Fourteen states now have domestic asset protection trust (DAPT) legislation, and a growing number of trust companies and attorneys are actively marketing DAPTs.1 Alaska and Delaware were the first states to enact DAPT legislation in 1997, followed by Rhode Island, Nevada, Utah, Oklahoma, Missouri, South Dakota, Tennessee, Wyoming, New Hampshire, Hawaii, Virginia and Ohio.2 Ohio’s Legacy Trust Act became effective this year.3 Asset protection strategies have traditionally been part of most estate-planning attorneys’ discussions with their clients. When a client asks an attorney about a DAPT that allows the client to transfer assets to a spendthrift trust of which the client is also a protected beneficiary, the attorney must balance incorporating appropriate asset protection strategies with maintaining ethical standards.
A Fine Line
The threshold challenges for all types of asset protection planning start with fraudulent transfer laws. No plan is immune to a valid fraudulent transfer claim, which may void the transfer to the DAPT before ever getting to the question of the DAPT’s validity.4
Because the purpose of fraudulent transfer laws is to prevent individuals from transferring assets to keep them beyond the reach of creditors, there can be a fine line between assisting a client in a fraudulent transfer and ethically and skillfully representing a client with an estate plan incorporating asset protection strategies that are meant to protect clients from creditor threats.5 This line gets even finer when considering a recent court opinion suggesting that having the intent to protect assets from creditors, even unknown but reasonably foreseeable future creditors, is enough to find sufficient intent to prove a fraudulent transfer.6 Not only is the plan at risk, but also, the attorney may face a disciplinary sanction and even a civil or criminal proceeding for assisting a client in a fraudulent transfer.7 Therefore, the first step an attorney should take when considering an asset protection trust for a client is to ask a lot of questions about the client’s financial situation, liability risks and motives for planning.
Performing Due Diligence
Determining the client’s solvency, bankruptcy risks, insurance coverage and financial situation is essential to performing adequate due diligence. Due diligence will also help target the best assets for a DAPT and the amount and value of assets that should be considered eligible for transfer to a DAPT.
The American Bar Association has put together the “Good Practices Guidance” and issued Formal Opinion 463. Both are useful tools to determine how to perform due diligence when considering DAPT planning for a client.8 In addition, a good start is for the attorney to draft an Affidavit of Solvency that outlines all the elements of a fraudulent transfer and incorporates affirmative statements by the client that the elements of a fraudulent transfer aren’t present or contemplated for the asset transfer to
The use of this type of affidavit has, in at least one case, helped to establish evidence in favor of the attorney who drafted a foreign asset protection trust (FAPT) for a client who later filed for bankruptcy and then claimed that she was insolvent at the time of the transfer of assets to the FAPT. In re Akram Niroomand9 involved a bankruptcy trustee that sued the drafting attorney of an FAPT and claimed legal malpractice for fraudulent transfer. The bankruptcy court conducted a bench trial and found in favor of the attorney using the Affidavit of Solvency to impeach the debtor’s claim that she was insolvent at the time of the transfer. The district court upheld the bankruptcy court’s final judgment, and the U.S. Court of Appeals for the Eleventh Circuit affirmed the district court’s judgment.
A fraudulent transfer cause of action is a tort claim in which the creditor isn’t questioning the trust’s terms, but rather the transfer of assets to the trust. One of the keys to defending a fraudulent transfer claim is for the client to maintain sufficient personal assets to honor obligations of existing and potential creditors.10
Laws. When drafting an Affidavit of Solvency, an attorney should review fraudulent transfer laws. Most states have enacted the Uniform Fraudulent Transfer Act (UFTA). Seven states have statutes based on the Uniform Fraudulent Conveyance Act or the Statute of Elizabeth, which have some subtle differences from the UFTA.11 Similar fraudulent transfer laws are also found in the federal Bankruptcy Code, but with a much longer look-back period of 10 years regarding asset protection trusts.12 Because it’s often difficult to prove a debtor’s intent to defraud creditors, attorneys should pay close attention to statutory and common law “badges of fraud” that are used to prove intent to hinder, delay or defraud creditors.13
It’s important to inform the client of the elements of a fraudulent transfer and why a risk analysis and complete review of the client’s current financial situation will determine whether a DAPT is an appropriate choice for planning. A thorough vetting of the client will not only uncover fraudulent transfer issues, but also reveal the most likely threats to the planning. Questions about family members expose possible divorce and liability risks, as well as possible protected exception creditors who may bring a claim against a DAPT allowed under the state’s laws. A review of past tax returns could unveil issues with the Internal Revenue Service or income from sources that haven’t been disclosed to the attorney. Inquiry regarding the settlor’s business, profession, assets and activities may reveal litigation risks and cash flow concerns.
Applicable law. How courts in non-DAPT states address fraudulent transfer or trust validity questions reveals the vulnerabilities this planning presents. When a creditor brings a fraudulent transfer claim in a state that doesn’t have a DAPT statute, the court must determine which state’s law to apply. If the claim arose in a non-DAPT state and the settlor and creditor are residents of a non-DAPT state, the court is likely to apply its own law to a fraudulent transfer claim, rather than the more relaxed fraudulent transfer law of the DAPT state.14 The creditor may not only seek redress for the creditor’s claim, but also punitive damages and attorney’s fees.15 Consequently, subtle differences between DAPT jurisdictions regarding statutes of limitations to bring claims may not be as important to consider as the chances of a creditor getting a judgment in a non-DAPT state or the settlor filing for bankruptcy. Recent case law suggests that the residence of the settlor may be more important
than the situs of the trust when contemplating whether to draft a DAPT for a particular client.16
Choice of Law
Another way a creditor may attack a DAPT is to challenge a spendthrift provision in the trust or the validity of the trust itself. These types of challenges are more complicated because the court must consider the choice-of-law provision of the trust document. The laws in the DAPT state will conflict with a non-DAPT state because the DAPT state will allow self-settled spendthrift trusts and the non-DAPT state won’t. Conflict-of-laws rules for trusts are found in Sections 267-282 of the Restatement (Second) of Conflict of Laws (Restatement (Second)). Section 273 provides that a spendthrift provision in a trust should be governed by the law of the:
... state, if any, in which the settlor has manifested an intention that the trust is to be administered and otherwise by the local law of the state to which the administration of the trust is most substantially related.
In re Huber involved the U.S. Bankruptcy Court for the Western District of Washington following the Restatement (Second) Section 270(a), comment (b), to find that the relation of the DAPT to Alaska was minimal, even though the settlor had chosen Alaska law to apply to the trust. The court stated that the only connection of the trust to Alaska was the location of the trust administration and one of the trustees.17 It further found that Washington had a substantial relation to the trust because it was where the debtor and beneficiaries resided, the assets were sitused and the attorney who prepared the trust and transferred the assets was located. Courts may also ignore a choice-of-law provision in a DAPT and apply the law of their own state if that state has a strong public policy against self-settled spendthrift trusts. In In re Huber, the court stated that Washington had a strong public policy against self-settled DAPTs as support for disregarding the settlor’s choice of Alaska law in the DAPT.
Enforcement of Judgment
The creditor will need to enforce a judgment entered in its favor. Sometimes, the creditor must bring an enforcement action in the DAPT state where the trust is being administered. In Hanson v. Denckla, the U.S. Supreme Court held that Delaware wasn’t compelled to give full faith and credit to a judgment from a Florida court because the Florida court lacked jurisdiction over the Delaware trustee.18 Nevertheless, a court in a non-DAPT state may use its long-arm statute to establish jurisdiction over a DAPT trustee if that trustee has sufficient contacts with the state.19 Arguably, a trustee who’s domiciled in a DAPT state could have sufficient contacts with a non-DAPT state if it advertises and solicits business in the non-DAPT state, and such activity is deemed to rise to the level of purposeful contact with that state.20
Alter Ego Theory
Even if the trustee has no contacts with the jurisdiction where the claim is filed, the court may apply an alter ego theory to obtain jurisdiction over the trustee. An alter ego claim involves a situation in which trust formalities are disregarded and the settlor exerts such dominion and control over the assets in the trust that it gives rise to an inference that the trust isn’t a bona fide structure, but rather, merely an extension of the settlor.21 For the assets of the DAPT to be subject to collection as if they were owned outright by the settlor, an alter ego claim must also include a showing that the settlor has used the trust to commit fraud, resulting in loss to the creditor. The Superior Court of the District of Columbia in Matijkiw v. Strauss held that the plaintiffs presented a viable theory of personal jurisdiction over a Delaware trustee when there was evidence that the trust was the alter ego of the grantor, the trust was used to commit fraud and the court had in personam jurisdiction over the grantor.22
Additionally, a non-DAPT state court may have in rem or quasi in rem jurisdiction over property in a DAPT if the property is located within the state’s borders.23 In the case of Rush University Medical Center v. Sessions,24 the downfall in the planning was that the FAPT was funded with real estate located in Illinois, and the creditor was able to levy on that real property interest.
It’s important to keep in mind federal bankruptcy law, which allows a bankruptcy trustee to claw back any fraudulent transfers to DAPTs within 10 years of filing for bankruptcy.25 In Battley v. Mortenson, the bankruptcy trustee was able to set aside a transfer of assets to an Alaska DAPT.26 Using federal law to determine that Thomas Mortensen transferred the property with the intent to hinder, delay and defraud present and future creditors, the court found the expressed purpose of the trust, “to maximize the protection of the trust estate or estate from creditors’ claims of the Grantor or any beneficiary and to minimize all wealth transfer taxes,” was evidence of fraudulent intent. The court also found additional evidence of fraudulent intent in Mortensen’s actions of transferring assets to the DAPT, rather than paying current creditors; and using the trust assets to make stock market investments and loans, contradicting his stated intention of preserving the property for his children.
1. David G. Shaftel, American College of Trust and Estate Counsel, “Comparison of the Domestic Asset Protection Trust Statutes” (updated through June 30, 2012). Shaftel compares 15 states, including Colorado, which I’ve eliminated because case law in Colorado shows that domestic asset protection trusts (DAPTs) probably aren’t valid there. See note on page 1 of Shaftel’s article. There hasn’t been any additional DAPT legislation passed since Ohio’s Legacy Trust Act (passed on Dec. 20, 2012 (Ohio HB 479), with an effective date of March 27, 2013) (58 Ohio Rev C. Chapter 5816); Jocelyn Margolin Borowsky and Richard W. Nenno identify 159 trust companies in five DAPT states in their BNATAX Management article, “A Comparison of the Leading Trust Jurisdictions” (2012).
2. See Shaftel, ibid. One can argue that Missouri had DAPT legislation in place before 1997, but it wasn’t clear until amendments were enacted in 2004.
3. ORC Ann. 5816.01 (2013).
4. See Battley v. Mortensen, 2011 Bankr. LEXIS 5560 (Bankr. D. Alaska May 26, 2011).
5. Uniform Law Commission, “Why States Should Adopt UFTA,” 2013, www.uniformalws.org/Narrative.aspx?title=Why States Should Adopt UFTA.
6. Supra note 4.
7. In re Hockett, 734 P.2d 877 (Or. 1987) (an attorney who was found to have violated disciplinary rules by assisting a client in conduct known to be fraudulent was suspended from the practice of law); Business Loan Express, LLC. v. Pak, 2004 U.S. Dist. LEXIS 12807 (D. Md. July 9, 2004) (an attorney who was found to be a willful and intentional member of a conspiracy to defraud a creditor was liable to the creditor for the amount of damage the attorney caused the creditor to suffer); New York Penal Law Section 185.00(2)(a) (if an attorney commits or assists in a fraudulent transfer knowing that a bankruptcy or insolvency proceeding is likely, the attorney may be found guilty of fraud in insolvency, which is a class A misdemeanor).
8. Resolution & Report 116, Voluntary Good Practices Guidance for Lawyers to Detect and Combat Money Laundering and Terrorist Financing, American Bar Association (2010), ABA Comm. on Ethics & Prof’l Responsibility, Formal Op. 463 (2013).
9. Goldberg v. Rosen (In re Akram Niroomand), 493 Fed. Appx. 11 (11th Cir. 2012).
10. See Waldron v. Huber (In re Huber), 493 B.R. 798 (Bankr. W.D. Wash. 2013). When showing badges of fraud, the bankruptcy trustee established that the debtor transferred all or substantially all of his property to the DAPT.
11. Alaska, Kentucky, Louisiana, New York, Maryland, South Carolina and Virginia.
12. 11 U.S.C. Section 548(e).
13. See In re Twyne’s Case, 3 Coke 80b, 76 Eng. Rep. 809 (Star Chamber 1601) (thought to be the case that established the concept of “badges of fraud” for fraudulent transfers); Uniform Fraudulent Transfer Act (UFTA) Section 4(b) and comments (5) and (6).
14. Supra note 1. Many DAPT states have modified their version of the UFTA by shortening the statute of limitations to bring a fraudulent transfer claim and by holding the creditor to a higher standard to prove a fraudulent transfer.
15. Klein v. Weidner, 2013 U.S. App. LEXIS 18240 (3d Cir. 2013).
16. Matijkiw v. Strauss, 2011 D.C. Super. LEXIS 13 (D.C. Super. Ct. 2011).
17. Supra note 10.
18. Hanson v. Denckla, 357 U.S. 235 (1958).
19. Int’l Shoe Co. v. Wash., 326 U.S. 310 (1945).
20. Roberts v. Piper Aircraft Corp., 670 P.2d 974 (N.M. Ct. App. 1983).
21. United States v. Evseroff, 2012 U.S. Dist. LEXIS 60344 (E.D.N.Y. 2012).
22. Supra note 16.
23. Rush Univ. Med. Ctr. v. Sessions, 2012 IL 112906 (Ill. 2012).
24. Supra note 23.
25. Supra note 12.
26. Supra note 4.