James J. White, Robert A. Sullivan Professor of Law, University of Michigan Law School in Ann Arbor, Mich.
Professor James J. White contends that any transfer to an asset protection trust is a fraudulent transfer “pure and simple.” (These are commonly also known as self-settled trusts because the trust is created or settled in whole or in part for the benefit of the settlor himself.) He doesn’t attempt to camouflage his disdain for such trusts. His ultimate conclusion is that the 17 or so state legislatures that have passed some form of asset protection for self-settled trusts were essentially duped by lawyers, bankers and others. It should be noted that asset protection trust legislation varies from state to state. Prof. White doesn’t list Arizona or Florida as asset protection jurisdictions even though they immunize the assets of the settlor who creates a trust for his spouse which, on the spouse’s death, remain in trust for the benefit of the settlor. He also doesn’t mention the several states that permit a trustee to reimburse the settlor for income taxes the settlor owes on income attributed to the settlor under the grantor trust rules, which would include a trust in which the settlor isn’t otherwise a discretionary beneficiary but who benefits from reimbursement by the trust for his income tax liability.
The article essentially begins by providing a brief history of asset protection trusts, focusing primarily on those in the Cook Islands and then those in Alaska and Delaware. This history portion of the article concludes that the purpose of such legislation is to protect assets from ex-wives and malpractice plaintiffs.
Prof. White then discusses how some states have revised their fraudulent conveyance (or transfer) acts, pointing out that these changes make it more difficult to attach the assets in a self-settled trust. It should be noted that these state law changes may also make it more difficult to attach assets owned by anyone against whom a judgment is sought, not just a self-settled trust. Also, not all states that have enacted asset protection trust legislation have changed their fraudulent transfer statutes in conjunction with such legislation.
All states have some sort of fraudulent transfer law under which certain transfers may be set aside and thereby become attachable by a transferor’s creditors. These laws apply whether the fraudulent transfer is to a self-settled trust or to anyone else. As the article points out, Section 548(e) of the U.S. Bankruptcy Code essentially says a transfer to a self-settled trust (or similar device) may be set aside if it was made within 10 years of the filing of the petition for bankruptcy and “with an actual intent to hinder, delay or defraud” a creditor. The article continues by pointing out that it will be difficult in some cases to prove actual intent. It then continues by pointing out that there’s a question under the laws of many states whether the transfer may be struck down as fraudulent only if the creditor is a current one as opposed to a future (unknown) creditor and that the law as to the meaning of a future creditor isn’t certain.
The article discusses the important and complicated issues of jurisdiction and choice of law. It mentions that determining which law should apply isn’t certain in many cases. It discusses at quite some length the tension between Restatement (Second) of Conflict of Laws Sections 270 and 273, which deal with ascertaining which state’s law will determine the validity of a trust, on the one hand, and the general ability of a settlor to determine which state’s law will control the rights of creditors of a beneficiary to attach interests in the trusts, on the other. It points out that some settlors have made it fairly easy to have the law of the forum of the lawsuit apply because the settlor hasn’t set up sufficient connections with the law of the state declared in the trust as controlling.
Toward the end of the article, the author discusses the use of limited liability companies and the possibility of acquiring a home in a state that provides complete or significant homestead protection, indicating his general displeasure with those because they can be used to protect assets from creditor claims. It seems that his arguments here prove too much. The law has long allowed businesses to be operated in entities, such as corporations, which may protect the owner’s personal assets from claims against the business as a general rule.
Although the purpose of the article apparently is to stem the tide of states passing asset protection legislation, it indirectly provides guidance on how to increase the chances of a self-settled trust successfully reducing the risk of the trust assets being attached by a creditor of the settlor.
Unfortunately, the article fails to acknowledge that there are reasons, which probably the vast majority of people believe are legitimate and not unfair, for creating self-settled trusts. These include the use of an individual retirement account. They also include the creation of a self-settled trust to use the temporary increase in the estate, gift and generation-skipping transfer tax exemption (scheduled to disappear after 2025) by a taxpayer who doesn’t believe he can afford permanently to give up access to so much wealth. To prevent the trust property from being included in the settlor’s gross estate for federal estate tax purposes (which would defeat the planning), the trust must be created in a self-settled trust jurisdiction. In addition, someone may wish to create a trust to reduce state income taxes but not to make a taxable gift in creating the trust. This planning is accomplished using what are commonly called “incomplete gift trusts” (ING trusts). Essentially, to create such a trust, the grantor must retain an interest in the trust, and the Internal Revenue Service will only rule favorably if the trust is created in a self-settled trust jurisdiction (such as Alaska, Delaware or Nevada). Few, it seems, would regard the creation of a trust to reduce estate or income taxes as improper or unfair. These trusts aren’t being created to “defraud” creditors unless one views an attempt to reduce taxes in compliance with the Internal Revenue Code as “cheating” the government.
As Prof. White details, domestic (U.S.) asset protection trusts that are proven to have been created to hinder, delay or defraud creditors haven’t generally been successful. He points out that creating such a trust outside of the United States, such as in the Cook Islands, provides much greater protection. These foreign trusts may be more expensive to create, but an individual with a serious creditor problem should consider going offshore rather than using a domestic trust because the possibility of a creditor defeating such a trust is much reduced.
Unfortunately, the author doesn’t tell us where he draws the line on legitimate asset protection steps, including between using self-settled trusts (such as to create an IRA or an ING trust) and using other types of trusts. He seems to condemn any use of self-settled trusts. It seems doubtful that his essay will stop states from adopting self-settled trust legislation. Although the author contends that transfers to self-settled trusts are per se fraudulent, that isn’t the current law, but he apparently hopes it will become so.