As more and more US States are adopting asset protection trust legislation, Alexander Bove examines the reasons behind this switch after 100 years of settled law.
Reversing more than 100 years of settled law, more and more states (now 14) of the United States are adopting asset protection trust legislation. These new laws are contrary to prior US law, in that they allow a person to establish a trust from which that person can receive unlimited benefits at the discretion of the trustee, while at the same time preventing that person’s creditors from reaching the trust assets.
In other states, the so-called ‘self-settled spendthrift trust rule’, which stands for the opposite result, still applies. This rule basically holds that the creditors of a settlor of a trust may reach the trust assets to whatever extent the trustee may apply them for the benefit of the settlor. For 14 US states, that law has changed, and the rule is the exact opposite between the two groups of states. The question is, will the US now be known as an asset protection jurisdiction?
The undisputed reason for the efforts to portray the US as an asset protection jurisdiction is an endeavour on the part of the banking and financial institutions, and perhaps to a limited extent on the legal profession, to sidetrack some of the huge flow of funds to trusts in the so called ‘offshore’ asset protection trust jurisdictions. These include the Cook Islands, Gibraltar, the Isle of Man and Liechtenstein, where in most cases it is virtually impossible for a creditor of the settlor to reach the trust assets if the trust was properly established.
The question raised by this new battle of the continents is, will the US asset protection trusts (APTs) be able to successfully compete with the offshore APTs? And does it matter where the settlor is domiciled? That is to say, for example, would a German settlor who established a US APT be just as well off or better off than a New York settlor who establishes a Delaware APT?
In fact, a US APT established by a non-US settlor in one of the US APT states would be protected against the non-US settlor’s creditors, provided the transfer to the trust did not constitute a ‘fraudulent transfer’. Briefly, this would be a transfer that was not made to prejudice the creditor and one that was not made within the applicable ‘period of limitations’. Every jurisdiction prescribes a period after any gratuitous or prejudicial transfer within which a creditor may ask a court to cause the transferred assets to be applied to satisfy the debt (the ‘open period’). Thus, transfers outside the open period would be considered beyond the reach of the transferor’s creditors even if it seemed to prejudice the creditor. A US APT established by a US person, however, may be vulnerable to something more than the period of limitations on fraudulent transfers.
One of the critical unresolved issues that faces a person who establishes an APT in any of the US states is the ‘full faith and credit’ clause of the US constitution. This clause basically provides that each state will give full faith and credit to the acts, records, and judicial proceedings of every other US state. Thus if a creditor of the New York settlor obtains a judgment, can the creditor apply the US constitutional law to enforce that New York judgment against the Delaware trust established by the New York settlor, when the laws of Delaware expressly provide that the trust assets may not be reached by that creditor? To date, this question, which is vital to the success of US APTs, remains unanswered, but there is convincing commentary arguing that the APT assets would be protected if the trust and the circumstances met the necessary protective requirements. So let’s take a look at the requirements among the several states to consider which might be the ‘better’ states in which to establish an APT - specifically noting here that I offer no comments on any tax considerations that might apply, except to say that a US APT established by a US settlor where she or her spouse is a beneficiary will be regarded as tax neutral for US federal income tax purposes.
The laws of all the 14 states that are considered APT states have certain requirements in common for trust to qualify. Generally, they require the trust to be irrevocable; to contain a ‘spendthrift’ provision (declaring that the trust assets are not available or reachable by creditors); to have a trustee in the APT state; and to have some of the trust assets administered in the state. Obviously, in all cases the settlor’s beneficial interest, if any, must be fully discretionary with the trustee (except in certain states where charitable remainder trusts, certain unitrusts and annuity trusts could qualify, but these are not regarded as asset protection trusts).
So, with all these provisions in common, what separates the good from the better and best APT states? In my opinion there are two criteria that should be considered before considering any others. The first is whether the law of the APT state in question recognises ‘exception creditors’, who could reach trust assets even though all other protective requirements are met. Exception creditors typically include those having claims for alimony, child support, and certain tort claims. Almost all the states make an exception for alimony and child support, Nevada being the only one that does not allow alimony. Of course, if such claims are not a concern for the particular settlor, then that criteria is not so important. As for tort claims (eg, personal injury or property damage), Delaware, New Hampshire, Rhode Island, and Utah make exceptions, but except for Utah, the exception only applies to claims that arose before or on the date of the transfer to the APT.
The other, perhaps more critical criteria is the open period of limitations, within which a creditor may make a claim against the trust assets without interference from the protective law of the APT state. This period ranges from five years (currently the longest, as provided in Virginia), to 18 months, (the shortest, as provided in Ohio). In between, are Delaware, Alaska, and the majority of others, which call for four years; Nevada and South Dakota, two years; and Utah, three years. A special extension is applied to these periods if the creditor’s claim exists at the time of the transfer to the APT. The extension is six months in the case of the shorter periods, as with South Dakota, Ohio, and Nevada, and one year for the longer periods. The extension begins at the time the creditor could reasonably have discovered the transfer, which typically happens after a judgment is obtained. For future creditors (those whose claim arise after the transfer to the APT), the respective periods are absolute, generally with no extension. That is, say that X transfers assets to a Delaware APT on 1 June 2013 and a creditor’s claim arises one month later, but the creditor does not bring suit for three years. If the trust was established in Ohio, Nevada, or South Dakota, the creditor would be out of luck as to reaching any assets in the trust because their open periods would have expired. In Delaware or most of the other states, however, there would still be time (about a year) for the creditor to attempt to prove that the settlor had the intent to prejudice his creditors when he established the trust, and if the creditor was successful, the trust assets could be reached.
All that said, it is relevant to note that it is neither a simple nor an inexpensive matter for a creditor to launch an attack on an APT. First, he must bring an action in the debtor’s home state and obtain a judgment. Next, he must bring an action in the APT state to have the judgment enforced. Next, he faces the difficult question of whether the judgment may be enforced against the ‘trust’, when the trustee of the trust is not the judgment debtor. The battle then would be joined, because the trustee has a duty to protect the trust assets, and the APT state courts have a duty to apply and uphold the law of the APT state, and the creditor wants his money. Lastly, regardless of the outcome (other than a settlement), the case would likely then go to a federal court.
Given the fact that hundreds, if not thousands of US APTs have been established over the various APT states, and that to date there have been no reported cases showing results one way or another, we can at the very least conclude that creditors are not readily defeating such trusts in the courts, and the US (or at least parts of it) may be seen as an asset protection jurisdiction.
Alexander A Bove
Alexander A. Bove Jr. of Bove & Langa, is an internationally known and respected trust and estate attorney with over thirty-five years of experience. He is Adjunct Professor of Law, Emeritus, of Boston University Law School Graduate Tax Program, where he taught estate planning and advanced estate planning for eighteen years. Prior to that he taught estate planning for four years at Northeastern University Law School. In 1998 he was admitted to practice as a Solicitor in England and Wales. In addition to his J.D. and LL.M. degrees, in 2013, he earned his Doctorate in Law from the University of Zurich Law School.