Offshore and "other" shore asset protection trusts.

• Author: Henzy, Eric
• Position: The Rise of the International Trust

Think of the liability system as a poker game. Each person, corporation, or other entity in the economy is a player. Players risk their chips, that is, their wealth, by tossing them into the pot, that is, investing them in liability-generating economic activity. Chips contributed to the pot are at risk of loss; the system can take them to satisfy liability. Chips withheld are not at risk.

This poker game has an odd twist to it. Withholding chips does not reduce significantly the amounts players can win nor players' likelihood of winning. Even players who don't put any chips in the pot--that is, players who are judgment proof--can keep playing the game and are eligible to win.

Why do players put chips in the pot? No rule requires them to do so. There are social, cultural, and economic pressures. But mostly, they do so for convenience. A wealthy player who wants that wealth available for use, but not in the pot to be lost through liability, must build arcane legal structures and document them through extensive record keeping.

In recent years, computer technology has dramatically reduced the cost of record generation and, consequently, the cost of keeping chips out of the pot. Major players are reducing their stakes. By doing so, they are breaking down the social norms and cultural barriers that prevent further reductions. The process is feeding on itself. Soon no one will have significant chips in the pot. When that happens the fundamental nature of the game will change. Liability will die.(1)

1. INTRODUCTION

   The use of offshore asset protection trusts to "keep chips out of the pot" has exploded in the last decade. In 1994, one commentator estimated that approximately $1 trillion was held in offshore trusts.(2) Less than five years later, Britain's Home Secretary Jack Straw estimated in a recent unpublished report that $6 trillion is now held in offshore trusts.(3) The Home Secretary report estimated that this is as much as a third of the wealth of the world's most affluent people.(4) An estimated five to ten percent of the $6 trillion, up to $600 billion, is held in the tiny British offshore islands of the Isle of Man, Jersey, Guernsey and Sark.(5) There are an estimated 100,000 offshore trust companies in the British offshore islands.(6)

   The use of offshore asset protection trusts is no longer limited to the ultra-rich. Offshore trusts are marketed in financial magazines and on the internet to people whose net worth is in the hundreds of thousands of dollars. Setting up an offshore trust is not cheap. Attorneys specializing in offshore trusts typically charge as much as $18,500 to set up a trust and several thousand dollars each year for maintenance of the trust.(7) However, if a person owns several million, or even several hundred thousand, dollars of assets and has trouble with creditors on the horizon, this may be a relatively small price to pay to put assets out of the reach of creditors.

   Recently, Alaska and Delaware have enacted trust laws that purport to provide some of the same type of protections against the claims of creditors that are found in the laws of offshore jurisdictions.(8) These domestic asset protection trusts may have several advantages over offshore trusts. First of all, they are cheaper: it may cost only $6,000 to $12,000 to set up an Alaska trust.(9) In addition, settlors may feel that their assets are safer in a U.S. trust than they would be in a foreign trust.(10)

   Asset protection trusts and asset protection trust laws are designed to protect a person's assets from the claims of his creditors. It is virtually impossible to obtain personal jurisdiction over an offshore trustee. Further, the typical offshore jurisdiction does not recognize foreign judgments.(11) Thus, a fraudulent conveyance, action in a United States court against an offshore trustee offers little or no hope for recovery.

   Offshore jurisdictions have either short statutes of limitation on fraudulent conveyance actions or, as in the case of Belize, no fraudulent conveyance statute at all. The Cook Islands trust law provides that a fraudulent conveyance action must be brought within two years of the time a claim accrues and within one year of the time assets are transferred to a trust.(12) The practical effect of these short limitation periods is that by the time a creditor finds out where the money is and files an action, the statute of limitations has run, thereby barring a suit. Even where a fraudulent conveyance action is available, the plaintiff-creditor carries a heavy burden of proof. For example, the Cook Islands law requires a creditor to prove beyond a reasonable doubt that the settlor of a trust had an actual intent to defraud the creditor bringing the action and that the transfer rendered the settlor insolvent.(13) Under the Cayman Islands law, a creditor must prove that the settlor transferred property with fraudulent intent and for inadequate consideration.(14)

   The laws of asset protection jurisdictions provide that self-settled trusts are valid, i.e., that assets in these trusts are not subject to the claims of creditors because the trust was self-settled. For example, section 12(4) of the Belize Trust Act of 1992 provides that "[a]ny rule of law or public policy which prevents a settlor from establishing a protective or a spendthrift trust of which he is a beneficiary is hereby abolished."(15) In 1997, section 34.40.110 of the Alaska statutes was amended to allow settlors to create spendthrift trusts.(16)

   Typically, asset protection trust laws provide that the settlor may specify that the courts of the asset protection jurisdiction have exclusive jurisdiction over the trust property and that the laws of the asset protection jurisdiction are applicable to interpret and determine the validity of the trust. For example, section 13.36.035 of the Alaska statutes provides that a settlor may choose Alaska law;(17) that the settlor's choice of Alaska law will be valid as long as, inter alia, (a) some or all of the trust assets are deposited in Alaska and are being administered by a "qualified person" (i.e. an Alaska resident, an Alaska trust company, an Alaska state bank, or a national bank with its principal place of business in Alaska), (b) the trustee is a qualified person who is designated as a trustee under the governing instrument or by a court having jurisdiction over the trust, and (c) part or all of the trust administration occurs in Alaska, including physically maintaining trust records in Alaska;(18) that Alaska courts have exclusive jurisdiction over trusts that contain a valid Alaska choice of law clause;(19) and that Alaska law be applied to determine the validity, construction and administration of Alaska trusts.(20)

   Obviously, asset protection trusts create problems for individual creditors. The August 3, 1998, issue of Business Week includes an article about Donald and Joanna Hess.(21) Two months before filing for divorce, Donald Hess allegedly transferred :ninety-two percent of the stock in Hess Holdings, which is estimated to be worth over $200 million, to an offshore trust in Gibraltar.(22) Despite the $600,000 Joanna Hess has spent in legal fees, she has failed in her attempts to assert a claim on the assets.(23)

   Asset protection trusts also create fundamental problems for our society. Professor Lynn LoPucki stated the problem succinctly in a 1996 Yale Law Journal article:

   Law is a system for controlling human behavior. In contemporary society, governments enforce law by essentially two mechanisms: incarceration and liability. These roughly correspond to the two spheres of the legal system: the criminal and the civil. In the criminal sphere, the wrongdoer is threatened with imprisonment; in the civil sphere, the wrongdoer is threatened with deprivation of wealth. Liability is crucial because it is one of only two principal means by which governments enforce law. The liability system enforces liability through the entry and forcible collection of judgments for the payment of money. Although liability is most closely associated with products liability and other tort actions, money judgments are also the means for enforcing contracts, civil rights, labor and employment law, environmental regulations, federal tax law, intellectual property law, most kinds of property rights, and just about every other kind of law on the books. Without liability, the American legal system would be radically different. .... The system by which money judgments are enforced is beginning to fail. The immediate cause is the deployment of legal structures that render potential defendants judgment proof.(24) Professor LoPucki recognizes offshore trusts as one of the leading judgment proofing legal strategies.(25)

   As the use of asset protection trusts grows, governments will respond. An orderly system of liability is too important to society to allow vast amounts of wealth to be placed out of the reach of creditors. However, to date, governments have not taken action. Individual creditors are left to pursue their remedies in both bankruptcy and nonbankruptcy forums.

   Faced with an increasing number of debtors who have transferred assets to asset protection trusts, judges, in particular bankruptcy judges, will have a difficult time accepting that creditors are without a remedy while a debtor retains an interest in substantial assets. This Article discusses several issues a court may face in addressing this problem and three recent cases on offshore trusts. The focus of this Article is on a debtor in a bankruptcy case. In part, this is because the few cases on this subject have been brought in bankruptcy courts. In addition, from a creditor's perspective there are advantages in pursuing assets in a protective trust in a bankruptcy court, such as the bankruptcy court's nationwide jurisdiction over persons and worldwide .jurisdiction over property of the bankruptcy estate. Many of the arguments should be...