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INTERNATIONAL LAW newsletterSUMMER.02

protection devices by which an individual can attempt to place funds Offshore Trusts out of the reach of U.S. creditors and courts while retaining some say in how the funds are spent. In most cases, the trusts are tax neutral and the Dream of and provide little or no tax benefits. For many years, offshore trusts have served as a mainstay of asset Asset Protection protection for the wealthy. They have regularly held a particular attraction for those involved in activities with the potential to create By Marc S. Cornblatt large claims when things go wrong, such as promoters of speculative

Schnader Harrison Segal Lewis LLP investments. In most cases, they have succeeded very well in 1600 Market Street | Suite 3600 achieving their purposes, but times and the world of offshore asset Philadelphia, PA 19103-7286 ph +1.215.751.2414 | fax +1.215.751.2205 protection are beginning to change. [email protected] The Concept – Self Settled Trusts

for most americans and much of the In its simplest form, an offshore asset protection trust arrangement involves a transfer by an individual (usually known as the “settlor”) of american media, the ultimate badge liquid funds to a trust in an appropriate foreign country under the of wealth has become not expensive control of a bank, trust management company or other respectable cars or yachts or multiple homes, but third party as . The trust normally names a number of beneficiaries, usually including the settlor’s family and one or more rather large bank accounts in exotic charities. It also includes the settlor himself as one of the foreign countries, holding money to beneficiaries. fund the high life, supposedly In theory, the settlor’s creditors cannot reach the assets in the trust, protected from taxes, spouses, ex- because those assets no longer belong to the settlor. Since the spouses, defrauded investors and all settlor is a of the trust, however, he may obtain the benefit other claimants. stories like the of the assets and, as a practical matter, the trustee who owes his position and probably future business to the settlor may do with the book and movie versions of john funds whatever the settlor requests. If a court does not accept this grisham’s THE FIRM have helped arrangement and orders money in the trust to be paid to the settlor’s establish the view that true nirvana creditors, the trust’s structure still provides potentially significant rests in “offshore” locations like protection, since United States courts have no enforceable power over property in foreign jurisdictions. the cayman islands. Americans establish these types of trust arrangements “offshore” While offshore fund vehicles do in fact mainly serve the wealthy, because they do not work in the United States. In all U.S. states they generally do so with little glamour or panache. Most commonly, under almost all circumstances, a trust in which the settlor is also a offshore entities take the form of trusts established in beneficiary is considered “self settled” and a nullity. All assets in accommodating foreign jurisdictions. They are designed as asset such a trust are deemed owned by the settlor and subject to the

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1 claims of his creditors.1 Also, all United States courts have the have made a major effort to obtain respectability and have probably power ultimately to reach assets anywhere in the country, and any become a mid-range jurisdiction on the scale of protection and trust or other arrangement in the United States is therefore subject to respectability. The Cayman Islands still actively protect trusts and challenge in a U.S. court. assets within their territory and do not readily open financial records to outsiders and therefore continue to be receptive and The hallmark of any offshore jurisdiction regularly used by United accommodating to offshore fund and deposit vehicles. The principal States residents for asset protection is the rejection of the doctrine business of the Islands, however, has grown from small offshore of self settled trusts. Each permits a settlor to transfer assets to a accounts to international finance, and the Caymans are now one of trust in which the settlor is a beneficiary and treats the transfer as the largest banking centers in the world. As a result, the Island valid and the transferred assets as owned and controlled solely by authorities are becoming progressively more concerned about being the trust as a separate legal entity, distinct from the settlor. Many considered as a haven for the proceeds of fraud or other misconduct jurisdictions have gone even farther and recognized the concept of and are becoming much more attune to the concern of outside the settlor in the role of “protector,” with the authority to approve or claimants to such proceeds. veto all distributions from the trust. At the far, but not nearly the farthest, point in the spectrum of Offshore Jurisdictions protection are probably the Cook Islands, former New Zealand The choice of a location for an offshore trust usually involves an evaluation of the balance of respectability and security of the the choice of a location for an offshore jurisdiction against the level of protection provided against creditor trust usually involves an evaluation of the claims. In most cases, as the safety and respectability factors balance of respectability and security of the increase so does the chance of a successful challenge to the trust jurisdiction against the level of protection arrangement, so that the most protective jurisdictions are usually the provided against creditor claims. most suspect to courts and other outsiders. While it is not possible to evaluate every available asset protection jurisdiction, three provide a good example of the spectrum of choices. possessions in the middle of the Pacific Ocean. A good deal of the business of the Cook Islands derives from offshore business, The Channel Islands in the English Channel off the coast of France investment and deposit, and the Islands understand the importance have traditionally been among the top choices for safe and well of accommodating offshore businesses, investments and settlors. regarded locations for offshore trusts. The Islands, including Jersey, While the Cook Islands do not sanction fraud and do permit Guernsey and Aldernay, recognize self settled trusts as valid and challenges to offshore trusts in some instances, the authorities are generally serve most of the purposes required for asset protection generally very protective of assets placed in trusts and other vehicles trusts. Because the Islands are part of the United Kingdom, they within the Islands. As shown in the Affordable Media case discussed offer the benefits and protections of the English common law system in the following article, of Cook Island trusts have been and courts and the stability of the British government and banking known to refuse the direct instruction of settlors, under order of and financial systems. As part of the British system, the Channel United States courts, to return funds. Islands authorities have great concern about respectability and about serving as a vehicle for the fraudulent or otherwise improper Creditors and the Courts – The Mechanics of Protection transfer of funds, and they take very seriously challenges to trust When a creditor asserts a claim or obtains a judgment against an arrangements on the grounds of such improprieties. American settlor of an offshore trust and exhausts all remedies Once considered the model of the exotic jurisdiction where anyone against the settlor’s United States assets, the protection component could hide anything in secret, the Cayman Islands in the Caribbean of the offshore trust vehicle “kicks in.” If the creditor finds the assets and identifies the trust, any attempt to reach the assets first confronts a legal structure in which the trust, not the settlor, owns

1 Alaska and Delaware have enacted statutes that in certain circumstances the property. Since the trust is not responsible for the settlor’s allow trusts in which the settlor is also a beneficiary. Alaska Stat. obligations, it declines to pay the settlor’s obligations with the trust’s §§13.36.105-220; Del. Code Tit. 12 §§3570-3576. Federal and other state courts have been slow to accept arrangements under these laws, and the assets. Often, such a position succeeds or is asserted strongly restrictions significantly limit the utility of the trusts for asset protection as enough to dissuade the creditor from proceeding further. compared to trusts in foreign jurisdictions. (continued on page 3)

2 If the creditor pursues the challenge to the ownership and control of trust assets, a court in the United States may find the transfer from The Recent Judicial the settlor to the trust void or invalid and direct payment of the Response to Offshore settlor’s debt from the assets of the trust. In such circumstances, the Asset Protection Trusts creditor must still deal with the very limited effect of United States By Eric L. Scherling court orders outside of the country. In order to collect from a foreign trust under a U.S. court order, a claimant must try to enforce the Schnader Harrison Segal Lewis LLP 1600 Market Street | Suite 3600 United States judgment in the foreign jurisdiction. In most instances, Philadelphia, PA 19103-7286 the courts in offshore jurisdictions will refuse enforcement of the ph +1.215.751.2377 | fax +1.215.751.2205 [email protected] judgment on the grounds that American courts do not have jurisdiction to enter orders against foreign trusts that have no The effectiveness and popularity of offshore trusts as a mechanism facilities, assets or business activities in the United States. for protecting assets from the reach of creditors have been If enforcement of the judgment is denied, collection of the claim will discussed elsewhere in this publication. While many experts agree require the creditor to pursue a separate proceeding under the laws that offshore asset protection trusts continue to provide significant and in the courts of the foreign jurisdiction to prove that the trust is protection from creditors, U.S. courts have begun to find ways to responsible for the debts of the settlor, most likely on the grounds circumvent the offshore trusts and assert their jurisdiction over the that the trust is invalid and that the trust assets belong to the settlor. sheltered assets. In so doing, the courts are demonstrating a level Such a position is close to the equivalent of asserting that the laws of of savvy to match that of the trust settlors and promoters. the offshore jurisdiction that permit self settled trusts are improper To date, the federal bankruptcy courts have been the most active in and allow fraudulent transactions - not a claim that the courts of litigation concerning offshore asset protection trusts. A Circuit most countries find very attractive. Also, litigation in foreign Court of Appeals has also addressed the subject. In these cases, countries can be extremely expensive, with many jurisdictions such bankruptcy trustees either have successfully challenged the as Great Britain requiring that losing parties pay their opponent’s establishment of the trust as a fraudulent conveyance or sought to legal fees. have trust assets included in the bankruptcy estate. The cases reflect the suspicion with which the courts have viewed the motives american courts do not have jurisdiction to of the trust settlors, and reveal a judicial resolve to prevent enter orders against foreign trusts that individuals from using the offshore asset protection trust as a tool to have no facilities, assets or business defraud creditors. activities in the united states. In re Portnoy

The first bankruptcy case to deal extensively with an offshore asset The Beginnings of Change protection trust was In re Portnoy, 201 B.R. 685 (Bankr. S.D.N.Y. 1996). Larry Portnoy surreptitiously created a self-settled While the classic model of the offshore trust described above on the island of Jersey several years after he remains very popular for asset protection and generally still personally guaranteed a $1 million loan to his corporation. When succeeds in its purpose, cracks have begun to appear in the system. the loan defaulted, the bank sued for payment and received a Many jurisdictions, including some considered the most protective, judgment. Portnoy refused to pay the judgment, and subsequently will now deny trust ownership of assets and enforce United States filed for Chapter 7 bankruptcy. Although Portnoy had transferred all judgments when funds have been transferred to trusts specifically to of his assets to the offshore trust, the bank argued that he retained avoid known creditors in so-called “fraudulent transactions.” As well complete control over the income while simultaneously attempting described in the next article, U.S. creditors are also beginning to to hide the existence of the trust from creditors. This scheme, the refocus their challenges to trust transfers. They have started to use bank claimed, constituted grounds to deny Portnoy a discharge of the courts to attack the system at its source and proceed against his debts. Portnoy moved for summary judgment. settlors, with growing success. The future will be interesting. The court rejected Portnoy’s summary judgment motion, finding that his interest in the Jersey trust was the property of the bankruptcy

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3 estate and his concealment of it was likely actionable. In order to Affordable Media reach this conclusion, the court had to determine whether the law of th Jersey or New York should apply. As the laws of the two jurisdictions In Fed.Trade Comm’n v.Affordable Media, LLC, 179 F.3d 1228 (9 conflicted over the validity of self-settled spendthrift trusts, the court Cir. 1999), the court dealt with the problem of its lack of power to looked to federal common law, which required application of the law enforce judgments in foreign jurisdictions. In that case, the Federal of the jurisdiction with the most significant interest in the case. After Trade Commission had brought suit against a husband and wife, evaluating the respective interests of Jersey and New York, the court Michael and Denyse Anderson, for their operation of a fraudulent decided that New York had the most significant interest in the matter. telemarketing enterprise. Prior to establishing the telemarketing Although the trust was created and administered in Jersey, the court business, the Andersons set up an irrevocable trust in the Cook found it more relevant that Portnoy and his creditors were domiciled in the United States, Portnoy’s creditors had no contacts with Jersey, while many experts agree that offshore asset Portnoy had greater contact with the United States, and Portnoy had protection trusts continue to provide reasonable grounds to foresee that United States law would apply to significant protection from creditors, u.s. interpretation of the trust. courts have begun to find ways to circumvent The court also emphasized the principle that a court should not the offshore trusts and assert their enforce a foreign statute if such enforcement would violate the jurisdiction over the sheltered assets. strong public policy of the forum state. New York, the court found, had a strong public policy against self-settled spendthrift trusts. Enabling Portnoy to conceal his assets from creditors while retaining Islands, designating themselves as co-trustees along with a control over them would deeply offend that public policy. The court company licensed by the Cook Islands. The federal district court in therefore held Portnoy’s trust to be invalid as a matter of New York Nevada issued an injunction against the Andersons, demanding the law, and its assets were deemed to be part of the bankruptcy estate. repatriation of their assets from the Cook Islands trust to the United States. In re Brooks The Andersons had included an anti-duress provision in the trust The next case, In re Brooks, 217 B.R. 98 (Bankr. D. Conn. 1998), instrument, which took effect immediately upon the issuance of the followed a similar analysis. B.V.Brooks, the debtor, transferred district court’s injunction. This provision terminated the Andersons stock certificates to his wife, who shortly thereafter placed them in as co-trustees, and left all powers over the trust to the remaining self-settled spendthrift trusts on the islands of Jersey and Bermuda. trustee. The remaining trustee refused to comply with the district The trust instruments expressly provided that the local law of the court order, and subsequently the district court found the Andersons respective jurisdictions would apply to issues of trust interpretation. in contempt of court.

As was the case in Portnoy, the court had to determine whether to In their appeal to the Ninth Circuit, the Andersons argued that the apply the law of the trust situs or the law of the settlor’s domicile, anti-duress provision made it impossible for them to comply with the Connecticut. The court acknowledged that, as a general rule, the order to repatriate the trust assets. The court recognized that intent of the settlor determines the law applicable to trust impossibility constitutes a defense to a charge of civil contempt. interpretation. The court also observed, however, that enforcement However, parties asserting impossibility have the burden of proving of the trust would contravene Connecticut’s clearly stated public their lack of control over their ability to comply with a court order. In policy against self-settled spendthrift trusts. Connecticut law the context of asset protection trusts, this burden is a rather sizable therefore applied. Brooks contended that the trusts were not even one, for courts view the motivation underlying these trusts with self-settled; it was not he, after all, but his wife who personally suspicion. The court cited “the likelihood that any attempted created the trusts and deposited the stock certificates. The court compliance with the court’s orders will be merely a charade rather rejected this argument, stating that since Brooks’ transfer of the than a good faith effort to comply.” The inability of the Andersons to certificates to his wife immediately preceded her creation of the compel the remaining trustee to repatriate the assets was not merely offshore trusts, he was a settlor nonetheless. As a result, the court a consequence of their creation of the trust, but instead was the very deemed the trusts to be unenforceable under Connecticut law and objective of the trust. The court refused to exonerate the Andersons thus part of the bankruptcy estate. on the basis of this self-induced impossibility.

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4 The court also found the conduct of the Andersons after the issuance skeptical of Lawrence’s claim that he created the trust purely for of the injunction to be revealing of their control over the trust. The retirement and charitable purposes, compared his situation with that designated the Andersons as protectors of the trust, of the Andersons. His impossibility was self-created as well. To giving them the power to appoint new trustees and to dictate if and grant relief to such a person, the court opined,“would be tantamount when the anti-duress provision would take effect. The protectors to succumbing to the pleas for sympathy from an orphan who has had the power to preempt or undo the effect of the anti-duress killed his own parents!” The court determined that the failure of provision, and thus had the ability to cause the assets to be Lawrence to turn over his trust assets or disclose trust transactions repatriated. Apparently cognizant of how their status as protectors constituted a continuous effort to hinder, delay and defraud his undermined their impossibility argument, the Andersons creditors in bankruptcy. Consequently, Lawrence received a heavy immediately attempted to resign as protectors after the issuance of fine and was put in jail until he turned over the entire trust amount. the injunction. The Ninth Circuit found that this behavior confirmed the Andersons’ control over the trust and upheld the district court’s Conclusion finding of contempt, and the Andersons served time in prison. These cases reflect a wariness on the part of the federal courts about what they perceived to be the genuine objective of the offshore asset In re Lawrence protection trusts, the avoidance of paying the settlors’ financial Finally, in the case of In re Lawrence, 238 B.R. 498 (Bankr. S.D. Fla. obligations. Where faced with a conflict of laws issue, the courts 1999), the bankruptcy court followed the approach taken by the determined that the greater domestic interests superseded the Ninth Circuit in Affordable Media in holding Wall Street options trader existence of a foreign choice of law provision. Applying domestic Stephan Jay Lawrence in contempt for refusing to comply with its law, under which self-settled spendthrift trusts are unenforceable, previous order to turn over the assets of his offshore trust and make the courts ruled the offshore trusts to be invalid. Furthermore, the full disclosure of all of his trust on transactions. Two months before a appearance of self-created impossibility barred the trust settlors substantial arbitration judgment was rendered against him, from arguing an inability to repatriate assets. Do these cases signal Lawrence transferred his assets to a trust on the island of Jersey. the certain demise of the offshore asset protection trust? Not One month before the judgment, Lawrence amended the trust to be necessarily. They do provide fair warning, however, that the courts spendthrift and changed the governing law to that of Mauritius, an have become increasingly wise to the purposes that may inspire the even more favorable jurisdiction for debtors than Jersey. creation of these trusts, and may on occasion possess both the creativity and the legal means to fashion ways around them. Lawrence contended that he lacked the authority to access the assets to pay the arbitration award or to compel the Mauritian trustee to repatriate the assets. The bankruptcy court, highly

5 Authors Biographies Recent Events

Marc S. Cornblatt is chair of the International Practice Team, co-chair of the July 5, 2002 - Martin Mendelsohn attended a meeting of the Board of Corporate Practice Group and a member of the Health Care and Directors of the Austrian Reconciliation Fund in Vienna, Austria. Mr. Bankruptcy, Workout and Business Reorganization practice teams. On the Mendelsohn is a member of the Board appointed by the U.S. government to international front, he advises United States residents with respect to represent the interests of Holocaust victims and survivors. overseas activities, has extensive experience in international commercial transactions and has regularly acted as United States counsel for foreign July 22-26, 2002 - J. Denny Shupe and Jonathan M. Stern will attend businesses and individuals. Mr. Cornblatt serves as Chairman of the the Farnborough Air Show in England, at the invitation of their clients Committee on Legal Education and Professional Development for the Hurel-Hispano and SNECMA. International Bar Association.

Eric L. Scherling is a member of the Business Services Department, the In The Next Issue Financial Services Practice Group and the Bankruptcy, Workout and Truths and Myths-Litigation in the United States - By J. Denny Shupe Business Reorganization Practice Team. He is experienced in researching and handling corporate and bankruptcy issues. Americans in Paris: Dispute Resolution and Litigation by Americans in France - by Bruno Quint of Granrut Avocats

Upcoming Events The International Group Newsletter is published quarterly by the firm as a service to our clients and friends. Articles should only October 2002 - IBA Conference in Durban, South Africa. Contact Marc be viewed as a summary of the law and and not as a substitute for Cornblatt at +1.215.751.2414 or [email protected]. legal consultation in a particular case.

November 11-14, 2002 - Airports Council International 11th Annual Conference in This newsletter can also be found at schnader.com. Salt Lake City. Contact Jeffrey Letwin at +1.412.577.5106 or jletwin@ schnader.com. @2002 All rights reserved

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