Domestic Asset Protection Trusts – Part 3 – The Domestic Trust

In my first two related articles, I provided the foundation for a better understanding of how trusts and trust laws evolved from the 15th century to the current period. I also explored the responsibilities and burdens of a Trustee. Now, I will cover the often misunderstood Domestic Asset Protection Trust (DAPT). Although there are a myriad of methods for employing partial asset protection such as joint tenancy for property and corporate shareholding for minority shares, the comprehensive ability to bring asset protection under the penumbra of trust and trust laws was once only available by using Offshore Asset Protection Trusts (OAPT). This practice was and continues to function for Americans wishing to protect their assets. 

However, only recently did any real advancement occur for domestic protection. Probably the first real effort at legislating domestic asset protection was by the state of Alaska. On April 1, 1997, Alaska’s then Governor Tony Knowles signed House Bill 101 into his state’s law. The purpose of Bill 101 was Alaska’s legislature effort to create a type of state stimulus package as well as to designate Alaska as a global player for asset protection. Bill 101 had four primary objectives: (i) to legally provide for the establishment of self-settled spendthrift trusts in Alaska; (ii) to create a legal atmosphere wherein to establish the choice of law provision, thus selecting Alaska law to govern a trust; (iii) to establish timing considerations as limits on fraudulent transfer actions which would enhance the then debtor-friendly fraudulent transfer laws and; (iv) to replace the statutory rule against perpetuities for trusts which would allow unlimited life for an Alaskan trust.

Bill 101 led the American legislative path contrary to the well-established 1487 English statute prohibiting self-settled spendthrift trusts, “[a]ll deeds of gift of goods and chattels, made or to be made in trust to the use of that person or persons that made the same deed or gift, be void and of none effect.” This 1487 statute is not dependent on the Settlor’s intent or lack of intent to defraud creditors currently or in the future, while other’s jurisdictions’ current Fraudulent Transfer laws focus heavily on the Settlor’s intent to defraud known or future creditors. Alaska’s self-settled spendthrift (discretionary) trust provides that the Settlor shall be the discretionary beneficiary of the trust that contains a spendthrift provision, one which prohibits the beneficiary’s creditors from reaching the trust assets, even though such assets could be discretionarily distributed to the Settlor. This Alaskan legislation was totally against public policy and, therefore, mitigating language was drafted into its legislation.

Even with the above legislative intent on Fraudulent Transfers, a creditor can attack the trust and reach trust assets in four exceptions:

1. The transfer was intended in whole or in part to hinder, delay, or defraud creditors or other defined persons.
2. The trust provides that the Settlor may revoke or terminate all or part of the trust.
3. The trust requires that all or a part of the trust’s income or principal, or both, must be distributed to the Settlor, or
4. At the time of the transfer, the Settlor was in default by 30 or more days of making a payment due under a child support judgment or order.

To offset those above exceptions’ allowance, Alaska’s new statute of limitations provides that a person who is a creditor when the trust is created may not bring an action with respect to a claim unless the action is brought within the later of (i) four years after the transfer to the trust is made, or (ii) one year after the transfer to the trust is, or reasonably could have been, discovered by the creditor. If the person became a creditor subsequent to the transfer of the trust, the action must be brought within four years after the transfer is made.

It is important to note that there are severe restrictions on the Settlor in retaining any interest in the trust. The trust must be created as an irrevocable trust, which means the Settlor must not possess any domain or control over the trust or trust property. Creditors will then only be able to stand in the shoes of the Settlor when or if the Trustee independently determines it is in the best interest of the Trust to distribute property to the Beneficiary. The Creditors can then push the Beneficiary away from that property distribution stream and claim that distribution as applied against the outstanding debt of the Settlor/Beneficiary.

It was not long after the successful implementation of the Alaska Trust Act that other states entered this trust arena. Later in the same year, 1997, Delaware adopted its legislation titled, “Delaware Qualified Dispositions in Trust Act.” Delaware continues to be instrumental in amending the initial Act in their State’s efforts to be the leader in DAPT. In addition to Alaska and Delaware, six more states are in the legislative enactment of DAPT laws and replacing the well-established English common law of the Rule Against Self-Settled Trusts.

At the date of this article, there are thirteen states legislatively utilizing DAPT: Alaska (1997), Colorado (1997), Delaware (1997), Nevada (1999), Rhode Island (1999), Utah (2004), Oklahoma (2004), Missouri (2004), and, effective July 1, 2005, the state of South Dakota. Additionally, other states have enacted legislation for DAPT, including as of this writing: Wyoming Qualified Spendthrift Trust Legislation On February 28, 2007, Tennessee’s Investment Services Act and Enhances Asset Protection of July 3, 2007, New Hampshire “Qualified Dispositions in Trust Act” January 1, 2009 and Hawaii’s Permitted Transfer In Trust Act July 1, 2010. Although all thirteen states are in concert with the legislative replacement of the public policy against self-settled trusts, these states’ jurisdictions provide for a self-settled trust to be entitled to the legal allowance of what was only in the past granted to a non self-settled spendthrift trust, the avoidance of attack from creditors if there was no intent to defraud creditors as discussed above.

Do not be confused of the belief that even though these eleven states have a common focus that the statutory language is therefore the same. Delaware seems the most active in changing its legislation to keep in front of other states’ legislative attraction to new trust formations within their jurisdictions. The state of Oklahoma statute has a one million dollar “cap” as to the value that can be protected under its legislated self-settled trust. The eleven states also differ in matters of limitations on the Statute of Limitations as it applies to fraudulent transfer rules that vary between 2 and 4 years. The character of assets that can be protected from within the trust will vary between DAPT states. Even the physical and legal location of assets within the trusts can vary between DAPT states.

Some states attempt to compete with OAPT in matters of secrecy and confidentiality. Alaska attempted to adopt strong “secrecy” provisions into its trust legislation in an effort to protect the confidential nature of the trust and any related information, including the identity of the beneficiaries of the trust and the assets of the trust. It is important to note that this type of legislation has limits within the DAPT framework. This state legislation may be successful against the premature disclosure of information relating to the trust while litigation is pending. However, this information will be discoverable in a post-judgment situation and most certainly discoverable by state and federal authorities. Even so, other states including Nevada have extended the right of privacy to the corporate world by providing that the officers and directors of a DAPT state’s based company can be “nominees,” persons who are disclosed as having and exercising their legal capacity for the company when in fact they are acting on behalf of undisclosed principals. As an example, Nevada’s legislation allows an individual to serve as an officer, manager, or director of a Nevada company without having his or her name disclosed on public documents such as contracts or other documents that might be entered as part of a business transaction or that might actually be even available in the public records. With the searching abilities on the internet, this secrecy provision may be preliminarily quite valuable when a potential litigant’s legal counsel determines financial worth of a possible defendant.

Some state’s statutes allow the Settlor to actually retain critical and salient powers: (i) to veto distributions, (ii) to appoint advisors, (iii) to appoint trust protectors to the trust, (iv) the retention of the power to direct investments, and (v) the appointment of investment advisors to the trust. A few states provide the power to allow the Settlor to remove and replace the Trustee. All of the abovementioned powers given via legislation to the Settlor are for the domain and control over the DAPT. If the Settlor had wanted such domain and control over an OAPT, then potential litigants would have a hugely significant advantage over the OAPT in which the litigant could obtain a judgment in the OAPT jurisdiction for payment of debts, obligations and judgments. As a word of caution, these states’ legislation with retention of powers clauses should be viewed with great trepidation since the oldest DAPT legislation is only 13 years old and not properly tested under a series of court cases, Federal or State, which would then give a more reasonable reliance on these retained powers that would normally destroy a person’s trust planning structure. There still needs to be more cases in which the trust is established in one of the DAPT jurisdictions and the trust assets in another jurisdiction, in which case, the center question is whether the asset location state will honor the DAPT legislation in place of its own laws.

Some states have gone the extra mile in trying to anticipate the Settlor’s wish of having the ability, legislatively, to redomicile the state trust to a foreign jurisdiction as an OAPT. This provision was enacted with the intent of the particular state’s legislators to ease the uncertainty over the total effectiveness of the DAPT functions and protections within the United States and internationally. Official state law allowing sanctioned offshore redomiciliations, wherein the Trustee may remove the trust and trust assets from potential litigation, is a massive win by the Settlor. The Settlor’s act of removal and redomiciliation is actually legally provided by under state law and, therefore, outside of any claimed civil liability to the Trustee.

Eleven states, as of this writing, have enacted variations of Domestic Asset Protection Trusts with each state claiming superiority over the other. The common threads that run between these state enactments are continued employment and revenue generation within the state. Most of these states are of sparse population or insufficient revenue collection. However, they do offer a choice somewhere between merely putting assets in all or part of another individual’s name such as tenancy in common or joint tenancy to the Offshore Trust jurisdictions. Before embarking on establishing a particular DAPT and the complexity and expense of transferring assets, it is best that you consult with an experienced and knowledgeable advisor, preferably with practical knowledge of how these DAPT entities will withstand the rigors of vigorous litigation. You may also seek to know whether these DAPT are capable of providing your particular level of protection for your particular assets and if, when under attack from a litigant, you have further options such as transmuting Trust assets to an OAPT without fatally losing your protected assets.

Americans are an interesting people with understandably mixed feeling of watching their lifetime of hard-earned assets leaving the shores of the United States. Still, they are filled with concern over the U.S. government’s positions that may decrease the value of the U.S. dollar, propose new legislation against transferring money and property overseas, and allow even more intrusion into a person’s privacy. My next article of this series will focus on Offshore Asset Protection Trusts and the initial procedure to determine their value and use for an individual’s benefit. I may write one additional article if it seems that the readers express a desire for additional information to fill any unintended gaps that were not addressed in the four articles.

If you have any questions, give us a call or email us so we can discuss your particular situation.

Michael B. Nelson, Esq.