Chapter 29 - § 29.8 • ASSET PROTECTION TRUSTS

• Jurisdiction: Colorado

§ 29.8 • ASSET PROTECTION TRUSTS

§ 29.8.1—Introduction

Asset protection is the process that includes reorganizing how a client's assets are held so as to make them less vulnerable should a claim be made against the client. Asset protection planning concepts may be applied to protect virtually every type of asset, whether cash, stocks, bonds, business interests, insurance, art, real property, etc. An overall integrated estate plan implements lifetime asset protection planning, which preserves assets during a client's lifetime, with more traditional death-time estate planning goals. The most effective form of an integrated estate plan is an offshore irrevocable trust, which is a trust domiciled in a foreign jurisdiction with protective laws.

§ 29.8.2—The Typical Integrated Estate Plan

A typical integrated estate plan (IEP) might combine a domestic or foreign integrated estate planning trust (IEPT) with a domestic or foreign family limited partnership (FLP) or limited liability company. The IEPT's settlor (the individual creating the trust) will appoint one or more trustees and the protector(s). One trustee may be an individual domiciled in the settlor's home jurisdiction (the domestic trustee). The second (or possibly sole) trustee is usually a corporate trustee (e.g., a foreign trustee) who is domiciled in the jurisdiction of the IEPT's applicable law. In many jurisdictions, the settlor may serve as the IEPT's protector, which essentially has an oversight authority on the actions conducted by the trustees. An IEPT's protector often has the following "negative" powers: (1) the power to veto investment decisions of the trustees, and (2) the power to veto distribution decisions of the trustees. Also, many times a protector holds the power to remove and replace trustees.

An IEPT settled under a foreign jurisdiction's laws can be very protective of assets contributed to it, especially to the extent its assets are placed beyond the jurisdiction of a U.S. court. Should a legal battle arise, a client's creditors will likely be forced to litigate (or even re-litigate) in the foreign jurisdiction and under the foreign jurisdiction's laws. This may create an aversion to proceeding with litigation in that the time involved and the expenses incurred may influence a domestic creditor to abandon hopes of "breaking the trust." Ultimately, however, the real strength or success of such planning depends on the ability to create an impenetrable brick wall using clear, unambiguous statutes in the controlling foreign jurisdiction.

§ 29.8.3—Domestic Asset Protection Legislation

As previously covered, self-settled spendthrift trusts can indeed be valid trusts; however, in general, they afford no protection as to creditors of the settlor. Importantly, this is the case not only with respect to present or subsequent creditors of the settlor, but this is the case as to future potential creditors as well, and for so long as the trust may be in existence.

In 20 domestic jurisdictions, there exists an exception to the above-referenced general rule. These states (which include Alabama, Alaska, Connecticut, Delaware, Hawaii, Indiana, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming) have passed legislation expressly designed to allow for the creation of self-settled spendthrift trusts, if certain statutory requirements are satisfied. It should also be noted that a trust created pursuant to Oklahoma's Family Wealth Preservation Act provides that the settlor may not be one of the "qualified beneficiaries" listed under the statute. Therefore, the reader should note that technically, an Oklahoma asset protection trust is a spendthrift trust, rather than a self-settled spendthrift trust. The settlor, however, may be able to revoke the trust and regain access to the assets, and therefore in that sense, it is self-settled.

Alaska

In 1997, Alaska's legislature enacted trust legislation that allows for the enforceability of spendthrift trust provisions in certain self-settled trusts. As such, assets of these self-settled trusts are not subject to claims of the settlor's future potential creditors. This legislation allows the settlor to be a discretionary beneficiary under the trust without automatically subjecting the trust assets to the settlor's creditors' claims, provided the settlor is not the trustee. The Alaska legislation also states that Alaska law shall govern the validity, construction, and administration of the trust. The legislation requires, however, that some assets of the trust be located in Alaska.

The Alaska legislation expressly carves out five exceptions where the trust assets will not be protected from future creditor claims. These statutes will not provide any protection to the extent that:

1) The settlor has the power to revoke or terminate all or part of the trust without the consent of a person who has an adverse interest;

2) Under the terms of the trust, the trust income and/or principal must be distributed to the settlor;
3) At the time the transfer to the trust takes place, the settlor was in default by 30 or more days in making a payment due under a child support judgment;
4) The transfer was intended to hinder, delay or defraud creditors. However, a fraudulent conveyance claim cannot be initiated unless the creditor existed at the time the trust was created and the fraudulent conveyance claim is brought within the later of four years after the transfer to the trust was made or one year after the transfer could have reasonably been discovered. If the creditor's claim comes into existence after the transfer to the trust is made, then the fraudulent conveyance claim can be made only if brought within four years after the transfer to the trust is made; or
5) If assets were transferred into a trust less than 30 days prior to marriage.

Later Alaska trust-related legislation was signed into law in 2003. Section 13.36.370 pertains to a trust's protector. A trust instrument may provide for the appointment of a disinterested third party to act as a trust's protector. A trust protector's powers may include the power to remove and appoint a trustee, modify or amend the trust instrument to achieve favorable tax status, increase or decrease the interests of any beneficiary to the trust, or modify the terms of a power of appointment granted by the trust. Further, a trust protector is not liable as a trustee or fiduciary because of an act or omission of the protector taken when performing the function of the trust's protector. Under § 13.36.375, a "trustee advisor" may also be appointed.

Section 34.40.115 pertains to "Subjecting appointed property to claims of donee's creditor." Property that a donee of a power of appointment is authorized to appoint is not subject to creditor claims except to the extent that a donee (1) is permitted by the donor of the power to appoint the property to the donee, the creditors of the donee, or the donee's estate; and (2) effectively exercises the power of appointment in favor of the donee.

During 2013, Alaska enacted Alaska Statute § 34.40.113, which substantially increases the protection of a beneficiary's discretionary interest in an Alaska Domestic Asset Protection Trust (Alaska DAPT). Alaska's 2013 legislation provides that a beneficiary's "discretionary interest" in an irrevocable trust is not a property interest or enforceable right. It is a mere "expectancy" that may not be attached by creditors. A beneficiary's interest in an irrevocable trust is a "discretionary interest" if the beneficiary's entitlement to the distribution is within the "discretion" of the trustee. A distribution is within the trustee's discretion if the trust uses the words "may," "shall," "sole and absolute," "uncontrolled," or similar words to describe the trustee's discretion to make distributions. A trustee is also given the authority to make payments to a third party for the benefit of the beneficiary instead of paying it directly to the beneficiary. For example, a trustee could make a house payment on behalf of a beneficiary to discharge the beneficiary's monthly mortgage obligation. This provision specifically provides that the trustee is not liable to a beneficiary's outstanding creditor for paying income or principal on behalf of a beneficiary.

Under this legislation, a creditor of a beneficiary cannot interfere with a trustee's decision to make a distribution to a discretionary beneficiary, nor may it compel a trustee to make a distribution. Further, a creditor cannot interfere with payments by a trustee to a third party on behalf of a beneficiary.

This legislation changes the relation between the trustee and a trust advisor, provides limitations on a trustee's liability for following the advice of the advisor, and clarifies an advisor's obligations to the beneficiaries. Alaska Statute § 13.36.375(b) permits a settlor to limit a trustee's liability for following the advice of an advisor. The statute goes further and relieves the trustee from any obligations to review, inquire, investigate, or make recommendations with respect to the advice given to the trustee. The advisor is a fiduciary with respect to the advisor's directions to a trustee. The advisor also has the exclusive obligation to account to the beneficiaries with respect to its direction to the trustees. A trustee who is mandated to follow the advice of the advisor is not liable to the beneficiaries.

The 2013 Alaska legislation adds a provision designed to limit the liability of a co-trustee if the terms of the trust instrument confer a specific power on one trustee to the exclusion of the other trustees. For example, one trustee might have the authority to exercise all authority over discretionary distributions and another trustee to exercise investment powers.

A 2011 case concerning an Alaska asset protection trust, commonly known as In re Mortensen, ...