and as of this writing there have been no significant court cases validating the benefits of DAPTs in tough debtor-creditor situations. At the same time, the false hype of the FAPT promoters, who claimed that an Anderson- or Lawrence-type situation could "never occur", are all too fresh in memory and similar claims are now being made by some DAPT promoters. Thus, it is a laudable goal to attempt to objectively evaluate how the DAPT might fare in certain scenarios, including scenarios that have already occurred with the very similar FAPT.
There are at least five glaring defects to the Domestic Asset Protection Trust that makes them, at best, a very weak asset protection method.
Glaring Defect #1: The trustee is subject to U.S. jurisdiction
If a U.S. court ordered an offshore trustee to do something, he could choose to simply ignore it since he is not bound by U.S. court decisions. However, a U.S. trustee can be compelled -- by being thrown in jail for contempt -- to do whatever the U.S. court wants. About as bad is the fact that the U.S. trustee is vulnerable to a civil lawsuit (trustee would rather give up your assets than his own), and also is available to law enforcement authorities that could bring money laundering charges, etc., to coerce the trustee to cooperate. This defect alone, of course, basically guts the alleged protection of the DAPT.
Glaring Defect #2: Full Faith and Credit
One of the best things about offshore trusts was that the offshore jurisdiction wouldn't recognize a U.S. judgment, meaning that a creditor would have to start all over and begin the trial process from Day 1, bringing in witnesses, etc., from the U.S. or wherever, all of which is very expensive and time-consuming, and a is huge deterrent to creditors. Not so for a DAPT. No matter which state you form the trust in, that state is required by the "full faith and credit" clause of the U.S. Constitution to recognize the judgment of any other state. This means that a creditor only has to take its judgment and register the judgment without having to retry the case (a very simple process, done every day by collection firms), and Voila! the creditor is back at your throat.
Glaring Defect #3: Attempts to "import" law or to make a "choice of law" in favor of the laws of Alaska, Delaware, or Nevada will probably fail
Think you can get an Oklahoma judge to apply Alaska law in favor of an Oklahoma resident against an Oklahoma judgment held by an Oklahoma creditor involving Oklahoma property? Ain't happening -- and if the trial judge rules against you then it is you (and not the creditor) who is fighting an uphill battle in a probably vain attempt to get the decision reversed on appeal, and in the meantime the creditor gets your assets and even if you win the appeal you might not get them back.
Glaring Defect #4: Federal Courts Will Ignore
Because of the Supremacy Clause of the U.S. Constitution, federal courts are not necessarily bound by state law, which is really ugly considering that the nightmare cases are about as often federal cases, or worse, defenses against federal administrative actions.
Glaring Defect #5: No Chance of Secrecy
Because the trustee is in the U.S., the trustee will be subject to discovery order and subpoenas, and as each states applies its own procedure (as opposed to substantive law) without regard to the other states' procedure, and the federal courts follow their own procedure, it means that any secrecy protections of the laws of the state where the trust is formed, will be totally irrelevant and ineffective.
Some Exemplary Scenarios
The scenarios that follow are based on the following hypothetical: The Settlor domiciled in a state that does not allow self-settled spendthrift trusts ("Non-State") transfers assets from Non-State to a DAPT formed in DAPT-State. Later, Settlor is sued by civil Claimant in federal court sitting in Non-State. Claimant wins judgment against Settlor. Federal judge chooses Non-State fraudulent transfer law to set aside transfer as a fraudulent transfer, or the federal judge determines that the DAPT is void against the public policy of Non-State.
Typically, asset protection cases are hotly contested cases involving competent litigators for both the debtor and creditor. This is because the average controversy does not become an asset protection case. The average case is settled, often with the settlement being paid by an insurance carrier. By contrast, asset protection cases have not settled since they have gone on to judgment, and typically pit affluent individuals seeking to protect their wealthy against determined and often well-financed creditors (and sometimes governmental creditors).
Additionally, asset protection presumes that the creditor is "right" and that the equities are on the side of the creditor. If this weren't the case, it was unlikely that the creditor would have obtained a judgment. Thus, the following scenarios anticipate that a judgment has been entered against the debtor by a judge who has come to believe that the judgment the judge has entered in favor of the creditor was warranted by the circumstances, and that the creditor should be paid on its judgment.
To more directly focus on the issues, it is presumed that the case is in federal court in a Non-State, and arises out from federal law, such as a claim arising under the Securities Act of 1933. Note, however, that many of the results below might still occur if the federal court was sitting in diversity, or if the suit were brought in state court for a claim arising under state law.
Scenario I
Direct FEDERAL COURT Order to Trustee
Relief Granted
Under the broad relief provisions of the Uniform Fraudulent Transfers Act adopted by Non-State, the federal judge enters an order compelling the DAPT Trustee to repatriate the assets to the Non-State.
Possible Effects
The Trustee risks contempt by not repatriating the assets as ordered by the federal judge.
If the Trustee repatriates the assets to the Non-State as required by the federal judge, the Claimant will be able to attach the assets.
Notes
This is a circumstance where an order entered by the courts of Non-State might not have the same power as an order issued by a federal court, since of course the state court's power to enforce its orders stops at its borders (but see the Bank of Nova Scotia scenario below). The powers of the federal courts are, of course, nationwide and not reliant upon the Full Faith & Credit Clause.
Possible Authority
Federal Rule of Civil Procedure 64 ("At the commencement of and during the course of an action, all remedies providing for seizure of person or property for the purpose of securing satisfaction of the judgment ultimately to be entered in the action are available under the circumstances and in the manner provided by the law of the state in which the district court is held, existing at the time the remedy is sought . . ..") (Emphasis added).
Scenario II
Anderson Scenario
The federal judge sitting in Non-State enters an order compelling Settlor to repatriate the assets from the DAPT-State to the Non-State.
Possible Effects
If the Settlor refuses, the federal judge can order Settlor held in contempt for years.
The Settlor might be held in contempt even if the Settlor has no ability to repatriate the assets to the Non-State.
Note
Those held in contempt in relation to FAPTs have consistently denied that they had any ability to repatriate the money from their foreign trusts, for example, but the judges involved have consistently ignored those claims.
A state court judge of Non-State could impose the same remedy.
Analogous Case
Federal Trade Commission v. Affordable Media, LLC, 179 F.3d 1228 (9th Cir. 1999) (affirming order incarcerating for six months settlors of Foreign Asset Protection Trust formed in the Cook Islands, with trust formed year prior to settlors' bad conduct, who refused to repatriate trust assets to Nevada; settlors' trust company later paid Federal Trade Commission settlement of $1 million to release trust company only from liability; Federal Trade Commission continues to pursuit settlors on underlying judgment) (this case is popularly known as the "Anderson case", since the Andersons were the settlors who were incarcerated and the real parties in interest in this appeal).
Scenario III
Lawrence Scenario
The Settlor files for bankruptcy, or is forced into bankruptcy, in federal bankruptcy court sitting in the Non-DAPT State. The federal bankruptcy judge determines, under the laws of the Non-DAPT State, that the assets of the DAPT are part of the Settlor's bankruptcy estate. The federal bankruptcy judge enters an order compelling the Settlor to repatriate the assets from the DAPT-State to the Non-State, and to turn the assets over to the federal bankruptcy trustee.
Possible Effects
If the Settlor does not repatriate the assets, the Settlor may be held in contempt literally for years by the federal bankruptcy judge.
The Settlor's discharge may be denied.
The Settlor may be charged with bankruptcy fraud.
The Settlor, the Settlor's Planners in both the Non-State and DAPT-State, and the Trustee, may be charged with conspiracy to commit bankruptcy fraud.
Analogous Case
Lawrence v. Goldberg, 279 F.3d 1294 (11th Cir. 2002) (affirming contempt order incarcerating debtor who had funded asset protection trust in Mauritius and then refused to list assets on bankruptcy schedule of assets or repatriate the assets to Florida; debtor originally incarcerated in 1999 and still incarcerated as of 2002; debtor's discharge denied).
Scenario IV
Bank of Nova Scotia Scenario
The Trustee of the DAPT keeps the trust assets with Coast-to-Coast Brokerage Firm, which has a branch in Non-State (or any Non-State). The federal judge enters an order against the Coast-to-Coast branch in Non-State requiring Coast-to-Coast to turn over the trust assets to the Claimant.
Possible Effects
Coast-to-Coast Brokerage Firm has to provide the assets to Claimant or face contempt and possibly significant fines.
Notes
This result would probably be the same if a court in Non-State ordered the local branch of Coast-to-Coast to turn over the trust assets to the Claimant.
Analogous Case
U.S. v. Bank of Nova Scotia, 740 F.2d 817 (11th Cir. 1984) (order of civil contempt fine of $25,000 per day and total fine of $1,825,000 affirmed against Miami branch of international bank that refused to disclose account records of Bahamas branch of bank to federal grand jury).
Scenario V
Civil Conspiracy Scenario
Claimant files a lawsuit for civil conspiracy under laws of Non-State against Settlor, and Settlor's planners in Non-State, Settlor's planners in DAPT-State, and against Trustee in Non-State. The federal judge finds that personal jurisdiction of DAPT-State Planner and Trustee is proper, insofar as the trust was intended to defeat the rights of creditors (whether known or unknown) in Non-State.
Possible Effects:
Civil conspiracy is an intentional tort. If Claimant's original action was dischargeable in bankruptcy, the effect is that the Settlor has converted a dischargeable action into one that is not dischargeable in bankruptcy.
Settlor's Non-State Planners, Settlor's DAPT-State Planners, and the DAPT-State Trustee become personally liable for underlying judgment against Settlor.
Settlor's Non-State Planners and DAPT-State Planners might be subject to professional discipline for engaging in a civil conspiracy in violation of the laws of Non-State.
The federal judgment for conspiracy against Trustee would be enforceable, despite the DAPT laws of the DAPT State.
Analogous Cases
Morganroth & Morganroth v. Norris, McLaughlin & Marcus, P.C., 331 F.3d 406 (3rd Cir. Appeal No. 02-2087, May 30, 2003). See also 1994 Land Fund II v. Ramur, Inc., No. 05-98-00074-CV (Tex.App. 5th Dist. 2001) (recognizing civil conspiracy theory arising from fraudulent transfer); A.T. Stephens Enterprises, Inc. v. Arnold Johns, 757 So.2d 416 (Ala. 2000) (judgment upheld for civil conspiracy to defraud creditors). Monastra v. Konica Business Machines, 43 Cal.App.4th 1628 (1996) (recognizing civil conspiracy action for defrauding creditors); Summers v. Hagen, 852 P.2d 1165 (Alaska, 1993) (in an action for conspiracy to fraudulently convey property, if the remedy of voiding the transfer is inadequate, the plaintiff is entitled to the lesser of the value of the property fraudulent transferred or the amount of the debt); McElhanon v. Hing, 728 P.2d 273 (Ariz. 1986) (a cause of action lies against a judgment debtor's attorney who conspires with the debtor to defraud the creditor).
SUMMARY
Where DAPTs might work
As lame as the DAPT is as an asset protection tool, it probably has a fair-to-middlin' chance of prevailing in the following circumstances:
First, you actually live in Alaska, Delaware, Nevada or a state that has adopted a similar statute, have all of your assets there, fund the trust well in advance, keep the assets in either property in that state or in banks that have no branches in non-DAPT states, follow all formalities, and avoid federal court actions.
Second, you actually live in Alaska, Delaware, Nevada or a state that has a adopted a similar statute, and you form a Foreign Asset Protection Trust (which, ironically, might stand up to some degree in these states since the Self-Settled Spendthrift Trust anti-public policy argument probably can't be effectively asserted in these states), keep all the assets abroad, and you are willing to flee the country if things get too ugly.
Everybody else should do something else, because for you this probably isn't going to work.
Conclusion
Conceptually, the mere existence of the DAPT is proof that there are serious questions about the FAPT. Many of the planners who used to crow about how "foolproof" the FAPT is (or, rather, was supposed to be), have now fallen off the offshore trust bandwagon in favor of domestic trusts. But don't be fooled by the imitator: While the FAPT has actually been repeatedly blown up in the U.S. courts, and the DAPT hasn't, the offshore trust is still a far superior asset protection method to its Domestic variant -- since at least with an FAPT you can flee the country and your assets are already outside the U.S. Personally, I think that the DAPT is sort of a legalistic "bad joke", unless of course you live in one of the states that allow these trusts, in which case it is simply a tool which, though anemic, is still probably better than nothing. Because of the potential flaws noted above, perhaps the term "Defective Asset Protection Trust" is a better name.
What this foreign/domestic vacillation really tells you is that the guys who make asset protection trusts a "centerpiece", or any major piece of their asset protection plan, are totally confused by the failure of their former-champion, the FAPT, and now really don't have much confidence in anything they are doing with trusts as an asset protection method. But as I stated at the outset of my discussion of trusts, in general trusts are fundamentally lousy asset protection vehicles, and they'd be better to abandon them entirely in favor of the numerous better methods that do work.
Domestic Asset Protection Trusts Neutered by Bankruptcy Reform
The 2005 changes to the Bankruptcy Code have created a new 10-year limitations period for transfers to self-settled trusts which are meant to hinder, delay or defraud creditors. This effectively means that all transfers to domestic asset protection trusts will be suspect for the 10 years prior to the date that a bankruptcy petition is filed. Because of this, domestic asset protection trusts should not be considered for asset protection planning and, indeed, in most circumstances it might be malpractice per se for an advisor to form a DAPT for his client if asset protection is a concern.
The Domestic Asset Protection Trust (DAPT) is variously known as an Alaska Trust, Delaware Trust, or Nevada Trust, since those states have been in the lead in authoring rather blatantly anti-creditor legislation that allows self-settled spendthrift trusts. However, in our Analysis section, we examine the possible flaws inherent in DAPT structures -- defects so serious that we wonder whether these trusts should be re-named the "Defective Asset Protection Trust".
The domestic variant of the offshore trust, has come into great favor as the alternative for the failed FAPT, and is perhaps the most obviously flawed asset protection tool, ever...
If you create a trust for your own benefit, you have established a "self-settled trust". If the trust instrument contains provisions that prevent your creditors from reaching your interest in trust assets, the trust is known as a "self-settled spendthrift trust" (or, more commonly, an "asset protection trust").
For many hundreds of years, the provisions of self-settled spendthrift trusts designed to protect trust assets from creditors of the settlor/beneficiary were ineffective. Beginning in the 1980's, certain offshore jurisdictions enacted specially-drafted trust laws overriding this long-standing rule of trust law. Foreign asset protection trusts quickly became popular. In 1999, the rush to form offshore trusts slowed a bit after Michael & Denyse Anderson were jailed for several months for their refusal (or inability, depending on the side from which one views the case) to return funds from their Cook Islands asset protection trust. Foreign asset protection trusts became even less attractive the following year when Stephen J. Lawrence was imprisoned for his refusal to turn over assets from his Mauritius asset protection trust. Lawrence was jailed in August, 2000, and remains jailed today.
In the late 1990s, Alaska led the charge of bringing self-settled spendthrift trusts to the U.S., Delaware, Nevada and a few other states soon adopted similar domestic asset protection trust (DAPT) legislation hoping to attract trust business to their states.
In the last few years, DAPTs appear to have overtaken offshore trusts as the asset protection product du jour, largely because of heavy marketing by trust companies. The popularity of DAPTs is surprising because their benefits are purely theoretical, There have been no cases validating them., The laws of most states, including those of the most populous states, prohibit self-settled spendthrift trusts. Indeed, we and many others have predicted that these trusts have little chance of working for debtors in non-DAPT states.
The heavy marketing of DAPTs had the effect that marketing usually has on asset protection strategies -- it attracted the attention of the press, and then, the attention of legislators. Although many bankruptcy reform bills bounced around the halls of Congress for several years none of them contained provisions relating to asset protection trusts. This year, however, while the Act was being debated on the floor of the Senate, the New York Times ran an article about DAPTs and how the rich would be able to protect vast amounts of wealth in these trusts while decades-old bankruptcy protections were stripped away from the poor.
The accuracy of the New York Times article was questionable as the bankruptcy courts had in several previous cases involving the foreign variant simply considered the trust to be an agency arrangement instead of a bona fide trust, thus including trust assets in the bankruptcy estate. Nonetheless, just before passage of the Act, the Senate tacked on an amendment offered by Missouri Senator Jim Talent which may kill the DAPT business just as it was starting to gain momentum.
Section 548 of the Bankruptcy Code relates to "Fraudulent Transfers and Obligations". Prior to the New York Times article, the Senate had only slightly modified Section 548 by changing the limitations period from one year to two years and some other minor changes. After the article, the Talent Amendment adds a new subsection (e) to Section 548 as follows:
(e)(1) In addition to any transfer that the trustee may otherwise avoid, the trustee may avoid any transfer of an interest of the debtor in property that was made on or within 10 years before the date of the filing of the petition, if--
(A) such transfer was made to a self-settled trust or similar device;
(B) such transfer was by the debtor;
(C) the debtor is a beneficiary of such trust or similar device; and
(D) the debtor made such transfer with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made, indebted.
Since this provision deals what appears to be a fatal blow to asset protection trusts, it is worthy of more detailed discussion.
The 10-year period is measured from the date of the filing of a bankruptcy petition, and there is no grandfather provision for existing trusts. This is a very significant change from previous law, since the ordinary bankruptcy limitations period was only one year (increased to two years by the new Act), and most states have four-year limitations periods for challenging fraudulent transfers.
Next, this 10-year limitations period only applies to self-settled trusts "or similar devices". The term "self-settled trust" is easy: It is a trust that you create for your own benefit. Asset protection trusts are typically self-settled trusts, as are living trusts.
But what about "similar devices"? Could a bankruptcy trustee use the new Section 548(e) to set aside transfers to trusts that are settled by the debtor, in which the debtor has a limited interest, such as a charitable remainder trust or a qualified personal residence trust? If a transfer to a charitable remainder trust were set aside, the (non-dischargeable) tax consequences to the debtor could be disastrous. Depending on the circumstances, the original deduction could be disallowed, and interest and penalties could apply retroactively.
Another concern of "or similar device" goes to certain types of insurance products, such as "Swiss Annuity" type products and variable universal life insurance products that give their purchasers some investment control, access to cash value, and have only the minimum amount of pure life insurance necessary to satisfy IRS requirements. A sophisticated creditor might make a convincing argument that these arrangements are in the nature of self-settled trusts and are colored with insurance only for technical tax purposes, and thus are within the "or similar device" orbit. With the overt marketing of some financial products, such as private placement life insurance, as asset protection tools, it is not difficult to imagine a court accepting an interpretation of Section 548 by a creditor or trustee to set aside transfers involving some of these types of products.
We are not concerned with ordinary life insurance and annuity products falling into the "or similar device" trap, where they clearly are insurance contracts governed by state insurance codes whose issuers are regulated by state insurance commissioners,. However, our musings here illustrate the vagueness of the "or similar device" language of Section 548(e) and the potential for its interpretation to encompass many asset protection strategies. It may be some time before we have sufficient case law to be able to say with any certainty that particular strategies fall into or avoid that trap.
It is clear that that the language of Section 548(e) protects future creditors, not just creditors existing at the time of the transfer. Section 548(e)(1)(D) refers to to existing creditors and to those who became creditors "on or after the date that such transfer was made." Congress clearly intended that Section 548(e) apply for the benefit of creditors who appeared only after the transfer occurred. Nonetheless, many promoters falsely proclaim that there is no fraudulent transfer risk if there are no current creditors' claims.
While the fact that a person has no claims against him at the time of a transfer certainly is favorable, it is not dispositive. Indeed, the same language referring to future creditors appears in (unchanged) Section 548(a)(1). Similar provisions appear in the Uniform Fraudulent Transfer Act, which expressly protects future creditors in many circumstances.
There have been some suggestions that the "actual intent" language means that a transfer to a self-settled trust can only be set aside if the debtor confesses that he intended to defraud creditors. Of course, no sober debtor would make such an admission if significant wealth was at risk. Thus, Congress used the exact same phrase that appears in Section 4(a)(1) of the Uniform Fraudulent Transfer Act: "actual intent to hinder, delay, or defraud." The same phrase appears in Section 548(a)(1)(A) and is part of the principal fraudulent transfer provision of the Bankruptcy Code, that was unchanged by the new Act.
Under both the UFTA and Section 548(a)(1)(A), it is clear that "actual intent" does not require a confession by the debtor. To the contrary, "actual intent" long has been proved by circumstantial evidence consisting of certain factors (the "Badges of Fraud") that would indicate the debtor's fraudulent intent. So even if a debtor professes innocence and points to substantial non-asset protection reasons for making transfers, the court may still find that the debtor had the "actual intent to hinder, delay, or defraud" if the circumstances tend to indicate that to the judge.
There is also a new subsection (e)(2) that makes it clear that subsection (e)(1) also applies to transfers in anticipation of a judgment or fine, etc., arising from a violation of state or federal securities laws, or "fraud, deceit, or manipulation in a fiduciary capacity or in connection with the purchase or sale of any security". Some have misread subsection (e)(2) to infer that the new 10-year limitations period for self-settled trusts applies only to securities fraud or breach of fiduciary duty, etc., but the "includes" language of (e)(2) is purely supplementary and not limiting.
It is important to keep in mind that the bankruptcy courts were in the habit of considering self-settled trusts to be in the nature of agency relationships, and thus were including self-settled trust assets in the bankruptcy estate anyway. There is no 10-year statute of limitation for this, so even those with "old and cold" asset protection trusts may be sadly disappointed in bankruptcy if their overall arrangement gives (direct or, as is the norm, indirect) control over the distribution of trust assets to the settlor/beneficiary.
If settlors of old and cold APTs clearly do not have control over the distribution of trust assets to themselves, the assets of such trusts would not be included in their bankruptcy estates. However, this presupposes at least two things: first, that there are APT settlors who truly have no direct or indirect ability to compel a trustee to make distributions to them; and second, that a bankruptcy trustee and/or judge would resist a likely urge to disregard the trust as an agency relationship in any event.
The effect of new Section 548(e) is that if asset protection trusts were not dead before, they should not now be used as anything like an ordinary asset protection technique. In more circumstances than not, it may now be the precipice of malpractice to recommend an asset protection trust to a client. The rare exception will be for those who establish foreign asset protection trusts and who are willing and able to flee the U.S. before the court enters the inevitable repatriation order.
So ends our survey of what asset protection planning tools will not work under the new Bankruptcy Act. Now we'll look at what still does work.
The Foreign Asset Protection Trust (FAPT) exists by virtue of spendthrift trust statutes in the offshore jurisdictions that specifically allow these trusts to be self-settled. Additionally, these trust statutes provide a variety of other statutory provisions meant to deter and defeat creditors, including shortened Statutes of Limitations that make proving fraudulent transfers nearly impossible, and flight clauses allowing the trustee to move the trust elsewhere if things get too hot in the original jurisdiction.
FAPTs can be a strong asset protection tool -- so long as you are prepared to flee the U.S. to join your assets. For U.S. judges in several landmark cases have demonstrated that they despise FAPTs and will do whatever is in their power to unwind them so that U.S. creditors can see their judgments satisfied, including sending the settlor to jail for literally years for contempt.
Asset Protection Trusts Neutered by Bankruptcy Reform Act
The 2005 changes to the Bankruptcy Code provide for what amounts to a 10-year clawback of transfers to self-settled trusts that are meant to hinder, delay, or defraud creditors. Since most FAPTs are set up for this very reason, such clawbacks may be automatic in many cases. At the very least, all transfers to an asset protection trust will be susceptible to being set aside for up to 10 years prior to the date that a bankruptcy petition is filed.
Some critics of foreign asset protection trusts might contend that this change was unnecessary, since foreign asset protection trusts had always failed in bankruptcy anyway. FAPTs may still be useful in very limited circumstances, such as for planning with international families or pre-immigration planning.
Caution that to avoid the stigma of the numerous cases where FAPTs have failed, some promoters have started giving them different names to try to disguise their character. Whether this disguise is meant for the court or their prospective customers is not clear.
Foreign Asset Protection Trust Statutes
All of the offshore debtor havens have some form of asset protection trust legislation, and we do not seek to study each and every statute. Suffice it to say that the Cook Islands and Nevis typically represent the cutting-edge of offshore trust legislation, at least as it relates to legislation geared towards U.S. persons, so their very-similar statutes are worthy of study.
The litigation history of the Foreign Asset Protection Trust is often intentionally or negligently misrepresented by promoters selling their cookie-cutter offshore trust structures. Follows are a list of the cases in chronological order (based on the date of the most important decision in the case), and a summary of their results. Additional and substantial information relating to each case is available by clicking on the links.
In re Colburn, 145 B.R. 851 (Bkrpt E.D.Va. 1992), did not involve incarceration for contempt, but the bankruptcy debtor who did not disclose his interest in a Bahamas trust was denied his discharge and the court suggested that the debtor had engaged in fraud.
Brown v. Higashi (Bkrpt Ak. 1995), involved an Alaska CPA who with his wife set up a Belize trust and then later was hit with a tort judgment. Although the case didn't involve incarceration for contempt, it did consider whether the assets of the Belize trusts should have been included in the bankruptcy estate, and the court ruled that those assets were in fact included. The court included the following unflattering language about FAPTs: "The fact that the trusts were established in Belize, a country notorious for its anti-creditor policies, rather than Alaska or Washington, indicates an intent to hinder, delay or defraud on the part of the defendants."
In re Portnoy, 201 B.R. 685 (S.D.N.Y. Bkrpt. 1996), involved a debtor, Portnoy, who entered into personal guarantees with a Bank to benefit his business, but then shortly before those personal guarantees were called by the Bank he set up a trust in the Isle of Jersey off the French coast and transferred nearly all his wealth to the trust. Soon thereafter, Portnoy filed for bankruptcy and filed a motion for summary judgment seeking to discharge the Bank's claims. However, the bankruptcy judge stated that he simply did not believe that Portnoy had any control over the Jersey trust (regardless of what the language of the trust said), and denied Portnoy's motion, suggesting in his opinion that Portnoy had made potentially fraudulent misrepresentations in his filings.
FTC v. Fortuna Alliance (1997), was a harbinger of things to come. The FTC while tracking an alleged pyramid scheme was able to get a U.S. District Court to issue arrest warrants for those running Fortuna Alliance, after which the defendants immediately agreed to return approximately $5 million from their Antigua offshore trust accounts. But because the case was a settlement and not reported, it was simply ignored by the offshore trust pundits.
Riechers v. Riechers, 679 N.Y.S.2d 233 (1998), involved a physician who tried to cheat his wife (who had helped him get started in his practice) out of her portion of $4 million of their marital assets by forming (ostensibly to protect against potential medical malpractice claims) a Colorado limited partnership that was owned by a Cook Islands trust. The New York state court said that although the wife could and should purse the assets in the Cook Islands, that the $4 million was part of the divorce estate and the wife would thus be awarded $2 million satisfied by both the trust and other marital assets in the U.S.
Westrate v. Westrate (1998), was a Florida divorce case where the husband transferred almost 90% of the couple's wealth to a Cook Islands Trust some four months after he first met with a divorce lawyer. The case quickly settled when the judge in the case found sufficient facts to invoke the crime-fraud exception to attorney client privilege between the husband and his lawyers and ordered those lawyers to answer interrogatories.
In re Brooks, 217 B.R. 98 (D.Conn. Bkrpt. 1998), involved a husband who transferred certain stock shares to an offshore trust formed in the Isle of Jersey by his wife, ostensibly for estate planning purposes. A year later, the husband was forced into bankruptcy. The bankruptcy court considered the self-settled nature of the Jersey trust, and found (after an extensive discussion of the subject) that it was incompatible with Connecticut law that forbid such trusts. The bankruptcy court then simply deemed the stock shares to be a part of the bankruptcy estate. This case is an excellent example of how a U.S. court can simply ignore the existence of an offshore trust for purposes of determining ownership to assets in the United States.
FTC v. Affordable Media, LLC, 179 F.3d 1228 (9th Cir. 1999) (a/k/a "Anderson case"), was the first case where the intense dislike by federal judges of foreign asset protection trusts finally bubbled over, and resulted in the Andersons, a couple who were pursued by the Federal Trade Commission for their participation in a telemarketing scheme, being incarcerated for six months after they claimed that they could not comply with a repatriation order from the federal court to bring back to the United States certain assets they had sent to their Cook Islands foreign asset protection trust. Later, the Andersons' trust company paid a $1 million settlement to the Andersons, and the Federal Trade Commission continues to pursue the Anderson for the balance of the judgment against them. Although the FAPT pundits would later claim that this case is a "bad facts make bad law" situation, they overlook that the Andersons formed and funded their offshore trust a year before the Andersons even got involved in the telemarketing scheme.
Because the Andersons spent only six months in jail, a theory quickly developed that six months was the longest that the court could hold the settlor of an offshore trust in contempt. Also, the Anderson case was seen by some planners as an anomaly -- a case from the "liberal 9th Circuit" that was unlikely to be repeated. The next case, the Lawrence case, answered the issue regarding contempt and showed that the Anderson result was the way that FAPTs would henceforth be treated by the federal courts.
SEC v. Brennan, 230 F.3d 65 (2nd Cir. 2000), involved a Gibraltar trust that was formed in 1994 and funded with $5 million by a notorious securities fraud artist. Later, when Brennan filed for bankruptcy in 1995, the foreign trustee exercised the flight clause in the trust and moved it first to Mauritius in the Indian Ocean, and then to Nevis in the Caribbean. Brennan did not include the trust assets in his initial bankruptcy petition, but later (apparently fearful of criminal bankruptcy fraud) amended his petition to include the offshore trust assets. The U.S. District Court then ordered Brennan to repatriate the trust assets back to the U.S. under penalty of contempt, but Brennan appealed to the U.S. Court of Appeals for the Second Circuit on the technical issue that the District Court's order violated the automatic stay provision of the bankruptcy laws, and won on a narrow 2-1 decision. Before anything further could happen in the case, Brennan was convicted of bankruptcy fraud and sent to jail for a very long prison term for bankruptcy fraud not related to the offshore trust (such as claiming that he had no assets while maintaining a box in a Las Vegas casino that held $500,000 in chips). From an asset protection perspective, the Brennan case thus resolved nothing other than showing that FAPTs could and would be used by hardened securities fraudsters to hide their ill-gotten gains.
SEC v. Bilzerian, 131 F. Supp. 2d 10 (D.C. 2001), like the Brennan case also involved a notorious securities fraudster. Bilzerian, a one-time corporate raider who had been convicted of insider trading, also tried to hide his assets from the SEC, and sought protection under the bankruptcy laws, but his discharge was denied by the District Court and affirmed the Eleventh Circuit, In re Bilzerian, 153 F.3d 1278 (11th Cir. 1998). Thus, the SEC's pursuit of Brennan's asset continued, and the District Court issued a broad order to Bilzerian to present financial information on the numerous "Bilzerian entities", including his family trust formed in the Cook Islands. Although Bilzerian argued that under the trust documents he had no power to obtain the financials, and the Cook Islands trustee refused to present them, the District Court ordered Bilzerian incarcerated anyway.
In re Stephen J. Lawrence, 279 F.3d 1294 (11th Cir. 2002), involved a derivatives trader who had suffered a margin call from Bear, Stearns securities resulting from the 1987 market crash. Only weeks before the results of his arbitration with Bear, Stearns was announced, Lawrence sent most of his wealth to an offshore trust. After the arbitration went against him, Lawrence continued to litigate against Bear, Stearns, but eventually (apparently weary of the costs) filed a voluntary petition in bankruptcy. After discovering the offshore trust, the bankruptcy court obtained an order compelling Lawrence to turn over the trust assets. When Lawrence refused, the federal bankruptcy judge ordered him incarcerated, and eventually the 11th Circuit (known for being very conservative, unlike the 9th Circuit) affirmed the incarceration. Lawrence's Writ of Certiorari to the U.S. Supreme Court was later denied, and as of August, 2003, Lawrence was attempting to argue that his contempt was really criminal in nature, thus entitling him to a jury trial to attempt to get out of jail.
The Anderson and Lawrence cases are "1-2 punch" that knocked out the (in retrospect, ridiculous) belief that U.S. courts would wilt in impotence against foreign asset protection trusts even when they had the settlors within their powers. Even today, the Anderson and Lawrence cases are an extremely sore spot with the planners who then championed FAPTs as the ultimate weapon against creditors, and who were later severely discredited when these cases turned out precisely opposite of how they had predicted.
BankFirst v. Legendre (2002), involved a Florida businessman who set up an offshore trust with the assets managed by Paine Webber. After being sued by BankFirst, Legendre filed for bankruptcy, but the U.S. bankruptcy judge order to him to jail for contempt and after only five days in the pokey, Legendre saw the light and according to press reports, "the businessman actively is assisting in unraveling the financial details of the Yawn Trust and Master Works, and turning the assets over to trustee Henkel for disbursement to creditors -- including, presumably, BankFirst."
J.W. v. Allvest, Inc., (Alaska Sup. 3rd Dist. No. 3AN-97-7192-CIV, 2002) involved a bizarre and stupid attempt by a person who ran a private prison and had lost an inmate lawsuit to engage in a series of transfers to drain the corporation which had suffered the judgment of its assets by way of bogus transfers to a series of shell companies, and then to transfer the assets to an offshore trust. When the plaintiff in the underlying lawsuit sued everybody involved in the transfers, including the owner of the private prison, the trust, the Alaska Trust Company, and even the attorneys who created this planning abortion, for civil conspiracy and fraud, the case reportedly settled for 100 cents on the dollar. A stellar example of how asset protection can be wrongly used to defraud legitimate creditors, and the remedies that a plaintiff can employ to stop such illegitimate subterfuges.
Bank of America v. Weese, 277 B.R. 241 (D.Md. 2002), involved debtors who in a brazen attempt to defraud their creditors established a Cook Islands trust and transferred their assets to it, and later were forced into an involuntary Chapter 7 liquidation after which a settlement of $12 millon was paid to the creditors.
Breitenstine v. Breitenstine, 2003 WY 16, 62 P.3d 587 (Wyo. 2003), was the Wyoming Supreme Court's consideration of a Bahamas FAPT that the Husband attempted to use to shield marital assets from his wife. The Court allowed a marital division based on the assets in the offshore trust, commenting in a footnote that "the use of such trusts to avoid alimony, child support, and a fair division of marital property upon divorce is reprehensible to us."
Nastro v. D'Onofrio, 263 F.Supp.2d 446, 50 UCC Rep.Serv.2d 888 (D.Conn. 2003), involved an attempt by a debtor to transfer certain stock shares and other assets to a trust in the Isle of Jersey. The court entered an injunction preventing the transfers to prevent creditor fraud, and held that the fact that the court could not assert personal jurisdiction over the offshore trustee would not keep the action from going forward.
Eulich v. U.S., (N.D.Tex. Case No. 99-CV-01842, August 18, 2004), involved a Bahamas offshore trust that was created a by a U.S. Settlor who later was investigated by the IRS. When the IRS served a formal request for documents from the trust, the Settlor refused to provide the documents and claimed that he had no control over the trust and had exhausted his powers to try to get the documents. The District Court disagreed, holding that the Settlor could still attempt to get the documents from the trust by appointing new administrators and by filing a lawsuit in the Bahamas. At any rate, the Court stated, it was not going to recognize the Settlor's "impossibility defense" because the impossibility was self-created, i.e., the Settlor's own drafting caused the impossibility. The Court found the Settlor in contempt and imposed a fine of $5,000 per day on the Settlor, to be increased to $10,000 per day after 30 days, and then after 45 days the Court would consider incarcerating the Settlor until the documents appeared.
U.S. v. AmeriDebt, Inc., 373 F. Supp. 2d 558 (D. Md. 2005), involved a defendant who was already under investigation by the Federal Trade Commission for running a credit counseling scam. Shortly after discovering information of the investigation set up, defendant started transferring assets to a series of foreign asset protection trusts. Citing the Anderson case (FTC v. Affordable Media), the Court ordered the defendant under penalty ofcontempt to repatriate the assets to the U.S. so that they could bemarshalled by a receiver.
U.S. v. Grant, S.D.Fla. (W.Palm Case No. 00-CV-8986), 2005, dealt with the tax liability of the settlors of offshore trusts created over 20 years ago. The court entered the repatriation order anyhow, stating that the trust assets must be returned to satisfy the tax assessment.
Foreign Trust Opinions
There have been a number of opinions of foreign courts, such as the Cook Islands and Nevis, relating to foreign asset protection trusts involving U.S. persons or assets. Most of the opinions rather predictably validate the trust laws of those jurisdictions (it would be very bad business not to), but a few exceptional cases are worth mention:
One of the traditional techniques for protecting assets, going back literally hundreds years of Anglo-American jurisprudence, trusts offer tremendous benefits when used appropriate circumstances and often are underutilized for planning. Caution, however, that certain transfers to trusts and types of trusts have been voided by the state legislatures or by Congress in the bankruptcy code.
Foreign Asset Protection Trusts (a/k/a "Offshore Trusts") Includes a synopsis of each significant case involving offshore trusts, a copy of the opinion where available, and other interesting documents relating to the case. Also includes the texts of the Cook Islands and Nevis trust statutes, and commentary about the efficacy of FAPTs in planning.
Spendthrift Trust Provisions A collection of landmark opinions from each state interpreting spendthrift trust provisions in the debtor-creditor context.
