Alaska on the Asset Protection Trust Map: Not Far Enough for a Regulatory Advantage, but Too Far for Convenience?

• Citation: Vol. 29
• Publication year: 2012

§ 29 Alaska L. Rev. 149. ALASKA ON THE ASSET PROTECTION TRUST MAP: NOT FAR ENOUGH FOR A REGULATORY ADVANTAGE, BUT TOO FAR FOR CONVENIENCE?

Alaska Law Review
Volume 29, No. 1, June 2012
Cited: 29 Alaska L. Rev. 1

ALASKA ON THE ASSET PROTECTION TRUST MAP: NOT FAR ENOUGH FOR A REGULATORY ADVANTAGE, BUT TOO FAR FOR CONVENIENCE?

Timothy Lee ^[*]

Abstract

In 1997, Alaska became the first state to recognize self-settled discretionary spendthrift trusts. This groundbreaking legislation was motivated by the legislature's desire to establish Alaska as America's financial center for asset protection. Almost fifteen years have passed since Alaska placed itself on the asset protection map. This Note examines the legislative history of Alaska's 1997 Trust Act and compares it with several other states that have followed its lead, and ultimately seeks to answer whether Alaska has met its goal of becoming the financial center it envisioned.

Introduction

The subject of Trusts and Estates has been a thorn in the side of law students and practitioners for decades and it is filled with incomprehensible concepts such as the rule against perpetuities ^[1] -one of only a handful of subjects in which a court will excuse an attorney for lacking mastery. ^[2] By the 1970s, offshore trusts had come to be seen as a way for those with wealth to shield their assets from U.S. tax liabilities. ^[3] In an attempt to close this tax loophole, Congress passed the Tax Reform Act of 1976, ^[4] which enabled the Internal Revenue Service (IRS) to treat assets transferred by an American to a foreign trust as the American settlor's assets. ^[5] Thus, beginning in the mid-1980s, the primary motivation for moving assets offshore changed from tax sheltering to protection from creditors. ^[6] Seeing a need to create asset protection shelters, several small island jurisdictions, led by the Cook Islands, began to develop a foundational legal structure to support the influx of U.S. assets. ^[7] In 1997, seeing the opportunity to compete against offshore asset protection trusts by developing a competitive environment, Alaska became the first state to recognize self-settled discretionary spendthrift trusts (also known as self-settled asset protection trusts) ^[8] as a way to shield a settlor's assets from creditors. ^[9]

Almost fifteen years have passed since Alaska became the first state to recognize the use of asset protection trusts. Since that time, commentators have written numerous articles about the race to the bottom, ^[10] the destruction of creditors' rights, and the general money-hungry state of our society. ^[11] What these materials have not addressed, however, is whether Alaska's decision to become the first state to offer such protection allowed it to reap the benefits intended by its legislature. This Note attempts to answer this question by providing a background on trusts and the current state of the U.S. asset protection landscape.

Part I provides a brief explanation of trusts and their uses through an examination of the history of asset protection trusts offshore. Part II examines the legislative history of Alaska's 1997 Trust Act and attempts to parse the legislature's various considerations and its primary motivations for passing the Act. Part II also examines the Act's substance and subsequent amendments. Part III describes the aftermath of the Act's passage, including other states' reactions and subsequent challenges to domestic asset protection trusts. Finally, in light of the preceding sections, this Note concludes by providing insight regarding whether Alaska has achieved the goals it set out during the Trust Act's passage.

I. Trust Basics

A. What is a Trust?

In Anglo-American law, a trust can be thought of as "a relationship in which one person is the holder of the title to property, subject to an equitable obligation to keep or use the property for the benefit of another." ^[12] The definition denotes three basic elements: (1) a trustee; (2) a beneficiary, or cestui que trust; and (3) the trust property, or trust res. ^[13] Trusts were developed in England with the purposes of reducing burdens generally associated with holding land, providing a means by which religious institutions could make profits from their land, and making assets easier to transfer. ^[14] Today, a "trust[] can be created for any legal purpose so long as the purpose does not violate public policy." ^[15] While there are many reasons to create a trust, in the U.S. trusts are generally created either for tax benefits or asset protection. ^[16]

There are four general types of asset protection trusts. Spendthrift trusts are generally used to protect beneficiaries from creditors. ^[17] A spendthrift trust is a "[t]rust[] in which the interest of a beneficiary cannot be assigned by him or reached by his creditors." ^[18] An example would be a parent who would like to provide for his or her children and chooses to place his or her assets in a trust for them because, for one reason or another, he or she does not want them to take ownership of the assets. Under these circumstances, a party with a claim against the children would be unable to reach the trust assets under the theory that the settlor (parent) is the owner of the property and can do with it as he or she wishes. Thus, nothing the children do can force the parent to part with his or her property outside of the parent's will. ^[19]

A second type of trust is the support and maintenance trust, which limits payment to the beneficiary of only as much income as is required for the support, maintenance, and education of the beneficiary. ^[20] What qualifies as a support and maintenance item is laid out in the trust instrument. Here, creditors are barred under the theory that only those purposes laid out in the trust instrument can trigger a distribution. ^[21]

A third type is the discretionary trust, where a third party trustee has sole discretion over disbursement. The trustee has the authority to distribute some, all, or even none of the assets of the trust. Here, a creditor would be barred because the trustee can simply refuse to make any disbursements to the beneficiaries that would go towards resolution of a creditor's claim. ^[22]

Finally, there is the protective trust with a forfeiture clause. This trust can be seen as a hybrid of both the spendthrift and discretionary trusts. Upon a triggering event, any interest in the trust is forfeited by the beneficiary and reverts solely to the trustee, who then gains full discretion. ^[23] A major drawback to a trust with a forfeiture clause is the possibility that an unforeseen triggering event could frustrate the settlor's purpose. ^[24]

B. Offshore Trusts

Prior to the passage of the Alaska Trust Act in 1997, U.S. based trusts did not afford creditor protection to the settlor of the trust. American professionals susceptible to malpractice suits had for years sought the protection of offshore asset protection trusts. ^[25] The laws of offshore jurisdictions were friendlier to these professionals because these jurisdictions did not have the traditional creditor protections that had long been a staple of U.S. trust law. ^[26] The Cook Islands became a leader in the area of offshore asset protection trusts. ^[27] Beginning with the foundation of a standard spendthrift trust, these jurisdictions made major changes, including offering settlors the ability to transfer money into a trust, the ability to appoint a trustee who has discretion over how to distribute the income to the beneficiaries, and, in the case of a self-settled trust, the ability to make the settlor a beneficiary. ^[28] Other primary protections offered by the Cook Islands, for example, included raising the level of proof for fraudulent transfer claims, ^[29] expressly providing that the Cook Island courts would not "enforce or recognize a foreign judgment against an international trust," ^[30] and flight clauses, which essentially authorized the trustee to "change the situs of the trust, change the applicable law, and move the trust assets to a new jurisdiction, if a claim against the trust threaten[ed] to be successful." ^[31] Such provisions, including confidentiality of settlors, were basically designed to guarantee that assets held in an offshore asset protection trust would be completely unavailable to creditors.

Despite these advantages, the asset protection trusts offered by offshore jurisdictions are not without their drawbacks. A major factor when considering the use of a foreign asset protection trust is the risk associated with political or economic instability of the foreign jurisdiction. ^[32] Additional considerations include the extremely thorough reporting standards required by the IRS for assets held in offshore trusts as well as possible tax implications. ^[33] Even with these potential drawbacks, the IRS reported in 2009 that upwards of $5 trillion is held in offshore "tax havens." ^[34] With the potential to benefit from both fees associated with servicing asset protection trusts and the potential influx of professional jobs created by the need to handle these trusts, the Alaska Legislature took aim at the market.

II. Alaska and Asset Protection Trusts

A. Background: Domestic Asset Protection Trusts

Until 1997, no state permitted self-settled asset protection trusts. Put another way, no state allowed settlors to shield the assets they put in trust for themselves...