The USA As An Asset Protection Jurisdiction

This is a trust that a person (the settlor) would establish primarily for herself as a beneficiary, with protection of the trust assets from her creditors as an objective. For centuries, such trusts were deemed to be against public policy, and creditors of the settlor/beneficiary were allowed to reach the full amount of the assets that the trustee was allowed to pay to or for the beneficiary.

Then, beginning in the 20th century, one by one by one, a number of the non-US common law jurisdictions, including most in the Caribbean but also the Pacific, began to realise that the allowance of such self-settled trusts could bring new money into the jurisdiction, and so they began to pass laws providing that such trusts established in their jurisdiction would be protected from attack by creditors of the settlor/beneficiary. And they were right. Over the years, billions of US (and other countries’) dollars poured into the new asset protection jurisdictions to fund the self-settled spendthrift trusts.

And Now

All this action forced the US to reconsider the public policy issue more carefully, and beginning in 1997 with Alaska and Delaware, after more than two hundred years of protecting public policy, the US decided that protecting assets was more important than protecting public policy and officially became an asset protection jurisdiction. Thus began a trend that today totals 21 states [1] that allow a person to establish a self-settled asset protection trust, now commonly referred to as an ‘APT,’ but in reference to the US asset protection trust as domestic versus foreign, the reference here and in most commentary is to a ‘DAPT.’

This article sets out the general requirements for establishing a DAPT and offers a few suggestions as to what might make one state’s asset protection laws more attractive than another.

The Basics

To begin with, there are five requirements common to the 21 states that the DAPT must follow:

1) The trust must be irrevocable by the settlor but the power to revoke can be given to other parties, such as the trust protector (Wyoming has an exception to this rule).
2) The trust must have a local trustee, but it could also have a co-trustee elsewhere, such as in the settlor’s domiciliary state – a bad idea, if protection is an objective.
3) Some of the trust assets must be located and administered in the DAPT state.
4) The trust must provide that its governing law is that of the DAPT state.
5) The trust must contain a ‘spendthrift’ provision specifically prohibiting attachment or reach by creditors or assignment by the beneficiaries.

There are also a few additional provisions that vary from state to state and that are seen as very important by ‘experts’ in assessing the desirability of one state’s DAPT over another. They include the period (statute) of limitations within which an action must be brought to challenge a transfer to the trust; ‘exception creditors’ (such as ex-spouses collecting alimony, child support obligations, and tort creditors), if any, whose claims override the protection of the DAP; and the level of the creditor’s burden of proof in challenging a transfer to the DAPT as ’fraudulent,’ meaning prejudicial to the creditor.

Time To Make A Claim

One of the most significant considerations is the statute of limitations, which runs from eighteen months in Ohio (currently the shortest) to five years in Virginia, the longest. Almost half of the rest are four years, including Connecticut, and the other half are two years. In virtually all the statutes, the burden of proof to establish a fraudulent transfer is by “clear and convincing evidence,” while Connecticut reduced even that liberal standard by requiring proof only by a “preponderance of the evidence” if the transferor is also a beneficiary of the DAPT, which would typically be the case with a self-settled DAPT. Furthermore, in most states the creditor must prove that the debtor’s transfer must have prejudiced that particular creditor and not just any creditor.

The idea of a period of limitations makes sense in some respects, as it would lead to chaos and widespread uncertainty in commerce and property ownership if creditors could surface and make a claim ten or twenty years after the claim arose. But that’s the way it used to be to prevent debtors from simply giving away their property to avoid creditors. In 1570, the first Queen Elizabeth passed a law that allowed creditors to lay claim to the transferred property at any time after the transfer, without limitation - it is called the “Statute of Elizabeth,” and is still the law in some jurisdictions. Of course, a reasonable limit on the open period developed, but what is reasonable? If some states, in an effort to attract more DAPT business, decided that 60 or 90 days was sufficient, would that create still another trend? Could a court ignore an unreasonably short period?

Exception creditors are the next important consideration. They are creditors whose claims take priority over the protection offered by the statute. Typically these are claims existing at the time the DAPT was created, for example for child support, alimony or marital settlements, which is the law in a majority of the DAPT states. Currently, only Nevada, Utah, and West Virginia have no exception creditors.

There are other requirements in establishing a DAPT, varying from state to state, but the foregoing are the essentials, meaning theoretically at least, that an individual could transfer a substantial portion of her assets to a DAPT (we should note that many advisors recommend not more than 30 or 40 per cent), and if there are no claims made within the open period of limitations, these trust assets would be protected from the reach of her creditors. In the meanwhile, she could receive whatever payments and other benefits, such as the use of property that may be in the trust, without fear of a creditor’s attack. At least that’s the plan.

Non-US Settlors

Settlors of a USDAPT who are domiciled outside the United States could have significant income tax advantages if their USDAPT is a ‘grantor’ (pass-through) trust, which most of such trusts are, but they must be sure their advisors are aware of that requirement. If that is the case, they will pay no US income tax on interest from bank accounts, corporate and government bonds, and most capital gains from investments other than real estate. Note that there are a number of additional US tax issues that could arise, and it is essential that non-US settlors obtain competent tax advice before establishing a US trust.

Open Questions For US Settlors

Unfortunately, the use of a DAPT in one state by a person domiciled in another state raises some issues of US constitutional law not clearly settled before (remember, the US did not previously recognise self-settled asset protection trusts). For example, say a Florida person establishes a DAPT in Nevada, and a creditor of the Florida person obtains a judgement against him, the US constitution requires each state to give “full faith and credit” to the judgements of another state. But if the Florida debtor says to his creditor “your judgement is against me, not against my trust, so you have to sue the trust,” the state of Nevada would no doubt do its best to protect its DAPT law, so the creditor would be faced with a long and expensive battle.

Then there is the issue of the period of limitations within which the creditor must make their claim. The period could remain open in the settlor’s home state but closed in the DAPT state (eg Florida’s period is four years while Nevada’s is two years).

As more states adopt DAPT law and more DAPTs are established, case law will no doubt develop, but at the moment, there are very few reported cases across the country, and none exactly on point. This could be good news for settlors of the DAPTs. Many advisors speculate that this is a sign that creditors who confront such trusts do not want to incur huge expense to test the law with no guarantee of success, and therefore will be inclined to settle. Furthermore, there are discussions among legal organisations of establishing a Uniform Asset Protection Trust law, which could help unify the laws across the country, but could also make the picture more complicated.

Whether or not that occurs, asset protection planning has become an important part of estate planning. We can unequivocally say that times and concepts have changed, and estate planners need to be mindful of that. Given the growing trends of the states to adopt DAPT laws, when we get to the “full Monty” where all or nearly all fifty states have DAPT laws, it may become borderline negligent for estate planners not to consider a DAPT in every estate plan.

When that happens, if people really could roll over in their graves, Queen Elizabeth The First would be in the likes of a spin class.

Copyright 2023 by Alexander A. Bove, Jr.

1   States that have passed DAPT laws. 2023: Alaska, Alabama, Arkansas, Connecticut, Delaware, Hawaii, Indiana, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virgina, West Virginia, Wyoming

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.