Volume VII, Number 2 – October 1998
© Donlevy-Rosen & Rosen, P.A.
INTRODUCTION. Many seminars and articles of late have introduced the concept of domestic asset protection trusts (APT’s). This is primarily a result of the 1997 enactment of “protective” trust legislation by Alaska and Delaware. In this issue we will examine how effective these domestic asset protection trust laws are in protecting assets. For ease of reading, we will usually only mention Alaska, but we are referring to both Alaska and Delaware.
U.S. CONSTITUTIONAL QUESTIONS. Two U.S. Constitutional issues are often raised when a discussion of domestic APT’s takes place: First, that the “full faith and credit” clause of the Constitution would require the Alaska Court to recognize and give effect to the judgment of a court of another state, and second, that the “supremacy” clause of the Constitution would prevent state law from protecting assets in the face of a conflicting federal judgment (e.g., a federal bankruptcy court). A third constitutional issue, relating to the “contract” clause of the Constitution, is also raised, but we think it is too esoteric to discuss here.
While there is apparently some accord on the supremacy issue, some writers, in an attempt to cloud the full faith and credit issue (or, giving them the benefit of the doubt, due to their lack of understanding of how creditors reach trust assets), have stated that the Alaska Court need not give effect to (for example) a Florida court’s judgment unless that Florida court had jurisdiction over the person against whom enforcement of the judgment is sought (the Alaska trustee). Thus, they argue, because the Alaska trustee is not the same person as the Florida settlor against whom the judgment has been entered, the Florida court has no jurisdiction over the trustee, and the Alaska Court need not enforce the Florida court’s judgment against the trustee (i.e., the full faith and credit clause will have no effect). This is true; however, in real life things work a little differently. Let’s see how a creditor of a settlor-beneficiary reaches trust assets after obtaining a judgment against the settlor.
HOW CREDITORS REACH TRUST ASSETS. Traditionally, the creditor can make two arguments to reach trust assets: first, he may argue that the trust is invalid because the settlor retained too many controls over the trustee or over the trust assets (hence, the assets still belong to the settlor), and/or second, the creditor may argue that the transfer of assets into the trust was a fraudulent transfer (See, APN, Vol. I, No. 5 and Vol. IV, No. 4). The fraudulent transfer argument will be the most likely one to be made (although neither Alaska nor Delaware has sufficiently disposed of the retained controls/validity issue, as certain offshore jurisdictions have). If the creditor is propounding a fraudulent transfer argument, he will join the trustee (not difficult if the trustee is located in the United States) as a party (transferee) in the fraudulent transfer case. In this manner, the trust assets will be reachable because the Florida Court (example) will then have jurisdiction over the Alaska trustee, and the “full faith and credit” clause of the Constitution will require the Alaska Court to enforce the judgment of the Florida Court against the Alaska trustee. This CANNOT HAPPEN with a properly structured offshore trust.
COMPARISON: DOMESTIC vs. OFFSHORE APT’s. Let’s review and compare the domestic and offshore APT’s on the “full faith and credit” issue: a creditor holding a fraudulent transfer judgment in his favor from a U.S. Court cannot hope to have the (properly selected) offshore jurisdiction enforce the judgment against the trust. The creditor must commence a new fraudulent transfer action in the offshore jurisdiction, and utilize a lawyer admitted to practice in that jurisdiction (not his U.S. lawyer). In most asset protection jurisdictions, lawyers cannot take cases on a contingency fee basis — this means that the creditor must make a significant personal financial commitment before his case even gets off the ground. What’s next? A consideration of the legal basis for creditor’s attack on the trust: if the trust situs jurisdiction has been carefully selected, its laws will preclude many conventional legal bases of attack, usually leaving as the only avenue of attack the fraudulent transfer argument. Here the creditor is faced with an insurmountable burden of proof (see below) and a severely contracted statute of limitations (in many cases, the statute of limitations will be zero). The foregoing hurdles in the legal obstacle course of attacking the offshore trust are not the end, however. If threatened with litigation in its original situs, the properly drafted offshore trust can move to another favorable offshore jurisdiction – requiring the creditor to start his litigation all over again.
How does this offshore legal obstacle course compare to that faced by a creditor attempting to reach assets held in a domestic APT? Let’s see: as discussed above, a creditor, using his U.S. lawyer, making a fraudulent transfer attack on a domestic trust, will be able to easily get jurisdiction over the trustee, and if successful with his case, get the trust assets. Protection? Remember, the foreign court will not enforce the U.S. judgment. Compare: the foreign court “will not enforce” with the fact that the Alaska Court will be required to enforce….. You decide: do you want to roll the dice, or eliminate risk?
OTHER CONSIDERATIONS. Some assets are required to remain in Alaska; a Cook Islands trust need not have any of its assets in the Cook Islands. Although not usually discussed, the trustee fees charged by the Alaska and Delaware trust companies (based upon a percentage of trust assets) are often more than twice as much as those charged by the Cook Islands trust companies (flat fees). The fraudulent transfer statute of limitations in Alaska and Delaware is four years, and may permit a subsequent creditor to bring an action. The statute can be as short as zero in the Cook Islands and subsequent creditors are precluded from bringing an action. The standard of proof required to establish a fraudulent transfer in Alaska or Delaware is our usual civil standard: “preponderance of the evidence” – not a difficult standard to meet, while the Cook Islands Law requires the significantly more difficult standard of proof “beyond a reasonable doubt” – a nearly impossible standard to meet. Finally, as mentioned above, neither Alaska nor Delaware has addressed the “invalidity” basis of attack in their statutes, thus leaving a significant avenue of attack available to a creditor; this issue has essentially been eliminated by Cook Islands legislation (See, APN, Vol. V, No. 1 and Vol. V, No. 4).
CONCLUSION. Our conclusion: let someone else experiment with Alaska and Delaware; effective asset protection and estate freeze benefits have long been available through the utilization of a properly structured offshore trust.