Asset Protection: Simple Techniques and an In-Depth Look ...€¦ · transfer of property to...

Online CLE

Asset Protection: Simple Techniques and an In-Depth Look at Domestic Asset Protection Trusts

1 General CLE credit

From the Oregon State Bar CLE seminar Advanced Estate Planning (2015), presented on June 12, 2015S

© 2015 Joshua Husbands. All rights reserved.

Chapter 6

Asset Protection Planning: A Few Simple Techniques and an In-Depth Look at

Domestic Asset Protection Trusts1

Joshua husbands

Holland & Knight LLPPortland, Oregon

1 © 2015 by Holland & Knight LLP.

Contents

I. Give It Away . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–1A. Transfers Fraudulent as to Present Creditors . . . . . . . . . . . . . . . . . . . . . . . . 6–1B. Transfers Fraudulent as to Present and Future Creditors . . . . . . . . . . . . . . . . . 6–3C. Creditors’ Remedies and Transferee Defenses . . . . . . . . . . . . . . . . . . . . . . . 6–4D. Statute of Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–4

II. Invest In/Own Exempt Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–5Washington . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–5Oregon . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–7

III. Entity Planning. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–7

Domestic Asset Protection Trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–8I. Asset Protection Trusts Generally . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–8II. Tax Consequences Relating to APTs . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–13III. Case Studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–14IV. Attorney Protocol for Establishing APTs . . . . . . . . . . . . . . . . . . . . . . . . . 6–22

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6–23

Chapter 6—Asset Protection Planning

Advanced Estate Planning 6–ii


Advanced Estate Planning 6–1

I. GIVE IT AWAY

A creditor cannot take from a debtor what the debtor does not own. An irrevocable transfer of property to another individual or to an irrevocable trust is the most effective asset protection technique in existence. It is also simple and typically inexpensive. However, a gratuitous transfer to another person, legal entity or irrevocable trust must be done well in advance of a creditor's claim or there is the possibility that the creditor will be able to reach the transferred asset by proving the transfer was fraudulent.

Washington Uniform Fraudulent Transfer Act Washington's Uniform Fraudulent Transfer Act describes fraudulent transfers in two

main ways. First, some transfers are fraudulent only as to present creditors. Second, other transfers are fraudulent as to both present and future creditors.

A. Transfers Fraudulent as to Present Creditors

There are two main ways that transfers can be fraudulent as to existing creditors: (1) the debtor is insolvent and did not receive equivalent value for the exchange; and (2) the transfer was to an "insider."

1. Debtor Insolvency

As to existing creditors only, a transfer or obligation is fraudulent if the debtor did not receive "reasonably equivalent value" in the exchange and the debtor was insolvent or "became insolvent as a result of the transfer or obligation." Wash. Rev. Code § 19.40.051(a).

The statute does not define "reasonably equivalent value," but it provides an example

which satisfies the inquiry. For purposes of this provision, the requirement is satisfied if a person acquires the debtor's interest through a "regularly conducted, noncollusive foreclosure sale" or through a "power of sale . . . upon default under a mortgage, deed of trust, or security agreement." § 19.40.031.

Insolvency is defined as where a debtor's debts are greater than his collective assets, "at a

fair valuation." § 19.40.021(a). Insolvency is presumed where a debtor is "generally not paying his or her debts as they become due[.]" Id. at (b). Partnership insolvency is determined by subtracting from its debts all partnership assets as well as each general partner's nonpartnership assets less its nonpartnership debts. Id. at (c).

Assets which are transferred with actual intent to hinder, delay, or defraud, or which are

transferred in such a way that the transfer is voidable under the Act, are not included as assets for this provision. Id. at (d); see Section I-C, infra at 4–5. Additionally, for insolvency purposes, debts "do not include an obligation to the extent it is secured by a valid lien on property of the debtor not included as an asset." Id. at (e). "Valid lien," in turn, is defined as a "lien that is effective against the holder of a judicial lien subsequently obtained by legal or equitable process or proceedings." § 19.40.011(13).



2. Transfers to Insiders

Additionally, a transfer is fraudulent as to existing creditors if: (1) "the transfer was made to an insider for an antecedent debt"; (2) the debtor was insolvent at the time of transfer; and (3) "the insider had reasonable cause to believe that the debtor was insolvent." Wash. Rev. Code § 19.40.051(b). For determination of whether a debtor is "insolvent," see Section I-A-1, supra at 1–2.

The Act includes an extensive definition of the term "insider" which depends on the

status of the debtor. For individual debtors, insiders include: (A) the debtor's relatives and relatives of "a general partner of the debtor"; (B) any "partnership in which the debtor is a general partner"; (C) another general partner of a partnership in which the debtor is a general partner; and (D) a "corporation of which the debtor is a director, officer, or person in control[.]" § 19.40.011(7)(i).

For corporate debtors, insiders include: (A) corporate directors; (B) corporate officers;

(C) persons "in control" of the corporation; (D) a "partnership in which the debtor is a general partner"; (E) any other general partner in a partnership in which the debtor is a general partner; and (F) a "relative of a general partner, director, officer, or person in control of the debtor[.]" § 19.40.011(7)(ii).

For debtors that are partnerships, insiders include: (A) general partners of the partnership;

(B) relatives of "a general partner in, or a general partner of, or a person in control of the debtor"; (C) "[a]nother partnership in which the debtor is a general partner"; (D) another general partner in a partnership in which the debtor is a general partner; and (E) a "person in control of the debtor[.]" § 19.40.011(7)(iii).

Insiders also include the debtor's affiliates and insiders of affiliates. § 19.40.011(7)(iv).

"Affiliates" include: (i) anyone who owns twenty percent or more of the voting securities of the debtor; (ii) a corporation owned twenty percent or more by the debtor (determined by voting shares); (iii) any "person whose business is operated by the debtor under a lease or other agreement, or a person substantially all of whose assets are controlled by the debtor"; and (iv) a "person who operates the debtor's business under a lease or other agreement or controls substantially all of the debtor's assets." § 19.40.011(2)(i)–(iv) .

Finally, insiders also include the debtor's "managing agent[.]" § 19.40.011(7)(v). The

latter term is not defined in the statute. Relatives are defined under the statute as anyone related within the third degree of

consanguinity "as determined by common law," spouses, and anyone related to spouses within the same degree. § 19.40.011(11). Adoptive relationships are included as within the degrees of consanguinity. Id.



B. Transfers Fraudulent as to Present and Future Creditors

There are two additional ways transfers can be fraudulent, both availale to present and future creditors. First, a transfer is fraudulent if made with actual intent to hinder, delay, or defraud the creditor. Second, a transfer is fraudulent if a transferee did not receive reasonably equivalent value for the exchange.

1. Actual Intent to Hinder, Delay, or Defraud

Any transfer that is made or obligation that is incurred is fraudulent as to existing and future creditors if made or incurred with "actual intent to hinder, delay, or defraud a creditor." WASH. REV. CODE § 19.40.041(a)(1). A court may determine actual intent by considering eleven nonexclusive factors: (1) whether the transfer was made or obligation was incurred to an "insider"; (2) whether the "debtor retained possession or control" of the transferred property subsequent to transfer; (3) whether the obligation or transfer was "disclosed or concealed"; (4) whether prior to the transfer or obligation, the debtor was "sued or threatened with suit"; (5) whether the transfer constituted "substantially all of the debtor's assets"; (6) whether the debtor "absconded"; (7) whether the debtor "removed or concealed assets"; (8) whether the debtor received consideration that had "reasonably equivalent" value to the value of the transferred asset or obligation incurred; (9) whether the debtor was or became insolvent soon after the transfer or obligation; (10) whether the transfer "occurred shortly before or shortly after" the debtor incurred a "substantial debt"; and (11) whether the debtor "transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor." § 19.40.041(b)(1)–(11).

"Reasonably equivalent value" is not defined for purposes of this section. See

§ 19.40.031(b) (section defining the phrase applies only for the "purposes of RCW 19.40.041(a)(2) and 19.40.051").

For what constitutes "insolvency," see Section I-A-1, supra at 1–2. For what constitutes

an "insider," see Section I-A-2, supra at 2–3. 2. Reasonably Equivalent Value

Any transfer that is made or obligation that is incurred is fraudulent as to existing and future creditors if the debtor made or incurred it "without receiving a reasonably equivalent value in exchange for the transfer or obligation" and one of the following two criteria are met: (i) the debtor "[w]as engaged or was about to engage in a business or transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction"; or (ii) the debtor "[i]ntended to incur, or believed or reasonably should have believed that he or she would incur, debts beyond his or her ability to pay as they became due." Wash. Rev. Code § 19.40.041(a)(2)(i)–(ii).

For what constitutes "reasonably equivalent value" for purposes of this provision, see

Section I-A-1, supra at 1–2.



C. Creditors' Remedies and Transferee Defenses

For actions against transfers or obligations, creditors may seek any of the following relief: (1) avoidance to the extent needed to satisfy their claims; (2) attachment of transferred assets or "other property of the transferee"; and (3) subject to equitable principles, injunctions, appointments of receivers, or "[a]ny other relief the circumstances may require." Wash. Rev. Code ; 19.40.071(a). A creditor may also levy execution on a transferred asset or its proceeds with court approval if he has obtained a judgment against the debtor. Id. at (b).

Transfers made with actual intent to delay, hinder, or defraud under Section

19.40.041(a)(1) are "not voidable" as against a good faith purchaser who paid "reasonably equivalent value," nor are they voidable against subsequent transferees or obligees. Wash. Rev. Code § 19.40.081(a).

To the extent a creditor may void a transfer, he may recover the lesser of the value of the

transferred asset (determined at the time of transfer and subject to equitable adjustment) or the amount needed to satisfy his claim. Id. at (b), (c). The creditor may recover from the initial transferee or a subsequent transferee, the latter only if not a good-faith transferee who "took for value[.]" Id. at (b)(1)–(2).

Even if a transfer is voidable, a good-faith transferee is permitted to obtain a lien on the

asset, enforcement of an obligation, or reduction in liability to the extent of the value paid. Id. at (d)(1)–(3).

Transfers under Sections 19.40.041(a)(2) or 19.40.051 are not voidable if they are: (1)

due to lease terminations on debtor default pursuant to lease or other law; or (2) pursuant to enforcement of security interests under UCC Article 9. Id. at (e).

Transfers to insiders under Section 19.40.051(b) are not voidable: (1) "[t]o the extent the

insider gave new value to or for the benefit of the debtor after the transfer was made unless the new value was secured by a valid lien"; (2) if the debtor and insider each made the transfer in the ordinary course of their business or financial affairs; or (3) "[i]f made pursuant to a good-faith effort to rehabilitate the debtor and the transfer secured present value given for that purpose as well as an antecedent debt of the debtor." Id. at (f).

D. Statute of Limitations

The statutory scheme contains a statute of limitations that depends on the type of fraudulent transfer. For transfers made with actual intent to delay, hinder, or defraud under Section 19.40.041(a)(1), a claim is extinguished after four years from when the transfer was made or the obligation was incurred, subject to a discovery rule of one-year from when it was discovered or reasonably could have been discovered if later than four years. Wash. Rev. Code § 19.40.091(a). For transfers to insiders under Section 19.40.051(b), a one-year statute of limitations applies starting with the date of transfer. Id. at (c). For all other fraudulent transfers, the statute of limitations is four years from the date of transfer or obligation. Id. at



(b). For determination of when a transfer is made or an obligation is incurred, see Wash. Rev. Code § 19.40.061.

Oregon Fraudulent Transfer Overview ORS Chapter 95 contains the provisions of the Oregon Uniform Fraudulent Transfer Act.

Under the Uniform Fraudulent Transfer Act, a creditor may set aside a fraudulent transfer or attach the transferred asset if it is able to prove the transfer was fraudulent. ORS 95.260. A fraudulent transfer is essentially one that was made by a debtor: 1) with actual intent to hinder, delay or defraud a current or future creditor; or 2) the transfer was made without receiving adequate consideration in return and the debtor: a) intended to engage in a business transaction for which the debtor would have insufficient assets to undertake; or b) knew or reasonably should have known that the debtor would incur debts beyond its ability to pay. ORS 95.230.

II. INVEST IN / OWN EXEMPT ASSETS Washington

Many provisions of Washington's Uniform Fraudulent Transfer Act are determined by reference to "assets." See, e.g., Wash Rev. Code §§ 19.40.011(12) (definition of transfer is made by reference to disposition of an "asset or an interest in an asset"); 19.40.021(a)–(e) (insolvency determined by starting with the debtor's assets); 19.40.031(b) (reasonably equivalent value requirement satisfied if asset purchased pursuant to regular foreclosure proceedings or pursuant to deed of trust).

The definition of "asset" under the statute expressly excludes: (i) "[p]roperty to the extent

it is encumbered by a valid lien"; and (2) "[p]roperty to the extent it is generally exempt under nonbankruptcy law." § 19.40.011(2). "Valid lien" is defined as a "lien that is effective against the holder of a judicial lien subsequently obtained by legal or equitable process or proceedings." § 19.40.011(13).

The statute does not define or list examples of exempt property under nonbankruptcy law.

One property exemption under Washington law is the homestead exemption. Wash Rev. Code §§ 6.13.010–.240. Under those provisions, a homestead is exempt from attachment and execution up to $125,000. §§ 63.13.030, 63.13.070(1). However, the homestead exemption will not protect fraudulent transfers which funded the purchase of the homestead. Casterline v. Roberts, 168 Wash. App. 376, 386, 284 P.3d 743 (2012).

Certain insurance proceeds are also generally exempt from creditors. Disability

insurance proceeds "which are supplemental to life insurance or annuity contracts" are "exempt from all liability for any debt of the insured" as well as for beneficiaries' debts when the proceeds are paid. Wash Rev. Code § 48.18.400. Proceeds from life insurance with beneficiaries other than the insured are payable to beneficiaries "against the creditors and representatives of the insured," and the proceeds are also exempt from beneficiaries' debts. § 48.18.410(1). However, life insurance proceeds are not exempt to the extent anyone's



rights to proceeds "have been transferred with intent to defraud creditors" or to the extent that premiums were paid "with intent to defraud creditors[.]" Id. at (3)(b)–(c). Group life insurance proceeds are "not liable . . . to be applied . . . to pay any liability of any person having a right under the policy." § 48.18.420. Moneys paid from fraternal benefit societies are not "liable to attachment, garnishment, or other process . . . to pay any debt or liability of a member or beneficiary[.]" § 48.36A.180. Additionally, insurance proceeds on property which is exempt are "exempt from execution, attachment, and garnishment." § 6.15.030. Annuity payments are exempt up to $3,000 per month (or installment), except as to premiums paid "with intent to defraud creditors[.]" § 48.18.430(1)(a)–(b).

Certain retirement benefits are also exempt. Pension payments to city employees are

exempt from "execution, garnishment, attachment, or any other process whatsoever[.]" Wash Rev. Code § 41.28.200. Pension payments to firefighters and law enforcement officers are exempt from "execution, garnishment, attachment, the operation of bankruptcy or insolvency laws, or any other process of law whatsoever[.]" § 41.26.053(1); see also §§ 41.24.240 (volunteer firefighters); 41.20.180 (city police officers); 43.43.310 (state police). Also exempt are retirement benefits paid to public employees, § 41.40.052, state employees, § 41.44.240, employees in the judicial retirement system, § 2.10.180, judges, § 2.12.090, and teachers, 41.32.052. Pension payments from the federal government are also exempt. § 6.15.020. Furthermore, any employee benefit plan payments (including from non-qualified plans, IRAs, and Roth IRAs) are exempt. § 6.15.020(3); see id at (4); § 49.64.020. However, once payments have been distributed, they may be subject to creditors. See Anthis v. Copland, 173 Wash. 2d 752, 764–65, 270 P.3d 574 (2012) (once payment from pension plan was distributed to police officer, it was not protected from creditors).

Additional exemptions include: public assistance payments for child welfare,

§ 74.13.070, general assistance, § 74.04.280, and the elderly, § 74.08.210; burial plots, § 98.24.220; payments to victims of crime (with various limitations), § 7.68.070; unemployment benefits (except for child support), §§ 50.40.020–.040; wages (greater of 75% of disposable earnings or thirty-five times the federal minimum wage), § 6.27.150; workers' compensation, § 51.32.040; and medical and health savings accounts, § 6.15.020(3)–(4).

Also exempt are the following: clothing (but furs, jewelry, and personal ornaments are

limited to $3,500), § 6.15.010(1)(a); private libraries up to $3,500 and all family photos and keepsakes, § 6.15.010(1)(b); household goods, furniture, appliances, and yard and home equipment up to $6,500, with a $750 limit per item, § 6.15.010(1)(c)(i); other personal property up to $3,000 (including cash up to $1,500), § 6.15.010(1)(c)(ii); motor vehicles up to $3,250 ($6,500 for the community), § 6.15.010(1)(c)(iii); child support, § 6.15.010(1)(c)(iv); health aids for the debtor or his dependent, § 6.15.010(1)(c)(v); bodily injury up to $20,000, § 6.15.010(1)(c)(vi); certain farm equipment up to $10,000, § 6.15.010(1)(d)(i); libraries, office furniture, equipment, and supplies for physicians, surgeons, lawyers, clergymen, and other professional persons up to $10,000, § 6.15.010(1)(d)(ii); tools of trade up to $10,000, § 6.15.010(1)(d)(iii); and some tuition credits, § 6.15.010(1)(e). The exemptions listed in Section 6.15.010 do not apply to the purchase price of property, restitution for crime victims, tax levies on property, or claims of certain child support agencies. § 6.15.050(2)–(4), (9).



Spouses are not liable for the pre-marriage debts of their spouses, and separate property is exempt from the separate debts of spouses. § 26.126.200.

Oregon Even absent a fraudulent transfer, this is not a very useful or practical strategy in Oregon. The assets that are exempted from the claims of creditors in Oregon are limited in scope and absurdly limited in value. For example, the homestead exemption, which is unlimited in states such as Texas and Florida, only protects up to $40,000 of value in a single debtor's homestead, and up to a whopping $50,000 for two or more members of the same household. ORS 18.395. The exempt amount for an automobile is $3,000. ORS 18.345. Two potentially valuable exempt assets under Oregon law are life insurance policies and qualified retirement plans. ORS 743.046(3) exempts the cash value in a life insurance policy from the claims of creditors if the beneficiary of the policy is not the estate of the insured. The proceeds of a life insurance policy are exempt under ORS 743.046(1) as long as they are payable to a beneficiary other than the insured. The payment of premiums in a manner that constitutes a fraudulent conveyance will cause the amount of fraudulent premiums paid, plus interest, to be subject to attachment by creditors when the policy proceeds are distributed to the beneficiary. ORS 743.046(4). Annuity payments made to a debtor are also exempt from a creditor's claims under Oregon law, but only to the extent the payments do not exceed $500 per month. ORS 743.049. As long as contributions made to a qualified retirement plan are "permitted contributions," the amounts received from the plan pursuant to its terms will be exempt from the claims of creditors. ORS 18.358(2). Permitted contributions are essentially those permitted by the Internal Revenue Code, pre or post tax, as long as they are not subject to federal excise tax. ORS 18.358(1)(c). III. ENTITY PLANNING If the debtor has a business or investment assets that may subject him, her or it to the claims of creditors, a valuable asset protection technique may be to establish a limited liability entity and transfer the risky asset(s) into that entity. The entity could be a corporation (whether it is a subchapter C or S corporation for tax purposes will not impact its efficacy as a vehicle to limit the shareholder liability), a limited partnership or a limited liability company. Under Oregon current law, the limited liability company is the most convenient and flexible option in most instances. By transferring the risky asset or operations to the limited liability entity, the debtor should be able to effectively isolate any liability that may arise from that asset and the assets to which a creditor might attach would be limited to the assets of the entity owning the asset or performing the services. To best ensure that the liability of the entity is not attributed to its owner (shareholder/partner/member), it is important to pay attention to the existence of the entity as a separate being and to respect any necessary formalities, such as required annual meetings, voting and action by resolution. Of great, if not the most, importance is that the entity be the party to all



contracts, the owner sign on behalf of the entity and not personally, that separate bank accounts are maintained for the entity, and that the owner not treat the entity account(s) as a personal "pocketbook."

Domestic Asset Protection Trusts

We live in an era of unprecedented litigiousness where doctors, lawyers, accountants and business owners frequently become defendants in lawsuits seeking damages in the tens of millions of dollars. Clients concerned about these potentially devastating liabilities are increasingly inquiring about the efficacy of establishing an asset protection trust (“APT”) as a part of a comprehensive estate plan to provide a measure of protection for their family's core savings.

An APT is an irrevocable, self-settled spendthrift trust that protects a portion of an individual’s assets from creditors. Since the late 1970s, APTs have been formed by U.S. citizens in offshore jurisdictions including Bermuda, the Isle of Man, the Cook Islands, and various Caribbean nations. Until recently, no U.S. jurisdiction extended spendthrift protection to trusts in which the grantor had retained an interest, at least to the extent of such retained interest. APTs have now been authorized in eleven U.S. jurisdictions: Alaska, Delaware, Missouri, Nevada, New Hampshire, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah and Wyoming. This article will focus on domestic APTs, rather than offshore APTs.

Some commentators question whether APTs are ethical since their raison d'être is to protect a portion of the donor's assets from creditors and, at the same time, allow the grantor to retain at least a limited interest in the trust. The honest answer is that APTs present a conundrum in which the law must balance two conflicting objectives: free alienation of property and protection of creditor's rights. This article will focus on the essential elements of a valid APT and the process which must be undertaken to strike a proper a balance between these two competing objectives. I. ASSET PROTECTION TRUSTS GENERALLY

Although domestic APT statutes vary in their details, they all share some common elements:

• Transfer property to an irrevocable trust • Resident trustee from the state of trust formation • Specific incorporation of state law • Inclusion of a spendthrift clause • Grantor’s retained interests • Tail periods for extinguishing claims

Transfer to Irrevocable Trust The transfer of assets must be to an irrevocable spendthrift trust. It may be a direct transfer from the grantor to the trustee or may result from the grantor’s exercise of an inter vivos power of appointment under an existing trust.



Resident Trustee or Qualified Trustee The trustee is typically an independent individual, bank, or trust company resident in the state of trust formation. Some states (e.g., Delaware) permit an out-of-state co-trustee. The grantor must not serve as the trustee, but may serve as an investment advisor and may reserve a veto power over distributions. The trustee must maintain custody of some or all of the trust corpus, must maintain trust records, prepare fiduciary income tax returns, or materially participate in the administration of the trust.

Trust Protector Many APTs have a trust protector, a fiduciary who may veto distributions and investments or remove and replace the trustee. The trust protector adds an additional layer of checks and balances in the management of the APT. Incorporation of State Law The trust instrument must expressly incorporate that state’s law to govern the trust’s validity, construction, and administration. For example, any claim involving a Delaware APT can only be brought in that state’s court. Spendthrift Clause The trust instrument must include a spendthrift provision prohibiting the attachment or assignment of any beneficiary’s interest in the trust. Grantor’s Retained Interests The typical APT permits the grantor to retain the following defined interests:

• Discretionary distributions of income and/or principal • Veto power over distributions • Special testamentary power of appointment

However, the Delaware Act permits the following additional retained interests:

Mandatory right to trust income Income or principal from a Charitable Remainder Trust Unitrust distribution (up to 5%) Receipt of principal at the trustee’s sole discretion or pursuant to an ascertainable

standard Right to remove the trustee or investment advisor Right to serve as an investment advisor Use of real property under a Qualified Personal Residence Trust Not limited to individuals—corporations and partnerships may create an APT



Tail Periods There are certain “tail periods” that begin to run upon the grantor’s transfer of assets to the APT. At the expiration of the tail period, the enforcement of nearly all future creditors’ claims is barred. Claimants who bring suit within the relevant tail period must prove the existence of a “fraudulent transfer.” Most APT statutes provide that future creditors (those creditors whose claims arise after the trust was created) must bring their claim within 4 years from the date of transfer to the trust. Existing creditors (those creditors whose claims arose before the trust was created) must bring their claim within the later of 4 years from the date of transfer to the trust or 1 year after the creditor discovered (or should have discovered) the existence of the trust. Fraudulent Transfer A creditor who brings a claim within the relevant tail period must prove that the transfer to the APT was a “fraudulent transfer.” Fraudulent transfer or fraudulent conveyance provisions exist under both the federal Bankruptcy Code and state law. Most states have adopted a version of the Uniform Fraudulent Transfers Act. An existing creditor may establish a fraudulent transfer if the grantor made the transfer without receiving reasonably equivalent value in exchange for the transfer; and the grantor was insolvent at the time (or the grantor became insolvent as a result of the transfer). A future creditor may establish a fraudulent transfer if the grantor made the transfer:

(1) With the actual intent to defraud any creditor; or (2) Without receiving reasonably equivalent value in exchange for the transfer; and the

grantor: (a) was engaged in a transaction for which his remaining assets were unreasonably

small in relation to the transaction; or (b) intended to incur (or believed he would incur) debts beyond his ability to pay as

they became due. The first test is a subjective “badges of fraud” test. Relevant lines of inquiry include whether the grantor has been sued or threatened with suit, whether the grantor effectively retained control over the assets, whether the grantor transferred substantially all assets to the APT, and whether the transfer to the APT occurred shortly before or after the grantor incurred a substantial debt. The essence of this test is whether the grantor could reasonably have anticipated the future creditor’s claim upon funding the APT. The second test is a more objective test which calls for an examination of the sufficiency of the grantor’s assets in light of the circumstances at the time of the transfer. If a creditor successfully challenges a transfer to an APT as being fraudulent, the creditor can recover its debt, plus any costs and attorneys’ fees allowed by the court. The existence of a



fraudulent transfer as to one creditor will not inevitably invalidate the trust for all creditors. Each creditor must demonstrate as to its own particular circumstances that a transfer was fraudulent. Exempt Creditors For public policy reasons, two classes of creditors enjoy special status (except in Nevada and Utah) and are exempt from the provisions of APT statutes: (1) spouses and children and (2) existing tort claimants. These creditors may reach trust assets without regard to any tail period and without having to prove the existence of a fraudulent transfer.

Trust assets will not be protected against child support claims or claims for alimony or marital property asserted by one who was married to the grantor at or before the time of the transfer to the trust. Since one does not acquire the status of “spouse” under this exemption if the grantor’s transfer pre-dates the marriage, an APT is a discreet alternative to a pre-nuptial agreement. APT statutes do not insulate trust property from tort claimants (death, personal injury, or property damage) on or before the date of the transfer to the trust where the injury is caused (in whole or in part) by an act or omission of the grantor or by someone for whom the grantor is vicariously liable. Efficacy of Domestic APTs Although domestic APTs are becoming an increasingly common asset protection device, their effectiveness has not been thoroughly tested in U.S. courts. APTs may be vulnerable to being set aside in bankruptcy court or in accordance with an out-of-state judgment. Even so, the mere existence of an APT is likely to act as a significant deterrent to a prospective plaintiff weighing the heavy costs of litigation against the likelihood of successful recovery.

Bankruptcy Court

No state statute can protect debtors from conflicting federal law. Federal bankruptcy law supersedes state law under the Supremacy Clause of the US Constitution. Thus, a bankruptcy court sitting in Connecticut could set aside an Alaska APT as being contrary to the public policy of Connecticut.

Full Faith & Credit

The Full Faith and Credit Clause of the U.S. Constitution requires courts of each state to recognize judgments rendered by courts of another state. As long as the rendering court has proper jurisdiction and the judgment was not fraudulent, the other state court must recognize it and give it the full effect that such judgment would have had if rendered by the such state’s own court.



Jurisdiction

A creditor must proceed in a state court that has jurisdiction over some aspect of the trust (this does not necessarily mean the state in which the APT was settled). The court will either have personal jurisdiction over the trustee, grantor, or beneficiaries; or in rem jurisdiction over trust assets.

There are several ways to obtain personal jurisdiction over a trustee, grantor, or beneficiary:

• Domicile: Individuals are always subject to jurisdiction of courts within their

domiciles. • Long-Arm: Long-arm jurisdiction arises if the trustee or grantor has sufficient

contacts with the forum state. • Corporations: Corporations are subject to jurisdiction of courts in their state of

incorporation and any state in which they conduct business.

There are also several ways to obtain in rem jurisdiction over the trust assets. State courts have jurisdiction over all property within the state’s borders, including real property, bank and brokerage accounts, and shares of stock of corporations incorporated in that state. If a trust holds stock in many different corporations, its property may be subject to the jurisdiction of several states’ courts.

Enforcement of Judgment

If a creditor has successfully obtained a judgment from another state’s court, it must find a way to have it enforced against the assets of the APT. If the other state court’s jurisdiction is based on the situs of trust assets, that court could compel the surrender of assets by court order (attachment, garnishment, etc.), forcing the party in possession to convey the assets to the creditor. If the court’s jurisdiction is over the trustee or the grantor, but not over the assets, the court might issue an order against the trustee or the grantor. Otherwise, the creditor must seek enforcement of the judgment in the state where the trust assets are located. This judgment may be enforced under the Full Faith & Credit Clause and might authorize the turnover of trust assets located in that state. To avoid this result a practitioner might consider the use of a limited liability entity such as a limited liability company or partnership formed in the state in which the trust sits to hold the assets that would otherwise be owned directly by the trust. The trust would then own the entity, rather than the assets themselves, and it may be more difficult to find that in rem jurisdiction exists in another state.



Integration with Other Planning An APT is not a stand-alone device. Rather, asset protection planning is part of an overall wealth preservation and management process that includes investment advice, insurance planning, income tax planning, estate planning and wealth protection. Candidates for APTs include professionals; individuals exposed to lawsuits arising from negligence, intentional torts, and contractual claims; officers, directors, and fiduciaries; and real estate owners with exposure to environmental claims. II. TAX CONSEQUENCES RELATING TO APTS Federal Income Tax Treatment If the grantor of an APT retains the right to receive discretionary income and principal distributions, the trust will be a grantor trust. Grantor trusts are disregarded entities and all trust income, whether or not received by the grantor, is taxed to the grantor. However, if distributions to the grantor must be approved by an adverse party, it could be a non-grantor trust, insulating the grantor from tax liability. PLR 200247013. Gift Tax A transfer to an irrevocable trust is not automatically a completed gift. If the grantor retains certain limited powers of appointment, completed gift status and the resulting potential gift tax consequences can be avoided. PLR 200148028. A transfer to an APT is a completed gift if the grantor surrenders control over assets. However, the inability of the grantor’s creditors to reach assets negates retained control. PLR 9837007. Escaping Income Tax and Gift Tax. Two private letter rulings permit the grantor to escape both income tax and gift tax. In these rulings, the grantor was not deemed the owner of the trust due to the existence of adverse parties who exercised discretion in making distributions, protecting him from income taxation. The same rulings further held that the grantor did not make completed gifts to an irrevocable trust, due to the retention of a limited testamentary power of appointment. PLRs 200148028 and 200247013. Estate Tax Inclusion of the trust assets in the gross estate depends on the degree of control the grantor retains in the trust. A discretionary receipt of income or principal is not a retained interest in the trust, absent an understanding with the trustee, whereas other retained interests would compel inclusion in gross estate. §2036(a). The inability of creditors to reach trust assets negates the implied ability to revoke or terminate the trust. §2038(a).



III. CASE STUDIES

1. Dahl v. Dahl, Civil No. 090402989 (Utah Dist. Ct. Nov. 1, 2011) Facts:

The Dahls created an irrevocable family trust in 2002, into which they conveyed an interest in real property. Dahl v. Dahl, Civil No. 090402989, slip op. at 5 (Utah Dist. Ct. Nov. 1, 2011), available at http://www.assetprotectionbook.com/casedocs/dahl/dahl_sj_01nov11.pdf. The case was a divorce case which had been going on for "many years." Id. at 1. Kim Dahl was the plaintiff and C. Robert Dahl, as investment trustee of the trust, and Charles Dahl, the husband, were the defendants. Id.; see id. at 7. Distributions to beneficiaries were in the sole discretion of the investment trustee, subject to Charles Dahl's veto power. Id. at 7. Even payments to Dr. Dahl were committed to the absolute discretion of the trustee. Id. Claims: 1. Plaintiff sought a determination that the trust was null and void. Id. at 5. 2. Plaintiff sought a determination that she had an "immediate interest" in the trust. Id. at 6. 3. Plaintiff sought a determination that the trust was revocable. Id. at 8. 4. Plaintiff sought an accounting of the trust. Id. at 14. The Court's Analysis and Disposition of the Claims: The trust was not null and void.

Plaintiff did not provide the court with a legal theory to find the trust null and void. Id. at 5. Plaintiff did not allege any facts to show the trust violated public policy nor did she allege duress, mistake, illegality, or undue influence. Id. at 6. Plaintiff's allegation that the trust was revocable was insufficient to provide a basis for the court to conclude that the trust was void. Id. The court therefore granted summary judgment to defendants on this claim. Id. Plaintiff did not have an immediate interest in the trust.

Any distribution under the trust to plaintiff was in the sole discretion of the trustee and was subject to Charles Dahl's veto power. Id. at 7. Furthermore, even distributions to Charles Dahl were in the trustee's absolute discretion. Id. Because plaintiff had "no fixed right to receive any distribution," she had no immediate interest in the trust; thus, summary judgment was granted to defendants on this claim. The trust was irrevocable.

Under statute in Utah, an irrevocable trust may be modified or terminated only with the consent of the settlor and all beneficiaries. Id. at 8, citing UTAH CODE ANN. § 75-7-411 (2004). As Dr. Dahl and his children did not consent to modification or termination, the plaintiff would have no rights to the trust corpus if the trust was irrevocable. Id.i at 9.

If the trust was revocable, the plaintiff might have a right as a settlor. Id., citing UTAH CODE ANN. § 75-7-605(2). However, the statute conditions its application by stating it does not apply if "the terms of a trust expressly provide that the trust is irrevocable[.]" Id.

The trust expressly stated that it was irrevocable. Id. at 9–10 (citing trust section titled "Trust Irrevocable" which stated "[t]he Trust hereby established is irrevocable"). According to the court, the second sentence, which read "Settlor reserves any power whatsoever to alter or amend any of the terms or provisions hereof[,]" merely "preserves the rights of the settlor



granted by statute, to amend, alter or terminate the irrevocable trust." Id. at 10. This right was limited to termination or modification with the consent of all beneficiaries. Id., citing UTAH CODE ANN. § 75-7-411. The court also found no trust provision titled "revocation," "amendment" or "alteration." Id. at 11.

Based on the "paramount rule of construction" that trust language is controlled by the grantor's intent, and utilizing a "four corners" approach, the court found that the trust was clearly intended to be irrevocable. Id. Furthermore, "commentators are unanimous in noting that where there is a question of whether the settlor intended to reserve the right to revoke, a statement that the trust is irrevocable will control." Id. at 13, citing GEORGE G. BOGERT, ET AL., THE LAW OF TRUSTS AND TRUSTEES § 992 (Rev. 2d ed. 2005).

Plaintiff also argued that the settlor's right to veto distributions meant that the trust was revocable. Id. at 11. The court found no authority for this proposition. Id.

That at one point the trustee deeded property out of the trust to the settlor so the settlor could obtain a loan on the property, which was then deeded back to the trust, did not change the analysis. Id. at 12. It was within the trustee's absolute discretion under the trust to make distributions, including in-kind distributions, and it was within the settlor's right to reconvey property into the trust. Id. at 12–13.

Furthermore, the trust provision on choice of law stated that Nevada law would govern the trust document. Id. at 14. Utah respects choice of law and choice of forum provisions. Id., citing Innerlight, Inc. v. Matrix Group, LLC, 2009 UT 31, 214 P. 3d 854. Under Nevada law, express statements of irrevocability in trusts mean that trusts "shall be irrevocable for all purposes, even though the settlor is also the beneficiary of such trust." Id., quoting NEV. REV. STAT. § 163.560.

Ultimately, the court found the trust irrevocable under both Utah and Nevada law. Id. Therefore, the court granted summary judgment to defendants on this claim. Plaintiff had no right to an accounting as a discretionary beneficiary of the trust.

The court determined that plaintiff was "at best a discretionary beneficiary and Settlor." Id. at 14. Under the trust, discretionary beneficiaries were not entitled to an accounting. Id. at 15. By statute, beneficiaries are only entitled to an accounting "[e]xcept to the extent the terms of the trust provide otherwise[.]" Id., quoting UTAH CODE ANN. § 75-7-811(1)–(2) (2010). Since the trust provided otherwise, which was consistent with the statute, the plaintiff had no right to an accounting. Id. at 16. Therefore, summary judgment was granted to defendants on this claim. ***The Dahl v. Dahl case was appealed to the Supreme Court of Utah. Dahl v. Dahl, 345 P.3d 566 (Jan. 2015). Relevant Issue: Whether the trust was irrevocable. Holding: The Supreme Court held that the trust was revocable because Dahl reserved an unrestricted power to amend the trust. Court’s Analysis: The trust granted Dahl “any power whatsoever to amend any of the terms or provisions hereof.” The Court held that this language allowed Dahl to modify any and all trust provisions, including the provisions that make the trust irrevocable. Dahl, 345 P.3d at 580. The Court cited Mary F. Radford et. al., The Law of Trusts and Trustees § 993 (3d ed. 2008) which said:

Although the holder of a power to modify may not directly revoke the trust, he or she may do so indirectly by first modifying the trust by the insertion of a power to revoke and then exercising that power.



They also cited a previous ruling, In re Estate of Flake, where they held that a settlor’s unrestricted power to amend a trust included the power to revoke the trust. Dahl, 345 P.3d at 581. Further, the Court looks to the enactment of the Utah Uniform Trust Code that came after their decision in Flake. Id. The Comments to § 75-7-605 (which governs a settlor’s power to revoke or amend a trust), say that “[a]n unrestricted power to amend may also include the power to revoke a trust.” Id. Therefore, Dahl’s unrestricted power to amend leads the Court to hold that the trust is revocable under Utah law. Id. Fallout: This lead the court to allow Ms. Dahl to withdraw her contributions to the trust “with regard to the portion of the trust property attributable to either her separate property or any marital property.” Id. at 582–3. 2. Rush Univ. Med. Ctr. v. Sessions, 2012 IL 112906, 980 N.E.2d 45 (2012) Facts:

Sessions created an irrevocable trust in the Cook Islands in 1994 in which he was settlor and lifetime beneficiary. Rush Univ. Med. Ctr. v. Sessions, 2012 IL 112906, ¶ 3, 980 N.E.2d 45 (2012). Nearly all of his assets were placed into the trust, including a family limited partnership interest. Id. The trust allowed the trustees to make principal and income distributions for the settlor's "maintenance, support, education, comfort and well-being, pleasure, desire and happiness." Id. The settlor was also named as the "Trust Protector," and as such he was expressly empowered to appoint and remove trustees and veto any of their decisions. Id. Under the trust, the grantor could change beneficiaries at any time by will or codicil. Id. The trust contained a spendthrift provision. Id.

In 1995, Sessions irrevocably pledged $1.5 million to a university medical center for construction of a president's house, which the university subsequently built and named after him. Id. at ¶¶ 4–5. In 1996, Sessions sent the university a letter confirming his pledge, in which he agreed to make provision in his will or trust for the pledge. Id.

Sessions was diagnosed with cancer in 2005, and he blamed the medical center for not diagnosing it sooner. Id. at ¶ 6. As a result, he made a new will with no provision for the pledge. Id.

The university sued Sessions' estate to enforce the pledge. ¶ 7. At Sessions' death, his estate contained less than $100,000. Id. Claims:

The university sued under three separate theories among four claims. Id. at ¶ 9. Only one common law claim was at issue on appeal. Id. That claim was under the common law principle that "if a settlor creates a spendthrift trust for his own benefit, it is void as to existing or future creditors and such creditors can reach the settlor's interest under the trust." Id.



Procedural Posture:

The circuit court granted the university's motion for summary judgment on its common law claim, finding the trust void as against the pledge. Id. at ¶ 10.

The trustees appealed, arguing that the state's Fraudulent Transfer Act (FTA) superseded the common law remedy. Id. at ¶ 11. The appellate court reversed the circuit court's decision, finding the common law claim inconsistent with the UTFA. Holdings: 1. The FTA did not displace the common law rule. Id. at ¶38. 2. The university was a creditor of Sessions under the rule. Id. The Court's Analysis: Common Law Abrogation Analysis

Common law remedies in Illinois remain in force unless the legislature or court expressly repeals them. Id. at ¶ 13 (citations omitted). A court will generally not find an implied abrogation unless it is "necessarily implied from what is expressed"; even then, an "irreconcilable repugnancy" must exist between a statute and the common law rule at issue. Id. at ¶ 17 (citations omitted). Where the common law rule provides more protection than does the statute and is not inconsistent with it, the common law rule will be upheld as supplementing the statute. Id.

Illinois' FTA contains no express abrogation language; indeed, it provides that the "law relating . . . to fraud . . . supplement[s] its provisions." Id. at ¶ 18, citing 740 ICLS 160/11 (West 2006).

There was also no implied abrogation. Id. at ¶ 19. The FTA's purpose is "to protect a debtor's unsecured creditors from unfair reducations in the debtor's estate to which creditors usually look to security." Id. (citations omitted). The common law rule's purpose also protects creditors, but addresses only the situation where a grantor retains an interest in a self-settled trust with a spendthrift provision. Id. at ¶ 20. Furthermore, the common law rule applies even where no fraudulent transfer occurred. Id., citing RESTATEMENT (SECOND) OF TRUSTS § 156 cmt. a (1959).

The estate argued that the common law rule was inconsistent with the FTA because the former treats acts as fraudulent per se that the FTA considers nonfraudulent. Id. at ¶ 22. According to the court, the common law rule focuses on the interest retained whereas the FTA's focus is on fraudulent transfers. Id. Additionally, both the rule and the statute operate independently of one another in some circumstances, which negates an inference that the rule would make the FTA superfluous. Id.

The court also found two errors in the appellate court's finding that the common law rule's treatment of self-settled trusts as per se fraudulent interfered with the FTA's requirement that transfers be proved fraudulent: (1) the supplemental language in the FTA shows that it intended common law rules to supplement it; and (2) the rule's policy is not limited to fraud, but extends to people utilizing trusts to enjoy their lifestyles and keep creditors from reaching their assets. Id. at ¶¶ 23–24.

Furthermore, fraudulent transfer statutes and the common law rule coexisted in Washington for centuries. Id. at ¶ 25. This tended to negate any implied abrogation on the part of the legislature when it enacted the most recent FTA. Id.



Analysis Under the Common Law Rule The estate argued that the common law rule did not apply to it because the settlor died

before the university brought its claim. Id. at ¶ 27. According to the estate, upon the settlor's death, the rule does not allow creditors to reach trust assets "that could have been, but were not, distributed to the settlor during his life." Id., citing RESTATEMENT (SECOND) OF TRUSTS § 156. To this argument, the court found that a settlor's "interest" includes "all income and principal that could have been distributed to the settlor, even when the trustee exercises complete discretion over such distributions." Id. at ¶ 28, citing RESTATEMENT (SECOND) OF TRUSTS § 156(2). It distinguished between that situation and cases where settlors irrevocably commit assets to other beneficiaries, thus leaving only an income interest to themselves. Id. In the present case the settlor had an interest in income and principal, because he could replace trustees at will and veto their decisions. Id. The court also distinguished a Connecticut case where a settlor's interest in trust principal did not trigger for 20 years. Id. at ¶ 29, citing Greenwich Trust Co. v. Tyson, 129 Conn. 211, 27 A.2d 166 (1942).

Defendants also argued that creditors cannot reach assets under the rule that could have been distributed during his lifetime but were not before his death. Id. at ¶ 30. The court found "no conceptual difference" between a settlor favoring himself over creditors as compared with favoring his beneficiaries over his creditors. Id. It found "no sound reason" to find creditors' rights cut off at the moment of a settlor's death. Id.

In In re Morris, 151 B.R. 900, 906–07 (C.D. Ill. 1993), heirs of a settlor who put funds in a self-settled spendthrift trust argued that the debtor could not be forced to turn over funds in which she had no interest due to her death. Id. The district court there found that because the trustee could distribute the entire trust corpus to the debtor, the entire corpus was subject to creditors' claims. Id. The court in Sessions found Morris to be "almost exactly on point" with the facts of the case. Sessions, 2012 IL 112906, at ¶ 32.

In Morris, however, the creditor was a judgment creditor before the settlor's death, whereas in Sessions the university did not become a judgment creditor until after the settlor's death and the pledge was not due until death. Id. The estate argued that this difference meant that the university was not a creditor for purposes of the common law rule. Id. The court found that the rule is not limited to creditors who become judgment creditors prior to death. Id. at ¶ 33, citing Johnson v. Commercial Bank, 284 Or. 675, 588 P.2d 1096, 1100 (1978). In Johnson, the court found that "'creditors may reach such assets even after the settlor dies' because the placement of the funds into the trust is void as against existing and future creditors, and it is as if placement into the trust never occurred." Id., quoting Johnson, 588 P.2d at 1100.

Furthermore, a creditor's claim is "not defeated merely by the death of the debtor," and the remainderman's interest is subject to creditors' claims. Id. at ¶ 34, citing Deposit Guar. Nat'l Bank v. Walter E. Heller & Co., 204 So.2d 856, 862–63 (Miss.1967).

According to the court, the common law rule is also not dependent on an actionable claim arising during a settlor's lifetime. Id. at ¶ 35, citing In re Estate of Nagel, 580 N.W.2d 810, 811–12 (Iowa 1998) (where joint tortfeasers were killed in accident giving rise to claim, court rejected argument that obligations must have arisen during lifetime of tortfeasers). In Nagel, the "facts precipitating [the claim] occurred during their lifetimes". Id., quoting Nagel, 580 N.W.2d at 812.

In the present case, the court found Sessions to be a "debtor" and the university a "creditor" during session's lifetime. Id. at ¶ 36, citing BLACK'S LAW DICTIONARY 396, 433 (8th ed. 2004). Sessions "incurred an obligation to pay plaintiff money, even if it was to be paid at the latest upon his death as a debt." Id. As in Nagel, the facts precipitating the university's claim



occurred during Sessions' lifetime. Id. The rule thus applied to Sessions, and the university was allowed to recover against the trust. Id. at ¶¶ 36–38.

3. In re Huber, 493 B.R. 798 (Bankr. W.D. Wash 2013) Facts:

The debtor was a real estate developer who started having financial difficulties during the real estate collapse in 2008. In re Huber, No. 11-41013, slip op. at 3–6, 493 B.R. 798 (Bankr. W.D. Wash 2013). He created an Alaska Domestic Asset Protection Trust (DAPT) on Sept. 23, 2008. Id. at 5. The debtor was the trustor of the DAPT, and the trustees were his son Kevin, another individual,1 and the Alaska USA Trust Company (AUSA). Id. at 6–7. The trust beneficiaries were the debtor and his children and stepchildren. Id. at 7.

The debtor created an Alaska LLC (DGH) on Sept. 4, 2008, into which he transferred $10,000 cash and his interests in over 25 entities (including his personal residence and the residence of his disabled daughter). Id. at 6. The DAPT owned 99% of DGH (the debtor's son Kevin owned the remaining one percent). Id. After the transfers to DGH, the debtor retained personal ownership of only a few assets, including five percent of a professional building, worthless accounts receivables, and 50% of one LLC. Id. Only the $10,000 cash was actually in Alaska (in a CD), with the remaining assets physically situated in Washington. Id. at 7.

The trust made discretionary income payments to the beneficiaries of over $700,000 between 2009 and 2010 for, among other things, personal expenses of the debtor and his children, educational expenses of his children and grandchildren, and payments to the debtor's former spouse. Id. at 7. After the bankruptcy petition was filed, the trust made payments of more than $400,000. Id. at 8. The payments were approved by the debtor's son Kevin as trustee. Id. Kevin did not meet with AUSA representatives regarding distribution requests, and AUSA was not involved with trust asset preservation or protection. Id. (calling AUSA a "straw man"). The Court's Analysis and Disposition of the Claims:

The Bankruptcy Trustee (Trustee) moved for summary judgment on five claims, discussed below. The court granted summary judgment for the Trustee on three of the claims. Validity of Trust

Because Alaska recognizes asset protection trusts and Washington does not, the court first examined the choice of law issue, id. at 10, ultimately finding that Washington law controlled. Id. at 12–13. It then analyzed the trust under Washington law, and found that it was invalid under that law. Id. at 13 A. Choice of Law

In federal question cases, including bankruptcy, courts apply federal choice of law rules. Id. at 10, quoting Lindsay v. Beneficial Reinsurance Co., 59 F.3d 942, 948 (9th Cir. 1995). The Ninth Circuit follows the Restatement (Second) of Conflict of Laws (1971). Id., citing Liberty Tool & Mfg. v. Vortex Fishing Sys., Inc., 277 F.3d 1057, 1069 (9th Cir. 2002). Under the Restatement, a living trust is valid if it is valid under the laws of the state the grantor selects to 1 The other individual was named Amber Hines. Id. at 6. The debtor had a stepdaughter named Amber, id. at 7, but it is unclear whether they are the same person.



govern the trust if that state has a "substantial relation to the trust" and applying that state's law would not violate a "strong public policy" of the state with which the trust has its "most significant relationship." Id., quoting RESTATEMENT (SECOND) OF CONFLICT OF LAWS § 270(a) (1971). A state has a substantial relation to a trust when it is the state in which the trust is administered, the trustee's place of business or domicil is located, the trust's assets are located, the settlor is domiciled, or the beneficiaries are domiciled. Id. at 11, quoting RESTATEMENT (SECOND) OF CONFLICT OF LAWS § 270 cmt. b. (1971).

Applying the Restatement factors, the court found that Alaska was not the domicile of the settlor or beneficiaries, nor was it where the assets were located (except for the $10,000 CD), and it was the domicile of only one trustee, AUSA. Id. at 12. Washington was the domicile of the settlor, beneficiaries, other trustees, creditors, and the drafting attorney, and nearly all of the assets were located there. Id. According to the court, Alaska therefore had only a "minimal relation" to the trust, whereas Washington had a substantial relation to it. Id. The court also found that Washington had a long-standing strong public policy against self-settled asset protection trusts. Id. at 12, citing WASH. REV. CODE § 19.36.020; Carroll v. Caroll, 18 Wash. 2d 171, 175 (1943). As a result of these findings, the court disregarded the debtor's choice of Alaska law and applied Washington law to determine the trust's validity. Id. at 12–13. B. RCW 19.36.020

Under Washington law, transfers to self-settled trusts are void as against creditors. Id. at 13, quoting WASH. REV. CODE § 19.36.020. Because the DAPT was a self-settled trust, the asset transfers into the trust were void as against the debtor's creditors. Id. Therefore, the court granted summary judgment to the Trustee. Id. Alter Ego

The Trustee moved for summary judgment on its alter ego/"reverse piercing" claim to reach the debtor's assets inside the trust. Id. at 13–14. Bankruptcy courts apply the forum state's alter ego law. Id., citing Towe Antique Ford Found. v. I.R.S., 999 F.2d 1387, 1391 (9th Cir. 1993). Washington had not previously applied the alter ego doctrine in a trust context. Id. As such, the court had to determine how the state supreme court would rule on the issue. Id. Because the Trustee did not cite any Washington judicial decisions or law relevant to deciding the issue, the Trustee failed to carry its burden. Id. at 14–15. 11 U.S.C. § 548(e)(1)

The Trustee also moved for summary judgment on its fraudulent transfer claim pursuant to the Bankruptcy Code. Id. at 15. Under that provision, a bankruptcy trustee may avoid any transfer made within 10 years: (A) to a self-settled trust; (B) by a debtor; (C) who is a trust beneficiary; and (D) the debtor had actual intent to "hinder, delay, or defraud" an entity to which the debtor was indebted. Id. at 15–16, quoting 11 U.S.C. § 548(e)(1).

The only element that the debtor did not concede was the actual intent requirement. Id. Circumstantial evidence may be used to show actual intent. Id., citing Barclay v. Mackenzie, 525 F.3d 700, 704 (9th Cir. 2008). In determining whether a debtor had the requisite intent, courts consider "badges of fraud," which "give[] rise to an inference of intent." Id. at 16–17, quoting In re Roca, 404 B.R. 531, 543 (Bankr. D. Ariz. 2009). These badges include: (1) "actual or threatened litigation"; (2) transfers of "all or substantially all of the debtor's property"; (3) debtor insolvency or unmanageable financial situation; (4) a "special relationship" between a debtor and transferee; and (5) subsequent debtor retention of the property transferred. Id. at 17, citing Acequia, Inc. v. Clinton, 34 F.3d 800, 806 (9th Cir. 1994) (internal citations omitted).



Analying the badges, the court found that: (1) litigation was threatened at the time of transfer, including foreclosures and defaults; (2) the debtor transferred nearly all of his property (more than 71%) to the trust; (3) the debtor was forced to sell property on which sale he was unable to pay taxes, pressured his business partner to pay him money, had a "strangling" debt load, and had many unpaid bills; (4) the debtor had a special relationship to the trustee, as they were the same person; and (5) the debtor effectively retained the transferred property because all of his requests for distributions were granted, the sole person reviewing requests was his son (who was also his business partner), and he took income of more than $14,000 per month from the trust. Id. at 18–20. Because the badges all weighed in favor of the Trustee, the court found that the debtor had the requisite intent under the statute, and it thus granted summary judgment to the Trustee on the claim. 11 U.S.C. § 544(b)(1) and RCW 19.40.041(a)

The Trustee moved for summary judgment on a state fraudulent transfer claim pursuant to the Bankruptcy Code. Id. at 21, citing 11 U.S.C. § 544(b)(1). Under Washington law, "a transfer is fraudulent if the debtor acts with actual intent to hinder, delay, or defraud a creditor," or if it makes a transfer without "'receiving equivalent value in exchange[.]'" Id. at 21–22, quoting WASH. REV. CODE § 19.40.041(a)(1)–(2). Courts consider eleven "non-exclusive" factors: (1) "[t]he transfer or obligation was to an insider"; (2) "[t]he debtor retained possession or control of the property transferred after the transfer"; (3) "[t]he transfer or obligation was disclosed or concealed"; (4) "[b]efore the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit"; (5) "[t]he transfer was of substantially all the debtor's assets"; (6) "[t]he debtor absconded"; (7) "[t]he debtor removed or concealed assets"; (8) "[t]he value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred"; (9) "[t]he debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred"; (10) "[t]he transfer occurred shortly before or shortly after a substantial debt was incurred"; and (11) "[t]he debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor." Id. at 22, quoting § 19.041(b); Sedwick v. Gwinn, 73 Wash. App. 879, 886 (1994).

Applying these factors, the court found many of them met: the debtor was threatened with suit; the transfer was of substantially all of his assets; the debtor retained control over the transferred assets; as trustee and settlor, the transfer was made to an insider; the debtor received no consideration for the transfer; and the debtor made the transfers to avoid creditors. Id. at 22–23.

The debtor's denial of fraudulent intent was insufficient to raise an issue of material fact. Id. at 23. Furthermore, although he stated estate planning—not avoidance of creditors—was his intent in making the transfers, the court found estate planning was not mutually exclusive with intent to shield assets from creditors. Id. at 24.

Because the badges weighed in favor of the Trustee, the court granted summary judgment on this claim. Denial of Discharge

Under Section 727(a)(2) of the Bankruptcy Code, discharge is precluded if a "debtor, with intent to hinder, delay, or defraud a creditor has transferred, removed, destroyed, mutilated, or concealed property . . . within one year before the petititon date[.]" Id. at 24, citing 11 U.S.C. § 727(a)(2)(A)–(B). Denial of discharge under the provision is "construed liberally in favor of the debtor and strictly against those objecting to discharge." Id. at 25 (citation omitted).



Because the transfers took place more than one year before the petition date, the debtor created the DAPT pursuant to Alaska law and with legal assistance, the court was unable to grant summary judgment on this claim. Id. at 24–25.

The Trustee also claimed that the debtor wrongfully used net loss carry forwards, but the court found that the Trustee did not carry its burden of showing the requisite fraudulent intent. Id.

Also, the Trustee claimed that because the debtor failed to disclose his own loans to one of his business entities, the court should deny discharge under Section 727(a)(4)(A) of the Bankruptcy Code. Id. at 26. That provision states that discharge should not be granted if "the debtor knowingly and fraudulently, in or in connection with the case . . . made a false oath or account[.]" Id., citing 11 U.S.C. § 727(a)(4)(A). To prevail on that claim, a plaintiff must show “(1) the debtor made a false oath in connection with the case; (2) the oath related to a material fact; (3) the oath was made knowingly; and (4) the oath was made fraudulently.” Id. (citations omitted). The court denied the Trustee's motion for summary judgment on this issue because it failed to establish that the debtor intended to deceive creditors by failing to list his loans. Id. at 27. IV. ATTORNEY PROTOCOL FOR ESTABLISHING APTS Due to ethical constraints, as well as the potential for civil or even criminal liability under certain circumstances, attorneys must be extraordinarily cautious in accepting and counseling clients with regard to the establishment of an APT. It is imperative that attorneys be fully aware of the client’s financial and legal situation, which should be independently verified through due diligence procedures to uncover any existing, foreseeable or threatened claims. Due diligence involves an objective investigation of the client’s personal finances, business dealings, legal record and other relevant information. Attorneys should also perform an analysis of the client’s financial solvency. This analysis includes the preparation of a net worth statement reflecting all of the client’s assets, subtracting all debts, liabilities, and claims, and subtracting assets that are already protected from creditors’ claims under federal or state law (e.g., homestead, qualified retirement plans, insurance and annuities). There is no magic number or safe harbor percentage in the amount of assets that should transferred to the trust. However, a larger transfer of assets to the APT reduces the client’s remaining solvency and increases the likelihood of scrutiny. Many commentators and practitioners recommend transferring less than one-third (1/3) of the grantor’s net worth. The factors to consider include the dollar amount of assets transferred, the nature of the client’s business and professional activities, the potential source of any claims and any additional asset protection planning tools available to the client. The goal should be to leave sufficient wealth to satisfy existing and foreseeable creditors. Providing adequate reserves for such claimants diminishes the odds of a successful fraudulent transfer assertion.



Without the benefit of hindsight, it is impossible to determine what will be deemed an appropriate level of due diligence. Such determination will depend upon the specific facts and circumstances presented by each client. However, the potential consequences of a failure to conduct sufficient due diligence in planning for an APT warrants an abundance of caution. Conclusion The litigation explosion that manifested itself in the American economy during the later half of the 20th century shows no signs of slowing down. Nowhere is it written, however, that an individual must preserve his or her assets for the satisfaction of unknown future claims and claimants. With the enactment of state legislation expressly authorizing the establishment of domestic APTs, asset protection planning has entered a new era. APTs formed under the proper circumstances and with the requisite due diligence can be expected to play an increasing role in the estate planning process for professionals and business owners.

Asset Protection: Simple Techniques and an In-Depth Look ...€¦ · transfer of property to...

Documents

Transcript of Asset Protection: Simple Techniques and an In-Depth Look ...€¦ · transfer of property to...