A U.S. District Court has ruled that the settlor of a foreign trust cannot be held in civil contempt for failing to comply with a repatriation order—because she has established to the court’s satisfaction that she is unable to repatriate the funds. United States v. Raymond Grant and Arline Grant, 2008 U.S. Dist. LEXIS 51332, U.S. District Ct., S.D. Florida, May 27, 2008
In 1983 and 1984, Raymond Grant (now deceased) established two foreign, self-settled trusts in Bermuda and Jersey for himself and his wife, Arline. At the time, the trusts were settled with about $2 million and the Grants claimed that they had no creditors nor any knowledge of taxes due. (Later, the Internal Revenue Service would claim that Raymond, being in the business of promoting tax shelters, had to know when settling the trusts that his taxes were understated.)
In 1991, the IRS assessed a tax deficiency for the years 1977 to 1987, arising from disallowed tax shelter partnership deductions. A final judgment was entered in 2003 in the amount of $36 million.
In 2005, the IRS moved in the U.S. District Court for the Southern District of Florida to repatriate assets in the Grants’ trusts. The government argued that the trusts gave Arline the power to “discharge an existing or acting Trustee…and to appoint such other Trustee in any jurisdiction throughout the world as [s]he may in her sole and unreviewable discretion determine.”
The Courts’ Reasoning
A magistrate judge held that “by giving Arline Grant total unreviewable authority over discharge and appointment of the trustees, she in actuality controls the corpus of each trust.” He therefore recommended that the government’s motion for repatriation be granted and that Arline be ordered to appoint a trustee in the United States or, alternatively, to repatriate the assets held in the trusts.
On May 27, 2008, the U.S. District Court considered the government’s motion to hold Arline in contempt for failure to comply with its 2005 order. But the court found that Arline had made sufficient efforts to repatriate the funds—to no avail.
Both her Jersey and Bermuda trustees refused to relinquish the funds, based on their respective lawyers’ advice that to do so would be a breach of their fiduciary duty owed to the other beneficiaries of the trust (the Grants’ children.) Those lawyers also advised that the exercise of Arline’s power to remove the trustees would not be a valid exercise of the power.
Citing the U.S. Supreme Court’s decision in United States v. Rylander, the district court concluded that, when compliance with the court’s order is impossible, “neither the moving party nor the court has any reason to proceed with the civil contempt action.”
So what impact will this decision have on offshore asset protection trusts?
Lessons
Naysayers have claimed that the threat of contempt makes foreign asset protection trusts ineffective, at best. As evidence, they point to the Lawrence decision of the U.S. Court of Appeals for the Eleventh Circuit. (See “Asset Protection’s Bad Boy,” Trusts and Estates, July 2004, p. 50).
But in that case, Stephen Lawrence did not convince the court that he was unable to comply and retrieve his funds. Also, the Lawrence court held that even if it was impossible for Stephen to comply, he himself had created that impossibility, so his defense was vitiated. Stephen Lawrence spent the next seven years in jail.
Now come the Grants.
The decision in Arline’s case would seem to indicate that when the settlor/debtor is able to convince the court that she has no control over the trust assets, the risk of jail for contempt is negated. Et voila! The effectiveness of the asset protection is greatly enhanced.
The protection foreign trusts can offer is striking when compared to what the result might have been if the Grants had used a domestic self-settled trust: Then, the court would have had jurisdiction over the trustees and the IRS would have had little difficulty collecting its judgment.
(As an aside, it also would have been better if Arline did not possess the power to remove and replace the trustees in the first instance.)
In the end, the effectiveness of foreign asset protection trusts depends greatly on the facts presented, the artfulness with which the trust is drafted, and the expertise of the lawyers defending the trust.
In the meantime, Arline has both the protection of her trust assets—and her freedom.