THE DOMESTIC ASSET PROTECTION TRUST AND … · THE DOMESTIC ASSET PROTECTION TRUST AND ITS...

THE DOMESTIC ASSET PROTECTION TRUSTAND ITS FEDERALISM IMPLICATIONS

Alexander B. Shiffman*

IN TRO D U CTIO N ............................................................................................ 853I. B ACK G RO UN D .................................................................................. 858

A. Trusts: Spendthrift and Self-Settled Shelters ................................... 858B. First Impressions: The Decision of In re Huber ............................. 860C. Full Faith and Credit: PraclicalApplications ................................ 862

1I . A N A LY SIS ........................................................................................... 864A. ABC's of a Legilimate Trust ........................................................ 864

i. C lassification s ...................................................................... 864a. Tim e of Transfer .............................................................. 864b. R evocabiliy ...................................................................... 865c. Who is the Benefiiay? .................................................... 866

ii. The Valid Self-settling Trust ............................................. 867B. Judicial Treatment of the DAPT .................................................. 868

i. Conflicts and Choices Between State Laws .................... 869ii. Strong and Adverse Public Policy .................................... 871

C . C onclusions ................................................................................... 872III. FAR REACHING IMPLICATIONS ...................................................... 874

A. Psychology of Federalism ................................................................ 874i. The Need to Compete ....................................................... 874ii. Efficiency of Regulation .................................................... 875

B. Are Delaware's Days Numbered? ............................. .. . . .. .. . .. . .. .. . . .. 877C O N CLU SIO N ................................................................................................ 879

INTRODUCTION

One of the inevitable consequences of a financial meltdown is thestaggering increase in individuals who are unable to cover the liabilitiesthey have incurred. This trend is most recently evidenced by the num-ber of bankruptcy filings in the wake of the 2008 financial crisis. Forthe three years immediately following the collapse of this country's fi-

* J.D. Candidate, 2015, Benjamin N. Cardozo School of Law, B.A., 2009, University of

Michigan. A special thank you to all of the editors and staffers at the Cardozo Public Law, Poly& Ethics Journal for their continued guidance and assistance throughout this process.

854 CARDOZO PUB. LAW, POLICY & ETHICS J.

nancial infrastructure, non-business bankruptcy filings throughout thenation, increased from approximately 823,000 in 2007' to 1.4 million in2009.2 While the desire to shield one's assets from their forfeiture toone's creditors has long been a sought after objective, a pivotal eventsuch as the 2008 collapse, has the tendency to reinvigorate the im-portance of asset protection, and to inspire creative methods to achievewhat seems to be the ultimate goal of increasing leverage while mini-mizing if not completely eliminating exposure. With the most recentuptick in this asset-security motivated behavior, the development of anew means of protection has sparked significant controversy and reper-cussions that have the potential of spanning to other fields of law.

Attempts to shield oneself and one's assets is by no means a newconcept. Financial planners have been devising methods for this pur-pose for centuries through the use of corporations and more recentlyLimited Liability Companies ("LLCs"), which make readily apparenttheir purpose right in their name.3 Some of the unique benefits general-ly offered by state laws to a LLC in addition to the personal liabilityshield for its members, include: more flexible management rules for itscontrollers, as well as "pass through" taxation, which provides for thecompany's earnings to be taxed just once upon distribution to theshareholders, as opposed to a corporation which is taxed upon its earn-ings initially, and then again when the earnings are distributed to itsshareholders.4 This concept of "pass through" taxation is also recog-

1 ADMIN. OFFICE OF THE U.S. COURTS, 2007 REPORT OF STATIsnCs REQUIRED BY THE

BANKRUPTCY ABUSE PREVENTION AND CONSUMER PROTECTION ACT OF 2005, WashingtonD.C., U.S. Government Printing Office, at 5 (2008), available at http://www.uscourts.gov/uscourts/Statistics/BankruptcyStatistics/BAPCPA/2007/2007BAPCPA.pdf (non-business filings refer to cases filed with predominantly non-business debt; statistic is comprisedof approximately 61% Chapter 7 filings, and 39% Chapter 13 filings; the former involves liqui-dation of assets where the non-exempt proceeds are distributed to creditors, whereas the latterconsists of the creation of an installment plan to be paid to the creditors if the debtor has suffi-cient income).

2 ADMIN. OFFICE OF TI-E U.S. COURTS, 2009 REPORT OF STAnSnCs REQUIRED BY THE

BANKRUPTCY ABUSE PREVENTION AND CONSUMER PROTECTION ACT OF 2005, WashingtonD.C., U.S. Government Printing Office, at 5 (2010), available at http://www.uscourts.gov/uscourts/Statistics/BankruptcyStatistics/ BAPCPA/2009/2009BAPCPA.pdf (this change ap-proximates a 70% increase in the amount of non-business bankruptcy filings over a two yearperiod).

3 See generally WII.LIAM A. KLEIN, J. MARK RAMSEYER & STEPHEN M. BAINBRIDGE,

BUSINESS ASSOCIATIONS 269 (Robert C. Clark et al. eds., 8th ed. 2012).4 Id.

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nized by federal law in the Internal Revenue Code,' which allows forthe founders of an LLC to elect to be treated as a partnership- 6 whichis not recognized as an individual entity, as far as the Code is con-cerned-in opposition to the likes of a corporation.

The establishment of a trust is another tool that has been longused for asset protection and estate planning. However, in the pasttwenty years or so a sub-category of this instrument has emerged in theform of what is known as the Domestic Asset Protection Trust (herein-after "DAPT"). This new category of trust is one that, not only allowsfor the beneficiary to be the one who established the trust, but furtheris also created within the United States, in contradiction to thelongstanding common law traditions of the fifty states, which have, un-til recently, opposed self-settled trusts.' Whereas many wealthy Ameri-cans have established such self-settled trusts in foreign jurisdictions fordecades, the emergence of this type of liability shelter within the UnitedStates was not recognized until 1997, when Alaska and Delaware enact-ed DAPT statutes validating self-settled trusts, under certain circum-stances, in their respective states.9 Since the initial enactment of theseDAPT-friendly laws by Alaska and Delaware, ten other states have fol-lowed suit0 in establishing their own recognition of this controversialprotection scheme, that many believe simply provides debtors with lit-tle more than an easier pathway to defraud creditors.

With an increasing number of states adopting DAPT legislation,the issue that has begun to present itself, is how these trusts are to behandled in relation to the, still majority of states, that have strong poli-cies in opposition to the recognition of self-settled trusts. Put into an-

5 26 U.S.C. (Title 26 of the U.S. Code is the Internal Revenue Code).6 Internal Revenue Service, LLC FILING AS A CORPORATION OR PARTNERSHIP,

http://www.irs.gov/Individuals/Self-Employed/LLC-Filing-as-a-Corporation-or-Partnership

(I.R.S. guidelines on how a LLC should be filed).7 26 U.S.C.A. § 701 (West 1954) ("Persons carrying on businesses as partners shall be liable

for income tax only in their separate or individual capacities.").8 RESTATEMENT (THIRD) OF TRUSTS 5 58(2) SPENDTHRIfr TRUSTS: VAILIDITY AND

GENERAL EFFEcT (2003).

9 Kurt A. Friesen, Domestic Asset Protection Trusts: 15 Years after Alaska and Delaware, ABA

TRUST & INVESTMENTS, 6 (Mar.-Apr. 2012), available at http://www.aba.com/Products/

ti/Documents/ 5a9c9898d3eb49b494796b4889c2948CoverStoryMAR_.APR 12.pdf.10 Id. at 8 (Missouri ("MO"), Alabama ("AL"), Delaware ("DE"), Nevada ("NV"), Rhode

Island ("RI"), Utah ("UT'), South Dakota ("SD"), Wyoming ("WY'), Tennessee ("TN"), New

Hampshire ("NH"), Oklahoma ("OK"), and Hawaii ("HI") all currently have passed legislation

validating the use of DAPTs).

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other context, what we have is essentially a "choice of law" controver-sy. The controversy as it applies to DAPTs consists of, which lawshould a court apply when a settlor chooses to establish a trust in astate, other than the one in which he resides, for the benefit of thatstate's self-settling trust policies? Some individuals have speculatedhow such circumstances might play out," but until the 2013 decision ofIn re Huber2 no court had rendered a decision on the specific subject.

The United States Bankruptcy Court for the Western District ofWashington in In re Huber through extensive "choice of law" analysiscame to the conclusion that a court need not automatically honor sucha clause that may be contained in the creation of the trust.13 The justifi-cation used to disregard the clause the settlor chose, was essentiallybased on the tenuous relationship that existed between both, the settlorand the trust's assets, and the state where the trust was created.4 Inaddition, the court reasoned that the forum state, which was also thestate where the settlor was domiciled and where his creditors existed,had a strong public policy that was adverse to the use of self-settledtrusts for asset protection from one's creditors." The court ruled thatWashington state law should govern the matter, and the resulting deci-sion was essentially a foregone conclusion. With no recognition of thevalidity of a self-settling trust, the creation of the trust provided abso-lutely no protection for the settlor against his creditors.

The holding of In re Huber, while giving us a benchmark as to howDAPTs may be treated moving forward,6 nonetheless raises additionalconcerns with potentially further reaching implications. The U.S. Con-stitution states, "Full Faith and Credit shall be given in each State to thepublic Acts, Records, and judicial Proceedings of every other State.""7

The facial interpretation of this provision seems to unequivocally sug-gest that the laws and judicial holdings of one state must be recognized

11 Bryan Nichols, Note, ' see the sword of Damocles is hanging above your head!" Domestic Venue

Asset Protection Trusts, Credit Due Judgments, and Conflict of 1-w Disputes, 22 REV. LITIG. 473, 491(2003) (author opines that a court should not feel obligated to apply the friendly DAPT laws

for trusts created in those states).12 In re Huber, 493 B.R. 798 (2013). See infra note 38, section 1(B).13 Id. at 807-809.14 Id

15 Id. at 809.16 Id.

17 U.S. CONST. art. 1V, 5 1 (the justification for this provision seems apparent, little effect

would be given to state laws and judicial holdings if every other state could simply ignore

them).

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by every other state in the Union. For example, if State A were to enacta valid law permitting a certain type of behavior, upon a purely textualinterpretation of this clause, State B could not prosecute an individualwho engages in that behavior in State A, when the individual returns toState B, where the behavior is criminalized. Despite the seemingly ele-mentary textual interpretation this clause of the Constitution might lenditself to, its application has been limited substantially by the U.S. Su-preme Court.8 This limitation, while not discussed explicitly in Hubr,1 9

may have been a motivating force behind the court's determination inthe case.

In light of the only decision to be rendered on the topic of self-settling domestic trusts and the protection, if any, they provide"- whatprinciples might we extrapolate? With the Full Faith and Credit Clauseof the Constitution being interpreted so narrowly, are there not otherlaws that may be susceptible to challenges on similar grounds? When itcomes to taking advantage of the friendly laws of another state, themost prominent example that springs to mind is Delaware's general in-corporation laws.2 ' In addition to the streamlined and specialized courtsystem Delware offers to its citizen businesses, one of the potentialbenefits the state provides to companies incorporated under its laws isthe allowance for a supermajority requirement to pass a corporate mo-tion.22 The practical implication of such a law, is that a shareholderwould now be able to maintain its controlling interest over the corpora-tion's decision making capabilities with substantially less than fifty per-cent ownership of its shares. This appears strikingly similar to the situ-ation the court was confronted with in Huber.23 In Huber the courtdetermined that the choice of law clause would not be upheld due tothe adverse interest of the forum state;24 in the case of Delaware how-ever, the argument for minority shareholders seems clear that the un-willingness of other states to adopt the beneficial Delaware provisionsdemonstrates a strong opposing policy to them. The analysis of this

18 Franchise Tax Bd. of Cal. v. Hyatt, 538 U.S. 488, 494 (2013) (the court differentiated the

deference that should be granted to the court judgments of other states, and to the laws of oth-

er states, concluding that judgments are entitled to greater deference).19 In re Huber, 493 B.R. 798 (2013).20 Id.

21 DEL. CODE ANN. tit. 8 (West 1953).22 DEL. CODE ANN. tit. 8, § 141 (West 1953).23 In re Huber, 493 B.R. 798 (2013).24 Id. at 809.

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Note will shed light on how the decision rendered in Huberwill not on-ly impact the field of asset protection as it pertains to estate and finan-cial planning moving forward, but also the impact on adjacent legaldomains as well.

I. BACKGROUND

A. Trusts.- Spendthrift and Sef-Settled Shelters

A trust, in so many words, is the designation of specific propertyto be held by one party for the benefit of another party."i The personor entity that creates the trust is known as the trustor, or settlor, theperson holding the trust is called the trustee, and the person or entitythat the property ultimately benefits is known as the beneficiary.26 Thetrust has numerous potential uses, such as: in the division of marital as-sets, the gifting of assets, both inter vivos and testamentary, and spend-thrift protection."i The practice of using the trust as a vehicle for assetprotection has been around for centuries, so it comes as no surprisethat over time this method has evolved and has been used in a varietyof ways to achieve liability protection. The general concept underlyingthe use of trusts as they pertain to asset protection are unambiguouslylaid out in the Restatement (Second) of Trusts § 266: "A person towhom the trustee has become liable cannot reach trust property in anaction at law against the trustee, although the liability was properly in-curred by the trustee in the course of the administration of the trust.,,28

So, the basic tenet can be summarized as: once a trust is valid, the set-tior's creditors have no rightful claim against the trust property despitehaving a valid claim against the settlor in general.

While trusts may be formed for a multitude of reasons in a pletho-ra of different forms, for the purposes of this analysis the specific cate-gory of trusts that must be understood is that of the spendthrift trust.Whereas often a trust is established to provide for gifting purposes, aspendthrift trust is created essentially to manage disbursement of thetrust assets solely by an independent trustee for the benefit of the bene-

25 RESTATEMENT (THIRD) OF TRUSTS § 2 (2003).26 RESTATEMENT (THIRD) OF TRUSTS § 3 (2003).27 See generally MARK S. POKER, Asset Protection Planning, in AMERICAN LAW INSTITUTE -

AMERICAN BAR ASSOCIATION CONTINUING LEGAi EDUCATION SU036 ALI-ABA (2013) (trea-

tise detailing the legal field of financial and estate planning).28 RESTATEMENT (SECOND) OF TRUSTS § 266 (1959).

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DOMESTICASSET PROTECTION TRUST

ficiaries.29 These types of trusts are often used in situations where thebeneficiary for some reason or another needs supervision over his fi-nancial expenditures. In order for a trust of this sort to be made, thetrust itself must specifically be designated as such through a spendthriftclause .

Within this narrow category of spendthrift trusts, there hasemerged recently a subset of spendthrift trusts, which also contain aself-settling provision. A self-settling trust is one by which the settloror trustor is also the beneficiary of the trust.3 Despite the fact thatsuch a trust is a permissible form of trust, the vast majority of stateswithin the United States hold that these self-settling spendthrift trustsare not protected from claims by the settlor's creditors.32 On the otherhand, trusts falling into this category have long been used by wealthyindividuals to avoid creditors by establishment in foreign debtor friend-ly jurisdictions. The courts of the United States have great difficultycompelling foreign trustees, whose laws allow for self-settling spend-thrift trusts, to adhere to domestic judgments.

Recent legislation, however, stands in contradiction to this long-standing principle. In 1997, Alaska became the first of what now aretwelve states33 to adopt legislation acknowledging the validity of a self-settling spendthrift trust.34 These trusts, now commonly referred to asDomestic Asset Protection Trusts, much like their foreign counterparts,allow for a self-settling spendthrift trust to remain unreachable by thetrustor's creditors.35 The legal requirements for effectuating these truststend to overlap from state to state; a representative set of statutory re-quirements is set forth in Alaska:

A person who in writing transfers property in trust may provide thatthe interest of a beneficiary of the trust, including a beneficiary whois the settlor of the trust, may not be either voluntarily or involun-tarily transferred before payment or delivery of the interest to the

29 POKER, supra note 27, at 789.30 Id.31 Id. at 792.

32 RESTATEMENT (SECOND) OF TRUSTS: WHERE THE SET1rLOR IS A BENEFICIARY § 156

(1959).33 Friesen, supra note 9, at 8.34 ALASKA STAT. ANN. § 34.40.110 (West 1997) (DAPT statutes for other eleven jurisdic-

tions referenced are omitted).35 Id.

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beneficiary by the trustee.36

Delaware's DAPT law, moreover, is bold enough to state outrightthat any claim brought by a creditor seeking access to a trust's assets isautomatically "extinguished."37 It is important to note, however, thateach of these laws contains a provision invalidating the trust if it isdeemed that the purpose of the trust's creation was merely to perpe-trate fraud against an existing creditor with a valid claim against the set-dor. This exception is perpetuated by most states' adoption of someform of the Uniform Fraudulent Conveyance Act ("UFCA"), or Uni-form Fraudulent Transfer Act ("UFTA"), which provides for declaringan instrument void against one's creditors upon demonstration of theexistence of either actual or constructive fraud.38 That said, it appearsthat the states that have enacted DAPT laws, feel adamant about thedeference they will be treated with, the protection they provide, and thepositive correlation between states with DAPT statutes, and states thathave opted not to follow the UFCA or UFTA. Alaska would be onestate whose Fraudulent Conveyances Act39 does not recognize con-structive fraud in any form and thus requires a clear showing of actualfraud in order to declare a trust void.40

B. First Impressions: The Dedsion of In re Huber

In May of 2013, the United States Bankruptcy Court for the West-ern District of Washington handed down the first decision to contem-plate the validity of a Domestic Asset Protection Trust.41 The court'sdecision was to strike down the debtor's DAPT exposing it to his credi-tors.42 The facts surrounding the case involve a debtor, Mr. Huber,who was a long time businessman throughout the Washington state ar-

36 Id.37 DEi.. CODE ANN. tit. 12, § 3572(A) ("Notwithstanding any other provision of this Code,

no action of any kind, including, without limitation, an action to enforce a judgment entered by

a court or other body having adjudicative authority, shall be brought at law or in equity for anattachment or other provisional remedy against property... unless the qualified disposition wasmade with actual intent to defraud such creditor.").

38 Stewart E. Sterk, Asset Protection TIThsts: T rst Law's Race to the Bottom?, 85 CORNELL L. REV

1035,1045 (2000).39 ALASKA STAT. ANN. § 34.40.010 (WVest 1997).40 Summers v. Hagen, 852 P.2d 1165, 1169 (1993).

41 In re Huber, 493 B.R. 798 (2013).42 Id.

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ea.43 In the wake of the financial collapse of 2007-2008, the debtor, us-ing his son to coordinate the transfer, sought the creation of an assetprotection trust for the express purpose of shielding the assets from hiscreditors.44 It is worth mentioning, that such a purpose does not in andof itself constitute an intent to defraud one's creditors.4" In the further-ance of this goal, the debtor transferred a minimal amount of cash aswell as his substantial, if not sole, interest in twenty-five separate enti-ties to the administration of the trust.46 The debtor, through the trust,named a number of beneficiaries in his family while also retaining aninterest for himself.47 Furthermore, all of the trust's assets were locatedin the state of Washington, save for the minimal cash deposit the debt-or deposited with the trustee in Alaska.48 In his formation of the trust,Mr. Huber included a choice of law clause, which stipulated that Alas-kan law would govern the adherence and distribution of the trust's as-sets.

49

Over the ensuing year, the debtor received a substantial amount ofpayments from the trust for his own personal expenses to the sum ofover $400,000. In February of the following year, Mr. Hubert pro-ceeded to file for bankruptcy protection under chapter 1 l," which ledto this lawsuit by his creditors seeking recovery from the trust in ques-tion. 2

To determine the validity of the trust, the court needed to deter-mine which state's substantive law should apply, because Washington,unlike Alaska did not recognize the validity of a self-settled spendthrifttrust.53 The court held that for cases concerning matters exclusively offederal jurisdiction, the Restatement (Second) of Conflict of Laws gov-

43 Id. at 802.44 Id. at 804-5.45 See In re Mortensen, 2011 WL 5025249 (Bankr. D. Alaska May 26, 2011) (one of the main

utilities of the trust is protection of assets, so something further than the trust's creation mustbe shown to demonstrate fraud, such as the trustor's expectation or knowledge of future or

pending litigation).46 Huber, 493 B.R. at 805.47 Id.48 Id.49 Id.

50 Id. at 806.51 11 U.S.C.A. Ch. 11 (Reorganization).52 Huber, 493 B.R. at 806.

53 Id. at 807.

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erns. 5 4 The Restatement declares such conflicts should be determined:

[U]nder the local law of the state designated by the settlor to governthe validity of the trust, provided that this state has a substantial re-lation to the trust and that the application of its law does not violatea strong public policy of the state with which, as to the matter at is-sue, the trust has its most significant relationship under the princi-ples stated in 5 6.S

5

As such, the court concluded that despite Mr. Huber designatingAlaskan law to govern the administration of the trust, the trust lacked a"substantial relation',5 6 to Alaska to justify applying its law over thestrong policy Washington maintained in opposition.7 Once the courtreached this conclusion, the decision was simple in the sense that thetrust, under Washington law, could not protect the assets from thedebtor's creditors.58

C. Full Faith and Credit: Practical Applications

The Full Faith and Credit Clause is set forth in Article IV, SectionI of the United States Constitution.9 As stated above, the provisionprovides that, "Full Faith and Credit shall be given in each State to thepublic Acts, Records, and judicial Proceedings of every other State."60

Endless debate has persisted since the Constitution's inception, at-tempting to ascertain the intent of the framers in including this clause.Chief Justice, John Marshall put forth one of the most prominentviews, stating that the phrase was designed merely to outline the pro-cess by which the laws and judgments of individual states may be used

54 Id.55 RESTATEMENT (SECOND) OF CONFLICT OF LAWS: VALIDITY OF TRUST OF MOVABLES

CREATED INTER ViVOS 5 270 (1971). (Section 6 entitled "Choice-of-Law Principles" describesthe factors that should be considered in determining which state has the most significant con-tacts assuming the state has no law providing guidance on this issue. Factors to consider in-clude: needs of the interstate and international system; policies of the forum; policies of otherinterested states; the protection of justified expectations; policies underlying the particular fieldof law; certainty, predictability, and uniformity of result, and; ease in determination and applica-tion of the law to be applied).

56 Id.57 Huber, 493 B.R. at 808-9.58 Id. at 809.59 U.S. CONST. art. IV, 5 1.60 Id.

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as evidence in the proceedings of other states.61 Despite this persistentinterpretation of the provision throughout the nineteenth century,62 ul-

timately, the Supreme Court of the United States would expand the ap-plication of Full Faith and Credit to require the recognition by states ofthe judgments of its neighboring states.63

The expansion of this clause to incorporate the deference due tothe judgments of other jurisdictions, has however not been applied tothe clause's application to the statutes enacted by the legislatures ofneighboring states. The Supreme Court has reasoned that the FullFaith and Credit Clause does not compel a "state to substitute the stat-utes of other states for its own statutes dealing with a subject matterconcerning which it is competent to legislate.' 64 Due to this abrogatingattitude towards the Full Faith and Credit Clause's application to statestatutes, the clause has essentially been relegated to a secondary consid-eration for claims involving conflicts of law.

The most prominent Supreme Court case dealing with a choice oflaw dispute is undoubtedly Allstate Ins. Co. v. Hague .65 In Allstate, a wifebrought suit against an insurance company in connection with thedeath of her husband in a motorcycle accident, in order to recover theproceeds of the decedent's multiple insurance policies.66 Despite the

accident taking place in Wisconsin, and all parties having resided inWisconsin, the wife brought the suit in Minnesota in order to take ad-vantage of its friendly statute allowing multiple insurance policies to bestacked on top of one another.67 Stacking allows for an individual torecover from each of multiple policies held by the decedent as opposedto just one.68 The Court held that bringing the suit in Minnesota didnot violate the Full Faith and Credit Clause of the Constitution.69 Thestandard set forth by the Court in this case states, "[T]hat for a State'ssubstantive law to be selected in a constitutionally permissible manner,that State must have a significant contact or significant aggregation of

61 Peck v. Williamson, 19 F. Cas. 85 (C.C.D.N.C.1813).62 Ralph U. Whitten, Full Faith and Credit for Dummies, 38 CREIGHTON L. REV. 465, 468

(2005).63 Mills v. Duryee, 11 U.S. 481 (1813).64 Pac. Emp'rs Ins. Co. v. Indus. Accident Comm'n of Cal., 306 U.S. 493, 501 (1939).65 Allstate Ins. Co. v. Hague, 449 U.S. 302 (1981).66 Id.

67 Id.

68 Id.

69 Id.

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contacts, creating state interests, such that choice of its law is neitherarbitrary nor fundamentally unfair."70 Essentially, the Court held in All-state that a federal court is able to arbitrarily choose which law to applywhen two states are involved, as long as each state meets this new min-imum contacts requirement. Contrarily, what the decision handeddown in Allstate does not do is instruct courts on how to handle con-flicts of law when the law of a specific jurisdiction has been explicitlyselected to govern the matter.

II. ANALYSIS

A. ABC's of a Legilimate Trust

i. Classifications

As discussed previously, trusts come in a plethora of varieties;some have overlapping purposes, while others are unique in the aspira-tions behind their creation. The Domestic Asset Protection Trust is aunique category of the trust and in order to understand its purpose andregulation, it is important to comprehend the unique characteristics thatgive it utility.

a. Time of Transfer

The process of constructing a trust as a tool for asset protectionbegins with the basic element of determining when the transfer of as-sets is to take place. Two options are presented in making this deter-mination: the trust can be made testamentary, by will, transferringproperty upon the death of the trustor, or the transfer can be made intervivos as a living trust, where property is transferred to a trustee while thetrustor still lives." In relation to an inter vivos trust, a testamentary trustis relatively uncontroversial and straightforward as far as its creationgoes. Complications may arise when it comes to the trust's disburse-ment to the decedent's estate, however such controversy arises underthe field of Estate Law, which is not relevant to this analysis, and needsnot be addressed here. The basic requirements for creation of such atrust include, "identification of the trust property, the beneficiaries, and

70 Id. at 312-3.71 RESTATEMENT (THIRD) OF TRUSTS: METHODS OF CREATING A TRUST 5 10 (2003) (see

"Comment on Clause" (a) and (b)).

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the purposes of the trust," which can usually be determined by the willitself.7 2 With each of these elements established, this trust is typicallyvalid and upheld against the claims of creditors. The controversy morefrequently comes into play in the context of asset protection, underconsideration of the living trust.

b. Revocability

Within the broad category of trusts in general, exists the furtherdistinction of revocability. An irrevocable trust as opposed to one thatis revocable, "can't be modified or terminated [by the grantor ortrustor] without the permission of the beneficiary."3 In other words,once the trust is created, the trustor has no right of rescission or altera-tion. This type of trust has certain practical implications. Irrevocabletrusts tend to be used often to take advantage of tax benefits, since anirrevocable trust removes all elements of ownership by the originatingparty.v4 How does this criterion impact the protection offered by atrust against the claims of creditors?

Since one of the major utilities of a trust is creditor protection, it isimportant for there to be safeguards against using this instrument inbad-faith or to defraud one's creditors. As mentioned, when assets areincorporated into an irrevocable trust, all ownership of the trustor is re-linquished to the trustee.7' This effect is a major policy support behindjustifying the trust's protected status against the trustor's creditors. Ifthe trustor maintained the ability to close the trust, or withdraw assetsat his own leisure, there would remain a strong sense of ownership forthe trustor. Continuing to enjoin creditors with valid claims against thetrustor under such circumstances, seems quite unjust. For this reason,it has long been the practice of most jurisdictions in the United Statesto only provide protection for irrevocable trusts where the trustor nolonger retains any rights to the assets.76

72 Id. § 17(2), CREATION OF TESTAMENTARY TRUSTS.

73 RESTATEMENT (THIRD) OF TRUSTS: POWER OF SETTLOR TO REVOKE OR MODIFY 5 63(2003) (see comments).

74 rd.75 Id.

76 In re Huber, 493 B.R. 798, 809 (2013) (finding that many states have a policy that is ad-

verse to the recognition of self-settled revocable trusts as valid).

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866 CARDOZO PUB. LAW, POL[CY & ETHICS J.

c. Who is the Benefiiay?

Possibly the most important factor when determining the protec-tion afforded trust assets is to determine who stands to benefit fromthe trust. Traditionally, the creation of a trust was typically made forthe benefit of a third party. However, as discussed in the backgroundinformation above, the development of self-settling trusts has gainedincreasing traction. The dominant school of thought when it comes toself-settling trusts is put forth in the Restatement (Second) of Trusts:"Where a person creates for his own benefit a trust with a provision re-straining the voluntary or involuntary transfer of his interest, his trans-feree or creditors can reach his interest.7 This principle has its rootsin English common law and has been adopted by numerous states.7 8

Most states that have not adopted comparable statutes have inevitably"produced the same result through [their own] common law." 9

Much like the revocability aspect of the trust creation, the signifi-cance of the beneficiary can also be viewed in terms of ownershiprights. Whereas revocability involves the trustor's ability to rescind oralter the trust, the beneficiary falls on the other end of the transfer andultimately enjoys the spoils provided for in the trust. If the trustor andbeneficiary are one in the same, you start to question the purpose of thetrust's creation from the onset. Courts use multiple factors in deter-mining whether a trust should be treated as self-settling, and while di-rect benefit received by the trustor is typically dispositive of the trustseffectiveness,8° it is not the only factor to consider. The other factorswhich are frequently taken into consideration include the level of con-trol or dominion the trustor retains over the trust's assets,81 and the re-tention of general powers of appointment to distribute the trust's as-sets.82 These aspects amongst others make evident that judiciaries are

77 RESTATEMENT (SECOND) OF TRUSTS: WHERE THE SETTI.OR IS A BENEFICIARY § 156(1959).

78 Elena Marty-Nelson, Offshore Asset Proteclion Trusts: Having Your Cake and Eating it Too, 47

RUTG ERS L. REV. 11,30 (1994).79 Id. at 31.80 Nelson v. Cal. Trust Co., 33 Cal. 2d 501, 501 (1949) (holding that it was against public

policy to allow a man to tie up his property in a way where he was still able to enjoy it, while hiscreditors could not).

81 State v. Hawes, 169 A.D.2d 919, 920 (N.Y. 1991) (holding that the defendants as co-

trustees had no right to protect the trust's assets from the plaintiff creditor).82 RESTATEMENT (SECOND) OF PROPERTY: CREDITORS OF THE DONEE- WHERE DONEE

CREATES GENERAl. POWER § 13.3 (1959).

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hesitant in allowing protection from creditors when the trustor remainsinvolved past the creation of the instrument.

ii. The Valid Self-settling Trust

The other school of thought pertaining to self-settling trustsemerged with the enactment of the first Domestic Asset ProtectionTrust statutes by Alaska and Delaware in the 1990's."3 In relation to theelements discussed in the previous section, the DAPT trust can general-ly be described as an irrevocable self-settling inter vivos trust. Prior tothe DAPT's development self-settling spendthrift trusts were onlyavailable to consumers in foreign jurisdictions.84 The only exception tothis principal is that of a 401(k) plan created under the Employee Re-tirement Income Security Act ("ERISA").8' The Supreme Court hasrecognized protection of these plans, which could aptly be character-ized as self-settling spendthrift trusts, against creditors.86 However, thisinstrument can be distinguished, as it was established by federal law andis limited in application to established retirement programs, whereas thecontroversial issue at play here concerns trusts that may be created forany number of reasons and are subjected to conflicting state laws.ERISA aside, offshore spendthrift trusts provide individuals with anunmatched level of creditor protection due to friendly privacy laws andregulations,87 in addition to the fact that foreign jurisdictions do notowe Full Faith and Credit88 to American judicial determinations. Thedownside to offshore asset protection trusts, however, is that they typi-cally come at higher costs, limiting their availability to the upper eche-lon of wealthy individuals.89

States eventually began to catch on to the value these offshore

83 See generaly ALASKA STAT. ANN. 34.40.110 (1997). See also DEL. CODE ANN. tit. 12,

3570-6.84 Ritchie W. Taylor, Domestic Asset Protection Trusts: The 'Estate Planning Tool of the Decade" or a

Charlatan?, 13 BYUJ. PUB. L. 163, 164 (1998).85 29 U.S.C.A. 5 1001 (West 1974).

86 Patterson v. Shumate, 504 U.S. 753, 757-8 (1992) (The Supreme Court held that an

ERISA plan could be excluded from the debtor's estate, as the law precludes the trust from be-

ing transferred in any way).87 Id. at 759.

88 U.S. CONST. art. IV, 5 1.

89 Elena Marty-Nelson, Offshore Asset Protection Trusts: Having Your Cake and Eating it Too, 47

RUTGERS L. REV. 11, 14 (1994).

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programs offered. Much like friendly tax laws9" and corporate structurelaws9 which are used by certain states to create havens which serve tofunnel substantial business and revenue, states realized they could dosomething similar with asset protection trusts. Inevitably, however,problems arise when states enact friendly laws that are in direct conten-tion with those of others. The determination that needs to be made, iswhen will these new, debtor friendly DAPT laws be upheld againstthose seeking to pierce the protection they provide?

B. Judicial Treatment of the DAPT

To date, very little exists in the way of judicial precedent concern-ing the validity of the Domestic Asset Protection Trust. This factmakes predicting their efficacy troubling. Until more decisions arehanded down, it would be wise for individuals to create these instru-ments with a sense of skepticism as to the actual effect they will havewhen challenged. This rings true especially when considering that thejudicial decisions that exist tend to suggest unfavorable judicial treat-ment toward the DAPT.9 2 Furthermore, the issues-in regards toDAPTs-tend to arise in the context of bankruptcy filings, which callinto question a variety of collateral issues.9" Such was the case in In reMortensen, where the court struck down the validity of the Alaskan de-fendant's asset protection trust.94 In Mortensen,9" like Huber,9 6 the factsunderlying the case suggested that both defendants created their respec-tive trusts with the intent to defraud current or future creditors.97 Thecourt in Huber faced similar circumstances, but to a greater extent; in

90 Mich. Pub. Acts 74-87 (2008) (multiple laws enacted to grant tax breaks to the film indus-

try, which resulted in the funneling of major productions to the state).91 DEL. CODE ANN. tit. 8 ch. 1 (Delaware's General Corporation Law is the reason more

than half of all U.S. corporations are incorporated in this state).92 In re Mortensen, Bankr. D. AK., 2011 WL 5025249 (2011).93 Id.

94 Id. at 8.95 Id. at 7 (despite the defendant's appearance of solvency when the trust was created, and

his affidavit attesting to such, his direct assertion that the trust be used to protect the assets

from future creditors, as well as the drastic spike in outstanding debt he incurred after the

trust's creation, led the court to reason that the trust was created in a bad-faith attempt to un-justly defraud the defendant's creditors).

96 Seegenerally In re Huber, 493 B.R. 798 (2013).

97 See id; See also ALASKA STAT. ANN. § 34.40.010 (West 1997) (because the Alaska Fraudu-

lent Conveyance law only recognizes actual and not constructive fraud, it was not relied on forthese rulings).

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addition to the essence of fraud at the core of the DAPT's creation, thecourt also faced, for the first time, a conflict of laws.9" Extrapolation ofthe principles formed by the court in Huber becomes tricky, however,because of the inherent injustice surrounding the defendant's fraud.The ultimate determination that needs to be made, is which aspects ofthe court's opinion can be considered precedent, and which aspectsshould be considered simply dicta.

i. Conflicts and Choices Between State Laws

The design of our Constitution lays out a system which "reservedto the states" all powers not otherwise explicitly granted to the federalgovernment.99 This concept of federalism was first expressed in theArticles of Confederation and was designed to ensure a joint delegationof power between the states and the federal government, and to protectagainst the dangers of tyranny inherent with providing any one bodywith too much individual power.00 Despite this admirable intentionand its probable necessity, the fundamental flaw with this type of gov-ernment, is that it allows for states to enact numerous different andconflicting laws among jurisdictions that are intimately associated withone another.

The guideline the Supreme Court established to counter this flawcame with the decision of Allstate v. Hague discussed in detail above.0 1

Since the "minimum contacts" standard was developed, laws aroundthe United States have evolved, without abandoning the original stand-ard, to provide for how courts in individual jurisdictions should treatconflicting laws in the courtroom.0 2 When it comes to a strictly federalissue such as bankruptcy and its application to trusts, the court in Huberunequivocally set forth the proper standard they felt should be ap-plied.0 3 The court in Huber refused to uphold the validity of the de-

98 Id. at 807.

99 U.S. CONST. amend. X.100 ARTICLES OF CONFEDERATION of 1781, art. II.101 Allstate Ins. Co. v. Hague, 449 U.S. 302 (1981).102 RESTATEMENT (SECOND) OF CONFLIcr OF LAWS: APPLICABILITY OF CHOICE-OF-LAW

RULES OF ANOTHER STATE (RENVOI) § 8 (1971) (the restatement gives guidelines for how con-flicts should be treated, some states provide for the law of another state to govern when there

are competing interests).103 Huber, 493 B.R. at 807 (federal law follows the Restatement of Conflicts standard, which

provides for the designated state's law to apply as long as the designated state has a significantrelationship with the trust, and the law does not offend the public policy of the state with the

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870 CARDOZO PUB. LAW, POLICY &ETHICSJ.

fendant's DAPT, because it determined that the trust had just minimalaffiliation with Alaska, whose laws were being relied on by the defend-ant, and that Washington in fact had more substantial connection to thetrust's interests.1

4

How could the defendant have overcome this burden? How diffi-cult is it to satisfy this "substantial relation"10' requirement, especiallyconsidering the defendant had specifically designated which law shouldgovern his trust? Federal courts abide by the premise that they have a"strong policy" deferring to and "favoring [the] enforcement of choiceof law provisions."'0 6 Such a policy seems to give way to the inferencethat meeting the standard should not be such a tall order, and perhapsit is not. All the defendant needed to show in order to meet this stand-ard was that it made sense to create the trust in Alaska for reasons oth-er than defrauding his creditors. The factors the court considers in de-termining whether or not a substantial relationship exists include butare not limited to: if "(1) the trustee or settlor is domiciled in the state;(2) the assets are located in the state; and (3) the beneficiaries are domi-ciled in the state."'0 7 One might think that if there were in fact a legiti-mate purpose to create a trust in another state, the trustor would beable to demonstrate that they meet these criteria in some way or anoth-er. It seems the defendant relied too heavily on the provision of Alas-kan law, which states that a DAPT is valid as long as some of the assetsare deposited within the state.' This would be a much lower standardthan the "substantial relation" test described above.

The fact that it was undisputed that the defendant here did notmeet any of these criteria just lends further credence to the argumentthat there was indeed a specific intent to defraud. That being said,while it was mentioned before, it bears repeating, the desire to shieldassets from creditors is not in and of itself evidence of fraud; theremust exist a specific intent to commit fraud.109 Under such a premise,for the sake of argument, if you set aside the assumption that Mr. Hu-ber intended to defraud his creditors, it might be possible that he couldhave taken a few relatively simple measures, which would have upheld

most significant relationship to the trust).104 Id. at 808.105 Id.106 In re Zukerkorn, 484 B.R. 182, 192 (2012).107 Huber, 493 B.R. at 808.108 Ai.AsKA STAT. ANN. § 13.36.035 (West 2015).

109 In re Mortensen, Bankr. D. AK., 2011 WL 5025249, at *6 (2011).

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the trust's validity. The most significant step being, that had the de-fendant transferred more of the assets to Alaska, rather than the mere$10,000 in proportion to the millions of dollars in assets the trust over-saw,110 the justification used by the court to strike it down, may havefocused simply on the fraud exception, and upheld the protection ofthe asset's generally under the DAPT law. As a matter of fact, theopinion explicitly states, "[T]he Debtor's choice of Alaska law designat-ed in the Trust should be upheld if Alaska has a substantial relation tothe Trust." '' That being said, there still remains the issue of the ad-verse treatment by the state with the most significant contacts.

ii. Strong and Adverse Public Policy

In addition to the relationship of the trust's assets to the two juris-dictions, the other prong the court in Huber focused on in its analysis ofwhich law should govern, is the public policy of the state in which theDAPT has its strongest connection."2 Washington state law has em-phatically limited the utility of self-settling trusts as they pertain to thetrustor's creditors.'13 Its law voiding self-settling trusts has been in ex-istence in one form or another since the mid-nineteenth century,"14

making the court's determination of whether or not it should be con-sidered as strong public policy, relatively simple. In reliance on thisprinciple, the court falls back on the treatment of a similar matter by aNew York Bankruptcy Court in the case of In re Portnoy. 5 However,the court in Portnoy did not base its decision to void the conveyance inquestion off of established state law, but rather justified its conclusionbased on equitable purposes; any other outcome just seemed to be un-fair.'16 Essentially, the court in Portnoy seems to be establishing thestate's public policy on its own.

110 Huber, 493 B.R. at 805.111 Id. at 808.

112 Id. at 809.113 WASH. REV. CODE ANN. § 19.36.020 (West 2006) (all conveyances made in trust for the

use of the one creating the trust are void against the individuals existing and subsequent credi-

tors).114 Huber, 493 B.R. at 809.115 Id. at 809.

116 In re Portnoy, 201 B.R. 685 (1996) ("Portnoy may not unilaterafly remove the characteri-

zation of property as his simply by incorporating a favorable choice of law provision into a self-

settled trust of which he is the primary beneficiary. Equity would not countenance such a prac-

tice.").

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872 CARDOZO PUB. LAW, POLICY &ETHICS J.

While the distinction between basing a decision to ignore a choiceof law clause-a provision that courts typically view with a presumptionof validity-on law or equity may seem trivial, the precedential impact ofsuch a decision may be noteworthy. Making the argument that a strongpublic policy exists, a provision established by the Restatement of Con-flict of Laws," 7 would seem much easier to make when there is actuallegislation in support of the premise than if the argument relies solelyon what seems inherently fair to the parties involved. Nonetheless, thecourt in Portnqy has opened the door to the possibility of jurisdictionswith no established legislation on the matter to create the presumptionof a violation of their state's "public policy," whether it exists or not."8

With this in mind, it may now be prudent to view all states withoutDAPT legislation to have strong policies against the use of such finan-cial instruments.

C. Conclusions

Taking into consideration the analysis above, the continued effica-cy of the Domestic Asset Protection Trust to protect against creditorclaims, is highly suspect at best, and futile at worst. The extent towhich individuals might hope to take advantage of friendly DAPT lawsis seemingly contingent upon a variety of factors. First, the establishedlaws of both the situs of the property included in the trust, as well asthe laws governing the state to which the beneficiary is domiciled. Themost appropriate, confident situation for one to look to the DAPTwould be for that of a person who is fortunate enough to keep theirprimary residence in one of the twelve states,1 9 and counting, to enactDAPT friendly legislation. Such circumstances provide for a high levelof certainty-assuming there is no intent to commit actual or construc-tive fraud-for an individual's assets placed in a self-settling trust to re-ceive protection from creditors.2 ' To this end, there would be no con-cern with choice of law validity' 2' considering the friendly law opted foris also the law of the presiding jurisdiction. Furthermore, a creditor's

117 RESTATEMENT (SECOND) OF CONFICT OF LAWS: VALIDITY OF TRUST OF MOVABLES

CREATED INTER VIVOS 5 270 (1971).118 Portnoy, 201 B.R. at 701.

119 Friesen, supra note 9.

120 It would also drastically increase the certainty of the trust's validity if the trust's assets are

also located within the DAPT friendly state.121 In re Huber, 493 B.R. 798, 808.

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challenge based on public policy'22 would similarly be found insuffi-cient, as such a claim cannot be made when the electorate has con-sciously adopted laws that contradict such a premise. In fact, barringthe aforementioned intent to commit fraud, from the assessment of theissues as laid out in Huber, the protection offered by DAPTs under the-se limited circumstances may very well be absolute.

The gray area to the usefulness of the DAPT begins to show itselfwhen either the instrument is created in a state other than where thetrustor resides, or when the bulk of the trust's assets are wholly inde-pendent from the DAPT friendly state. Nonetheless, such circum-stances are not in and of themselves conclusive in determining such atrust's validity. While the defendant in Huber faced an uphill battle per-suading the court that his trust maintained a "substantial relation" tothe state of its creation, this can be attributed to the insignificant pro-portion of assets placed in the DAPT state, in comparison to the dras-tic proportion that resided in the non-DAPT state.123 Trustors who donot live in DAPT states would be wise to seek out this protection onlywhen they are willing and able to transfer the vast majority of the assetsto be protected, to the friendly jurisdiction. To this point, the simpletransfer of ownership to the trust in the DAPT state, could very well bedeemed insufficient to qualify as a "substantial relation.'' 124 While thecontrol may reside with the trustee, in the instance of real property oran entity, the most significant contact may still remain with the statewhere the entity or property physically inhabits; this of course couldnullify the contention that the property actually resides in the friendlystate. For this reason, such an instrument would be most suitable toliquid assets, such as cash and cash equivalents and not so much for re-al property. The greater proportion of assets one is willing to transferto a neighboring state, the more confident they can be in their protect-ed status.

Despite these determinations, no peace of mind can be fully real-ized without taking into account the adverse public policy element. Itseems quite clear at this point from the holding of Huber, that courtswill not honor a DAPT when the home of the majority of the trust as-

122 Id. at 809.123 Id. at 805 (finding only $10,000 in cash out of millions of dollars in trust assets was actu-

ally deposited in AL. The rest remained, mostly in the form of real property, in WA).124 Id.

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874 CARDOZO PUB. LAW, POLICY &ETHICS J.

sets specifically prohibits the trust's use.25 Furthermore, Portnoy sparksgreater hesitation in upholding the notion that a public policy need notbe explicitly conveyed, but the offense of justice might be sufficient toestablish one.'26 However, an imperative aspect to remember is that thepublic policy prong applies only when the trust's assets have a moresignificant relationship to the jurisdiction with the adverse policy, thanto the friendly DAPT jurisdiction.'27 Remember that the Restatementstates that the law designated will apply so long as there exists a rela-tionship, and the other jurisdiction with contradicting policy does nothave a stronger connection to the assets.12

1 With this in mind, takinginto consideration allocation of trust assets, as discussed in the previousparagraph, may have the effect of solving the potential issue with publicpolicy as well. If it has not become clear at this point, outside of thelimited circumstances described above, the DAPT offers little in theway of certainty. While steps can be taken to increase the likelihoodthat the instrument's protection will be respected, it would be highlyadvisable to consult an experienced financial planner or attorney beforeemploying this method of asset protection, and it would be equallyprudent to regard any professional's conveyed certainty on this subjectwith a healthy measure of skepticism.

II1. FAR REACHING IMPLICATIONS

A. Psychology of Federalism

1. The Need to Compete

Taking a step back from assessment of DAPTs in the light of howfriendly states relate to non-friendly states, the incentive for these lawsdraws into focus: competition. Competition is one of the most basicmotivations stimulating behavior, and helps to explain theories as fun-damental as evolution, where, to some extent, survival is predicated onthe struggle over scarce resources.'29 This driving force is an innate in-stinct that often cannot be explained. Take for instance the phenome-

125 Id. at 808.126 In re Portnoy, 201 B.R. 685, 701 (1996).127 Huber, 493 BR. at 808.128 RESTATEMENT (SECOND) OF CONFLICT OF LAWS § 270, supra note 55.129 Deepak Molhotra, The Desire to Win: The Effects of Competitive Arousal on Motivation and Be-

havior, 111.2 ORGANIZATIONAiBFI-IAV1OR AND HUMAN DECISION PROCESSES 139, 139 (2010).

[Vol. 13:853


non of the driver on the highway, plugging along at their own constantpace, which happens to be a little slower than the pace of the surround-ing traffic; notice how when a small window presents itself in the ad-joining lane and the trailing car moves to make the pass, more oftenthan might be expected, the lead car will accelerate slightly closing thegap before the pass can be completed. What could be the reason forthis behavior? The passing car had absolutely no impact on the leaddriver, who would have been free to continue on their route at theirchosen speed without any hindrance. Yet this intrinsic impulse con-veyed to the driver, who may not have even been conscious of theirown acceleration, that it would be undesirable for someone else to getahead of them.

Expanding the scope of its application, the same instinct can beused as one of the foremost justifications behind the enactment of statelaws that contradict one another.' In conjunction with the broad evo-lutionary goals of competition such as survival of the fittest, one of themore specific objectives gained through competition is increased attrac-tion. This would be a plausible rationalization for why states adoptlaws, many of which have long denounced, that open the door to theprevalent possibility of abuse. While one might argue that certain lawsare simply prudent policy, the more appropriate argument is that thesecompeting ideologies make one state more attractive than its neighborin a particular field. DAPT friendly laws are just one example of thisattraction-incentivized policy making. Consider also, corporation stat-utes, to be discussed in detail later, which also serve to funnel foreignbusiness, to within the state's own borders.'3'

ii. Efficiency of Regulation

Competition breeds excellence; competition breeds success; com-

petition breeds innovation. All three are common expressions that hintat just how important this concept is to society. However, the benefitsof free competition cannot be evaluated in such a simple manner, espe-

130 See generaly Sterk, supra note 38, at 1056-1065 ("Interjurisdictional competition" adheres

to the same principles governing private economic behavior. Businesses will compete with one

another up to the point that cost of production equals the price a purchaser is willing to pay.

States will further weigh the costs and benefits of a law contradicting their neighbors and if the

benefits outweigh the costs the legislation is advantageous, but if the costs are greater the law isnot worth the increased business.).

131 Sterk, supra note 38, at 1059.

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876 CARDOZO PUB. LAW, POLICY & ETHICSJ.

cially as it applies to interjurisdictional competition. Charles Tieboutargued that uninhibited competition will inherently give way to efficientregulation.132 In other words, if states act in their own self-interest, thesurrounding jurisdictions will inevitably adjust to compensate in orderto continue to compete. While the Tiebout Model133 may be valid tojustify the efficient regulation of certain laws, broad application tointerjurisdictional regulation does not hold up.34 The trouble thispremise runs into is the existence of externalities, or the extent towhich the "regulatory decisions of a state . . . spill over into otherstates. 135 The greater the externalities of a specific statute, the moreinefficient state regulation will be. For example, Colorado's legalizationof marijuana'36 has little likelihood of having any significant adverse ef-fect on the other states.137 As such, there is no reason to believe thatColorado's own law would be insufficient to regulate the behavior of itscitizens and no reason to infer that the law creates inequity betweenColorado and each state that has not elected to legalize marijuana.Contrarily, trust law is another animal entirely. From the aforemen-tioned case of Hube 38 the externalities prevalent with a DAPT lawseem boundless. With the trust being an instrument that is freely trans-ferrable from one jurisdiction to another with little difficulty, the likeli-hood of the entanglement of opposing laws becomes drastically greater.In this area of law, considering that individuals may conduct business139

freely across jurisdictions, inequity seems inevitable. Trust law is clearlynot the only area that concerns an interplay of commercial elementsfrom one state to another, and the only aspect left to address, is howthese other areas may be affected.

132 William W. Bratton & Joseph A. McCahery, The New Economics ojJurisdictional Competition:

Devolufionag Federalism in a Second Best World, 86 Gko. L.J. 201, 211 (1997) (Tiebout was an eco-

nomics professor who came up with this notion now called the Tiebout Model.).133 See generally Charles M. Tiebout, A Pure Theog of Local Expenditures, 64.5J. Poi. ECON. 416

(1956).134 Sterk, supra note 38, at 1064.135 Id.136 COLO. CONST. art. 18, 5 16.137 Many may refute this statement, claiming any number of adverse impacts, however, from

a commercial standpoint, the legalization does not take away opportunity from any other statewho has not chosen to enact their own legislation.

138 In re Huber, 493 B.R. 798 (2013).139 The clear example is DAPT laws and situations between debtors and creditors in differ-

ent jurisdictions.

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B. Are Delaware's Days Numbered?

Perhaps there exists no other law amongst the 50 states that is tak-en advantage of by out-of-staters as much as Delaware's General Cor-poration Law. Currently, there are over one million business entitiesthat have incorporated in the state, including over 50% of all publiclytraded companies within the United States.4 Needless to say, the ma-jority of these entities are not located within the state's borders, nor dothey conduct the majority of their business in Delaware. There are amultitude of reasons entities opt to use Delaware as their legal resi-dence,4' however it is the statutory benefits that are relevant to thisanalysis. In addition to the option for a supermajority voting require-ment,14 2 discussed in the Introduction, the Delaware Law also providesfor an extraordinarily high level of protection for a corporation's offic-ers and directors, essentially indemnifying such individuals from any li-ability for their actions absent a showing of fraud or bad-faith."4 Asthese provisions differ from the corporate charter laws of many otherstates, the inevitable question becomes, in the wake of a decision suchas Huber,'" has this Delaware Law become susceptible to a similar chal-lenge?

The motive for Delaware's entire corporate legal structure canclearly be attributed to the small state's desire to compete economicallywith the rest of the country; the infrastructure and legislation serve tochannel commercial activity from coast to coast. Once again, as it wasdetermined with the DAPT laws, this type of law seems to run afoul ofthe Tiebout Model,' as the externalities attached to it seem plentiful.In a corporate setting, where shareholders are often scattered freelyamong the 50 states and beyond, it does not take a stretch of the imagi-nation to see how the effects of this law might spill over into neighbor-ing jurisdictions. When this takes place, individual regulation is insuffi-

140 About Agenty, DELAWARE DIVISION OF CORPORATIONS, http://www.corp.delaware.gov/aboutagency.shtml.

141 LEwIS S. BLACK, JR., WHY CORPORATIONS CHOOSE DELAWARE (2007), available at

http://corp.delaware.gov/whycorporations-web.pdf (benefits provided include, a highly spe-

cialized Court of Chancery and a legislature which is highly committed to maintain current cor-

porate law).142 DEL. CODE ANN. tit. 8, §141.

143 DEL. CODE ANN. tit. 8, §145 (West 1953).

144 In re Huber, 493 B.R. 798 (2013).145 Tiebout, supra note 133.

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cient for equitable treatment of all jurisdictions.'46 Moving forward,consider the following hypothetical. A lawsuit is filed in Washingtonby a shareholder in a Delaware corporation which has its principal placeof business in Washington and conducts the majority of its business onthe West coast. The claim is premised on the obstruction of a mergerby two of the six board members. Suppose, for argument's sake, thatWashington law provides only for a majority, whereas, per Delawarelaw,'47 the company's corporate charter requires a supermajority of two-thirds to authorize a restructuring. What this theoretical situation es-sentially demonstrates, is a situation similar to the DAPT law in that anentity has simply chosen the beneficial law of one state to govern, de-spite having its strongest relationship to another.

Now that it has been demonstrated that free competition and in-dividual regulation would be insufficient in this context, how shouldsuch a claim as the one described above, be evaluated? Setting asideany claim for actual or constructive fraud, approaching this matter asthe court did in Huber, the first issue to decide, is which law must beapplied. Should Washington law govern, the merger should have beenapproved, whereas under Delaware law, the motion was properly de-feated. The starting point for analysis is the Restatement of Conflict ofLaws; much like the "substantial relation" standard set forth in Huber,'4 8

for corporate laws, the Restatement follows the Internal Affairs Doc-trine, unless there is another state that has a more "significant relation-ship" to the issue.'49 The Internal Affairs Doctrine states that for mat-ters concerning the internal activities of a corporation, its directors, andshareholders, the court will apply the law of the state of incorpora-tion."15 While the majority of states do in fact follow this doctrine, thesituation presented undoubtedly meets the exception provided for inthe Restatement, as the only connection the entity has with Delaware isthat it was the state chosen as its corporate home. Furthermore, goingback to Full Faith and Credit, the Supreme Court of the United States

146 Sterk, supra note 38.147 DEL. CODE ANN. tit. 8, §141.148 Huber, 493 B.R. 798 (the law chosen will govern provided there is a substantial relation to

the jurisdiction and its application does not violate a strong public policy with which the entityhas the most significant relationship).

149 RESTATEMENT (SECOND) OF CONFLICT OF LAWS: OTHER ISSUES WITH RESPECT TO

POWERS AND LIABILMES OF A CORPORATION § 302 (1971).150 Note, The Internal Affairs Doctrine: TheoreticalJustifications and Tentative explanations for its Con-

tinued Primag, 115 HARV. L. REV. 1480,1480 (2002).

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has made it clear, that a court need not substitute the laws of anotherstate for its own on matters it is fully capable of legislating.15' Nonethe-less, it would be unlikely for a court not to elect to apply the law of thestate of incorporation'S2 as individuals have notice of the place of in-corporation upon their initial engagement with the company.

Such a decision would lead to an outcome that is difficult to rec-oncile with this new adjudication in DAPT law. The court in Huber de-cided in so many words that it would be unfair to apply friendly DAPTlaw in a state that has none,5 3 whereas in this example the court wouldcontrarily hold that the foreign law should in fact govern, despite thefact that no practical relationship exists between the entity and the stateof incorporation. Chief Justice of the Supreme Court Harlan Stonewould roll over in his grave, as the inequity of these outcomes clearlyoffend his oft quoted "traditional notions of fair play and substantialjustice.'

15 4

CONCLUSION

In summation, this note has demonstrated that foreign55 law shallbe applied in some circumstances and ignored in others. Differingstandards have been applied to different areas of law, that are not al-ways reconcilable, leaving uncertainty in the reliability of the fundamen-tal premise of federalism enjoyed in the United States. While corpora-tions have long enjoyed the harbor of Delaware's open doors, a federalcourt on the opposite side of the country has opened another door;perhaps the draft created will force the first one shut.

151 Pac. Emp'rs Ins. Co., 306 U.S. 493 (1939).152 RESTATEMENT (SECOND) OF CONFLICT OF LAWS: OTHER ISSUES WITH RESPECT TO

POWERS AND LIABILITIES OF A CORPORATION § 302 (1971).153 Huber, 493 B.R. 798.154 Int'l Shoe Co. v. Washington. 326 U.S. 310, 316 (1945).155 Foreign, meaning out-of-state.

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