TABLE OF CONTENTS

Page

I. INTRODUCTION...... 1 II. ASSET PROTECTION PLANNING AND FRAUDULENT TRANSFERS...... 1 A. The Client’s Right to Asset Protection Planning...... 1 B. The Danforth Article...... 2 C. Fraudulent Transfers...... 3 1. GENERAL PRINCIPLE...... 3 2. TYPES OF CREDITORS...... 4 3. WHAT CREDITORS SHOULD BE PROTECTED?...... 5 D. Proper Planning...... 5 E. Conclusion...... 7 III. DOMESTIC STRATEGIES...... 7 A. Introduction: Multiple-Entity Planning...... 7 1. DEFINITION...... 7 2. THEORY...... 8 3. METHODS...... 8 4. LAWS OF THE STATES...... 8 B. Homestead...... 9 C. Personal Property...... 10 D. Life Insurance and Annuities...... 10 E. Income...... 10 F. Retirement Plans...... 10 G. Federal Statutes...... 11 H. College Savings Plans...... 12 I. Joint Property Ownership...... 12 J. Marital Property Positioning...... 12 1. GENERAL RULES OF MARITAL PROPERTY LIABILITY...... 12 2. MARITAL PROPERTY PLANNING...... 13 K. Business Arrangements—General...... 14 1. LIABILITY ASSOCIATED WITH SPECIFIC ACTIVITIES...... 14 2. OTHER THREATS TO WEALTH...... 14 3. RESPECTING THE BUSINESS ENTITY...... 16 L. Gifts, Trusts, and Disclaimers...... 16 1. TRUSTS: ASSET PROTECTION CHECKLIST...... 17 2. ASSET PROTECTION IMPLICATIONS OF COMMONLY USED ESTATE PLANNING TRUSTS...... 19 IV. DOMESTIC VENUES FOR ASSET PROTECTION TRUSTS...... 22 A. Introduction...... 22 B. Overview of Domestic Venue Asset Protection Trust Legislation...... 22 1. THE ALASKA TRUST ACT...... 22 2. THE DELAWARE TRUST ACT...... 23 3. THE NEVADA TRUST ACT...... 24 4. THE UTAH TRUST ACT...... 24 5. THE RHODE ISLAND TRUST ACT...... 25 6. THE OKLAHOMA FAMILY WEALTH PRESERVATION ACT...... 25 7. THE SOUTH DAKOTA QUALIFIED DISPOSITIONS IN

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TRUST ACT...... 26 8. THE MISSOURI UNIFORM TRUST CODE...... 26 C. Domestic Venue Asset Protection Legislation Vulnerabilities...... 27 1. FULL FAITH AND CREDIT PROBLEMS...... 27 2. SUPREMACY CLAUSE CONCERNS...... 31 3. CONTRACT CLAUSE PROBLEMS...... 36 D. Aside from Constitutional Problems, the Status of Domestic Venues as Pro-Debtor Jurisdictions is Questionable...... 37 V. OFFSHORE TRUSTS...... 37 A. General Principles...... 37 B. Methods of Attack...... 37 C. Exporting the Assets Versus Importing the Law...... 38 1. EXPORT THE ASSETS...... 38 2. IMPORT THE LAW...... 38 D. Enforcement of Judgments...... 39 E. Transfer of Situs...... 39 F. Location of Trust Assets...... 40 G. Nest Egg vs. In Toto...... 40 1. IN TOTO...... 40 2. NEST EGG...... 40 H. Control...... 40 I. Beneficial Enjoyment...... 41 VI. PRACTICAL IMPLEMENTATION...... 41 A. Step One: Investigate the Client and the Situation...... 41 1. FINANCIAL CONDITION...... 41 2. CLAIMS OR THREATENED CLAIMS...... 41 3. THE SOLVENCY ANALYSIS...... 41 4. POSSIBLE CRIMINAL ACTIVITY...... 42 5. COMPETENT ASSISTANCE...... 43 B. Step Two: Explore Motives...... 43 1. ECONOMIC OR INVESTMENT ISSUES...... 43 2. TAX OR ESTATE PLANNING ISSUES...... 43 3. PERSONAL OR FAMILY ISSUES...... 44 C. Step Three: Select Jurisdiction...... 44 1. AGGRESSIVE VS. NON-AGGRESSIVE LEGISLATION...... 45 2. RELUCTANCE TO RELOCATE ASSETS...... 45 3. CONSIDER THE LIKELY ORIGIN OF A CLAIM...... 45 4. LOCAL LAW...... 45 5. ECONOMIC AND POLITICAL STABILITY...... 46 6. COSTS...... 46 7. TRANSPORTATION AND COMMUNICATIONS...... 46 8. BANKS AND INVESTMENT ADVISORS...... 47 9. CRIMINAL ACTIVITIES...... 47 10. INFLUENCES OF OTHER COUNTRIES...... 47

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D. Step Four: Plan the Structure of the Offshore Arrangement...... 47 1. STRUCTURAL VARIATIONS...... 47 2. DRAFT AGREEMENT...... 49 3. LOSS OF CONTROL...... 49 4. ADDRESSING THE CONTROL ISSUE...... 49 5. RELATED PLANNING FOR PROTECTING ASSETS...... 50 6. DOCUMENTS...... 51 E. Step Five: Select Local Professionals...... 52 1. MORE THAN ONE PROFESSIONAL REQUIRED...... 52 2. FAMILIARITY WITH PROFESSIONALS...... 52 F. Step Six: Review Recent Case Law...... 52 G. Step Seven: Obtain Legal Advice...... 55 H. Step Eight: Execute the Documents and Deliver the Funds...... 56 VII. CONCLUSION...... 56

CHART A EXPORT THE ASSETS...... 57 CHART B IMPORT THE LAW...... 58 CHART C PRIVATE TRUST COMPANY/PURPOSE TRUST...... 59 CHART D "DROP-DOWN" CORPORATION...... 60 CHART E "SISTER" CORPORATION...... 61 CHART F LIMITED PARTNERSHIP...... 62 CHART G EXISTING CORPORATION (CONTROLLED BY SETTLOR)...... 63

iii PLANNING FOR ASSET PROTECTION Page 1

PLANNING FOR ASSET PROTECTION1

I. INTRODUCTION

There is increasing demand from wealthy clients for asset protection planning advice. Many such individuals sense a risk of serious economic threats and liabilities no matter what professional, business, or personal activities they undertake. They genuinely believe that the plaintiff's bar can make a case and generate liability under even the most absurd and unlikely sets of facts, and they consider our legal system to be capricious, unpredictable, and unlikely to render a fair result. Running parallel with this cynicism toward the court system is a similar skepticism with respect to legislative and regulatory bodies. Because of laws like CERCLA2, the Sarbanes-Oxley Act of 20023, and the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “BAPCPA”), business men and women have become increasingly wary of the government’s propensity to pass new legislation with potential liability consequences of dire and immediate impact.

At least six recent articles4 have raised the issue that a lawyer engaged in estate planning may have a duty to his clients to advise them about asset protection planning in addition to more traditional trust, estate, and tax planning advice. Whether or not such a duty exists, prudence suggests that estate planning attorneys be fully informed and able to address asset protection issues with their clients.

II. ASSET PROTECTION PLANNING AND FRAUDULENT TRANSFERS

A. The Client’s Right to Asset Protection Planning

The debate between advocates of creditors rights and advocates of asset protection is now, and long has been, a vigorous one. Articles on both sides of the debate from practicing lawyers are numerous and informative. Until recently, however,5 most of the articles written by law professors on this topic were “Johnny-one-note” choruses of criticism of asset protection planning (almost polemical in some cases) punctuated with titles ringing of indictment, such as: “Putting a Stop to ‘Asset Protection’ Trusts,”6 “Domestic Asset Protection Trusts: Pallbearers to Liability?,”7 “Asset Protection Trusts: Trust Law’s Race to the Bottom?,”8 and “Offshore Asset Protection Trusts: Testing the Limits of Judicial Tolerance in Estate Planning.”9

While proclamations from the ivory tower have occasional value for the practitioner, it is far too easy for a legal purist peering down from high aloft to focus on a few instances of flagrant abuse by asset protection planners and their clients, such as the Anderson10 and Lawrence11 cases, stake out a position of moral outrage, and then universally condemn anyone who dares to engage in asset protection planning. Although perhaps satisfying to the author’s sensibilities and finely-honed sense of moral rectitude after years in the academic community, such a reaction is simplistic, unhelpful, and unsupportable after even a cursory look at the law, the asset planning abuse protections already well established in the law (i.e., fraudulent transfer prohibitions and sanctions), and the equally well recognized legitimate nature PLANNING FOR ASSET PROTECTION Page 2 and function of estate and asset planning activities (e.g., wills, trusts, homesteads, life insurance, annuities, retirement plans, family limited partnerships, tenancies by the entirety, and on and on and on…).12

Almost all estate planning lawyers, almost all of the time, represent honorable, law abiding clients, men and women who daily contribute to society by their productivity and with their generosity, who pay their bills and their taxes, and who are not deadbeats, cheats, frauds or criminals. These same good people, some of whom have acquired significant wealth by their own hard work or that of their forebears, are legitimately concerned about the excesses of an American litigation system which sometimes more resembles a lottery-like payoff game than it does a reliable forum for the settlement of genuine claims. These clients of integrity, the persons who make up the vast majority of the clients with whom ethical attorneys deal every day, are both willing and eager to plan and act within the time-honored and well established rules of estate planning and asset protection planning. Such clients have the right to conduct estate and asset protection planning, and, as some have argued, we attorneys have a duty to assist them in this endeavor.13

Let’s be clear on this notion of duty. Even if some estate planning attorneys resist the idea, you can be assured the plaintiffs’ bar will not. The next wave of creative malpractice actions could well be against estate planning attorneys who fail to advise clients about asset protection alternatives, filed by clients who have suffered financial reverses which could have been avoided with such planning. The estate planner’s defense would be, of course, that “I do not do asset protection planning. I was engaged for estate planning purposes.” And any semi- competent plaintiff’s lawyer would have a field day with that response. Make no mistake about it, estate planning is about asset protection. Indeed, what are we estate planners about if not the preservation of wealth? Is the tax collector’s grasp the only one we are charged to avoid by all legitimate means for our clients? The creditor’s lawyer and the divorce lawyer can be every bit as much a predator as the tax collector. To ignore legitimate asset protection planning alternatives (including the asset protection trust) is to court disaster, for both your client and yourself.

The debate between advocates of creditor’s rights and advocates of asset protection cannot, then, turn on whether asset protection is proper. Rather, the only meaningful debate is the determination of the lawful and proper scope of asset protection planning.14

B. The Danforth Article15

In January 2002, Robert T. Danforth of Washington and Lee University School of Law published a balanced, provocative, and insightful article on creditor’s rights and trust law in the Hastings Law Journal. Anyone ready to take sides in the debate on creditor’s rights versus asset protection planning should read this thoughtful presentation for the new perspectives it brings to that debate. While there is far too much substance in Professor Danforth’s article to attempt to summarize his arguments and observations here, a few of his comments and conclusions are particularly noteworthy. PLANNING FOR ASSET PROTECTION Page 3

Professor Danforth’s most provocative and significant conclusion stems from his examination of the tautological maxim of American law that one cannot create a self-settled spendthrift trust. Professor Danforth points out that while the rule is essentially set forth in both Professor Austin Wakeman Scott’s treatise16 and the Restatement (Second) of Trusts17 (for which Professor Scott was the reporter and principal author), neither source offers a solid, independent rationale or theoretical basis for the rule.18 Moreover, and most interesting, the cases cited by Professor Scott do not, in fact, support the rule as he lays it out.19 As Professor Danforth gently remarks about these cases, it seems that “(Professor Scott) read them somewhat generously in support of his position.”20

Professor Danforth further argues that the rule against self-settled spendthrift trusts as espoused by Scott is not based on sound legal theory for a number of reasons. 21 First, the rule ignores the rights of non-settlor beneficiaries, since the creditor can defeat the interests of those beneficiaries as well as the interests of the settlor.22 It assumes a collusion between the settlor and the trustee in which the trustee will blindly comply with the settlor’s bidding, ignoring the legal obligations of fiduciaries.23 It grants creditors greater rights than the settlor, since the creditor can compel distributions and the settlor cannot.24 Finally, the rule fails to distinguish situations in which the settlor retains a power of disposition from those in which the settlor does not.25

Professor Danforth reminds us that such learned scholars of jurisprudence as Dean Erwin N. Griswold have criticized any rule against self-settled spendthrift trusts.26 Mindful that heirs and donees of wealth could avoid exposing inherited or gifted assets to the risks of creditors by having those assets placed in a spendthrift trust created by a parent or donor, Dean Griswold noted:

“[W]e may well question the soundness of a rule which allows a man to hold the bounty of others free from the claims of his creditors, but denies the same immunity to his interest in property which he has accumulated by his own effort.”27

C. Fraudulent Transfers

Asset protection planning is like tax planning, and all estate planning lawyers do tax planning. To do tax planning properly and legally, it must be done within the rules set forth in the tax code and tax regulations. In asset protection planning, the parallel rules are, in essence, the laws of fraudulent transfer.28

1. GENERAL PRINCIPLE.29 The statutory law regarding fraudulent transfers derives from the Statute of Elizabeth enacted in the year 1570. Most notably, this law declares "utterly void" conveyances, alienations, etc. designed to "delay, hinder, or defraud creditors."30 The Statute of Elizabeth is the historical model for modern fraudulent transfer statutes. At its heart, the Statute of Elizabeth is a legal remedy.

The general principle upon which the remedy (i.e., fraudulent transfer law) rests is that if a court determines that an asset transfer is fraudulent, a creditor can set aside the transfer. The fraud can be actual or constructive, and the law protects both existing and future PLANNING FOR ASSET PROTECTION Page 4 creditors.31 While statutes provide the general legal framework, case law usually supplies guidance in the determination of whether a transfer was made sufficiently in advance of the ripening of a creditor obligation so as not to be deemed fraudulent, but rather be considered prudent and permitted planning.

2. TYPES OF CREDITORS. At the risk of oversimplification, there are three categories of creditors one must consider when planning asset protection strategies.

a. Present Creditor. A present creditor is one against whom a tort was committed, or with whom a debt was contracted, by the client prior to the asset transfer in question.32 Credit card debt is an obvious example. Although intent to defraud always renders a transfer fraudulent, such intent need not be proved by a present creditor seeking to set aside a transfer. Rather, a transfer is fraudulent as to a present creditor if, regardless of the transferor's intent, the transfer renders the transferor insolvent.

b. Potential Subsequent Creditor. A potential subsequent creditor is a creditor whom a client could reasonably expect to face, i.e., a reasonably foreseeable claimant. In this category, the obligation arises after the asset transfer, and so the law is, by definition, protecting a future creditor. However, the event giving rise to the obligation may occur before the asset transfer. For example, in the tort context, one person may injure another, then transfer assets, and subsequently become a debtor of the injured party through a court judgment. In these circumstances, the transferor’s intent (whether actual or constructive) becomes critical. That is, a creditor whose claim arises after the transfer generally must show that the transferor intended to keep assets out of the creditor’s reach. Because intent may be difficult to prove, "badges of fraud" have been identified and articulated as evidence of intent.

"Badges of fraud" are fact patterns that frequently accompany fraudulent transfers. Generally, no single badge of fraud is conclusive in and of itself, but more than one badge of fraud, considered together, may lead to an inference of fraud. Commonly recognized badges of fraud include the following:33

(1) The debtor retained possession or control of the transferred property after the transfer.

(2) The debtor transferred substantially all of his or her assets.

(3) The transfer occurred shortly before or shortly after a substantial debt was incurred.

(4) Before the transfer was made or obligation was incurred, the debtor was sued or threatened with suit. PLANNING FOR ASSET PROTECTION Page 5

c. Unknown Future Creditor. An unknown future creditor is a creditor whom a client cannot reasonably foresee; for example, a party injured by the client in an auto accident at some future date, and for which accident the client is found liable. The courts have typically focused on protecting only those creditors whose claims are proximate in time to the asset transfer. Unknown future creditors removed in years and in events from the asset transfer have generally not been protected by the courts.34

3. WHAT CREDITORS SHOULD BE PROTECTED? Nowhere is it written that an individual must preserve his assets for the satisfaction of unknown future claims and claimants. If this were not the case, inter vivos dispositions of all sorts would be prohibited, be they gifts to children or friends, charitable contributions, or the settlement of trusts for the benefit of others. As Clifton B. Kruse, Jr. has said,35 “In order to establish that a conveyance is in fraud of creditors, there must be evidence that creditors exist (or creditors who could be reasonably anticipated) who could be defrauded. . . . Creditors alleging that a transfer was fraudulent must have, as a legal foundation for such allegation, an obligation that was present or not so remote as to have been foreseeable, to be other than a future possible creditor of an alleged debtor. There must be some scent of wrongdoing evidenced by gratuitous insolvency. Planning for one’s future well-being may be distinguished from fraudulently injuring creditors.”36

Professor Danforth concurs in this analysis. “[M]ost courts are unwilling to void transfers whose purpose and effect is to shelter assets from creditors that were unknown at the time of the transfer.”37 Professor Danforth also cites the writings of Professor Peter A. Alces, who argues for a “causal link”38 between an asset transfer and the injury allegedly suffered by a creditor:

[t]he focus on causality provides a means to distinguish between the actions that operate directly to prejudice a particular creditor and those actions that in some remote, not foreseeable way, have after the passage of considerable time or the occurrence of an intervening cause, compromised a creditor’s financial interest.39

The debate between advocates of creditor’s rights and advocates of asset protection can, and should, ultimately depend on which creditors are protected. The most serious and difficult challenge in this regard is to distinguish between a potential subsequent creditor and an unknown future creditor. That determination will always call for the exercise of the estate planner’s professional judgment, not unlike the “hard calls” involved in tax planning. Despite numerous and flagrant abuses in tax planning, no one has yet called for an end to tax planning. In the same way, though there have been abuses of asset protection planning tools and methods, that should not end the right to asset protection planning for those clients who are willing to play by the rules. PLANNING FOR ASSET PROTECTION Page 6

D. Proper Planning40

The proper approach to effective, careful asset protection planning begins with a solvency analysis of the client.

In an accurate solvency analysis, the lawyer should make a complete list of all of the client’s assets and then make three subtractions from the total value. The first subtraction should be the value of all current debts. Reserves must be established to satisfy these obligations. This action protects present creditors.

The second subtraction should include all liabilities, claims, contingent liabilities, threats, guarantees, contingent claims, pending lawsuits, and potential claims faced by the client. The lawyer should aggressively identify, document and quantify all of these liabilities. To assist in this exercise, it may be appropriate to conduct independent internet database research of the client’s financial/legal situation. In some cases, an audited financial statement is very helpful and should be secured. Furthermore, the attorney should inquire about the client's business and professional reputation. For example, does the physician client have a history of malpractice claims? Does the business client have a history of disputes with creditors, associates, etc.? After all liabilities are evaluated and summed, reserves must be set aside to satisfy them. This action protects potential subsequent creditors.

The third subtraction in the solvency analysis involves all client assets already protected from creditors under the law (e.g., homestead, insurance, and retirement plans). Such exemptions and protections vary tremendously from state to state, of course. In some cases, it may be advisable to join an attorney from another state (if that is where some assets are located) and/or join an attorney with creditor’s rights expertise (if there are pending claims against the client) as co- counsel.

Finally, at the end of the solvency analysis, the lawyer must devise a methodology to protect creditors. Indeed, that “creditor protection plan” is the entire purpose of the solvency analysis and is, in fact, the linchpin of prudent, careful asset protection planning.

For example, assume a client with the following assets and liabilities:

$ 20,000,000 total assets - 2,000,000 current debts - 3,000,000 claims, guarantees, contingent liabilities, threats, etc. (fully researched and quantified) - 4,000,000 protected assets, e.g., ERISA plan, homestead, annuities, life insurance $ 11,000,000 Unprotected net worth

The first element of the “creditor protection plan” is to set aside reserves sufficient to fulfill obligations to all present creditors and potential subsequent creditors ($5,000,000 in this PLANNING FOR ASSET PROTECTION Page 7 example). At this point, if the solvency analysis has been done thoroughly and correctly, then theoretically it is possible to do asset protection planning with the entire remaining unprotected net worth of $11,000,000. Such a course may, however, be unwise. In the event of a later challenge, the client will need to be able to demonstrate with some certainty that a reasonable margin of solvency existed at the time of any asset protection planning-motivated asset transfers. Planning with the full $11,000,000 by definition takes the client to the brink of insolvency.

Instead, lawyers and advisors should consider the concept of “Nest Egg” planning.41 The core idea of this technique is to plan with only a portion of the unprotected net worth available, leaving substantial wealth in the client’s hands and available to address the “unknown future creditor” problem.

In all events, a solvency analysis should be performed both before and after the asset protection plan is implemented. It is imperative to be able to demonstrate solvency both prior and subsequent to execution of the plan. Such an approach completes a conservative, defensible “creditor protection plan” and will make it extremely difficult for any claimant to sustain a fraudulent transfer argument. Again, an analogy to tax planning is appropriate: Always remember, pigs get fat and hogs get slaughtered.

E. Conclusion

Critics of asset protection planning are basing their resistance to such planning on arguments from the past without fully engaging the realities and client needs of the present. The law is alive. It evolves as times change, and “the times they are a changin’.” We live in an era of unprecedented litigation and litigiousness.42 The federal government, through ERISA, has explicitly sanctioned the concept of self-settled spendthrift trusts. Justice Scalia in the Grupo Mexicano case43 has all but blessed asset protection planning. Even the most outrageous asset protection trust cases, like Anderson, are being won or settled on terms generous to settlors.44 And last, but certainly not least, there is tremendous client demand for asset protection strategies that will preserve wealth against attacks from unexpected quarters in a world grown more uncertain than ever before. Whether the source of that demand is an echo of 9/11 fears, recent corporate scandals and the new emphasis on accountability in the corporate world, the liability insurance crisis, paranoia fed by asset protection marketers, or just simple foresight and prudence, clients want asset protection planning.

A major asset protection planning tool is the asset protection trust, the sort of trust that has historically often been an “instrument of tax reform” – especially when the laws require modernization.45 There are by some counts over sixty offshore jurisdictions with asset protection and asset protection trust legislation on the books. Eight states of the United States have adopted asset protection trust legislation which makes the self-settled spendthrift trust a reality in this country. Asset protection planning opportunities and techniques are readily available for our clients. It is incumbent upon us to help them take full advantage of those opportunities. PLANNING FOR ASSET PROTECTION Page 8

III. DOMESTIC STRATEGIES46

A. Introduction: Multiple-Entity Planning

1. DEFINITION. To help clients protect their wealth from potential creditor claims and possible future judgments, sophisticated attorneys engage in "multiple-entity" planning through the use of limited partnerships, corporations, various trust arrangements, foundations, retirement plans, life insurance and the like which, while perhaps originally conceived for the purpose of tax planning or wealth transfer, have the additional benefit of asset protection.

2. THEORY. "Multiple-entity" planning dictates that wealth should be segregated and placed in isolated, sheltered legal compartments.

3. METHODS. Opportunities for asset protection planning abound in domestic legal vehicles such as corporations, limited partnerships, limited liability companies, limited liability partnerships, trusts, retirement plans, life insurance, annuities, homesteads, spousal arrangements, inheritances, and foundations. Permutations and combinations of these entities and variations of the law between jurisdictions offer even more opportunities. For example, passive assets can be segregated from those with liability exposure (e.g., marketable securities can be segregated from an apartment complex); certain entities may be separated into multiple entities in order to achieve superior asset protection (e.g., two limited partnerships can be created to hold two pieces of real estate, each of which has an inherent risk or liability); limited partnerships can be deployed in conjunction with trusts; and corporations or limited partnerships can be formed in hospitable jurisdictions such as Delaware and Nevada.

4. LAWS OF THE STATES. The laws of the fifty United States vary markedly in what they offer by way of creditor protection.47 Recent attention has focused on Alaska and Delaware, and, to a lesser extent, Nevada, Utah, Rhode Island, Oklahoma, South Dakota, and Missouri, which now have statutes that purport to protect self-settled discretionary trusts from creditor attack. A discussion of possible weaknesses of these statutes (including constitutional issues raised thereby) is found at Part IV below.48 However, although opportunities for domestic asset protection planning exist in every state, the asset that is shielded in one jurisdiction may be exposed in another.

The BAPCPA may have the effect of making it more difficult for debtors in bankruptcy to take advantage of a given state’s protections simply by moving before filing for bankruptcy. The BAPCPA amends 11 U.S.C.A. § 522, which grants debtors their choice of exemptions between those provided in § 522(d) or those provided under other federal law [including the exemptions available for jointly-owned property and retirements accounts under § 522(b)(3)(B) and (C), respectively] and the state law of the debtor’s domicile. 49 Under pre- BAPCPA law, domicile was determined for state exemption purposes by the debtor’s domicile during the 180 days immediately preceding filing of the bankruptcy petition. The BAPCPA expands this period to 730 days (two years). Alternatively, if the debtor has not been domiciled in the same state during the preceding 730 days, domicile will be the state where the debtor was PLANNING FOR ASSET PROTECTION Page 9 domiciled during the 180-day period preceding the 730 day period, or for the longer portion of such 180-day period if debtor resided in more than one place. Finally, if under the BAPCPA rules the debtor does not qualify as a domiciliary of any state, then he or she may opt for the federal exemptions under § 522(d).

The most obvious effect of these new provisions will be to prevent a debtor from moving on the eve of bankruptcy in the hopes of taking advantage of more favorable state exemptions. However, consider Debtor who resided in State A for six months before moving to State B, where he resided for two months. From State B, Debtor moved to State C, where he resided for one year, then to State D, where he resides when he files for bankruptcy one year later. Under this scenario, Debtor’s domicile for § 522 purposes would be State A, even though he resided in three other states since living in State A and he resided in two of those states for a longer period than in State A. Of course, whether this change benefits or hurts Debtor will turn on whether State A provides strong exemptions or weak ones.

B. Homestead

Most of the jurisdictions in the United States have enacted protective legislation for the homesteads of domiciliary debtors. The value and acreage amounts that are protected vary widely from state to state. For instance, New Jersey, Pennsylvania, Rhode Island, and the District of Columbia provide no protection whatsoever for a debtor's residence, while Texas and Florida protect up to 200 rural acres and 160 rural acres (and 10 urban acres and one-half of an urban acre), respectively, with no value limitation on the land or improvements. However, even in those states that have generous homestead protections, the homestead is not completely exempt from the claims of all creditors. Several types of claims are uniformly allowed against otherwise exempt homesteads. These claims include claims for purchase-money debt, claims for money lent to construct or make improvements to the homestead, claims for ad valorem taxes on the homestead property, and, in many cases, federal statutory liens such as federal income tax liens. Other commonly allowed claims are those for mechanic's, materialman's, and workman's liens, and any liens created by the grant of a valid security interest in the homestead.

The BAPCPA limits the homestead exemption for debtors in bankruptcy. For debtors choosing state exemptions, the BAPCPA adds new subsections (o) through (q) to 11 U.S.C.A. § 522. Subsection (o) reduces the value of the exemption for the homestead to the extent that (1) such value is attributable to property that the debtor “disposed of” in the 10-year period preceding the petition date; (2) the debtor disposed of the property with the intent to hinder, delay, or defraud a creditor; and (3) such property or portion of property would not have been exempt on the petition date if debtor had not so disposed of it. New subsection (p) limits the value of the homestead exemption to $125,000 if the debtor acquired the homestead in the 1215-day (approximately 40-month) period preceding the filing of the petition. This provision does not apply to any amount transferred from the debtor’s prior residence to his or her current residence in the same state if the prior residence was acquired outside the 1215-day period. Subsection (q) caps the homestead exemption at $125,000 (except that it may be increased if reasonably necessary for the support of the debtor and his dependents) if the debtor: (1) is convicted of a felony evidencing that the filing of bankruptcy was abusive; or (2) owes a debt PLANNING FOR ASSET PROTECTION Page 10 arising from (a) violations of federal or state securities laws, (b) fraud, deceit or manipulation of a fiduciary capacity in the purchase or sale of securities, (c) violations of RICO, or (d) any other criminal act, intentional tort, or willful or reckless conduct resulting in physical injuries in the preceding 5 years.

As with all new legislation, the full effect of the changes will not be known until the courts have begun to apply them to actual cases.50 However, the effects of the homestead provisions are likely to be felt most extensively in states like Florida and Texas, which provide for unlimited homestead exemptions. Subsection (q) may be especially significant in the context of planning for directors of publicly-traded companies. However, careful long-term planning may help to curb these effects.

C. Personal Property

There are wide variations among U.S. jurisdictions regarding exemptions for personal property. Some states emphasize protecting the tools of one's trade while others focus on livestock and other farm and ranch assets. Still others focus their protection on homestead furnishings. Some of the laws are antiquated and reflect the priorities of a previous century, and some have been modernized to cover victim's reparation awards, health aids, copyrights, trademarks, and personal injury awards.51

D. Life Insurance and Annuities

The protections for life insurance and annuities reflect the relative power of the insurance lobby. As to life insurance, protection for the debtor varies depending upon pre-death versus post-death statutes, the beneficiary named, and the status of premiums. Some states deal with annuities along with life insurance and some ignore annuities altogether.

E. Income

Many states offer a wide variety of protections for wages and other income, depending on the classification of that income. Some states allow garnishment of earned income while others do not. Additionally, some protect wage replacement income such as veterans' benefits or disability income.

F. Retirement Plans

The asset protection features of retirement plans are affected by both state and federal law. In general, federal law uniformly protects the assets of qualified retirement plans from the employer's or the employee's creditors. Each state may have additional exemptions that apply to plans not covered by federal law. In addition, state protections, if any, are applicable after assets have been distributed from a qualified plan. These protections vary widely from state to state.

ERISA and the Internal Revenue Code operate to provide very broad protection of qualified retirement plans (plans within the scope of Internal Revenue Code § 401(a)--pension, profit-sharing, stock bonus or annuity plans). ERISA requires that the assets of a qualified plan PLANNING FOR ASSET PROTECTION Page 11 be held in a trust that is not subject to the claims of the sponsoring employer's creditors. These types of plans must also contain provisions that prohibit employees from assigning their interests in the plan. Of course, this protection does not insulate the plan assets from the claims of a spouse, former spouse, or child under a qualified domestic relations order. ERISA provides no protection for nonqualified deferred compensation plans or individual retirement accounts.

Due to the significant amounts that many people accumulate in qualified retirement plans today over their working lifetimes and beyond, these exemptions are extremely important. The presence or absence of a state statute protecting individual retirement accounts might be a significant factor for a retiring participant considering whether to leave retirement plan monies in a qualified retirement plan on retirement, or to roll them over into an IRA. The variation in the protection afforded IRAs among the states might also be a factor in this decision for a relocating retiree.

Section 522(d)(10)(E) of the Bankruptcy Code exempts payments from certain retirement plans to the extent reasonably necessary for the support of the debtor and his or her dependents, but courts have been split for some time as to whether IRAs were covered under this provision. As a result of this split and the more favorable exemptions available under some state laws, debtors have often opted for state law protection for IRAs, where available. In April 2005, the U.S. Supreme Court decided Rousey v. Jacoway,52 which resolved a three-way split among federal circuit courts by unanimously holding that IRAs are covered under § 522(d)(10)(E). The significance of the Rousey decision will likely be limited by the enactment of the BAPCPA that same month, which adds new subsections (b)(3)(C) and (d)(12) to § 522. These new provisions expressly exempt IRAs for debtors who elect state exemptions or federal exemptions, respectively. New subsection (n) caps the exemption, however, at $1 million, exclusive of amounts attributed to qualified rollovers. It appears that the cap under subsection (n) will apply to limit the exemption, whether taken under subsection (d)(12) or state law.53 The cap may make other planning tools more attractive. For example, SEPs and SIMPLE-IRAs are expressly excluded from the $1 million cap. Individuals who qualify to participate in 403(b) and 457 plans may want to roll large IRAs into those plans because such plans are not capped. Furthermore, because of the unlimited exemption for rollover contributions, it may be a good idea to keep IRAs funded with rollover contributions separate from those funded with annual contributions.

The BAPCPA also added new subsection (b)(4) to § 522, creating a presumption that retirement funds that have received a favorable ruling of qualified status from the IRS may be exempted from the bankruptcy estate. On the other hand, funds that have not received a favorable determination will be exempt if the debtor establishes that a court or the IRS has not issued a contrary ruling and either that the funds have been administered in substantial compliance with Internal Revenue Code or that the debtor was not responsible for any such failure to comply. Subsection (b)(4)(C) provides that rollovers from one exempt fund to another will not lose exempt status. Finally, subsection (b)(4)(D) permits an exemption for either “eligible rollover distributions” [as defined under IRC § 402(c)]54 or distributions from certain qualified plans that are rolled over into another qualified plan within sixty days. PLANNING FOR ASSET PROTECTION Page 12

G. Federal Statutes

A number of federal statutes protect individual assets: one law, for example, protects a seaman's clothing, while other laws shelter trillions of dollars in retirement plans. The federal government protects certain benefits derived from military service; for example, the pension of a Medal of Honor recipient cannot be attached or garnished.

H. College Savings Plans

Federal law allows states to create college savings plans in which the income earned may be effectively tax-free if used for certain educational expenses. These plans are commonly open to participation by residents and non-residents alike, so that everyone can shop all plans available in the U.S. to determine what plan best fits a student’s needs. Most state statutes creating these plans provide the assets in the plan with some protection from the claims of the owner’s or beneficiary’s creditors. However, there is some question as to how effective these provisions may be for residents of other states. For this reason, care should be taken to examine the exemptions available in the state of residence, as well as the state sponsoring the plan.

The BAPCPA amended 11 U.S.C. § 541 to exclude from the bankruptcy estate certain education IRAs and tuition plans under §§ 529 and 530 of the Internal Revenue Code. In general, these funds must benefit a child, stepchild, grandchild, or step-grandchild of the debtor. The exclusion for § 529 plans is limited to (1) funds not exceeding the contribution limits of § 529 (amount necessary to provide for the beneficiary’s education expenses) that were contributed not later than a year preceding filing of the petition, and (2) $5,000 for all such accounts having the same designated beneficiary during the period between 1 year and 2 years preceding the petition date. The exclusion for education IRAs is limited to (1) funds not exceeding the contribution limits of § 4973(e) ($2,000 or less) that were contributed not later than a year preceding filing of the petition, and (2) $5,000 for all such accounts having the same designated beneficiary during the period between 1 year and 2 years preceding the petition date. The effect of these provisions is to include in the bankruptcy estate the amounts not qualifying for the new exclusions. However, these amounts may be pulled back out of the estate as exempt if the debtor opts for state law exemptions under § 522 and the debtor's state protects such contributions from creditors. The BAPCPA also amends § 521 to require a debtor (the “contributor” under §§ 529 and 530) to file a notification of an interest in an education IRA or qualified state tuition program.

I. Joint Property Ownership

Another simple domestic asset protection strategy involves the structuring of property ownership. Joint ownership of property provides little theoretical protection from creditors. However, as a practical matter, certain joint ownerships effectively discourage creditors. Even switching from a co-tenancy to a joint tenancy can provide a modest improvement in asset protection. PLANNING FOR ASSET PROTECTION Page 13

J. Marital Property Positioning

1. GENERAL RULES OF MARITAL PROPERTY LIABILITY. The rules of liability for debts of a married couple depend on when the debt was entered into, what kind of debt is at issue, and what kind of property is at issue. The first question is which spouse has liability for the debt. In general, one spouse has no liability for the debts of the other spouse unless the spouse is liable under other rules of law, or one spouse acts as agent for the other. Both spouses are generally liable for debts for necessaries. Once spousal liability has been determined, the availability of each type of property is considered. One spouse’s property should not be subject to another spouse’s debts. However, especially in community property states, the liability of marital or community property for one spouse’s debts may be an issue.

2. MARITAL PROPERTY PLANNING. Planning for appropriate ownership of marital property can have important asset protection benefits. Of course, any marital property planning that has as its goal asset protection will have far-reaching implications to each spouse. It will alter the spouses’ rights with respect to their property, including the spouses’ rights to property in the event of divorce, and the division of property on death. Changing community property into separate property will allow only one-half of the property to receive a step up in basis at one spouse's death (whereby the basis of the property for capital gain purposes is deemed to be its value on the date of death, rather than the purchase price), whereas under current law, all of the community property will receive a step up in basis at one spouse's death. Due to these wide-ranging implications, it is preferable for each spouse to have separate legal counsel in marital property planning situations.

a. Books and Records. The most important step in any marital property planning is that the parties keep good books and records concerning the ownership of their property. The danger is that the different types of property unintentionally may become mixed together and lose any asset protection benefits that may be available. If only one spouse is to be liable for a specific debt, the spouses should take care in their representations to any potential lender that they do not lead the lender to believe that the other spouse's property may be available to satisfy the debt.

b. Marital Property Agreements. Spouses generally can change the nature of their marital property through premarital agreements or marital property agreements. These agreements can directly affect what property will be available to satisfy a creditor's claims by changing the ownership of the property. Sometimes the purpose behind these arrangements is to allocate all of the property to the spouse with the least creditor exposure. In other cases, the goal may be simply to divide the property equally, so that only half will be subject to the claims of the creditors of one spouse.

c. Gifts Between Spouses. Another way to accomplish the allocation of property to one spouse is for the spouses to make gifts to each other. A marital property agreement specifying that the gift has taken place and addressing the future income from the gifted property may or may not be done in conjunction with such a gift. Any such gifts between PLANNING FOR ASSET PROTECTION Page 14 persons contemplating marriage should be done after marriage, so that the marital deduction will be available and the gift will not be subject to gift tax.

Achieving asset protection by shifting the ownership of assets between spouses involves a determination as to which spouse is the most likely to be subject to creditors’ claims, which is always a gamble with varying degrees of risk (depending mostly on the parties' professions). However, when that shifting is done by means of gifts, the spouse making the gift can create a trust for the benefit of the other spouse, thereby shielding the assets from the claims of both spouses’ creditors.55 The use of trusts also allows the gifting spouse to retain some control over the ultimate disposition and management of the assets.

d. Tenancies by the Entirety. In states where ownership of property as tenants by the entireties is possible it may provide significant asset protection benefits. This form of joint property ownership, available only between married persons, generally protects property from the claims of one spouse’s creditors. When one spouse dies, the other takes the property free of the first spouse’s debts. However, this protection is available only so long as the parties are married. Once the property is wholly owned by one spouse, the property may be reached by that spouse’s creditors. Similarly, if the property is converted into some other form of joint ownership, each spouse’s portion will be subject to his or her debts.

K. Business Arrangements—General

1. LIABILITY ASSOCIATED WITH SPECIFIC ACTIVITIES. Individuals are often engaged in activities that have inherent liability risk, such as the ownership of real property. By placing the activities that generate these risks into a limited liability vehicle, such as a corporation, a limited liability company, or a limited partnership, the client can insulate, to some degree, the rest of his wealth from liabilities associated with the activity. The choice of the specific entity will depend on an analysis of the complexity of administration of each business structure, the exposure of the activity and the entity to the state taxes, and the client's estate planning goals with respect to the property. The shareholders of a corporation and the members of a limited liability company are not liable beyond their investments for claims arising out of the activities of the entity. Limited partners in a limited partnership have a status similar to that of shareholders in that regard. However, a limited partnership must have a general partner whose liability is not limited in this respect. Therefore, if this type of asset protection is desired, the general partner should not be an individual, but a limited liability company or corporation.

2. OTHER THREATS TO WEALTH. Contribution of assets to family- owned business entities may also provide some protection from an owner's general creditors. Creditors of an individual owner of an interest in a business entity generally have access only to that interest, not the assets of the entity. Any interest in a family-owned business entity will be subject to the claims of the creditors of the owner of that interest to some degree. However, ownership of such an interest may not be appealing to a creditor, which may be a factor influencing settlement of a case. There are two key reasons that such ownership may be unappealing. First, it may be a minority interest that gives the creditor little or no control over PLANNING FOR ASSET PROTECTION Page 15 the manner in which the business is run. In addition, it may not be marketable, either due to transfer restrictions or simply because no buyers are willing to buy the interest. These are, of course, the same features that depress the value of interests in these entities for federal estate and gift tax purposes. The key feature of both of these "discounts" in value for interests in a business entity is ownership by multiple parties. In general, the more control an individual party has over the business entity, the more exposed the entity is to the claims of the individual's creditors.

a. Corporations. Corporations are probably the least effective of business entities in this regard. If a creditor seizes shares of a corporation, the creditor may exercise all of the rights of a shareholder. These rights may not be significant to the creditor if he or she has a small minority interest. If there are multiple owners of a corporation, some protection may still be available if the seizure triggers a buy-sell agreement that has been previously negotiated.

b. Limited Liability Companies. Limited liability companies, on the other hand, have significant asset protection features. These features vary on a state by state basis. Membership in a limited liability company is personal to the individual member. Only members or their designated managers have a voice in management of a limited liability company. A judgment creditor may petition a court for a charging order against the interest of a member in a limited liability company, so that the creditor has a right to receive distributions with respect to that member's interest and rights to certain information. The creditor has no right to become a member. The creditor may be subject to income taxes on the income attributable to a membership interest, even if it is not distributed.56

These rules are designed to protect the members of a limited liability company from the interference of an uninvited third party. As such, the degree to which they will be respected if the limited liability company has only one member is still being determined by the courts. A limited liability company with only one member may not be afforded the same types of protection as a company having multiple members.

c. Limited Partnerships. Limited partnerships also offer some asset protection features. Limited partners by their nature do not have rights in the day-to-day management of the partnership; this authority rests with the general partner. Typically, in a family-owned entity, there are also significant restrictions on the ability to transfer limited partnership interests. However, a creditor of a limited partner has even fewer rights than the limited partner himself.

Under most state statutes, a judgment creditor of a partner may petition a court for a charging order with respect to a limited partner's interest in the partnership, which gives the creditor the right to receive any distributions that would otherwise be made to the debtor/partner. Under some circumstances and in some states, the creditor may actually be able to obtain the underlying partnership interest, which also gives the creditor the status of an assignee. Assignees of a limited partner's interest have even fewer rights than limited partners have; they have only the rights to share in PLANNING FOR ASSET PROTECTION Page 16

distributions to the extent the general partner chooses to make them. However, the assignee is subject to income taxes on the income earned by any pass-through entity, whether received or not. They cannot become limited partners without the approval of all of the other partners (or pursuant to any other procedure specified in the partnership agreement). Even if a creditor is able to sell the interest to a third party, he will likely have to discount the price substantially (if he can find a buyer in the first place) due to the lack of control and illiquidity that characterize interests in limited partnerships.

The general partner's role in a limited partnership is critical. If an individual is a general partner and his interest is alienated, it is generally treated as a withdrawal from the partnership. The general partner's interest may be converted to a limited partnership interest or may be purchased by the partnership or the other partners upon a vote by the limited partners. If any general partners remain, the partnership is continued if the agreement so provides. If no general partners remain, the limited partners may vote to continue the partnership and appoint a new general partner. The presence of more than one general partner is therefore important. If the general partner is a corporation or limited liability company, ownership by multiple parties is important so that the creditors of one party cannot gain control over the general partner and thereby the partnership.

3. RESPECTING THE BUSINESS ENTITY. With each kind of business entity that might be used for asset protection purposes, protecting the integrity of the entity is important. The creditor's argument is basically "why should I be forced to respect the structure of the entity, if the owners have chosen not to?" In the corporate context, this theory has been used to impose liability on the shareholders for a corporation's debt, and is known as "piercing the corporate veil." This traditional concept of piercing the corporate veil is also being used by courts to ignore the business entity and allow the creditors of an individual owner to access assets owned by the business entity. This “reverse-veil piercing” theory is being used against corporations, limited partnerships, and limited liability companies. As illustrated by one leading case in this area, C.F. Trust, Inc. v. First Flight Limited Partnership, 580 S.E. 2d 806 (Va. 2003), the courts’ decisions are heavily influenced by the individual facts of each case, as well as the court’s overall impression of the equities involved.

As a practical matter, this issue is not as serious for limited liability companies and partnerships as for corporations, simply because there are fewer formalities to be observed. However, preserving the financial life of these entities separate and apart from that of their owners is critical to their success as asset protection vehicles. For this reason, owners should avoid such obvious pitfalls as paying personal expenses from business accounts, or having a business entity own a primary residence which a member or partner is allowed to use rent-free.

L. Gifts, Trusts, and Disclaimers

Many U.S. asset protection opportunities exist in the traditional estate planning areas of gifts, trusts, and disclaimers. While state statutes differ in their treatment of disclaimers (in some PLANNING FOR ASSET PROTECTION Page 17 states it can be a fraudulent transfer and in others it is not, even with an existing creditor), old- fashioned estate planning through gifts and trusts enables many patriarchs and matriarchs to insure the financial future of successive generations. Surprisingly, however, many states ignore or dilute the protection afforded by "spendthrift" clauses.57 Therefore, a practitioner's knowledge in this area might lead to the conclusion that forum shopping within the fifty United States is appropriate even for life insurance trusts, "Crummey" trusts, and other commonplace estate planning trusts.

1. TRUSTS: ASSET PROTECTION CHECKLIST. Leaving assets to a beneficiary in trust has been the traditional method of shielding the assets from the claims of the beneficiary's creditors, or saving the beneficiary from himself. Although the use of trusts is currently being pursued in many new contexts, the traditional spendthrift trust remains the most common asset protection planning device.

a. "Spendthrift" Protection. A spendthrift trust is one that contains a provision prohibiting the beneficiary from assigning his interest in the trust, and also prevents a beneficiary's creditors from reaching the beneficiary's interest. Spendthrift provisions are respected as being within the power of a donor to place conditions on any potential gifts. This principle does not extend to the individual himself - the large majority of American jurisdictions adhere to the traditional rule that a person cannot shield his own assets from the claims of his creditors.

Because a person cannot effectively place assets in a spendthrift trust for his own benefit, identifying who created the trust and transferred assets to it is important for asset protection purposes. A person who is entitled to receive funds but requests the payor to pay the funds to a trust will be considered the settlor of that trust. If two people create identical trusts for each other, under the “reciprocal trust” doctrine, each will be considered as creating his or her own trust. Finally, a beneficiary’s powers over the trust assets may be so extensive that the beneficiary is treated as the owner of all of the trust assets, and therefore a creator of the trust. The identification of the settlor does not stop at the names on the trust document, or even the identity of the persons who made the physical asset transfers.

b. Interest of the Beneficiary. If a creditor is able to reach assets held in a spendthrift trust, the creditor can reach only the beneficiary's interest in the trust. For this reason, defining and limiting that interest is very important.

(1) Distribution Standard. A creditor of a beneficiary will have more difficulty reaching a beneficiary's interest in a trust if distributions to that beneficiary are not fixed, but are subject to the discretion of the trustee. The broader the trustee's discretion, in general, the greater the protection. This protection is magnified if there are multiple beneficiaries among whom a trustee may "sprinkle" distributions. Finally, a beneficiary's interest in a trust may change depending on his or her circumstances. For example, a trust providing for mandatory distributions might convert to a discretionary trust if the beneficiary becomes insolvent. PLANNING FOR ASSET PROTECTION Page 18

(2) Powers of Appointment. Many trusts that are motivated by tax planning contain general powers of appointment which give a trust beneficiary the authority to vest trust assets in himself, his estate, his creditors, or the creditors of his estate. There is a split of authority as to whether or not a creditor may reach trust assets subject to a beneficiary's power of appointment. One line of authority is that a power of appointment is a property right, and a creditor should have all that the beneficiary may reach.58 This view is certainly the case in bankruptcy proceedings. The more common rule under state law, however, is that a power of appointment is an intensely personal right, and exercise of that power may not be forced by a creditor.

A second issue is whether or not the lapse of a power of appointment causes the trust to be a self-settled trust, thereby nullifying the effect of any spendthrift clause. A lapse of any power of appointment has this effect for income tax purposes. Lapses of powers of appointment in excess of the greater of $5,000 or 5% of the trust assets certainly have this effect for estate, gift, and generation-skipping transfer tax purposes. This question is largely unanswered in most states.

c. Duration of the Trust. One limitation on spendthrift protection is that it only applies so long as trust assets remain in the trust. Once in the hands of the beneficiary, the assets are fair game to creditors. Placing the assets in trust for as long as possible therefore has asset protection advantages. Most states still subscribe to the traditional rule against perpetuities, which states that all interests in property must vest no later than twenty- one years after the death of the last survivor of "lives in being" on the creation of the interest. Translated in practical terms, the Rule requires termination of a trust no later than twenty-one years after the death of the last survivor of a group of people who are living when the trust is executed. Several American jurisdictions have modified this rule or abolished it altogether.

d. Selection of the Trustee. Appointment of a trustee who is not a beneficiary of the trust is generally preferable for asset protection purposes. At common law, if the trustee was also the sole beneficiary of the trust, equitable and legal title to the trust assets were "merged," and the trust was disregarded. This rule has been eroded to a significant degree. For example, many state statutes provide that a spendthrift trust is by definition not subject to the merger doctrine. In addition, many courts have held that any interest, even a remote, contingent interest, held by any other beneficiary, will defeat the doctrine of merger. However, separation of these two roles continues to be the most effective course for asset protection. Recently, the authors of the Restatement (Third) of Trusts seem to have embraced a position that spendthrift provisions may be weakened or undermined when the beneficiary of a discretionary trust is also the trustee.59 Although this view has not been widely accepted, if a beneficiary is also a trustee, a creditor can more easily make arguments that the trust should be disregarded due to a beneficiary’s lack of observance of the trust terms, or easy availability of trust assets.

e. Threats to Assets Held in Trust.

(1) Limits on Spendthrift Protection. The most serious limit on spendthrift protection has already been discussed; that being that the protection only exists so PLANNING FOR ASSET PROTECTION Page 19 long as the assets remain in trust. However, there are other common limitations. For example, state law may allow child support payments owing by a beneficiary to be recovered from a trust, but only to the extent the trustee actually makes distributions from the trust. In addition, a creditor who provided necessaries to the beneficiary may be able to reach those trust assets that the trustee would apply for the beneficiary's support in the exercise of reasonable discretion.

In a few states, limitations on spendthrift protection are more extensive. Spendthrift clauses may protect only a certain amount of trust assets in some states. Or spendthrift trusts may be vulnerable to claims for child or spousal support, or claims by the state or the United States. A few states allow tort creditors of a beneficiary to reach spendthrift trust assets.

The presence of this wide divergence in trust law underscores the importance of the question of which law applies. When the settlor, beneficiary, and trustee live in different states, the question of which state law will apply to a creditor's claim will depend on the trust terms and the nature of the trust question at hand. Although a trust may specify the state's law that is to be applied in interpreting a trust, these types of directions may not be respected in all cases or with regard to all questions, especially if that state has no other connection to the trust.

(2) Disregarding the Trust. Sloppy record-keeping and a trustee commingling its personal assets with those of the trust can seriously undermine any asset protection that would otherwise be afforded to trust assets. This danger is particularly acute if the beneficiary is also the trustee and has failed to segregate personal assets from trust assets. Even though courts are reluctant to disregard spendthrift protection, and any such errors would be a breach of trust, an inability to demonstrate that a real trust exists may place the assets in jeopardy, especially in the divorce and bankruptcy contexts.

2. ASSET PROTECTION IMPLICATIONS OF COMMONLY USED ESTATE PLANNING TRUSTS.

a. Credit Shelter Trusts/Bypass Trusts. Probably the most commonly used type of trust in estate planning is a trust created at the death of one spouse for the benefit of the surviving spouse to utilize the deceased spouse’s unified credit against estate and gift taxes. This amount today shelters the first $2 million of a person’s assets from estate tax. For example, a person’s will might provide that $2 million will pass to a trust for the benefit of the surviving spouse. The trust assets will be sheltered by the deceased spouse’s estate tax exemption and will not be subject to estate tax at the surviving spouse’s death. The very features that cause these trusts to escape estate tax at the surviving spouse's death make them effective asset protection vehicles. For maximum asset protection, an independent trustee should be appointed, and distributions should only be made in the trustee’s discretion.

Spouses can also create these types of trusts while they are alive. Making large lifetime gifts is a very effective estate planning tool because it allows all future income and appreciation to escape estate and gift tax. However, many individuals are not quite ready to PLANNING FOR ASSET PROTECTION Page 20 completely remove large sums of money from the pool of assets that might be available for their support in the future. In this situation, one spouse can create a trust that is available for the other spouse’s support if needed. Any remaining assets will pass tax-free to the couple’s children at the spouse’s death. In this way, both tax planning and asset protection goals may be achieved.

b. Marital Deduction Trusts. Many people today are reluctant to make gifts that require the payment of gift tax. Today, the exemption from estate tax is $2 million, yet only $1 million of this amount may be applied towards lifetime gifts. With exemptions from estate tax on the rise, it may very well be that the client’s assets will not be subject to estate taxes at his death. Once a client has given away his full exemption from gift tax, if further gifts to a spouse are desired, a marital deduction trust should be considered. These types of trusts can be created at the death of one spouse, or during both spouses’ lifetimes. Gifts to this type of trust generate no gift or estate tax when the trust is created. For this reason, the terms of these trusts are largely governed by the Internal Revenue Code. All income must be paid to the spouse/beneficiary. To the extent the spouse/beneficiary receives this income, spendthrift protection is lost, unless some other state exemption applies.60 However, principal can be accumulated or distributed in the trustee’s discretion. The trust assets are subject to estate tax at the spouse/beneficiary’s death. However, the trust assets should not be subject to the claims of the spouse/beneficiary’s creditors.

c. Generation-Skipping Trusts. Trusts that are designed to be preserved for several generations, or generation-skipping trusts, are generally designed to avoid estate tax at the passing of each generation. For example, a parent might create a trust for a child’s benefit that would last for his lifetime, with the remainder passing to the child’s children. The trust would be structured so that it would not be subject to estate tax at the child’s death, thereby “skipping” a generation of tax.

There is a generation-skipping transfer tax that applies when assets “skip” a generation of taxes in this way. However, each person has an exemption from this tax, which is currently $2 million. So, a parent could place $2 million in this type of trust today, and the trust, including all growth of the trust assets, would be protected from estate tax, the generation- skipping transfer tax, and the claims of the beneficiary’s creditors.

Once the $2 million limit is reached, additional assets may be placed in trusts that last for the beneficiary’s lifetime. These trusts should be structured so that they are subject to estate tax or generation-skipping transfer tax at the death of the member of the second generation (i.e., the child of the donor). However, all of the other asset protection features available to generation-skipping trusts are available to these types of trusts as well.

Other general principles of trust law are important here as well. For maximum asset protection, a beneficiary should not be the sole trustee. Distributions to the beneficiary should be made in the trustee’s discretion. Formalities of the trust must be observed. However, the spouse of the donor may be a permitted beneficiary of the trust if this type of safety net makes the donor more comfortable in making these gifts. PLANNING FOR ASSET PROTECTION Page 21

d. Crummey Trusts. Each person may give up to $12,000 per year to as many people as he wishes without gift tax. Persons who wish to utilize these annual exclusions from gift tax by making gifts to minors often do so by making gifts to trusts. Crummey trusts give the beneficiary a power to withdraw the amount of any gift made to the trust, which lapses if unexercised after a short period (often thirty days). This withdrawal power allows the gift to be subject to the annual exclusion.

The property subject to the withdrawal power is vulnerable to creditors during the period it exists. Whether or not the lapse of a withdrawal power has adverse asset protection consequences is an open question in most states.61 Although the asset protection exposure is generally limited with these types of trusts, it can become larger if "hanging" powers of withdrawal are used. These powers of withdrawal lapse only to the extent of the greater of $5,000 or 5% of trust assets per year, while the rest of the property continues to be subject to the power. This amount can grow quite large over a period of years, and it continues to be vulnerable as long as the power exists.

e. Life Insurance Trusts. Life insurance trusts are commonly structured as Crummey trusts. However, the investment of trust assets in life insurance may be a factor that increases the asset protection available for assets in these trusts.

f. Charitable Remainder Trusts. Charitable remainder trusts provide for the payment of a fixed amount (a percentage of the trust assets or a fixed dollar amount) to a beneficiary for a specified period of time, followed by a payment to charity at the trust's termination. These trusts allow the donor to obtain a charitable income tax deduction for the value of the charity’s interest at the time the trust is created. The trust itself is not subject to income tax. Taxes are paid by the beneficiary as funds are received from the trust.

The fact that the payment is fixed reduces the asset protection available to a beneficiary, since a trustee generally has no discretion to accumulate the distribution rather than pay it to the beneficiary, unless some other state exemption would protect these payments. 62 In contrast, if a person creates a charitable remainder trust for his or her own benefit, some asset protection might be achieved. The settlor’s interest in the trust would generally not be protected by a spendthrift clause. However, the settlor's only interest in the trust would be the right to the fixed payments; the corpus of the trust would be protected. In states that allow self-settled spendthrift trusts (see Part IV below), it may be possible to protect the settlor’s undistributed interest in a spendthrift trust.

g. GRATs, GRUTs, and QPRTs. GRATs and GRUTs are creatures of the tax code. A settlor who establishes a GRAT or a GRUT retains the right to a payment of a fixed amount (a percentage of the trust assets or a fixed dollar amount) for a specified period of time, after which the assets pass to another party. The value of the settlor’s gift is the present value of the remainder interest on the day the trust is created. There is the potential for large value shifts if the trust “beats” the rate of return used to determine the value of the remainder interest when the trust is created. By definition, GRATs and GRUTs are self-settled trusts, and therefore, a spendthrift provision generally will not prevent a creditor from seizing the settlor's PLANNING FOR ASSET PROTECTION Page 22 interests in them. The settlor's interest is the stream of payments that he retains when the trust is established. Like the charitable remainder trust, because the settlor's interest is fixed, the entire trust corpus cannot be reached by his or her creditors, and the settlor may actually achieve some asset protection that he would not have if he owned the assets outright. In states allowing self- settled spendthrift trusts (see Part IV below), additional protection for the settlor’s interest may be achieved. The settlor’s creditors can reach the payments he receives unless some other exemption applies.

In a QPRT the settlor transfers his residence to a trust and retains the right to live there for a specified period of time. At the end of the term, the assets generally pass to the settlor’s children. The value of the settlor’s gift is the present value of the children’s future right to the home on the day the trust is created. In this way, a 50 year old person could give away a $1,000,000 home at a gift tax value of $150,000. The settlor's retained right in a QPRT is merely the right to live in the residence during the term. An argument can be made that this type of right is personal and cannot be seized by a creditor. Consideration should be given as to whether contributing a residence to a QPRT affects the settlor's homestead exemption. In fact, the QPRT is often used in states where no (or limited) homestead protection is otherwise available to shelter homestead assets. It could also be used to provide some asset protection for a vacation home that would not be classified as a "homestead."

IV. DOMESTIC VENUES FOR ASSET PROTECTION TRUSTS63

A. Introduction

Alaska, Delaware, Nevada, Utah, Rhode Island, Oklahoma, South Dakota and Missouri (the "Domestic Venues")64 have enacted legislation with a view toward becoming viable venues for establishing asset protection trusts. Although all Domestic Venue statutes appear to offer substantial (or at least some) asset protection (especially against the claims of future creditors), none of these states can be as protective a site for establishing trusts as an offshore jurisdiction because they are a part of the United States and are, therefore, bound by the United States Constitution. By virtue of the "full faith and credit" mandate in the Constitution,65 the courts of one state must recognize judgments rendered under the laws of less debtor-friendly states. In addition (and as more fully discussed below), the enactment of laws enabling asset protection trusts may itself violate the Constitution's contract clause.66 Finally, due to the supremacy clause67 of the Constitution, no state statute can protect debtors from conflicting federal law (i.e., bankruptcy law). Even if state asset protection trust legislation passes constitutional muster, it does not necessarily defend an asset protection trust from some of the arguments available to a creditor through other existing state laws. The new statutes, existing statutory provisions, and common law provide various opportunities for a sympathetic court, whether in a Domestic Venue or elsewhere, to set aside or penetrate the trust structure in favor of creditors.68

B. Overview of Domestic Venue Asset Protection Trust Legislation

1. THE ALASKA TRUST ACT. Under the Alaska Trust Act,69 a person who transfers property to a trust may make the beneficial interests subject to spendthrift PLANNING FOR ASSET PROTECTION Page 23 provisions. That is, the beneficial interests are protected by provisions in the trust agreement from being alienated, either voluntarily or involuntarily, before they are distributed to the beneficiaries. Furthermore, as long as a settlor (a) did not make the transfer with an intent to defraud creditors, (b) is not in default by thirty or more days on child support payments, (c) retains no right to mandatory distributions, and (d) has no power to revoke or terminate the trust, the Alaska Trust Act will allow that settlor to be a discretionary beneficiary of such a trust and will prevent that settlor's creditors from gaining access to the trust assets.70 Thus, a settlor can protect assets from the claims of creditors by placing them in such a trust and nevertheless continue to enjoy the benefit of such assets.71

Recently, substantial legislative changes to the Alaska Trust Act have been made which were designed to increase the efficacy of the Alaskan domestic venue asset protection trust. First, the amendments to the Alaska Trust Act addressed the issue of the unlimited statute of limitations for a pre-existing creditors to set aside transfers as fraudulent, which exists as a consequence of that portion of the statute which gives a creditor one year after "discovery" of the transfer. An unlimited statute of limitations is common to all domestic venue asset protection statutes. The amended Alaska Trust Act addresses the pre-existing creditor issue by extinguishing any action to set aside a transfer to the trust as fraudulent by a pre-existing creditor unless the pre-existing creditor brings the action within the later of four years after the date the transfer to the trust is made or one (1) year after the date the transfer is discovered by the creditor if the creditor can prove (by a preponderance of the evidence) that he or she has asserted a specific claim before the transfer.72 Because the pre-existing creditor must have previously asserted the claim or must bring the action at the latest, four years after the transfer, this amendment was intended to bring a level of certainty to a settlor with potentially unknown pre- existing creditors.

Second, the amendments to the Alaska Trust Act substantially narrowed the definition of a “fraudulent conveyance.” Prior to the amendments, a transfer to a trust was a fraudulent conveyance if the transfer was “intended in whole or in part to hinder, delay, or defraud creditors or other persons.” For a transfer to a trust be fraudulent under the amended Alaska Trust Act, the creditor must be a creditor of the settlor and “the transfer of property in trust was made with intent to defraud that creditor.”73

Third, the Alaska Trust Act was amended to include elements common to foreign trusts, trust protectors74 and trustee advisors.75 Statutorily, unless the trust agreement states otherwise, both trust protectors and trustee advisors are not liable as fiduciaries of the trust.

Fourth, the Alaska Trust Act was amended in 2003 to ensure that certain assets of the trust, such as real property and tangible personal property, could be made available for the “use” of a beneficiary, without exposing such assets to a creditor as a “payment or delivery.” 76 Such a “use” provision arguably permits the settlor to contribute a residence to an Alaska asset protection trust and continue to reside in that home. PLANNING FOR ASSET PROTECTION Page 24

Lastly, in 2004 the Alaska Trust Act was amended to clarify the legislature’s intention that a spendthrift trust restriction under Alaska law falls under the federal bankruptcy law exception for spendthrift trusts.77

2. THE DELAWARE TRUST ACT. The Delaware statute attempts to achieve a result similar to the Alaska statute in a somewhat parallel manner. The Delaware Qualified Dispositions in Trust Act78 provides that a transferor may make a disposition of property in a trust and also be a discretionary beneficiary of such trust. The trust must expressly name Delaware law as the governing law of the trust, be irrevocable, and contain Delaware's statutory spendthrift language.79 As long as the settlor is not made a mandatory beneficiary, the assets in trust are free from the claims of the settlor's creditors.80 However, the protection from creditors does not extend to (a) existing claims for alimony or support of a spouse, former spouse, or children, (b) a division of marital property, and (c) existing tort claimants.81 Furthermore, creditors' rights under the Delaware fraudulent transfer act are expressly protected.82 The statute of limitations for claims existing on the date of the transfer is the later of (i) four years after the transfer or (ii) one (1) year after the transfer was (or could reasonably have been) discovered by the creditor. For claims arising after the date of transfer, the statute of limitations is four years after the transfer.83

The Delaware statute possesses some unique qualities. For example, a settlor’s retention of a right to income from the trust is protected under the statute.84 Additionally, the statute permits a corporation or partnership (not just individuals) to create an asset protection trust.85 Delaware also extends qualification under the statute to charitable remainder annuity trusts, charitable remainder unitrusts, and qualified personal residential trusts.86

The law was amended in 2003 to address the issue of another state attempting to exercise jurisdiction over a trustee of a Delaware trust.87 Under the amended act, in the event the non-Delaware state court declines to apply Delaware's law with respect to the validity, construction or administration of the Delaware trust, the trustee's authority over the trust is immediately terminated and the successor trustee succeeds to the trusteeship.88 In the event the trust instrument fails to provide a successor trustee, the Court of Chancery appoints a successor.

3. THE NEVADA TRUST ACT. The Nevada legislation89 is intended to effect asset protection results similar to the Alaska and Delaware statutes, but it has certain idiosyncrasies (an action for fraudulent transfer may be brought four [or more] years after the transfer)90 and weaknesses from the settlor's point of view (an action for enforcement of a judgment from another state may be brought within six years after the date of the judgment).91 These provisions alone considerably reduce the asset protection capabilities of a Nevada asset protection trust.

A Nevada asset protection trust must be irrevocable, and all or part of the trust corpus must be located in Nevada. The settlor must be domiciled in Nevada or the trust must have a qualified trustee. The settlor may be a potential beneficiary of trust principal and income. As to claims against the settlor existing on the date of the transfer to the trust, the statute of limitations is the later of (i) two years after the transfer, or (ii) six months after the transfer was (or PLANNING FOR ASSET PROTECTION Page 25 reasonably could have been) discovered by the creditor. As to claims against the settlor arising after the date of the transfer to the trust, the statute of limitations is two years after the transfer.92

4. THE UTAH TRUST ACT. In 2003, the Utah legislature amended the trust provisions of the Utah Uniform Probate Code to provide additional protection for assets of trusts.93 Specifically, the Code now states that a transferor may make an irrevocable disposition of property in a trust and remain a discretionary beneficiary of such trust. The assets of the trust will not be subject to the claims of the transferor’s creditors except in seven defined instances, some of which include: (a) existing claims for child support exceeding thirty days from the date of transfer, (b) claims for state taxes, (c) where the transferor retains a right to mandatory distributions, and (d) where the transfer was made with the intent to defraud an existing creditor or the transfer renders the transferor insolvent.94 The trust instrument must affirmatively state that it is subject to the jurisdiction of Utah and at least one trustee must qualify as a Utah trust company.95 Furthermore, Utah amended its rule against perpetuities to permit transfers in trust that do not exceed 1,000 years in duration.96 The statute of limitations for claims existing on the date of the transfer is the later of (i) three years from the date of the transfer or (ii) one (1) year after the transfer is or reasonably could be discovered.97 For claims arising after the date of transfer to the trust, the claim is extinguished unless it is brought within two years of the transfer.98

5. THE RHODE ISLAND TRUST ACT. The Rhode Island Qualified Dispositions in Trust Act99 is virtually identical to the original, unamended 1997 Delaware Qualified Dispositions in Trust Act. The Rhode Island statute does not, however, incorporate the 1998 and 1999 amendments to the Delaware law.

A Rhode Island asset protection trust must be irrevocable and state that Rhode Island law governs the trust. The trust must contain a spendthrift clause and have a qualified trustee. The settlor may be a potential beneficiary of trust principal and income. As to claims against the settlor existing on the date of the transfer to the trust, the statute of limitations is the later of (i) four years after the transfer, or (ii) one year after the transfer was (or reasonably could have been) discovered by the creditor. The statute bars enforcement of a judgment obtained in another jurisdiction. As to claims against the settlor arising after the date of the transfer to the trust, the statute of limitations is four years after the transfer.

6. THE OKLAHOMA FAMILY WEALTH PRESERVATION ACT. In 2004, the Oklahoma legislature passed the Family Wealth Preservation Act100 creating a new breed of asset protection trusts with a rather extraordinary feature – revocability.

Effective November 1, 2004, any individual, including non-residents of Oklahoma,101 can place up to $l,000,000 into an Oklahoma preservation trust ("Preservation Trust"). The first $1,000,000, and the growth thereon, funded into the Preservation Trust is essentially exempt from creditors.102 Unlike most asset protection trusts, the Preservation Trust is not created for the benefit of the grantor. The "qualified beneficiaries" of a Preservation Trust are the grantor's descendants, the grantor's spouse, and IRC § 501(c)(3) charities.103 The trust must at all times have an Oklahoma-based bank or Oklahoma-based trust company serving as the PLANNING FOR ASSET PROTECTION Page 26 trustee.104 The statute defines an Oklahoma-based bank or Oklahoma-based trust company as a bank or trust company chartered under the laws of Oklahoma, or a nationally chartered bank or trust company having a physical place of business in Oklahoma.105 The statute requires that the trust be funded solely with Oklahoma assets, which includes the following: stock in an Oklahoma-based company; Oklahoma state, county or municipal bonds or other obligations; accounts in Oklahoma-based banks or trust companies; and Oklahoma real property.106 Additionally, the Preservation Trust must recite in its terms that it is subject to taxation under the income tax laws of the State of Oklahoma.107 The statute does not appear to preclude funding the trust with the grantor's interest in an Oklahoma-based company (which is defined to include corporations, limited liability companies, limited partnerships, and limited liability partnerships formed or domesticated in Oklahoma with a physical principal place of business in Oklahoma108) that hold assets located outside Oklahoma.

The most interesting feature of the Preservation Trust is its revocability.109 While a grantor may revoke the trust at any time, no grantor may be compelled to revoke it by a court or other judicial body.110 Once a Preservation Trust is revoked, the creditor protection features are lost as of the date of revocation.111 Transfers to the Preservation Trust are subject to the provisions of Oklahoma's Uniform Fraudulent Transfer Act and transfers within three years of bankruptcy are presumed fraudulent.112 Although a grantor may not establish more than one Preservation Trust, the grantor may establish a new Preservation Trust upon revocation of a preceding one.113

7. THE SOUTH DAKOTA QUALIFIED DISPOSITIONS IN TRUST ACT. South Dakota’s legislation permitting self-settled spendthrift trusts114 applies to qualified dispositions made after June 30, 2005. The South Dakota legislation permits the transferor to retain beneficial interests in and powers over a spendthrift trust. To qualify, the trust instrument must contain a spendthrift provision and incorporate South Dakota law to govern its validity, construction, and administration.115 The trust must also be irrevocable, but it will not be deemed revocable simply because the transferor retains certain enumerated powers or beneficial interests.116

According to the act, the trust may be penetrated only if the disposition violated the South Dakota fraudulent transfer statute.117 Both present and future creditors may attack the trust on this basis, but they must establish their claim by clear and convincing evidence.118 In the event a creditor is successful, the trust will only be liable for the amount necessary to satisfy the creditor’s claim, together with associated costs.119 Further, if the court determines that a trust beneficiary has not acted in bad faith, the avoidance is subject to the right of the beneficiary to retain any distributions from the trust made by a qualified trustee prior to the commencement of the action.120 Notwithstanding these provisions, some creditors are afforded other protections under the act, which does not apply in any respect to (1) indebtedness owed by the transferor under a domestic relations order, regardless of when the order is obtained,121 and (2) tort claimants who were damaged on or before the date of the transfer.122 The act purports to limit the liability of trustees, trust advisors, and persons involved in the counseling, drafting, preparation, execution, or funding of the trust.123 PLANNING FOR ASSET PROTECTION Page 27

8. THE MISSOURI UNIFORM TRUST CODE. Although Missouri amended its spendthrift statute as early as 1986 in an effort to provide trust settlors spendthrift protection for non-fraudulent transfers, a local bankruptcy court decision undermined its effectiveness.124 As part of the Missouri Uniform Trust Code enacted in 2004,125 the state’s spendthrift statute was further amended to make clear that a spendthrift provision in an irrevocable trust will protect trust assets from creditor claims, with two exceptions: (i) a fraudulent transfer of assets to the trust has no spendthrift protection, and (ii) to the extent of the settlor’s beneficial interest in the trust assets, there is no spendthrift protection if the settlor is the sole beneficiary of either the income or principal of the trust or retained the power to amend the trust, or the settlor is one of a class of beneficiaries and retained a right to receive a specific portion of the income or principal of the trust.126 Thus, in a Missouri trust containing a spendthrift provision, if there is more than one beneficiary, the settlor is a discretionary beneficiary of income or principal, and there has been no fraudulent transfer, the trust settlor will have spendthrift protection.

C. Domestic Venue Asset Protection Legislation Vulnerabilities

1. FULL FAITH AND CREDIT PROBLEMS.

a. Introduction. If a judgment creditor of a settlor of an asset protection trust wants to pursue trust assets in a post-judgment enforcement action, the creditor ultimately must involve a court that has jurisdiction over the trust assets or over a party in control of the trust assets.127 The assets of a Domestic Venue trust could be reached by a creditor who never even sets foot in the trust situs state's courts. More likely, however, the assets could be reached by a creditor who appears in the situs state court on a pro forma basis to have the court enforce a judgment rendered by the court of another state. As will be shown, this ability of creditors to sue effectively outside the trust situs state obviates some of the protection the drafters of the Domestic Venue statutes intended to provide.

b. Jurisdiction. In order for a judgment creditor of the settlor to enforce a judgment against assets of a trust that the settlor has created and funded, the creditor must proceed in a court that has jurisdiction over some aspect of the trust. If the trust is a Domestic Venue trust, this does not necessarily mean a Domestic Venue court. Another state's court may have jurisdiction over the trustee, the settlor, or the trust assets.128

A leading case in the trust jurisdiction area is Hanson v. Denkla.129 While this case is sometimes cited for the broad proposition that a judgment-rendering state court must have jurisdiction over the trustee for its judgment to receive full faith and credit in another state (e.g., a Domestic Venue state), a careful reading of the case fails to support this conclusion. In determining whether a Delaware court was required to give full faith and credit to a Florida judgment, the U.S. Supreme Court simply held that since Florida law made the trustee an indispensable party to a Florida lawsuit, and because the Florida court in this case had no personal jurisdiction over the trustee (or in rem jurisdiction over the trust assets), the Florida judgment was void (and therefore, quite logically, not entitled to full faith and credit treatment in Delaware or anywhere else). Hanson v. Denkla does not answer the question of whether PLANNING FOR ASSET PROTECTION Page 28 jurisdiction over the trustee is an across-the-board requirement for a judgment creditor seeking full faith and credit treatment in another state. However, it may soon become required reading for judgment creditors’ attorneys.

A modern sounding view of relevant jurisdictional factors can be found in the Hanson v. Denkla dissents of Justices Black and Douglas.130 Suffice it to say that there are numerous creative arguments for jurisdiction over a trustee, settlor, or trust assets which extend far beyond traditional notions of the physical location of those persons and things, including where the trustee might be deemed to be “doing business” and whether jurisdictional questions can be analyzed with a “center of gravity” approach, just like choice-of-law determinations.

A court could have jurisdiction over the trustee or settlor in a number of ways. First, individuals are always subject to the jurisdiction of courts within their domiciles.131 Generally, this means that a non-Domestic Venue trustee or settlor is subject to the jurisdiction of his or her home state's courts. Jurisdiction may also exist under a long-arm statute if the trustee or settlor has sufficient contacts with the forum state.132

Corporations are subject to the jurisdiction of the courts in the state of their incorporation.133 They are also subject to the jurisdiction of courts in any state in which they do business.134 For large corporate trustees such as banks, including those based or with offices in a Domestic Venue, this could effectively give jurisdiction to the courts of many states.

A state's courts also will have jurisdiction over all property within the state's borders.135 This includes real property, bank and brokerage accounts, and shares of stock issued by corporations incorporated in that state.136 If a trust holds stock in many different corporations, its property may be subject to the jurisdiction of several states' courts. Furthermore, any non-Domestic Venue activities in which the trust participates will likely involve the maintenance of accounts outside that state, which would become targets of creditors seeking to pursue their claims outside of the Domestic Venue courts.

c. Legal Theories. The mere fact that a court outside of a Domestic Venue has jurisdiction to hear a creditor's post-judgment enforcement action does not guarantee a creditor victory. The judgment creditor must also advance an argument that convinces the court that it should enforce the underlying judgment on the merits against the assets of the judgment debtor's Domestic Venue asset protection trust. A judgment creditor's arguments typically will fall into one or more of the following categories, which might be pled individually or in the alternative: (i) the asset protection features of the Domestic Venue trust offend public policy in the state where the post-judgment action is brought and, therefore, the governing law of the trust (Domestic Venue law) should be ignored in favor of the law of such state;137 (ii) the Domestic Venue trust is a "sham" trust or is the alter ego of the settlor and, because the settlor never really parted with dominion and control over the trust assets, the court should disregard the trust structure; or (iii) the settlor's transfer to the Domestic Venue trust was a fraudulent transfer and, therefore, should be set aside.138 PLANNING FOR ASSET PROTECTION Page 29

(1) Public Policy. A court that has determined that its jurisdiction is proper must decide whether to apply its own state's law or the governing law of the trust (Domestic Venue law). The general rule for trusts is that courts will apply the governing law of the trust.139 However, there is an exception to this rule. If the state where a court exercises jurisdiction has a sufficiently strong public policy against a pertinent provision of the governing law of the trust, the court will ignore the governing law of the trust and substitute its own state law to resolve the matter before the court.140

One of the key provisions of the Domestic Venue laws is that they permit and recognize the validity of "self-settled" discretionary trusts. That is, a settlor can set up a trust, the assets of which are not reachable by the settlor's creditors, and still retain an interest in the trust (i.e., the ability to receive distributions at the discretion of the trustee). For public policy reasons, nearly all other states have either statutory or case law to the effect that self-settled discretionary trusts are void with respect to creditors' claims,141 and all assets of such a trust that are subject to the settlor's ability to receive discretionary distributions are also fully reachable by the settlor's creditors. Thus, if the court outside of a Domestic Venue decides that this rule is a sufficiently strong tenet of its state's public policy, the court may decide to ignore the asset protection provisions of the Domestic Venue statute in favor of its own laws and declare the trust assets reachable by creditors, thereby eliminating the protection the trust was designed to achieve.142

(2) Sham or Alter Ego. The court outside of a Domestic Venue could decide to apply Domestic Venue law but nonetheless invalidate the trust on the basis that it is a "sham" or the "alter ego" of the settlor.143 Because many of these trusts will be used chiefly to provide asset protection, the settlor will be the primary (or only) beneficiary. He or she may also be a co-trustee, a protector, or otherwise retain significant control over the trust. A court faced with these facts might be very receptive to an argument that the settlor is not really a "discretionary" beneficiary, as the Domestic Venue laws require.144 Moreover, pursuant to a pattern of behavior revealing a relationship between the trustee and settlor suggesting that the settlor has not, in fact, parted with dominion and control over the trust assets, the creditor might persuade a court to disregard the trust structure because it is a sham or the alter ego of the settlor. Discovery efforts by the creditor to reveal facts indicative of such a pattern of behavior will be accomplished under U.S. procedural rules promulgated pursuant to the due process guarantees of the Constitution. This contrasts sharply with discovery procedures in foreign countries concerning facts related to foreign trust activities, which can be very burdensome.145

(3) Fraudulent Transfer. The court outside of a Domestic Venue could decide to apply Domestic Venue law but nonetheless permit a creditor to reach trust assets by determining that the judgment debtor's transfer of assets to the Domestic Venue trust was a fraudulent transfer under applicable state law.146 If the creditor prevails, the transfer of such assets to the trust will be void, resulting in full ownership and possession of the trust assets by the settlor, free of any trust, and subject to the creditor's claim. It should be possible for a judgment creditor to bring the post-judgment fraudulent transfer claim in a Domestic Venue court in connection with the creditor's appearance to enforce the underlying judgment on the merits via full faith and credit. It also should be possible, however, for such a claim to be heard PLANNING FOR ASSET PROTECTION Page 30 and judgment rendered in a court outside of the Domestic Venue that has jurisdiction over the judgment debtor.

d. Enforcement. Even if a court outside of the Domestic Venue renders a judgment in favor of the creditor pursuant to one of the three foregoing arguments, the creditor's battle is not over. The creditor must also find a way to have this second judgment enforced against the assets of the Domestic Venue asset protection trust. If the court's jurisdiction is based on the situs of trust assets, the court should be able to force the turnover of those assets from the judgment debtor to the creditor by a court order (attachment, garnishment, etc.) that forces the party in possession of the assets to give them to the judgment creditor.

However, if the court has jurisdiction over the trustee or settlor but not over the assets, the situation will be different. The court might issue a turnover order against the trustee or the settlor or both.147 Failing that, the creditor would have to take the judgment to the jurisdiction where the trust assets are located to enforce the judgment obtained in the post-judgment proceeding. If that jurisdiction is any state of the U.S., including Domestic Venues, the judgment could be enforced pursuant to the application of the full faith and credit clause of the U.S. Constitution.

All state courts are bound by the Constitution and federal statutes to give full faith and credit to judgments rendered by the courts of sister states.148 As long as the rendering court had proper jurisdiction under its own law (as interpreted by the rendering court) and pursuant to due process requirements of the Constitution, and the judgment was not procured by fraud, the sister state court, including courts in Domestic Venues, must recognize it and give it the full effect that such judgment would have had if rendered by the sister state's court.149 This rule applies even if the rendering state's court based its judgment upon a misapprehension of Domestic Venue law and even if the judgment was based upon a cause of action that would be against law and public policy of the Domestic Venue.150

Of course, the trustee could be expected to vigorously defend such a proceeding on a number of fronts.151 In fact, some writers have argued that the full faith and credit clause should operate in favor of wealth protection as states must respect the legislative acts of their sister states.152 However, constitutional scholars point out that historically that has not been the case. “[Y]et virtually the entire effect of the clause and its implementing statute has occurred in the context of interstate enforcement of judicial decisions. The impact on the disregard of other states’ laws has been minimal.”153

e. Credit Due Laws. A less-discussed constitutional issue focuses on how the full faith and credit clause informs the enforcement of a state’s statutes.154 This issue has not been addressed in any reported cases, but it might be raised in a case against the trustee of a Domestic Venue asset protection trust in a non-Domestic Venue. The party asserting the claim against the trustee could claim that the trust, or at least the spendthrift protection for the trust assets, is invalid under the law of the forum. Conversely, the trustee would defend the trust on the basis that it is valid under the laws of the state in which it was formed and administered. PLANNING FOR ASSET PROTECTION Page 31

Assuming that jurisdiction is proper, the narrow constitutional issue would be whether the full faith and credit clause would determine the choice of law under these circumstances.

The jurisprudence in this area is not entirely settled, but cases in two areas may be instructive: worker’s compensation and fraternal benefit societies. In the former area, the U.S. Supreme Court mandated greater deference to the laws of sister states,155 but more recent cases significantly loosened so that now the “only real constitutional limitation is that the law chosen be the law of a state having some significant contact or relation to the transaction.”156 Thus, in a worker’s compensation case, if jurisdiction is proper in the forum state, then the forum would likely be able to apply its own laws.

In contrast to the worker’s compensation cases, the U.S. Supreme Court has consistently held that the forum state must apply the law of a sister state in a line of cases involving fraternal benefit societies.157 Under this line, the Court has determined that full faith and credit requires a weighing of the interests of forum state against the need for national uniformity in the application of the laws of a sister state.158 If applied to Domestic Venue asset protection trusts, this rule would like help to protect the validity of such a trust. However, the rule appears to apply only to a unique form of insurance provided by fraternal benefit societies, and the incongruities to an asset protection trust controversy are likely substantial enough to distinguish the rule.159 Further, the continuing authoritative value of these cases may be suspect considering that no state choice of law decisions has been invalidated since 1951.160

The Supreme Court could also choose to adopt the Restatement standard to determine the applicable choice of law rule. The Restatement (Second) of Conflicts of Laws provides that the validity of a trust holding personal property is determined under the law of the state designated by the settlor or testator, as long as the designated state has a “substantial relation” to the trust and the law of such state does not violate a “strong public policy”161 of the state with which the trust has its most significant relationship or of the testator’s domicile at death.162 Conceivably, a non-Domestic Venue forum could determined that the trust is valid under the law of the Domestic Venue, but the spendthrifts protections afforded thereby violate the policy of forum state. With respect to trusts holding personal property, the Restatement provides that the local laws of the state that the settlor intended to apply will determine whether creditors can reach trust assets.163 However, because the Restatement was drafted years before the advent of Domestic Venue trust legislation164 and does not appear to contemplate Domestic Venue trust laws, it is questionable whether the Restatement would guide the Court’s formulation of the choice of law principles operating behind the full faith and credit clause.

2. SUPREMACY CLAUSE CONCERNS.

a. Federal Question/Diversity Jurisdiction. Under the U.S. Constitution’s Supremacy Clause165, federal courts are not bound by state laws. If a judgment creditor can obtain jurisdiction over a judgment debtor or the debtor’s assets in a Domestic Venue asset protection trust by virtue of federal question jurisdiction166 or diversity jurisdiction167, the creditor will have the opportunity to avoid the debtor-friendly provisions of PLANNING FOR ASSET PROTECTION Page 32 the Domestic Venue asset protection laws, thereby stripping the judgment debtor of one of his most significant asset protection shields.

b. Federal Bankruptcy Laws. A judgment creditor facing a judgment debtor who has been rendered "insolvent" by virtue of a transfer to an asset protection trust may be able to force the debtor into involuntary bankruptcy. In that case, pursuant to a judgment against the settlor rendered by a United States Bankruptcy Court under Bankruptcy Code rules, it is again possible that the Constitution's supremacy clause will come into play. The Bankruptcy Code takes precedence over any conflicting state law as a result of the effect of the supremacy clause, and although the success of a creditor using this approach has heretofore been theoretical, the enactment of the BAPCPA has strengthened creditors’ positions substantially.

(1) Pre-BAPCPA. Prior to the enactment of the BAPCPA, a debtor might be heard to argue that § 541(c)(2) of the Bankruptcy Code exempts his or her beneficial interest in a trust that is subject to restrictions on transfer of its assets, and that such restrictions are enforceable under applicable nonbankruptcy law. The debtor's position would be that the "applicable nonbankruptcy law" is that of the trust, not the debtor's domicile. Accordingly, the restrictions on the debtor/beneficiary's ability to transfer trust assets of an asset protection trust should be determined by looking to the law governing the trust.168

The creditor, on the other hand, could advance two arguments against the use of Domestic Venue law to determine whether the trust assets are exempt from creditors' claims. First, the creditor could contend that § 541(c)(2) does not apply in the case of a Domestic Venue asset protection trust. To support this argument, the creditor could point out that the legislative history of § 541(c)(2) indicates that it was intended to protect "spendthrift trusts,"169 arguably in the traditional understanding of such trusts, which are trusts created by one party for the benefit of another party that contain provisions restricting the beneficiary’s ability to transfer or assign its interest in the trust. The argument would assert that not only were Domestic Venue asset protection trusts not contemplated when Congress considered passing § 541(c)(2), but they are not "spendthrift trusts" as understood by Congress at such time. Hence, prior to the passage of the Domestic Venue statutes, only trusts settled by someone other than the debtor could contain valid spendthrift provisions that protect the debtor. Furthermore, a creditor could argue that language of the new statutes that protects Domestic Venue trusts from creditors' claims 170 is not a restriction on transfers within the meaning of § 541(c)(2). Instead, it is in the nature of an exemption.171

If a creditor could convince a bankruptcy court that a beneficial interest in a Domestic Venue self-settled trust either was not the sort of interest Congress intended to protect under § 541(c)(2) or that the Domestic Venue statutes do not contain a restriction on transfers within the meaning of § 541(c)(2), then the debtor would be faced with the prospect of arguing that the protection afforded Domestic Venue trusts by their statutes was an exemption to be respected independently of § 541(c)(2). However, this argument would be successful only if made by a Domestic Venue debtor because § 522(b)(2) of the Bankruptcy Code provides that the exemptions to be applied in bankruptcy are those of the debtor's domicile state, regardless of where the assets subject to the exemption are located.172 Thus, unless the settlor was a PLANNING FOR ASSET PROTECTION Page 33 domiciliary of the Domestic Venue, § 522(b)(2) of the Bankruptcy Code (due to the supremacy clause) would mean that the laws of the debtor's home state, lacking an exemption for self-settled trusts, would apply. Therefore, the trust assets would be reachable by the creditor under the domiciliary state's rule against creditor protective self-settled trusts.

Second, the creditor could plead (alternatively) that even if § 541(c)(2) did apply, the "applicable nonbankruptcy law" should be determined by a "governmental interest" or "significant relationship" test, asserting that the interests of the debtor's domicile prevail over those of the Domestic Venue. Thus, the enforceability of transfer restrictions under § 541(c)(2) should be determined under the domiciliary state's laws.173

(2) Post-BAPCPA. The BAPCPA has made a number of revisions to the Bankruptcy Code that substantially increase the likelihood of successful creditor claims. First, the BAPCPA enlarges the period for avoiding a fraudulent transfer under 11 U.S.C. § 548(a) and (b) from one year to two years. This change may require greater foresight in making any transfer if bankruptcy is potentially on the horizon. The BAPCPA also expressly provides that transfers include “any transfer to or for the benefit of an insider under an employment contract.” This language was present in previous versions of the Act as early as 2002,174 and apparently attempts to bolster protection of employees from unscrupulous conduct of corporate executives.175

Second, the BAPCPA adds new subsection 548(e), which provides a ten-year clawback provision for transfers by the debtor to a “self-settled trust or similar device” if the transfer was made with the actual intent to hinder, delay, or defraud present or future creditors. The “hinder, delay, or defraud” language in subsection 548(e) is virtually identical to the language in § 548(a)(1)(A), which contains the general fraudulent transfer provision. The general provision has been in the Bankruptcy Code for some time, and cases construing it should serve to elucidate the meaning and effect of new subsection 548(e).

Although it may be tempting to assume that new subsection 548(e) targets only asset protection trusts, the language is broader than that, including transfers to a self-settled trust “or similar device.” This latter term potentially applies to an array of planning tools in which the settlor retains an interest. The legislative history indicates that the amendment adding this language to the Act (Amendment 121) was adopted instead of Amendment 42, presented by Senator Schumer. Amendment 42 would have capped contributions in the preceding 10 years to an “asset protection trust” at $125,000, but specifically excluded qualified retirement plans from the term “asset protection trust.” This exclusion is not contained in Amendment 121. This omission may imply that some other vehicle in which the debtor retains a beneficial interest, such as retirement plans, life insurance, annuities, and tenancies by the entirety, is a “similar device” subject to the 10-year clawback provision. It is not clear what other planning arrangements may be affected by this language, and a creative creditor will almost certainly attempt to stretch its meaning to other, more traditional, planning arrangements.

Despite this uncertainty, it is the authors’ view that a balanced and common-sense approach would suggest that, absent a fraudulent transfer, most of PLANNING FOR ASSET PROTECTION Page 34 these well-understood and statutorily authorized trusts would not be deemed “similar devices.” The vagueness of the term “similar devices” should not in most cases be applied to arrangements defined and authorized by ERISA or the Internal Revenue Code. Rather, “similar devices” should be applied to schemes obviously constructed to allow control and beneficial enjoyment by the transferor/debtor and yet defeat the claims of creditors. One sees annuities which are so configured. Another example might well be the Lazarus Exempt Trust described in In re Bradley,176 where there was in fact a third-party settlor, yet the majority of the funding came from the beneficiary/debtor who also controlled the investments and had all the beneficial enjoyment.

For purposes of new subsection 548(e), the term “transfer” is expressly enlarged to include transfers made in anticipation of a judgment resulting from (A) violations of federal or state securities laws, and (B) fraud, deceit or manipulation of a fiduciary capacity in the purchase or sale of securities. A reading of the legislative history of this amendment makes clear that well-publicized cases of corporate fraud were a driving force behind this amendment. Senator Talent, who introduced the amendment in the Senate, derided APTs because he claims they permit perpetrators of corporate fraud to hide assets from their creditors. However, the language is not limited to corporate fraud and, instead, applies broadly to all debtors who settle an APT or a “similar device” within the ten-year period preceding bankruptcy with the requisite intent to defraud creditors.

This new statutory recognition of asset protection trusts may be a double-edged sword. On the one hand, the ten-year clawback provision is extraordinarily long and may be viewed as evincing a national public policy against such trusts. On the other hand, the provision requires actual intent to defraud. As such, it may be viewed as acceptance and validation of the use of asset protection trusts when the settlor does not have an actual intent to defraud creditors. Regardless of which view prevails, these new provisions highlight the need for nest egg planning based on a thorough solvency analysis diligently performed each time a client transfers assets to an asset protection trust. More than ever, however, settlors need to be able to demonstrate a reasonable estate planning or business purpose for making a transfer of assets to an asset protection trust because asset protection motivations, alone, may invite a challenge from creditors.

Domestic Venue asset protection trusts may feel the bite of these new Bankruptcy Code provisions more than their foreign counterparts. Bankruptcy courts, armed with these new statutory provisions and federal preemption of state laws in bankruptcy, may be able to reach into a Domestic Venue and force the trustee of the asset protection trust to disgorge trust assets to the bankruptcy trustee. Some Domestic Venues attempt to protect against such efforts by bankruptcy courts, but the strength of those protections are yet to be tested.

Of course, the court must find that the settlor had the actual intent to defraud creditors, and proving actual intent will be more difficult if the settlor can demonstrate non-asset protection reasons for establishing the trust. Domestic Venue trusts offer estate planning benefits outside of and in addition to asset protection. For instance, common tools such as inter vivos QTIPs, QPRTs, CRTs, CLTs, GRITs, GRATs, or trusts funded with the PLANNING FOR ASSET PROTECTION Page 35 exemption equivalent amount offer the well-documented advantages of removing assets from the settlor’s estate so that asset growth can occur inside the trust, rather than in the settlor’s estate. Additionally, in jurisdictions that have abolished perpetuities periods, GST-exempt trusts can grow free of GST liability for multiple generations to come. Domestic Venue trusts may also provide income tax benefits for residents of states that impose a state income tax.

Moreover, the BAPCPA may have shifted the paradigm in asset protection planning because it significantly reduces a debtor’s protections in bankruptcy. Whereas bankruptcy has sometimes been viewed by planners as a way to wash creditors away, the Bankruptcy Code will now be outfitted with powerful tools for retrieving assets that were once believed to be free of creditors’ claims. With these changes, a creditor who previously may have preferred to avoid bankruptcy court may now want to force the debtor into involuntary bankruptcy.

According to 11 U.S.C. § 303, if the debtor has twelve or more creditors,177 any such creditor may impose involuntary bankruptcy on the debtor with the joinder of two or more other secured creditors. If the debtor has fewer than twelve creditors, a creditor may commence the involuntary bankruptcy suit without joinder by any other creditor. A savvy debtor may attempt to weaken the ability of a large creditor to force bankruptcy by incurring a number of small debts, such as credit cards or utility bills. Courts are split as to whether the payees of such small, recurring debts should be considered creditors for purposes of § 303. Some courts reason that § 303 is clear, unambiguous, and does not exempt such debts from consideration.178 Other courts deny the inclusion of such debts on the basis that the small creditors should not be permitted to dilute the capacity of a large creditor to force involuntary bankruptcy.179 Depending on the debtor’s domicile, such small, recurring debts may be the difference between being forced into bankruptcy or not.180

These new bankruptcy law provisions and the prospect of involuntary bankruptcies are not particularly threatening to a client whose potential liability is limited to one large judgment (e.g., a physician sued for malpractice). However, involuntary bankruptcy may become a real concern for debtors whose potential creditors are numerous, even if each creditor’s claim is relatively small (e.g., claimants in a class action suit against a director of a large, publicly-traded corporation). Knowing each client’s particular situation and needs will be paramount in order to recommend and implement the optimal planning situation.

Although involuntary bankruptcy is a real threat, debtors are provided with potential defenses. First, assuming that the debtor contests the filing, a court can order relief against a debtor in an involuntary bankruptcy case only if the debtor is generally not paying his or her debts as they come due unless such debts are subject to a bona fide dispute as to liability or amount.181 Consequently, a debtor may be able to avoid involuntary bankruptcy if (1) she is generally not in default, (2) she contests the amount of such debts in good faith, or (3) she contests her liability for such debts in good faith.

Second, a debtor may have a remedy under § 303(i) against creditors who file an involuntary petition in bad faith. A creditor who files in bad faith may be PLANNING FOR ASSET PROTECTION Page 36 forced to pay costs, fees, and actual and punitive damages. The creditor’s good faith is presumed, and the burden is on the debtor to rebut the presumption by a preponderance of the evidence.182 Because the Bankruptcy Code does not define “bad faith,” courts have developed and employed the following tests for making the determination: (1) the “improper use” test, focusing on whether the creditor is attempting to obtain a disproportionate advantage for itself, such as improperly collecting a debt; (2) the “improper purpose” test, where the creditor is motivated by ill will, malice, or an intent to harass the debtor; (3) the “objective” test, which asks whether a reasonable person would have filed the involuntary petition; (4) the “subjective” test, which (like the “improper use” test) looks at the creditor’s motive for filing; and (5) the “combined” or “two-part” test, which determines bad faith on the basis of both the “objective” and “subjective” tests.183

Finally, an amendment made under the Act may provide a would-be involuntary debtor a defense simply by refusing to undergo credit counseling. Section 303(a) permits the filing of an involuntary petition against a person “that may be a debtor.” The Act amended § 109 to provide that a person may not be a debtor unless he undergoes certain credit counseling prior to the filing of the petition.184 This amendment was almost certainly aimed at deterring abusive voluntary petitions, but the language of the amendment seems to cover involuntary cases as well. This effect was probably not intended and, notwithstanding the language of the amendment, courts will be unlikely to dismiss an involuntary petition on the basis of a debtor’s unilateral refusal to undergo such counseling.

Of course, it is impossible to fully foresee or understand the practical effects that the BAPCPA will have on Domestic Venue trusts. However, it certainly seems to provide creditors with new weaponry in their attempts to assault Domestic Venue trusts.

3. CONTRACT CLAUSE PROBLEMS. The Constitution prohibits states from enacting any law that impairs the "Obligation of Contracts."185 This provision is known as the "contract clause," and was specifically intended by the framers to prevent the states from passing extensive debtor relief laws.186 In order to run afoul of the contract clause, the law in question must substantially impair the obligations of parties to existing contracts or make them unreasonably difficult to enforce.187 Even when the law meets one of these criteria, it is not automatically void; instead, it is subjected to the "strict scrutiny" standard of review: that is, to be valid, it must be narrowly tailored to promote a compelling governmental interest.188

A creditor could argue that the Domestic Venue statutes violate the contract clause by eliminating the creditor's ability to seize assets to which he would otherwise have had access before the enactment of such statute. Even though the U.S. Supreme Court has in the past recognized a distinction between laws that regulate the substantive obligations of contracts and those that merely regulate the remedies for breach of those contracts, this distinction is no longer rigidly followed. Moreover, a creditor could argue that the new statutes do not just affect the remedies of the creditor, but that they also alter the substantive obligations of the settlor/debtor. Because the settlor can potentially continue to use the assets that have been "discretionarily" distributed, the settlor's enjoyment of the trust assets is not impaired, but the possibility of creditors PLANNING FOR ASSET PROTECTION Page 37 reaching those assets is restricted. Because the debtor will not be harmed if he refuses to repay the debt, the debtor's obligation to do so becomes illusory. A creditor could argue that by changing its law to allow the assets of discretionary self-settled trusts to be protected from creditor's claims, Domestic Venues have thwarted the repayment obligations of debtors who choose to set up such a trust.

D. Aside from Constitutional Problems, the Status of Domestic Venues as Pro-Debtor Jurisdictions is Questionable

Although many of the barriers to the entry of the Domestic Venues into the asset protection arena exist because they are states of the United States and subject to American laws, problems also exist with the statutes as written, as well as with existing provisions of local laws. That is, even if Domestic Venues were not prevented by the U.S. Constitution from becoming asset protection trust havens, the Domestic Venue statutes do not give the maximum possible protection to settlors. This is due to the failure of the legislation to control the effect of other aspects of Domestic Venue laws, such as their own creditor-friendly fraudulent transfer laws.

The new legislation of the Domestic Venues purport to give settlors a viable alternative to locating their asset protection trusts offshore. These laws are only partially successful. The statutes require significant work to close creditor-friendly loopholes, but the major problem faced by Domestic Venues is that each is one of the fifty states and is subject to the restrictions of the U.S. Constitution. Domestic Venues are unable to bring their laws in line with the more aggressive asset protection laws in some offshore jurisdictions, because to do so would violate constitutional mandates. Their statehood prevents them from being able to control fully a creditor's right to obtain and enforce judgments against trust assets. Therefore, a settlor who is contemplating choosing a Domestic Venue as the jurisdiction for an asset protection trust must realize that a stateside trust cannot protect assets as well as a trust in an offshore jurisdiction. Although there may be other reasons for locating an asset protection trust in a Domestic Venue,189 those states cannot match offshore jurisdictions when it comes to the primary reason for creating such a trust: shelter from the claims of creditors.

V. OFFSHORE TRUSTS

A. General Principles

There are two primary attractions of offshore trusts. First, like the domestic asset protection trusts discussed above, it is possible for a settlor to create a spendthrift trust and yet remain a beneficiary. Second, because it is jurisdictionally severed from the United States, an offshore trust is less likely than a domestic trust to be targeted as a source for satisfying a future judgment or claim. The difficulty in accessing the trust, both physically and legally, might influence a potential future claimant's decision to pursue an action, or, at a minimum, incline the claimant to settle in ways more favorable to the defendant. PLANNING FOR ASSET PROTECTION Page 38

B. Methods of Attack

Typically, a creditor who is attempting to reach the assets of an offshore trust will first obtain a judgment against the debtor in a United States court. The judgment creditor will then attempt to satisfy this judgment with assets in the offshore trust. In order to reach such assets effectively, the judgment creditor may be forced to bring suit against the trustee in either the jurisdiction where the trustee is domiciled or in a jurisdiction where trust assets are located. In situations in which the creditor is alleging that a fraudulent transfer occurred or in certain other situations (e.g., in a bankruptcy context), the suit may also be brought in the jurisdiction of the settlor's domicile.

As with domestic asset protection trusts, the judgment creditor's arguments generally will fall into one or more of the following categories, which might be pled individually or in the alternative: (i) the asset protection features of the offshore trust offend public policy in the jurisdiction where the post-judgment action is brought and, therefore, the governing law of the trust (i.e., the laws of the offshore jurisdiction) should be ignored in favor of the laws of the jurisdiction in which the action is brought; (ii) the settlor's transfer to the offshore trust was a fraudulent transfer and, therefore, should be set aside; or, (iii) the offshore trust is a "sham" trust or is the alter ego of the settlor and, because the settlor never really parted with dominion and control over the trust assets, the court should disregard the trust structure.

In planning and implementing an offshore trust for an American settlor/beneficiary, the asset protection lawyer should remember that any initial action against the settlor or the trust will usually be brought in the United States and will almost certainly involve one or more of the three creditor legal theories cited above.190

C. Exporting the Assets Versus Importing the Law

There are two fundamental, and at times conflicting, methods of achieving asset protection through a foreign trust.

1. EXPORT THE ASSETS. The first method is to place the assets in a foreign jurisdiction with a foreign structure and a foreign trustee and to arrange the entire configuration to sever all jurisdictional ties with the U.S. federal and state judicial systems. This method requires a claimant seeking to satisfy a U.S. judgment to travel to the selected jurisdiction in an effort to enforce the claim, thereby entering a legal environment in which chances of success are bleak and costly. This method is known as "exporting the assets" to a foreign trust. See Chart A.

2. IMPORT THE LAW. The second alternative is to select a foreign jurisdiction with a favorable (i.e., aggressive) body of trust and fraudulent transfer law enacted to be protective of the settlor and the beneficiaries and to implement the asset protection plan so that this favorable body of law is applicable to the trust entity even though the trust assets remain in the U.S. PLANNING FOR ASSET PROTECTION Page 39

Under this method, the settlor implements the foreign trust in conjunction with a U.S. family limited partnership or other domestic legal entity that holds some or all of the settlor's assets. The settlor conveys all or a portion of the domestic limited partnership interests or the domestic corporation's shares to the foreign trustee. Under this arrangement the hard assets remain in the domestic partnership or corporation and, therefore, are physically situated in the U.S. Of course, being situated in the U.S., the assets are theoretically susceptible to local in rem proceedings. The goal, however, is that the barricades of the aggressive foreign law applicable to the foreign trust will have been brought "onshore" to the U.S. in such a way as to defeat or severely discourage the claimant. Using this method, one "imports the foreign law." See Chart B.

When one imports the foreign law, it may still be possible to export the assets at a later time. If the structure initially involves retaining the hard assets physically in the U.S., but a problem thereafter arises, the assets can then be moved offshore (for instance, by virtue of a liquidation right provided to the trustee/limited partner in the partnership agreement). The risks, of course, are that the assets will be frozen by a court order before they can be moved or that the timing of the asset move itself will be viewed as a fraudulent transfer. Some assets are difficult or impossible to move, such as real estate or a professional practice. Hypothecation of such assets and removal of the cash may provide some flexibility here. Nonetheless, in such a situation the timing of the asset removal is critical.

D. Enforcement of Judgments

If the assets are physically offshore, a claimant or creditor pursuing the assets of a foreign trust typically will have to do so in, and under the law of, the jurisdiction in which the trust was created. Most offshore jurisdictions require that their own laws dictate the foreign claimant's rights. Some jurisdictions will not enforce foreign judgments or will only do so after the case is heard or retried under local law. In some countries, contingent fee arrangements are not permitted, and plaintiffs are required to make substantial down payments (e.g., ten to fifteen percent of amount claimed) as a condition precedent to filing a lawsuit.

As additional protection, some foreign trust documents contain "anti-duress" provisions to shield assets from enforcement orders directed at a U.S. co-trustee or other party subject to U.S. jurisdiction. These provisions obligate the foreign trustee to ignore directions from any person who is acting under court compulsion.

In light of the foregoing, when using a foreign trustee as either a co-trustee or sole trustee, consider the following factors which may facilitate enforceability of a claimant's judgment by subjecting the foreign trustee to the jurisdiction of a U.S. court:

. it has a U.S. subsidiary;

. it is a subsidiary of a U.S. corporation;

. it has a subsidiary in a country with which the U.S. has a treaty for enforcement of judgments or a similar treaty; PLANNING FOR ASSET PROTECTION Page 40

. it is a subsidiary of a corporation based in a jurisdiction with which the U.S. has a treaty for enforcement of judgments or a similar treaty; or

. it has some other U.S. nexus.

E. Transfer of Situs

For maximum flexibility, it may be advisable to plan mobility into the offshore arrangement. Structuring the transaction so that the trust or other entity can move from one jurisdiction to another provides further protection from claimants. The attorney should make sure that the law of the original jurisdiction permits this mobility, often called "redomiciliation," and should include appropriate facilitating language in the documents.

F. Location of Trust Assets

It is usually possible to have trust assets in jurisdictions other than the trust situs. In protecting assets from creditors, this factor can be either a further advantage or a decided disadvantage, depending on the physical location of the assets and the additional jurisdiction laws to which the trust assets are subject. The primary benefit is the severance of the jurisdictional nexus (e.g., a lawsuit filed in the trust situs jurisdiction may be ineffective if the trust assets are not located there), but this benefit can be lost through incomplete or careless planning (e.g., a foreign trust with a custodial arrangement with a branch of a U.S. bank abroad may inadvertently expose trust assets to the jurisdiction of U.S. courts).

G. Nest Egg vs. In Toto

What percentage of a client's assets should be offshore or in an offshore structure?

1. IN TOTO. Some attorneys argue that putting virtually all of a client's assets in a U.S. family limited partnership and putting 99% of the limited partnership interests into a foreign trust provides substantial protection, even if the underlying assets are located within the physical jurisdiction of U.S. courts. However, the possibility of judicial attachment of the ownership interest in the domestic entity held by the foreign trustee on the basis of in rem jurisdiction places the "in toto" approach at or near the "less creditor protective" end of the asset protection planning spectrum.

2. NEST EGG. At the other, "more creditor protective" end of the asset protection planning spectrum, representing perhaps the most conservative philosophy, is the "nest egg" approach. This strategy contemplates placing a limited percentage of assets in an offshore trust, severing all jurisdictional ties, and locating the cash, stocks, or other wealth physically offshore. Moreover, the arrangement should have well-documented purposes other than, or at least complementing, asset protection. The "nest egg" approach is less likely to give rise to fraudulent conveyance claims because the client, by definition, still passes a solvency test after settlement of the offshore trust. Furthermore, there is not a well-developed body of conflicts of law cases, relatively speaking, in the area of offshore trusts. With respect to in toto- type arrangements in which all or a large portion of a client's wealth is ostensibly subject to the PLANNING FOR ASSET PROTECTION Page 41 law of the foreign trust's situs, but the assets remain physically within the U.S., the possibility of an unfavorable conflicts of law ruling by a court (i.e., favoring the law of the jurisdiction in which the assets are physically located) poses a serious risk. That element of uncertainty must be considered in determining how much of a client's wealth should be subjected to the risk of an unfavorable outcome of a conflicts of law analysis.

H. Control

Client control over assets is an overriding preoccupation in offshore planning. A core concept of offshore asset protection is that client control of assets is inversely related to achieving asset protection. Most clients resist surrendering control of their assets to a foreign trustee. That sacrifice must be made, however, to achieve the protection afforded under an "exporting the assets" approach. There are a number of specific methods of addressing the control issue (protectorships, letters of wishes, advisory committees, co-trusteeships, and the like), but the advising attorney must determine at what point the extent of retained client asset control renders the trust a sham and, therefore, indefensible in court.191

The problem with all of the configurations designed to give the settlor some measure of control is that, no matter how elaborately structured or formally observed, there exists the possibility that the trust can be attacked as a sham either under U.S. law or applicable foreign law. The greatest danger exists when the settlor is aggressive about retaining control. If the arrangement is ultimately controlled by the settlor, and if the settlor has, in effect, complete beneficial enjoyment, a court could easily deem the entire structure a sham and order turnover of the assets.192 With regard to those clients seeking a high degree of control, avoiding a sham arrangement presents a serious challenge.

I. Beneficial Enjoyment

In addition to the desire to maintain control, the client generally wants to retain, either currently or prospectively, the right to beneficial enjoyment of trust assets. While the concept of shifting, expanding, and contracting beneficial enjoyment may be new to the U.S. trust practitioner, it is commonly used in foreign trust planning.

VI. PRACTICAL IMPLEMENTATION

A. Step One: Investigate the Client and the Situation

1. FINANCIAL CONDITION. The attorney assisting a client in establishing an offshore trust should fully and completely explore the client's financial situation. It is always advisable to secure an affidavit of solvency and financial statement from the client. If there is any question whatsoever with respect to the solvency of the client, the attorney should refuse to implement any plan that would hinder a present or potential subsequent creditor.

2. CLAIMS OR THREATENED CLAIMS. The attorney should examine all client debts, liabilities, and obligations in detail and should carefully itemize all risks, exposures, PLANNING FOR ASSET PROTECTION Page 42 guarantees, and contingent liabilities. The attorney should also gather information about the client's historical method of doing business and investigate his or her general reputation among business associates and past creditors.

3. THE SOLVENCY ANALYSIS. As was previously described in Part II, with respect to any case, the attorney should perform an in-depth analysis of the client's financial solvency. The solvency analysis begins with a listing of all client assets, a subtraction of current debts and liabilities, a subtraction of all claims and contingent liabilities, and a subtraction of assets that are already protected from creditors' claims under applicable state and federal law, (e.g., homestead and ERISA qualified retirement plans, insurance and annuities). The attorney must insist that the client identify all liabilities and contingent liabilities (i.e., not only debts, but guarantees, contingent claims, pending lawsuits, and even potential claims). In some cases, it may be appropriate to engage a certified public accountant to produce an audited financial statement. The attorney should inquire about the client's business and professional reputation, (e.g., asking whether a physician client has a history of malpractice claims, or determining whether a business client has a history of disputes with creditors, associates, etc). Information on the Internet can be tremendously helpful here. If anything untoward arises in the course of the solvency analysis, the attorney should secure the relevant facts and critically evaluate them.

Finally, at the end of the solvency analysis, the attorney should devise a methodology which is sure to protect creditors. For example, assume a client with the following situation:

$ 15,000,000 TOTAL ASSETS - 1,000,000 Current debts and liabilities -2,000,000 Claims, contingent liabilities, guarantees, pending lawsuits - 2,000,000 Protected assets (e.g., homestead, ERISA qualified retirement plans, insurance and annuities) $ 10,000,000 SOLVENCY x 25% $ 2,500,000 AVAILABLE FOR OFFSHORE ASSET PROTECTION PLANNING

There is no magic to the 25% figure shown in the example; it is a matter of subjective judgment. However, the more that the amount transferred reduces remaining solvency, the greater the likelihood of scrutiny. The determining factors are the size of the assets (i.e., the absolute dollars involved), the nature of the client's business and professional activities, the potential source of any claims, and the additional asset protection planning tools that might be available for the client. The client must leave significant wealth available for creditors. Such an approach minimizes the chances of a successful fraudulent transfer argument because an effort has been made to provide adequate reserves for all possible claimants. PLANNING FOR ASSET PROTECTION Page 43

4. POSSIBLE CRIMINAL ACTIVITY. Attorneys engaged in foreign-based asset protection planning must be wary of the new client who wishes to move offshore in a hurry, lest the attorney become an unknowing participant in a money laundering operation, the fraudulent transfer of assets to avoid creditors, or a scheme to hide illegally obtained wealth.193 The most common criminal activity associated with the creation of asset protection trusts is money laundering, which is a specific intent crime. In order to be convicted of this crime in the United States, an individual or entity must engage in a financial transaction knowing that the funds are derived from an unlawful activity and intending either to further the unlawful activity or to conceal the true nature of the funds.194 If the attorney thoroughly investigates his new client and after such investigation has no reason to suspect criminal activity, then the attorney should be protected from criminal liability, even if the client is involved in criminal activity, unless the attorney deliberately ignores incriminating facts.195 Because several United States courts have held attorneys liable for their role in attempts by clients to defraud others, if there is any question that a client might be involved in a criminal venture or in defrauding creditors, then the attorney should refuse (or cease) representation of the client.

5. COMPETENT ASSISTANCE. The advice of co-counsel with expertise in creditors' rights and fraudulent transfers is strongly recommended.

B. Step Two: Explore Motives

The attorney should discuss thoroughly with the client all reasons for creating an offshore trust. Fraudulent transfer is all about the intent of the transferor/debtor. If the trust is later challenged, the existence of non-asset protection motivations will help counter charges of fraudulent intent.

Non-asset protection motivations for creation of an offshore trust generally fall into three classes: (1) economic or investment, (2) tax or estate planning, and (3) personal or family issues.196

1. ECONOMIC OR INVESTMENT ISSUES.

a. economic diversification - Engaging a foreign portfolio manager to oversee the international investment component of one's assets arguably reduces economic risk and increases the potential portfolio return. Such an advisor, with ready access to local information and to facts or insights about the investment has a decided advantage over U.S. money managers trying to make foreign investment decisions from America. While a U.S. investor does not necessarily need a foreign trust to take advantage of foreign money management, this arrangement helps to ensure that these assets are coordinated with a comprehensive estate plan;

b. participation in investments not otherwise available to U.S. investors - U.S. or foreign law also may suggest the use of a foreign corporation, trust, or other entity. Due to the Securities and Exchange Commission's regulations, certain foreign mutual funds, hedge funds, and other investment vehicles are not available directly to a U.S. investor, but are available to foreign trusts and foreign corporations, even if owned by, controlled by, or benefiting a U.S. investor; PLANNING FOR ASSET PROTECTION Page 44

c. preplanning in anticipation of currency controls or restrictions on ownership of bullion; and

d. liability protection, tax planning, or strategic advantage in the context of an active trade or business abroad.

2. TAX OR ESTATE PLANNING ISSUES.

a. transfer tax planning (e.g., establishing a vehicle for a foreign non- grantor trust, which may also make use of the generation-skipping transfer tax exemption);197

b. perpetual trusts - With the abolition of the rule against perpetuities in many jurisdictions, more and more clients are considering perpetual trusts. Whether the trusts should really be drafted to last in perpetuity, or just for long periods of time (e.g., 200-500 years) is open to debate. However, a compelling case can be made for perpetual trusts, one based on tax planning and the other on creditor and spendthrift protection.198

c. income tax planning (e.g., establishing a per se defective grantor trust);

d. accessing the offshore life insurance market; and

e. using a foreign QPRT.

3. PERSONAL OR FAMILY ISSUES.

a. planning for the contingency of changing one's domicile or citizenship - Because the offshore trust makes it substantially easier for a client to expatriate or repatriate, it also serves the purpose of "keeping options open" for forward-looking clients. An offshore trust will establish a new set of financial and legal relationships and will expedite further movement of a client's wealth to a new base in the event the client makes the decision to relocate;

b. the achievement of a "low profile" or anonymity with respect to wealth;

c. the avoidance of forced dispositions;

d. premarital planning; and

e. marital property planning (e.g., establishing a vehicle to receive partitioned community property, spousal gifts, and to establish QTIP trusts).

Of course, none of these reasons can, or should, be manufactured. It is essential that the planning attorney be knowledgeable about all aspects of a client's wealth and PLANNING FOR ASSET PROTECTION Page 45 objectives. Careful exploration in this context may uncover multiple benefits of an offshore trust and influence the way the plan is ultimately structured.

C. Step Three: Select Jurisdiction

Early focus on the selection of the jurisdiction to be used will facilitate the process of establishing an offshore trust.

1. AGGRESSIVE VS. NON-AGGRESSIVE LEGISLATION. When "importing the law," one seeks the protection of those jurisdictions which have aggressive asset protection legislation (such as the Cook Islands, Nevis, Gibraltar, and the Bahamas). Alternatively, when "exporting the assets," one seeks the comfort of jurisdictional severance and the greater security for assets provided by established financial centers (such as The Isle of Man, one of the Channel Islands, Bermuda, or Liechtenstein).

Although much is made of the aggressive legislation in some jurisdictions and the certainty that is afforded by such laws, one should not summarily dismiss venues that have less specific and less targeted trust and fraudulent transfer laws. If such a less protective jurisdiction is selected, the lawyer may wish to be more creative with certain provisions of the trust instrument itself, such as the redomiciliation clause or the trustee and protector provisions. Similarly, one can include inherently protective elements in the overall structure, such as nominee and holding companies and depository custodians with no U.S. ties. Indeed, the client should consider the argument that even if the primary objective is asset protection, it is not necessarily appropriate to select a jurisdiction that has aggressive legislation. A potential claimant could assert that aggressive asset protection legislation is the only reason one selects such a jurisdiction and use this argument in support of a fraudulent transfer claim.

2. RELUCTANCE TO RELOCATE ASSETS. Another jurisdiction selection issue arises when a client does not want to move assets offshore. In such a case, even though, at the time of planning, there will be no concerns about fraudulent transfers or bankruptcy discharges (at least if one follows the authors' advice), one inevitably must choose an offshore jurisdiction with highly specific asset protective legislation because such legislation is more likely to extend to assets not physically located in that jurisdiction.

3. CONSIDER THE LIKELY ORIGIN OF A CLAIM. This consideration should be very speculative, because a properly planned offshore structure should already make provision for likely claims. Nevertheless, the nature of the client's activities may suggest that either a private party (e.g., medical malpractice claimant) or governmental agent (e.g., EPA demanding payments for environmental infractions) is the more probable plaintiff. A governmental claimant may well be able to achieve results in a foreign jurisdiction that a private party could not, particularly in a jurisdiction in which the U.S. influences local policy (e.g., in the Caribbean).

4. LOCAL LAW. Most foreign jurisdictions have some form of fraudulent transfer law or other regime designed to protect creditors or certain classes of creditors. These laws vary, as do the laws of spendthrift trusts. Sometimes a settlor can be the sole beneficiary, PLANNING FOR ASSET PROTECTION Page 46 sometimes a remainderman, sometimes a member of a class of current beneficiaries, and sometimes none of the above. An opinion letter on such issues from local counsel may be advisable.

In the exercise of analyzing local law, there is a natural tendency to stop with the trust law and fraudulent transfer law. However, other aspects of local procedural and substantive law that demand attention in a comprehensive review include the following:

a. Rules regarding contingent fee arrangements (e.g., are they permitted?)

b. Theories for damages and the basis for amounts (e.g., are punitive damages allowed?)

c. Rules regarding the awarding of attorney fees and court costs (e.g., is there a loser pay rule, and, if so, what is covered?)

d. Statutes and case law on confidentiality

e. Conventions or laws on the enforcement of foreign judgments

f. Conventions or laws on the taking of evidence (e.g., is the venue a party to the Hague Convention on taking evidence abroad?)

g. Statutes and case law on conflicts of law

b. Bankruptcy law

a. Taxes

Such laws can, in fact, be as important as the basic trust law and fraudulent transfer law.

5. ECONOMIC AND POLITICAL STABILITY. Great weight should be given to political and economic stability. A country’s economic stability is typically related to its political security, but not always. The ideal locale should have a certain economic substance measured by the status of its population, domestic output, infrastructure, and professional community. A healthy range in the choices of banks, accountants, trustees, attorneys, and investment advisors provides proof of a comforting level of professional and economic activity.

6. COSTS. Of particular concern to the client will be local fiduciary, legal, and accounting fees, formation costs, taxes (if any), etc. As a general rule, reputable professionals in foreign jurisdictions have reasonable charges. Competition and professionalism seem to keep trustee, legal, and accounting fees at appropriate levels. It generally is advisable to consult with more than one attorney (or firm) and to inquire about that lawyer's charges as well PLANNING FOR ASSET PROTECTION Page 47 as other costs and fees. Making it known that one will be conducting further inquiries before selecting professionals promotes competitive responses.

7. TRANSPORTATION AND COMMUNICATIONS. Transportation and communications are very important. It is relatively easy to travel to most offshore jurisdictions, but certain issues need to be addressed.

a. Does travel depend upon a politically sensitive connecting terminal?

b. Do local holidays affect travel logistics?

Personal tastes are also a factor in the selection of jurisdiction. Some clients simply prefer to go to Europe and are comfortable there, while others may have the same attitude about the Caribbean.

8. BANKS AND INVESTMENT ADVISORS. Most offshore trust structures require the participation of a foreign custodian bank. Thorough inquiries should be conducted regarding the bank's reputation, integrity, and financial wherewithal. The use of a branch of a well-known U.S. bank or an international bank must be carefully and cautiously considered. The bank's presence in other jurisdictions (for example, the U.S.) could compromise the level of protection otherwise afforded the client's assets.199 Many banks in foreign countries have high quality money managers. However, independent investment professionals also are available and many provide high quality investment advice.

9. CRIMINAL ACTIVITIES. One of the greatest risks in the use of an offshore trust is an erroneous choice of local professionals. In some offshore jurisdictions, there are trustees, lawyers, accountants, and bankers involved in tax evasion, money laundering, and perhaps other activities that are not necessarily illegal in the host country but are illegal under U.S. laws. Therefore, it is extremely important to be sure that one is dealing with honorable professionals. Obviously, references and professional listings are critical to the thorough examination of this issue.

The lawyer and client can also expect to be scrutinized by reputable professionals abroad. Foreign trustees, lawyers, bankers, and accountants who conduct their careers and lives in honest, ethical, and honorable fashions are wary of new business. Therefore, the attorney, as well as the client, might be asked for references and be subjected to close examination. If one thoroughly investigates the people with whom one chooses to deal, presents them with detailed information and references, as well as assurances that the offshore arrangement will be planned within the bounds of the legal and tax framework of the client's jurisdiction and the host jurisdiction, problems will be few.

10. INFLUENCES OF OTHER COUNTRIES. Most offshore jurisdictions are small countries and are subject to the economic clout and political influence of larger countries. The U.S., for example, has the potential to force the Caribbean Basin Initiative on many Caribbean island countries. Many of the jurisdictions have some tie to the United PLANNING FOR ASSET PROTECTION Page 48

Kingdom, which may retain powers over certain aspects of the international dealings of its former colonies or dependencies.200 The impact of these relationships should be considered and evaluated.

D. Step Four: Plan the Structure of the Offshore Arrangement

1. STRUCTURAL VARIATIONS.

a. Single Trust. A single foreign trust with only a portion of the client's assets (a "nest egg") will be appropriate for a large number of clients.

b. Multiple Trusts. The geographic preferences of family members, investments targeted to specific countries, foreign bases of certain operations, and asset segregation and management may require the use of multiple trusts. Multiple trusts provide additional asset protection. However, careful planners avoid creating multiple trusts merely to confuse creditors. Instead, they use multiple trusts for the above mentioned reasons.

c. Private Trust Company. This method places trusteeship in a company established by the settlor, the shares of which are typically owned by a “purpose trust” established for the sole purpose of holding the company's shares (there are no beneficiaries of such a "purpose trust"). The settlor should be able to serve as director of the private trust company without compromising the arrangement, thereby exercising a higher degree of control over the trusteeship of the trust.201

d. Ancillary Entities. The structure of the arrangement typically will involve not only an offshore trust, but also an ancillary foreign corporation. A foreign trust will typically utilize an ancillary corporation to hold title to trust assets. This ownership method can be used for, inter alia, the following reasons: control issues; limitation of liability; additional anonymity; facilitation of business transactions; ownership of assets in civil law jurisdictions which do not recognize the common law trust; and participation in foreign bank and mutual funds and other investments not available to U.S. individuals. Three possible structures are as follows:202

(1) "DROP-DOWN" CORPORATION. A "drop-down" corporation is a foreign corporation that is created and wholly owned by the trust for the purpose of holding title to one or more assets.

(2) "SISTER" CORPORATION. A "sister" corporation is an unrelated foreign corporation organized by the trustee in its nonfiduciary capacity for the sole purpose of holding legal title to assets that are beneficially owned by the company as trustee.

(3) LIMITED PARTNERSHIP. When jurisdictional severance of assets is not possible, clients sometimes will place such assets in a limited partnership with the limited partnership assets being held in the foreign trust. PLANNING FOR ASSET PROTECTION Page 49

e. Non-Trusts. Other offshore entities offer interesting options which, in appropriate situations, may provide more flexibility than a trust. Two examples from Liechtenstein are illustrative of this point:

(1) STIFTUNG. Similar to what U.S. lawyers know as a private foundation, a stiftung may also have individuals as beneficiaries.

(2) ANSTALT. An anstalt is an alter-ego mechanism which can serve anonymity purposes very effectively.

f. Caution. In order to avoid adverse tax consequences, entity structure must be carefully chosen.

2. DRAFT AGREEMENT. The attorney should present the client with a draft trust agreement and a comprehensive letter of explanation at an early stage. There will be new concepts and clauses for even the most sophisticated client to digest.

3. LOSS OF CONTROL. The most troublesome issue for the client typically results from the necessity of placing assets beyond U.S. federal or state court jurisdiction. This issue of severing jurisdictional ties always creates a certain amount of anxiety for the client because it means loss of control. Most clients want to maintain maximum control of their assets, a preference which militates against the advantages of severing the jurisdictional nexus. For example, if the client insists on being the trustee, and the client is a U.S. citizen or resident, then the client will be subject to a U.S. federal or state court order. If, on the other hand, the client selects a foreign trustee, and the trustee has no contacts with the U.S., then a potential claimant would have to pursue the assets in a foreign jurisdiction.

4. ADDRESSING THE CONTROL ISSUE. The desire for control typically is the most sensitive point with the client. The more the client relinquishes control, the more asset protection he or she has.203 The more the client maintains control, the less protection he or she has. There is a spectrum of intermediate arrangements between the extremes of naming the client as trustee (and, therefore, having complete control over the assets) and naming a foreign trustee who has complete control of the client’s assets.

a. Some clients are satisfied with an informal, non-binding letter of wishes which describes how the client desires assets to be managed.

b. A slightly more structured approach is an advisory committee. An advisory committee generally would consist of a group of "advisors." The range of powers given to the committee would vary depending on the settlor's objectives. While the composition of the committee will also vary depending upon the settlor's objectives, possible members include the settlor, his or her spouse, and his or her attorney. The advisory committee can be given actual power in limited circumstances (e.g., removal of an independent trustee and replacement with another independent trustee). PLANNING FOR ASSET PROTECTION Page 50

c. A more formal solution is the use of a protector. When using a protector, the powers given to the protector and the decision of who holds the office of protector are important variables in the range of solutions and will affect the amount of control relinquished. The powers of the protector are described in detail in the trust document itself.

d. Maximum control can always be achieved with a co-trustee who either is the client or will be subordinate to the client's wishes. If such offices are filled by U.S. citizens or residents, an aggressive duress clause will have to be employed in an attempt to retain asset protection features. Indeed, this was the arrangement in the Anderson case and is at the "less creditor-protective" end of the asset protection planning spectrum.204

e. A practical method of retaining power short of acting as co-trustee, however, would be for the settlor to have signatory authority on the bank account of the trust, binding the trustee with joint signature rights. (Many banks, appropriately, resist this approach.)

f. Sometimes a client will prefer to address the issue by a system of checks and balances. In many situations, a foreign trustee and a foreign attorney are involved. Co-trusteeships or other arrangements in which the foreign professionals are charged with administrative responsibility as well as the duty to monitor each other can give the client the desired level of comfort.

g. A fairly complex way to address control involves the use of a private trust company in conjunction with a purpose trust.205

h. Control can also be preserved by the configuration of the assets held in the trust. For example, if the trust holds units of a limited partnership and the settlor is either (i) the general partner or (ii) controls the corporate general partner, the foreign trustee's real authority is quite circumscribed.206

i. Limited liability companies or other corporations (which are, in fact, holding companies for the investments) might also comprise the assets of the trust. The grantor can "re-enter" in such a "drop-down" entity as an officer, director, or manager and thereby re-achieve a measure (a substantial measure, if desired) of control.207 If the trust holds as its principal assets limited liability companies or other corporations which are directed by the settlor and serve as the vehicles to hold the investments, the tax issues become complex. However, with careful planning, the arrangement can still be tax neutral. Similarly, the corporate trustee can create a new corporation which is owned by the corporate trustee, as opposed to being owned by the trust, to serve as a nominee corporation. Such a "sister" corporation also permits "re-entry" by the grantor as an officer or director.208

j. The grantor can create a corporation to be a nominee corporation for purposes of control. This device in effect causes all assets to revert to the grantor's control unequivocally.209

k. Any structure considered should be reviewed against (1) substance over form or "sham" principles, and (2) U.S. income tax issues. PLANNING FOR ASSET PROTECTION Page 51

l. While the authors have attempted to outline a variety of methods for addressing the control issue, they have a strong preference for the protector solution.

5. RELATED PLANNING FOR PROTECTING ASSETS.

a. Expanded Class of Beneficiaries. The settlor could be one of a permissible class of beneficiaries. The trustee would have complete discretion as to whom distributions of income would and would not be made. In addition, the trustee should be given the authority to remove (at its discretion) a beneficiary from the permissible class and to substitute new beneficiaries, including charitable beneficiaries.

b. "No Interest" Term. One commonly used device is a provision which creates a term during which the beneficiaries are persons other than the settlor. During this term, the settlor has no rights to income or principal. Upon the happening of certain events, this term can be extended. Under this arrangement, the settlor has no interest that claimants can reach. The term could coincide with, or at least be sensitive to, the foreign jurisdiction's statute of limitations period.

c. Triggering Event. Another option is to allow the settlor to be a beneficiary until the happening of an event which triggers a new class of current beneficiaries. For example, if a claimant secures a judgment against the settlor, then the settlor's beneficial interest in the trust automatically becomes the last to be recognized under the terms of the trust, and a new class of beneficiaries is established.

d. Abeyance Period. An abeyance period is yet another possibility.210 This mechanism gives the trustee the power to hold the settlor's right to income and principal of the trust in abeyance until the "danger" to the trust assets has passed. For example, upon notice of a malpractice suit against a physician-settlor, the trustee would notify the settlor that his rights to the trust's assets have been cancelled. Then, once the suit had been fully adjudicated, the trustee would cancel the abeyance by further notice to the settlor.

e. Non-Self-Settled Trusts.211 With narrow exceptions, trusts benefiting only third parties (i.e., not the settlor) are protected by the spendthrift trust laws of every state. For those client-settlors who desire the opportunity to become a trust beneficiary at some point, the trust can provide for the addition of beneficiaries (including the settlor) at a later date. Perhaps this arrangement might prove useful in the context of the new bankruptcy rules under BAPCPA. If the trust settlor is not a trust beneficiary during the ten-year period after assets are transferred to the trust, but is added as a beneficiary thereafter, the trust is (arguably) not self-settled and, therefore, is not subject to BAPCPA’s ten-year clawback provision applicable to self-settled trusts.

f. The authors prefer the first solution wherein the settlor is one of several wholly discretionary beneficiaries. PLANNING FOR ASSET PROTECTION Page 52

6. DOCUMENTS. Other than the trust deed and the documents necessary to create the ancillary corporation or limited partnership, at least three other contracts typically must be prepared.

a. Nominee agreement between trustee and ancillary corporation.

b. Custody agreement between trustee and bank/custodian.

c. Money management agreement between trustee and portfolio manager.

E. Step Five: Select Local Professionals

After the client has made appropriate investigation with the assistance of U.S. counsel, the client must select local professionals.

1. MORE THAN ONE PROFESSIONAL REQUIRED. Local legal counsel, a bank or trust company, a portfolio manager (if this service is not to be provided by the bank), and a local accountant (if the attorney does not have an in-house accountant) are generally required.

2. FAMILIARITY WITH PROFESSIONALS. Encourage the client to interview lawyers and money managers in the offshore jurisdictions under consideration. The issue of control, as discussed above, is always addressed in part by the level of comfort the client has with the resident professionals. If the client is able to establish a solid relationship with a local banker, a local attorney, and a local trustee, his or her willingness to cede power to those individuals, or some combination of them, may be increased, and consequently, there will be enhanced asset protection.

F. Step Six: Review Recent Case Law212

The plan should be back-tested against recent case law. At this writing, at least four recent cases, three in federal bankruptcy courts213 and one in the U.S. Court of Appeals for the Ninth Circuit,214 have found in favor of the party seeking to penetrate the asset protection structure. In response, the financial press has suggested that these decisions sound the death knell for offshore asset protection trusts.215 A careful analysis of these cases reveals, however, that offshore planning is still very much alive and well, and the cases provide helpful guidance for practitioners seeking to better understand what can and cannot be done in the realm of asset protection.

The Anderson case has received the most attention. The Andersons, a Nevada couple, operated a telemarketing venture that the Federal Trade Commission successfully attacked as a fraudulent investment scheme. The Andersons had previously established a Cook Islands trust and transferred millions of dollars of telemarketing proceeds into it. The FTC argued that the Andersons were running a Ponzi scheme, and the trial court ordered the Andersons to repatriate the telemarketing proceeds in their offshore trust to repay defrauded investors. When the Andersons failed to do so, they were held in contempt of court and actually jailed for a period of time.216 PLANNING FOR ASSET PROTECTION Page 53

In Brooks, the debtor settled an asset protection trust in Jersey, Channel Islands, a jurisdiction that honors self-settled spendthrift trusts. The bankruptcy court in Connecticut, however, found that Connecticut's long-standing public policy prohibiting its citizens from creating self-settled spendthrift trusts was an important enough public policy that Connecticut law (and not Jersey law) should apply; thus, the assets of the trust were held to be available to the trustee in bankruptcy. Portnoy, a New York bankruptcy case more complicated than Brooks, also held that the law of the settlor's domicile (in this case, New York) should apply rather than the law governing the trust (observing in passing that "Jersey does not claim to have exclusive jurisdiction over its trusts").217

Most of the attention paid to the Anderson case focuses on the fact that the settlors were jailed for six months for civil contempt. Proponents of asset protection trusts are fully aware of this potential threat to settlors.218 In the area of asset protection planning, concerns about imprisonment are often answered by the notion that “impossibility” is a defense to civil contempt. That is, an individual cannot be jailed for failing to perform an act (e.g., repatriate assets) that is impossible to perform. If a defendant is ordered to do an act, but he cannot comply, imprisonment for contempt is not permitted.219

The core question regarding the impossibility defense is, “What if the defendant created the impossibility by his or her own action?" In the world of asset protection trusts, the most convenient “impossibility” for a settlor is the inability to repatriate trust assets when so ordered by a court. This is usually accomplished by a “duress clause” in the trust which directs the trustee to refuse to make distributions to a beneficiary if the beneficiary is under a court order to repatriate trust assets. Conservative asset protection planners maintain that putting this clause into the trust instrument will be viewed as a form of lawyer trickery, enraging judges, and gaining immediate judicial sympathy for creditor claimants.220 That seems to be the case.

In Anderson, the Court of Appeals struggled with the impossibility defense issue but did not resolve it. The Court implied that a self-imposed impossibility might not be a defense, but avoided the question by determining that the Andersons could comply, and, therefore, the District Court's repatriation of assets order was upheld. (In fact, the Court discussed the Andersons' ability to control the trust at great length, and it was this analysis that led the Court to the conclusion that the Andersons could repatriate their wealth.) However, in the Lawrence case,221 the Eleventh Circuit met the impossibility defense issue head on and held that impossibility is not a defense in contempt proceedings when the person charged with contempt created the inability to comply. Likewise, a U.S. District Court in Texas has imposed a $5,000 per day fine upon, and threatened incarceration of, the settlor of a Bahamanian trust who failed to obtain certain documents from the trust and claimed the impossibility defense as an excuse therefor.222 Thus, there is now precedent for findings of civil contempt and for the penalty of confinement in self-imposed impossibility cases. The creditors' rights bar will be encouraged by Anderson and Lawrence (and by Portnoy and Brooks) and will not be so quick to settle cases where assets are located in an offshore asset protection trust. The Weese and Legendre cases continue the trend of aggressive attack on asset protection trusts, especially in situations where fraudulent transfer arguments seem well founded.223 PLANNING FOR ASSET PROTECTION Page 54

However, these cases also provide very helpful and valuable lessons for the asset protection bar. For example, in Anderson the Court's focus on the Andersons' control of their offshore assets is instructive. The Andersons were co-trustees and protectors of their Cook Islands trust. It is axiomatic that the more control a settlor has, the less asset protection he or she has.224 Indeed, the only solid asset protection trust structure is one in which the settlor cedes total control of the assets. The settlor should not serve as trustee, co-trustee, protector, co-protector, or retain a power to appoint a trustee or protector. All trustees and all protectors should be independent and not subordinate to the will or control of the settlor. In addition, no U.S. person or entity should fill those roles.

Likewise, the settlor should not attempt to maintain control through some other device. For example, neither the settlor, nor an LLC or corporation controlled by the settlor, should be the general partner in a limited partnership, the interests of which are in an offshore trust. A close reading of Anderson and Weese demonstrates that U.S. courts are both persuaded and moved by the issue of asset control. Settlors who want viable asset protection trust structures must be willing to forego control.

Beyond the control and contempt issues, Anderson, Lawrence, Brennan, and Legendre also teach lessons on trust funding levels. Asset protection planners have long debated in toto planning versus nest egg225 planning. One significant failure of the Andersons' planning was that they put all of their wealth into the trust. Not only did that lend credence to the Court's conclusion that the Andersons retained control, but it also supported the fraudulent transfer claim against them. In toto planning, by definition, brings a settlor to the very limits of solvency, and the Andersons' transfer of all their wealth offshore made them appear to be avoiding creditors.

All of these recent cases are instructive for asset protection planners in both offshore trust creation and implementation. Offshore trust creation should begin with a thorough due diligence review of the client's pending claims, threats, and creditors. Reserves should be set aside for these liabilities. Thereafter, only a limited percentage of a client's net wealth may be used to fund an offshore asset protection trust in an export-the-assets structure.226

The lawyer should assist the client in the selection of independent, highly-reputable fiduciaries (trustees and protectors). All fiduciaries should be non-residents and non-citizens of the United States. The "foreignness" of the structure is further enhanced if the custodian and the assets themselves are foreign. Ideally, the assets should be kept in a foreign bank that has no U.S. presence (because a U.S. branch of the bank could be ordered to turn over the foreign assets, under penalty of contempt), and the assets should be invested in foreign securities (stocks, bonds, and deposits). (Note that in Weese, Maryland real estate was transferred to the Cook Islands trust and, as a consequence, a U.S. court had no trouble finding jurisdiction over the Cook Islands trustee.)

The trust provisions should include distribution clauses that give total discretion to the fiduciaries; i.e., distributions are wholly discretionary. The trust should be for the benefit of multiple beneficiaries, including family members and, preferably, one or more charities. The trust should be irrevocable and contain comprehensive spendthrift language, a redomiciliation clause, and provisions for shifts in beneficial enjoyment. The trust should not contain a duress clause. PLANNING FOR ASSET PROTECTION Page 55

The trust should be part of an overall estate plan and should have purposes beyond asset protection. While the Riechers case227 stands for the proposition that asset protection planning as the sole goal of an offshore trust is proper, additional valid and appropriate reasons for creating an offshore trust help defend the trust against fraudulent transfer claims. Fraudulent transfer claims are all about the intent of the transferor. If the transferor's intent is defensible, the transferor's actions are necessarily legitimate. Proper motivations could include international diversification of wealth, anonymity with respect to wealth or certain assets, tax planning (for example, to secure offshore private placement life insurance, to establish a dynasty trust, or to establish a foreign non- grantor trust on the death of the settlor), investing in funds or securities not otherwise available to U.S. investors, pursuing foreign business opportunities, and achieving foreign tax planning. Lawyers should not manufacture purposes, but careful exploration of a client's goals and agenda will frequently uncover companion purposes to asset protection.

After implementation, the trust should be operated in a wholly professional manner. The trustee should behave with due regard for its duties and should, at all times, honor the integrity of the trust structure. Communications with the trust beneficiaries should be circumspect, and a trustee should not act on the whim or instructions of a beneficiary regarding investments, distributions, or other aspects of the trust administration. The keeping of proper trustee’s minutes is highly recommended. The trustee must be the only decision maker. Properly observed, these procedures will emphasize the lack of client control over the trust assets and will help avoid claims that the trust is either a sham or alter ego of the client.

Finally, asset protection attorneys must be constantly attuned to (and avoid any involvement with) clients or potential clients who “push the envelope” on the issue of fraudulent transfers. Both at home and abroad, courts are taking an uncompromising position with regard to any such attorney involvement. In the Cook Islands version of the Weese case, the Cook Islands Court of Appeal upheld a lower court order of disclosure of otherwise attorney-client privileged documents. While paying the usual homage to the important role of attorney-client privilege in Western legal systems, the court determined that if a strong prima facie case of fraud by the client against a creditor can be established, then a court may require disclosure by the client of what would otherwise be privileged information. “We see an obvious need for disclosure of the advice the (client) received from their legal experts experienced in the intricacies of protective trusts in order to ascertain whether it is being advanced as mere window-dressing to conceal their alleged purpose of defrauding the (creditor).”228

Closer to home, the U.S. Court of Appeals for the Third Circuit held that John DeLorean’s attorneys (who allegedly actively participated in DeLorean’s fraudulent scheme to hinder and delay a creditor’s efforts to enforce a judgment against DeLorean) could themselves be liable to the creditor for fraud even though the attorneys made no misrepresentation to the creditor and even though the creditor did not detrimentally rely on any such misrepresentation (if it was made).229 The harsh facts of this case may limit its impact on the larger world of asset protection planning [i.e., conspicuously bad acts by the attorneys (making material misrepresentations to the court, fraudulent concealment of facts, and wrongful withholding of information) which occurred during the pendency of a claim and after judgment], but creditor attorneys may try to launch similar civil conspiracy theories against asset protection attorneys in PLANNING FOR ASSET PROTECTION Page 56 an effort to set aside asset protection plans which were in place well ahead of the creditor’s claim and which (as intended) are making it hard for the creditor to collect on its claim.

G. Step Seven: Obtain Legal Advice

Attorneys should consider securing legal opinions for the client on a number of matters. For example, foreign counsel might address the following: local fraudulent transfer law; local bankruptcy law; local trust law (e.g., spendthrift issues); local banking law with an emphasis on confidentiality; enforcement of foreign judgments; other issues depending on the objectives identified; and local taxes and expenses.

H. Step Eight: Execute the Documents and Deliver the Funds

Three originals of the trust document may be necessary. One for the client, one for the U.S. attorney, and one for foreign counsel. Consider, however, the advisability of having the original documents held only by the foreign trustee or foreign counsel. Typically, the initial corpus will be nominal, and substantial sums will be wired thereafter. It might be advisable for the client to wire funds to the U.S. attorney's trust account, which then wires them to the foreign attorney's trust account, which then wires them to the offshore trust account.

VII. CONCLUSION

The question most frequently asked of lawyers who specialize in asset protection trusts is "What jurisdiction do you prefer?" There is no single answer to this question. From the analysis of the Alaska, Delaware, Nevada, Utah, Rhode Island, Oklahoma, South Dakota and Missouri options presented above, and considering solely the issue of asset protection, foreign venues clearly offer U.S. citizens more secure solutions than domestic venues. Each foreign venue is different, and each has its own strengths and weaknesses. From time to time, the authors have used these jurisdictions (as well as others) for asset protection trusts and related entities and structures. However, the legal scene constantly shifts. Only by a careful and ongoing analysis of the client's objectives, the domestic legal environment, and the foreign options can a lawyer assure a client of the best in asset protection.

As a practical matter, even poorly conceived and ineptly implemented offshore trusts have proven highly successful at asset protection. Penetrating an offshore trust and seizing assets held therein is a daunting prospect and an expensive, time-consuming, almost insurmountable task. Some creditors will simply walk away if informed that the debtor's assets are in an offshore trust or, in the alternative, will promptly settle their claims for a reasonable figure.230

The multiple-entity theory of estate planning involves the creative use of a variety of different legal compartments. For many years, estate planners have employed homestead laws, marital property rights, trusts for family members, pension and profit sharing plans, limited partnerships, life insurance, and other arrangements to provide tax advantages for clients and leverage when dealing with client creditors and claimants. In the context of a multiple-entity plan, an offshore trust represents one more tool in the estate planner's tool box; not the solution for all PLANNING FOR ASSET PROTECTION Page 57 asset protection worries, but an excellent tool if carefully integrated into a comprehensive estate plan.

Implicit in the notion of multiple-entity estate planning is that no single legal compartment is watertight. Each has its own vulnerability but, grouped together in complementary fashion, these various legal compartments (including offshore trusts) can constitute an estate planning vessel fully capable of navigating the hazardous rocks and shoals presented by the tax-man, the creditor, and the plaintiff’s lawyer. PLANNING FOR ASSET PROTECTION Page 58

CHART A

Export The Assets

SETTLOR

FOREIGN TRUST FOREIGN PROTECTO R

FOREIGN TRUSTEE PLANNING FOR ASSET PROTECTION Page 59

CHART B

Import The Law

SETTLOR

1% 99%

LIMITED GENERAL PARTNER PARTNERSHIP

FOREIGN TRUST PROTECTO R

DOMESTI FOREIGN C TRUSTEE TRUSTEE PLANNING FOR ASSET PROTECTION Page 60

CHART C Private Trust Company/Purpose Trust

SETTLOR (and/or PRIVATE TRUST SETTLOR’S FAMILY 1 COMPANY

5

4 3 2

FOREIGN FOREIGN FOREIGN PURPOSE TRUST TRUST TRUST TRUST NO. 1 NO. 2 NO. 3

1. Settlor creates Private Trust Company and acts as a director.

2. Settlor creates Purpose Trust and places shares of Private Trust Company stock into it. (There are no beneficiaries of a Purpose Trust.)

3. The “purpose” of the Purpose Trust is to hold and vote the stock of the Private Trust Company.

4. Settlor or members of settlor’s family create foreign trusts.

5. Private Trust Company acts as trustee of Settlor’s and/or Settlor’s family’s foreign trusts. PLANNING FOR ASSET PROTECTION Page 61

CHART D “Drop-Down” Corporation

FOREIGN TRUST SETTLOR 2 COMPANY

1

7 FOREIGN 3 TRUST

4

5 FOREIGN BANK CORPORATION 6

1. Settlor creates foreign trust.

2. Settlor transfers assets to foreign trust company, as trustee of foreign trust.

3. Foreign trust company holds assets as trustee of foreign trust.

4. Foreign trust company, as trustee of foreign trust, creates foreign corporation, transfers assets to it, and owns all shares.

5. Foreign corporation places assets into bank account.

6. Foreign corporation contracts with bank regarding custody and management of assets.

7. Settlor may re-enter arrangement as director and/or officer of “drop-down” corporation. PLANNING FOR ASSET PROTECTION Page 62

CHART E “Sister” Corporation

FOREIGN TRUST SETTLOR 2 COMPANY

3

1 4

FOREIGN 6 FOREIGN TRUST BANK CORP. 7

5

1. Settlor creates foreign trust.

2. Settlor transfers assets to foreign trust company, as trustee of foreign trust.

3. Foreign trust company holds assets as trustee of foreign trust.

4. Foreign trustee (as independent entity and not as trustee of trust) creates foreign corporation and owns all shares.

5. Foreign trust company (as trustee of trust) contracts with foreign corporation to act as nominee and transfers assets to it.

6. Foreign corporation places assets into bank account and acts as nominee.

7. Foreign corporation contracts with bank regarding custody and management of assets. PLANNING FOR ASSET PROTECTION Page 63

CHART F Limited Partnership

SETTLOR

2 1

LIMITED 2 ENTITY GENERAL PARTNERSHIP PARTNER

3

FOREIGN TRUST

1. Settlor creates S corporation or limited liability company to act as general partner of limited partnership.

2. Settlor places assets in limited partnership in which general partnership interest is 1% of total and belongs to S corporation/LLC, and in which settlor owns remaining 99% limited partnership interests; assets remain on shore.

3. Settlor transfers limited partnership interests to foreign trust. PLANNING FOR ASSET PROTECTION Page 64

CHART G Existing Corporation (controlled by settlor)

3 SETTLOR FOREIGN TRUST COMPANY

1 2

4

FOREIGN FOREIGN 5 BANK CORPORATION TRUST

6

7

1. Settlor creates foreign corporation and may act as director and/or officer.

2. Settlor creates foreign trust.

3. Settlor transfers assets to foreign trust company, as trustee of foreign trust.

4. Foreign trust company hold assets as trustee of foreign trust.

5. Foreign trust company, as trustee of trust, contracts with foreign corporation to act as nominee and transfers assets to it.

6. Foreign corporation places assets into bank account and acts as nominee.

7. Foreign corporation contracts with bank regarding custody and management of assets. PLANNING FOR ASSET PROTECTION Page 65 1© Copyright 2003 by Duncan E. Osborne and Jack E. Owen, Jr.

The materials in this outline derive in part from Asset Protection: Domestic and International Law and Tactics, a four-volume treatise published by Clark Boardman Callaghan in 1995. The author/editor of the treatise is Duncan E. Osborne, the co-author is Elizabeth M. Schurig, and the assistant editor/author is Leslie C. Giordani. For information, call West Group Corporation at 1-800-221-9428. 242 USC § 9601. 3Sarbanes-Oxley Act of 2002, 15 U.S.C. §§ 7201 et seq. (2003). 4See Peter Spero, Search and Rescue Missions, A.B.A. J., Oct. 1999 at 70; Samuel L. Braunstein and Carol F. Burger, Protecting the Wealth, A.B.A. J., Nov. 1999 at 58; Mario A. Mata, International Trusts and Related Wealth Preservation Strategies, in TEXAS BAR CLE: ADVANCED ESTATE PLANNING AND PROBATE 2003, tab 26, available at http://www.texasbarcle.com; Ritchie W. Taylor, Note, Domestic Asset Protection Trusts: The “Estate Planning Tool of the Decade” or a Charlatan?, 13 BYU J. PUB. L. 163 (1998); Santo Bisignano, Jr. & Toby M. Eisenberg, Asset Protection Without a Passport, in TEXAS BAR CLE: ADVANCED ESTATE PLANNING AND PROBATE 2003, tab 25, available at http://www.texasbarcle.com; Duncan E. Osborne & Jack E. Owen, Jr., Asset Protection Planning: The Estate Planner’s Duty, PERS. FIN. PLAN. MONTHLY, March 2003, at 11. 5Robert T. Danforth, Rethinking the Law of Creditors’ Rights in Trusts, 53 Hastings L. J. 287, 289 (2002). 6Randall J. Gingiss, Putting a Stop to “Asset Protection” Trusts, 51 Baylor L. Rev. 987 (1999). 7Henry J. Lisher, Jr., Domestic Asset Protection Trusts, Pall Bearers to Liability?, 35 Real Prop. Prob. & Tr. J. 479 (2000). 8Stewart E. Sterk, Asset Protection Trusts: Trust Law’s Race to the Bottom, 85 Cornell L. Rev. 1035 (2000). 9David C. Lee, Offshore Asset Protection Trusts: Testing the Limits of Judicial Tolerance in Estate Planning, 15 Bankr. Dev. J. 451 (1999), see also Karen E. Boxx, Gray’s Ghost – A Conversation About the Onshore Trust, 85 Iowa L. Rev. 1195 (2000). 10Federal Trade Commission v. Affordable Media, L.L.C., 179 F.3d 1228 (9th Cir. 1999) (this case is usually referred to as “the Anderson case” in asset protection circles). 11In re Stephan Jay Lawrence, 238 B.R. 498 (Bankr. S.D. Fla. 1998). 12As early as 1890, the U.S. Supreme Court endorsed the notion of legitimate asset protection planning. Schreyer v. Scott, 134 U.S. 405 (1890). Citing Carr v. Breese, 81 N.Y. 584 (1880), the Court agreed that, absent evidence of intent to defraud creditors, “ . . . any business man has a right . . . to provide against future misfortune when he is abundantly able to do so.” Schreyer at 415. 13Howard D. Rosen and Gideon Rothschild, Asset Protection Planning, 810-2nd Tax Management Portfolios (2002); Peter Spero, Search and Rescue Missions, A.B.A. J. Oct. 1999, at 70; Dennis M. Sandoval, Judicial Foreclosures and Constitutional Challenges: What Every Estate Planning Attorney Needs to Know, Financial and Estate Planning, at ¶ 32,491 (2002). 14See Report on Tax Haven Abuses: The Enablers, the Tools and Secrecy released in conjunction with S. Comm. on Homeland Security and Governmental Affairs Permanent Subcomm. on Investigations August 1, 2006 Hearing (109th Cong.). This bipartisan Senate report is the product of a year-long investigation into tax haven abuses, which included the issuance of more than 70 subpoenas, the scheduling of more than 80 interviews, and the review of more than 2 million pages of documents. The report lambastes the evasion of U.S. taxes by means of sham trusts, shell corporations, and fake economic transactions facilitated by offshore tax haven secrecy laws which can be used to hide assets and transactions from the IRS and other U.S. regulators. Of note, however, the report in no way condemns the general practice of asset protection planning by reputable lawyers on behalf of honest, tax-paying, law-abiding clients, and, like all American citizens, such asset protection attorneys and their clients welcome any and all thoughtful, measured efforts to reduce abuses in this area of the law. 15Danforth, supra note Error: Reference source not found, at 294. 16Austin Wakeman Scott and William Franklin Fratcher, The Law of Trusts, § 156.2, at 176 (4th Ed. 1987). 17Restatement (Second) of Trusts § 154 (1959). 18Danforth, supra note Error: Reference source not found, at 292-301. 19Id. at 298. 20Id. 21Id. at 294, 302, and 305. 22Id. at 302. 23Id. at 302-303. 24Id. at 305. 25Id. 26Id. at 361; Erwin N. Griswold, Spendthrift Trusts, § 474, at 542-542 (2nd Ed. 1947). 27Id. at 361. 28The following series of articles by Neal L. Wolf is helpful in this regard: "Understanding the Uniform Fraudulent Conveyance Act and Its Application in Creditor Attacks," J. Asset Prot., Sept./Oct. 1995, at 38; "Fraudulent Conveyance Law as Contained in the U.S. Bankruptcy Code," J. Asset Prot., July/August 1996; at 25; and "The Right of 'Future Creditors' Successfully to Maintain Actions Under the Fraudulent Conveyance Statutes," J. Asset Prot, May/June 1997, at 52. If an individual makes a gratuitous transfer and later is subject to the fraudulent transfer rules of the United States Bankruptcy Code, the transfer may be invalidated, or set aside, if the transfer was made within one year of the date that the bankruptcy petition was filed if either constructive or actual fraud is proved. 11 U.S.C. § 548 (Supp. 1990). As a practical matter, if the assets were transferred to a vehicle that is beyond the reach of the bankruptcy trustee (such as an offshore trust) and the judicial set aside is ineffective, the debtor is likely to be denied his discharge in bankruptcy. The issue of the discharge will be resolved for or against the debtor depending on the timing and the structure of the vehicle to which the assets were transferred. (From the creditor’s perspective, however, the debtor’s failure to be discharged may be cold comfort since the creditor will be unable to recover the transferred assets.) 29Duncan E. Osborne, Advanced Practical Asset Protection Planning – Here, There or Everywhere? A Case Study, Address Before the Spring A.B.A. Meeting, (April 25, 2002) (transcript available from the author). 3013 Eliz. Ch. 5 (1570). 31See, e.g., United States v. Chapman, 756 F.2d 1237, 1240 (5th Cir. 1985). 32Barry S. Engel, When is a Subsequent Creditor Not a Subsequent Creditor?, 3 J. Int'l Tr. & Corp. Plan. 105, 106 (1994). 33See Uniform Fraudulent Transfer Act § 4(b) & Comment (1), 7A ULA 639, 653 (1984) for a comprehensive list of the most common badges of fraud cited by the courts. 34But see U.S. v. Townley, 77 A.F.T.R.2d (RIA) 2484 (9th Cir. 2006). In Townley, the defendants’ repeated admission that they transferred property to avoid potential future creditors provided direct evidence of fraud on the IRS. The Townley case was contrary to most other cases dealing with unknown future creditors, but it may nonetheless be the law in Washington. See also, Rubin and Rothschild, “Ninth Circuit Trends on an Established Right,” Trusts and Estates (Nov. 2006). 35Osborne and Schurig, Asset Protection: Domestic and International Law and Tactics, § 2:23 (1995). 36Wantulok v. Wantulok, 214 P2d 477, 484 (Wyo 1950). See also Weinhart v. Weinhart, 193 Misc 424, 84 NYS2d 375 (1948) (“To constitute a fraudulent conveyance there must be a creditor [who could] be defrauded”); City of Philadelphia v. Stephan Chemical Co., 713 F Supp 1491 (ED Pa 1989); In re Kusar’s Estate, 5 Ohio Misc 23, 211 NE2d 535 (1965); In re Oberst, 91 BR 97 (BC CD Cal 1988). 37Danforth, supra note Error: Reference source not found, at 330. See, e.g., In re Kusar’s Estate, 5 Ohio Misc. 23, 211 N.E.2d 535 (1965); In re Oberst, 91 B.R. 97 (Bankr. C.D. Cal. 1988). 38Id.; see also Peter A. Alces, The Law of Fraudulent Transactions ¶ 5.79 (1989). 39Danforth, supra note Error: Reference source not found, at 330-331. 40See Duncan E. Osborne and Elizabeth M. Schurig, What ACTEC Fellows Should Know About Asset Protection, ACTEC Notes, Spring 2000, at p. 367. 41Duncan E. Osborne and Jack E. Owen, Jr., The Case for “Nest Egg” Planning, Asset Prot. J., Winter 2003, at 23. 42See, e.g., Erik Moller, Nicholas M. Pace, and Stephen J. Carroll, Punitive Damages in Financial Injury Jury Verdicts, RAND Institute for Civil Justice, Document No. MR-888-ICJ (1997). 43Grupo Mexicano de Desarrollo, S.A., et al. v. Alliance Bond Fund, Inc., 527 U.S. 308, 119 S.Ct. 1961, 144 L.Ed.2d 319 (1999), particularly footnote 11. 44See, e.g., Federal Trade Commission, Press Release, 2002 WL 31784178, December 13, 2002. This document is also available at http://www.ftc.gov/opa/2002/12/fyi0265.htm . 45Osborne and Schurig, supra note Error: Reference source not found at 367-368, nn 10-14. 46While effective utilization of federal bankruptcy law quite correctly can be considered a domestic asset protection "strategy," this outline focuses on preventive rather then remedial measures. 47A state-by state discussion of asset protection statutes can be found in Osborne and Schurig, Asset Protection: Domestic and International Law and Tactics (1995). 48See also Giordani and Osborne, "Will the Alaska Trusts Work?", 3 J. of Asset Prot. No. 1 (Sept/Oct 1997). 49However, more than half the states force their residents to utilize state exemptions because the state has “opted out” of making the federal exemptions available to their residents. 50Two early cases construing the new homestead provisions read them in conflicting ways. The court in In re McNabb, 326 B.R. 785 (Bankr. D. Ariz. 2005), ruled that the homestead cap applies only as a result of “electing” federal exemptions; therefore, the cap did not apply in states (such as Arizona) that have “opted out” of permitting their residents to elect federal exemptions in bankruptcy. This approach was expressly rejected in In re Kaplan, 2005 Bankr. LEXIS 1948 (Bankr. S.D. Fla. Oct. 6, 2005), where the court found that the Florida homestead exemption was capped by this provision, even though Florida is an opt-out state. Subsequent cases on this issue have tended to support the Kaplan approach. 51For example, Maine protects the debtor's interest in one boat, not exceeding 5 tons burden, reflecting, naturally enough, that state's heritage. New York is the only state that specifically protects a seeing-eye dog (and its food). 52544 U.S. 320 (2005). 53An argument may be made that subsection (n) does not cap a state exemption that exceeds $1 million for IRAs. The exemption under § 522(b)(3)(C) is available to debtors opting for state exemptions, but the exemption is actually provided under federal law. This means that debtors opting for state exemptions have both state and federal exemptions available to them. Subsection (n) does not specifically address whether IRAs exempted under state law are meant to be capped by subsection (n). Consequently, a creative debtor might argue that IRAs in excess of $1 million are exempted under state law, not under 522(b)(3)(C). Ultimately, the authors believe that this argument fails because subsection (n) is not tailored in that way and because such a reading would effectively render the cap meaningless for debtors opting for state exemptions. 54IRC § 402(c) permits rollovers of certain distributions made from qualified plans directly to the plan beneficiary. However, under section 402(c), those distributions must be rolled over into another qualified plan within 60 days in order to qualify for the favorable tax treatment. Under the language of section 522(b)(4)(D), an argument may be advanced that the exemption for such “eligible rollover distributions” from the bankruptcy estate applies regardless of whether such distributions are rolled over into another plan. However, while this argument may find support in the language of section 522, it seems inconsistent with the purposes of both IRC 402(c) and the rest of section 522(b)(4). 55Of course, care should be given not to run afoul of the “reciprocal trust” doctrine. Reciprocal trusts are created when two settlers create identical or similar trusts for the benefit of the other, and each settlor is deemed to be the settlor of the trust created for his or her benefit. Although the doctrine is most often applied in the tax arena, it is also applicable in the context of asset protection. See Sec. Trust Co. v. Sharp, 77 A.2d 543 (Del. C. Chanc. 1950). 56See Rev. Rul. 77-137, 1977-1 C.B. 178 and Evans v. Commissioner, 447 F.2d 547 (7th Cir. 1971) [assignee treated as a partner for federal income tax purposes]; but see Riser, Tax Consequences of Charging Orders: Is the "K.O. by the K- 1" K.O.'d by the Code?, 1 Asset Protection J. No. 4 (Winter 2000). 57For an example of a recent judicial attack on spendthrift trusts, see Sligh v. First National Bank of Holmes County, 704 So. 2d 1020 (Miss. 1997). 58Restatement (Third) of Trusts, § 56, comment b. 59Restatement (Third) of Trusts, § 60, comment g; but see Restatement (Third) of Trusts, § 58, comment b; see also Harris and Klooster, “Beneficiary-Controlled Trusts Can Lose Asset Protection,” Trusts and Estates 37 (Dec. 2006). 60For example, Delaware law might protect these payments if paid into a Delaware bank account. 61Some states have specifically addressed this issue through legislation. For example, Texas law provides a beneficiary will not be considered a settlor because of a lapse, waiver, or release of a beneficiary’s right to withdraw trust property of the greater of (a) the greater of $5,000 or 5% of trust assets [IRC § 2041(b)(2) or § 2514(e)], or (b) the annual exclusion gift amount [IRC § 2503(b)]. Tex. Prop. Code § 112.035(e)(2). 62For example, a state statute protecting annuity payments might apply to this type of payment. 63The following discussion is based, in part, on Giordani and Osborne, Will the Alaska Trusts Work?, 3 J. of Asset Prot. No. 1 (Sept/Oct 1997) and Giordani and Osborne, Stateside Asset Protection Trusts: Will They Work?, Estate and Personal Finance Planning (Edward F. Koren ed., West Group 1997). 64In addition to the existing Alaska, Delaware, Nevada, Utah, Rhode Island, Oklahoma, South Dakota and Missouri statutes, asset protection trust legislation is now pending in New York. Further, some commentators argue that that Colorado statutes provide some basis for asset protection trusts against future creditors. Further, the Colorado statute regarding spendthrift trusts provides: “All deeds of gift, all conveyances, and all transfers or assignments, verbal or written, of goods, chattels, or things in action, or real property, made in trust for the use of the person making the same shall be void as against the creditors existing of such person.” COLO .REV. STAT. § 38-10-111 (2006). Although the statute’s plain language suggests that self-settled spendthrift trusts are not void as to future creditors, courts’ interpretation of the statute has not been uniform. See Connolly v. Baum, 22 F.3d 1014, 1017 (10th Cir. 1994) (holding that an irrevocable self-settled trust was not void as against future creditors under Section 38-10-111 of the Colorado Revised Statutes); but see In re Cohen, 8 P.3d 429, (Colo. 1999) (stating in dicta: “But even if there were no creditors at the time the trust was settled, the oral irrevocable spendthrift trust could not and did not protect the settlor-beneficiary from future creditors.”) 65U.S. Const., Art. IV, Sec. 1. 66U.S. Const., Art. I, Sec. 10. 67U.S. Const., Art. VI, Sec. 2. 68In designing an asset protection structure, the lawyer must do more than simply read the Domestic Venue asset protection legislation. To probe for weaknesses, the lawyer must envision how the attack on the trust is likely to be played out. Also, note that the same thorough analysis is called for in reviewing asset protection features of foreign jurisdictions. 69AK ST § 13.36.105-220. 70AK ST § 34.40.110(b). 71Based in part on the inability, under the Alaska Trust Act, of the settlor-beneficiary's creditors to reach her interest in a trust created under said statute, the IRS recently ruled that the settlor-beneficiary's transfer to the trust was a completed gift for gift tax purposes. However, the ruling did not specifically address whether or not the assets would be included in the settlor's estate for estate tax purposes. PLR 9837007 (June 10, 1998). 72AK ST § 34.40.110(d). 73AK ST § 34.40.110(b). 74AK ST § 13.36.370. 75AK ST § 13.36.375. 76AK ST § 34.40.110(a). 77Id. But see 2 below discussing the 2005 federal bankruptcy reform dealing with self-settled trusts. 78Del. Code Ann. tit. 12, § 3570 et seq. 79Del. Code Ann. tit. 12, § 3570(10). 80Del. Code Ann. tit. 12, § 3571 and § 3572. 81Del. Code Ann. tit. 12, § 3573. 82Del. Code Ann. tit. 12, § 3572. 83 Del. Code Ann. tit. 12, § 3572(b)(1). 84Del. Code Ann. tit. 12, § 3570(10)(b)(3). 85Del. Code Ann. tit. 12, § 3570(11). 86Del. Code Ann. tit. 12, § 3570(10)(b). 87Del. Code Ann. tit. 12, § 3572. 88Del. Code Ann. tit. 12, § 3572(g). 89Nev. Rev. Stat. § 166.001 et seq. (1999). 90Nev. Rev. Stat. § 112.230. 91Nev. Rev. Stat. § 11.190. 92Nev. Rev. Stat. § 166.170. 93Utah Code § 25-6-14. 94Utah Code § 25-6-14(2)(c). 95Utah Code § 7-5-1(1)(d). 96Utah Code § 75-2-1203. 97Utah Code § 25-6-14(4)(a). 98Utah Code § 25-6-14(4)(b). 99R.I. Gen. Laws §§ 18-9.2-1 – 18-9.2-7 (1999). 100Okla. Stat. tit. 31, §§ 10-18. 101Okla. Stat. tit. 31, § 11(1). 102Okla. Stat. tit. 31, § 12. 103Okla. Stat. tit. 31, § 11(6). 104Okla. Stat. tit. 31, § 11(5). 105Okla. Stat. tit. 31, § 11(3). 106Okla. Stat. tit. 31, § 11(5)(d), 11(2). 107Okla. Stat. tit. 31, § 11(5)(e). 108Okla. Stat. tit. 31, § 13. 109Id. 110Okla. Stat. tit. 31, § 16. 111Okla. Stat. tit. 31, § 13. 112Okla. Stat. tit. 31, § 17. 113Okla. Stat. tit. 31, § 18. 114S.D. Codified Laws §§ 55-16-1 to 55-16-16. 115S.D. Codified Laws § 55-16-2. 116Id. 117S.D. Codified Laws § 55-16-9. 118S.D. Codified Laws § 55-16-10. 119S.D. Codified Laws § 55-16-16. 120Id. 121This provision expressly excludes a claim based on forced heirship or legitime. S.D. Codified Laws § 55-16-15. 122S.D. Codified Laws § 15-16-15. 123S.D. Codified Laws § 55-16-12. 124In re Enfield, 133 B.R. 515 (Bankr. W.D. Mo. 1991). 125Mo. Ann. Stat. §§ 456.1-101 to 456.11-1106. 126Mo. Ann. Stat. § 456.5-505.3. 127In many cases, an attack on an asset protection trust will be either the second phase of a lawsuit or a second suit entirely. The first action will have been the cause, cast in tort or contract, that gave rise to the liability. The second action will likely be against the trust in an effort to satisfy the judgment. 128It can be argued that trustees are "necessary parties" to all suits involving trust assets, i.e., that they must be joined in such action for the court to validly adjudicate the dispute. However, since the revision of Federal Rule of Civil Procedure 19 in 1966, there has been a general trend by both state and federal courts away from characterizing any party not present as "necessary" or "indispensable." Instead, many states (and all federal courts) have moved to a more pragmatic analysis, mandating only that certain parties should be joined "if feasible." See, e.g., Fed.R.C.P. 19 (federal courts); C.C.P. § 389 (California); CPLR § 1001 (New York); Tex.R.C.P. 39 (Texas). This approach gives courts more latitude to adjudicate disputes without joining additional parties. For example, the Texas Supreme Court, in Cooper v. Texas Gulf Industries, 513 S.W.2d 200, 204 (Tex. 1974), said "[i]t will be rare indeed if there were a person whose presence was so indispensable in the sense that his absence deprives the court of jurisdiction to adjudicate between the parties already joined." 129357 U.S. 235 (1958). 130357 U.S. at 256 and 262. See also Atkinson v. Superior Court, 49 C2d 338 (Cal Sup Ct 1957). 131See, e.g., Milliken v. Meyer, 311 U.S. 457 (1940). 132See, e.g., International Shoe Co. v. Washington, 326 U.S. 310 (1945). 133Restatement 2d, Conflict of Laws, § 41 (1971). 134See, e.g., International Shoe Co. v. Washington, 326 U.S. 310 (1945); Gulf Oil Corp. v. Gilbert, 330 U.S. 501 (1947). 135See, e.g., Green v. Van Buskirk, 74 U.S. 139 (1868). 136Id. 137Cf. In re Brooks, 217 B.R. 98 (Bankr. E.D. Conn. 1998) (on grounds of public policy, court applied Connecticut law to determine the enforceability of spendthrift provisions of self-settled Jersey and Bermuda trusts; held, spendthrift provisions were unenforceable and trust assets therefore were property of the bankruptcy estate.) 138 Compare In re Esteem Settlement, 2003 JLR 188 (Royal Ct.) (upholding a trust despite creative theories of attack by creditors of the settlor-beneficiary). 139See, e.g., Scott on Trusts, § 626(c) (4th ed. 1989); First Nat'l. Bank v. National Broadway Bank, 156 N.Y. 459, 51 N.E. 398 (1898). 140With regard to trusts, see, e.g., In re Brooks, 217 B.R. 98 (Bankr. E.D. Conn. 1998); In re Larry Portnoy, 201 B.R. 685 (Bankr. S.D.N.Y. 1996); First Nat'l Bank in Mitchell v. Dagget, 497 N.W.2d 358 (Neb. 1993). With regard to the general principle that foreign law will not be used if it contravenes the forum state's public policy, see, e.g., Loucks v. Standard Oil Co, 120 N.E. 198 (N.Y. 1918) (Cardozo, J.); see generally, Scoles and Hay, Conflict of Laws, § 3.15 et. seq. (2d ed. 1993). 141All states that have dealt with this issue have declared, either by statute or case law, that spendthrift provisions in self-settled trusts are void against existing creditors and that a wholly discretionary interest retained by the settlor will be interpreted in light of the trustee's discretionary authority to distribute all trust assets, thereby allowing creditors complete access to them. See, e.g., Osborne and Schurig, Asset Protection: Domestic and International Law and Tactics, Ch. 14 (1995). For example, in Texas, "[p]ublic policy does not countenance devices by which one frees his own property from liability for his debts, or restricts his power of alienation of it; and it is accordingly universally recognized that one cannot settle upon himself a spendthrift or other protective trust, or purchase such a trust from another, which will be effective to protect either the income or the corpus against the claims of his creditors, or to free it from his own power of alienation. The rule applies in respect of both present and future creditors and irrespective of any fraudulent intent in the settlement or purchase of a trust." In re Shurley, 115 F.3d 333 (5th Cir. 1997), citing Glass v. Carpenter, 330 S.W.2d 530, 533 (Tex.Civ.App. - San Antonio 1959, writ ref'd n.r.e). The Second Circuit, Seventh Circuit, and Tax Court have read the laws of New York, Indiana, and Maryland, respectively, to say that a settlor's discretionary right to income is not reachable by his or her creditors, but no state court has concurred with this conclusion. Furthermore, commentators have correctly noted that settlors have not chosen to rely on the circuit courts' interpretation. See, e.g., Hompesch, Rothschild, and Blattmachr, Does the New Alaska Trusts Act Provide an Alternative to the Foreign Trust?, 2 J. of Asset Prot. No. 9 (July/Aug 1997). Missouri Revised Statutes § 456.080 has been interpreted to allow creditor-proof discretionary trusts, but, again, settlors have not chosen to rely on this interpretation. Missouri courts have traditionally disallowed creditor protection for self-settled trusts, and a local bankruptcy court has specifically declared that the statute does not change the "existing" rule prohibiting self-settled creditor protective trusts. In re Enfield, 133 B.R. 515 (Bankr. W.D. Mo. 1991). Things may be changing in Missouri, however. See notes Error: Reference source not found-Error: Reference source not found and accompanying text. 142See In re Brooks, 217 B.R. 98 (Bankr. E.D. Conn. 1998). Another dispute in which a court might choose to apply the law of the debtor's domicile, and not Alaska or Delaware law, is in the context of a community property claim. In the states that have adopted a community property system of marital property ownership (e.g., California, Texas, New Mexico), with few exceptions, all property acquired during a marriage belongs equally to both spouses, regardless of which spouse actually earned it. Thus, the validity of a claim against trust assets made by the spouse of a settlor domiciled in a community property state would have to be decided under the law of the settlor's domicile, even in an Alaska court. For example, although the Alaska statute provides that no trust or transfer is void or voidable because it "avoids or defeats a right, claim, or interest conferred by law on a person by reason of a personal or business relationship with the settlor or by way of marital or similar right" (AK ST § 13.36.310), to the extent it deprives the settlor's spouse of property rights that had vested in a community property state, it probably violates due process. Any conveyance to a trust made with the intent to deprive the spouse of her community interest would be fraudulent, and it is unlikely that the courts would defer to the Domestic Venue's economic interest in maintaining a haven for fraudulently funded trusts. 143For a discussion of these causes of action, see generally, Scott on Trusts §§ 156, 156.2 (4th ed. 1989). 144See, e.g., AK ST § 34.40.110. Cf. PLR 9837007, in which the IRS ruled that a transfer to a trust created under the Alaska statute would be a completed gift for gift tax purposes "[b]ased on the representation that there is no express or implied agreement between the Donor and the Trustee as to how the Trustee will exercise its sole and absolute discretion to pay income and principal among the beneficiaries." 145For example, offshore trust jurisdictions generally are not parties to the Hague Convention on the Taking of Evidence Abroad on Civil or Commercial Matters. 146Osborne and Schurig, Asset Protection: Domestic and International Law and Tactics, Ch. 2 (1995) provides a general discussion of fraudulent conveyance issues in the asset protection trust context. 147Alternatively, the creditor would have the option of asking the court to issue a turnover order against the settlor with regard to future distributions. Presumably, the trustee would then cease making distributions to the settlor. The creditor would not benefit, but the settlor would lose the ability to enjoy the assets himself. 148U.S. Const., Art. IV, Sec. 1; 28 U.S.C. § 1738. 149See Scoles & Hay, Conflict of Laws, 2d ed. (1992), at 968-986. 150See, e.g., Restatement 2d, Judgments § 17 (1982); Fauntleroy v. Lum, 210 U.S. 230, 237 (1908). 151See, e.g., Nenno and Sparks, Delaware Dynasty Trusts and Asset Protection Trusts, Special Pamphlet to the 99-4 Supplement (1999) of Osborne and Schurig, Asset Protection: Domestic and International Law and Tactics (1995). An analysis of the possible defenses are beyond the scope of this discussion and are, in any event, too fact-specific for anything other than theoretical, treatise-length speculations. 152Santo Bisignano, Jr. & Toby M. Eisenberg, Asset Protection Without a Passport, in TEXAS BAR CLE: ADVANCED ESTATE PLANNING AND PROBATE 2003, tab 25, available at http://www.texasbarcle.com; Richard W. Nenno, Perpetual Dynasty Trusts, UPAIA Section 104 and Total Return Trust Statutes, and Domestic Asset Protection Trusts, in 4 PLANNING TECHNIQUES FOR LARGE ESTATES 1843 (ALI-ABA 2002). 153Lea Brilmayer, Credit Due Judgments and Credit Due Laws: The Respective Roles of Due Process and Full Faith and Credit in the Interstate Context, 70 IOWA L. REV. 95 (1984). 154 For a discussion of the Constitutional underpinnings of this issue, see Laycock, “Article: Equal Citizens of Equal and Territorial States: The Constitutional Fondations of Choice of Law,” 92 Colvin. L. Rev. 249, 289-315 (March 1992). 155See Bradford Elec. Light Co. v. Clapper, 286 U.S. 145, 158-60 (1932) (holding that the state court must apply the law of a sister state unless doing so was “obnoxious” to the policy of the forum state and emphasizing the greater contacts with the non-forum state than with the forum state); Alaska Packers Ass’n v. Indus. Accident Comm’n, 294 U.S. 532, 547-50 (1935) (holding that the interests, as opposed to contacts, of each state should be considered and the law of the state with the more weighty interest should apply); Pac. Employers Ins. Co. v. Indus. Accident Comm’n, 306 U.S. 493, 501-04 (1939) (same); Carroll v. Lanza, 349 U.S. 408, 413-14 (1955) (holding that application of forum law did not offend the full faith and credit clause and noting the forum state’s interest in applying its law). 156Richards v. U.S., 369 U.S. 1, 15 (1962). See Lea Brilmayer, SYMPOSIUM: Credit Due Judgments and Credit Due Laws: The Respective Roles of Due Process and Full Faith and Credit in the Interstate Context, 70 Iowa L. Rev. 95, 109, 112 (1984). 157Order of United Commercial Travelers of Am. v. Wolfe, 331 U.S. 586 (1947); Supreme Council of the Royal Arcanum v. Green, 237 U.S. 531 (1915); Modern Woodmen of Am. v. Mixer, 267 U.S. 544 (1925). 158Wolfe, 331 U.S. at 624-25. 159See id. at 601-07. 160See Eugene F. Scoles et al., Conflict of Laws: Hornbook Series, § 3.24 n. 18 (4th ed. West 2004). 161The holdings in the few cases that have addressed whether self-settled trusts violate public policy are split. Compare Estate of German v. United States, 7 Cl. Ct. 641, 645 (1985) (finding no strong public policy in Maryland courts against persons placing property in trust for their own benefit where there is a remainder interest); with Outwin v. Comm’r, 76 T.C. 153, 166 (1981) (noting that there is a strong public policy in Massachusetts against persons placing property in trust for their own benefit and shielding that property from creditors’ claims). 162Restatement (Second) of Conflicts of Laws §§ 269(b)(i), 270(a) (1971). 163Id. § 273. 164Compare 71 Del. Laws 159 (passed in 1997); with Restatement (Second) of Conflicts of Laws (1971). 165U.S. Const., Art. VI, Sec. 2. 16628 U.S.C. § 1331. 16728 U.S.C. § 1332. 168See, e.g., In re Remington, 14 B.R. 496 (Bankr. NJ 1981) (court held that Pennsylvania law [the law of the trust] applies to determine extent of New Jersey debtor's right to trust assets). 169See HR Rep. No. 595, 95th Cong., 1st Sess. 369 (1977). 170See, e.g., AK ST § 13.36.310. 171The Alaska statute simply denies creditor access to self-settled discretionary trusts. Unlike certain other states' laws (e.g., Delaware), it does not statutorily confer "spendthrift trust" status on such trusts. 172United States Bankruptcy Code, 11 U.S.C. § 522(b)(2). 173See, e.g., In re Larry Portnoy, 201 B.R. 685 (Bankr. S.D.N.Y. 1996) (holding that New York law should determine debtor's rights in a Jersey (Channel Islands) trust because "the trust, the beneficiaries, and the ramifications of [debtor's] assets being transferred into the trust have their most significant impact in the United States . . . and that application of Jersey's substantive law would offend strong New York and federal bankruptcy policies."). This second argument is similar to the argument a creditor might advance in a non-bankruptcy context to convince a court not to apply the governing law of the trust. 174See H.R. 5525, 107th Cong. (2002). 175See 148 Cong. Rec. H7010 (Oct. 3, 2002). 176Case No. 02-12741-FM (Bankr. W.D. Tex., Oct. 28, 2004). See also In re Sullivan, 204 B.R. 919 (Bankr. N.D. Tex. 1995). 177Only creditors holding a claim “that is not contingent as to liability or the subject of a bona fide dispute” may bring the involuntary suit. 11 U.S.C. § 303(b)(1). "If there is either a genuine issue of material fact that bears upon the debtor's liability, or a meritorious contention as to the application of law to undisputed facts, then the petition must be dismissed." In re Eastown Auto Co., 215 B.R. 960, 965 (B.A.P. 6th Cir. 1998). 178See, e.g., In re Rassi, 701 F.2d 627 (7th Cir. 1983) and In re Okamoto, 491 F.2d 496 (9th Cir. 1974). 179See In re Denham, 444 F.2d 1376 (5th Cir.); In re Blaine Richards & Co., 10 B.R. 424 (Bankr. E.D.N.Y. 1981). 180Query what amount constitutes a “small” debt. In a 1987 case, the Fifth Circuit implied that it would apply a threshold of approximately $25 to such claims. In re Runyan, 832 F.2d 58 (5th Cir. 1987). In 1990, a Florida bankruptcy court extended the amount up to $275. In re Smith, 123 B.R. 423 (Bankr. M.D. Fla. 1990). In 2000, a Texas bankruptcy court rejected the Smith approach as an inappropriate extension of Denham, supra note Error: Reference source not found, and limited the exclusion to debtors with claims of $58 or less. In re Moss, 249 B.R. 411 (Bankr. N.D. Tex. 2000). 18111 U.S.C. § 303(h)(1). 182In re Landmark Distribs., Inc., 189 B.R. 290 (Bankr. D. N.J. 1995); In re Alta Title Co., 55 B.R. 133 (Bankr. D. Utah 1985). 183In re Cannon Express Corp., 280 B.R. 450 (Bankr. W.D. Ark. 2002) (citing Landmark Distribs., Inc., supra note Error: Reference source not found.) 184§ 106 of the Act (adding Code § 109(h)). 185U.S. Const., Art I, Sec. 10. 186Wright, The Growth of American Constitutional Law 64 (1967); Home Building & Loan Assoc. v. Blaisdell, 290 U.S. 398, 427-428 (1934) (Hughes, J. discussing historical background of the contract clause). 187Wright, The Contract Clause of the Constitution (1938); Nowak and Rotunda, Constitutional Law, at 11.8 (5th Ed. 1995). 188The U.S. Supreme Court first used the contract clause to invalidate a state law on the basis of unreasonable interference with contracts in Fletcher v. Peck, 10 U.S. 87 (1810). The Court continued to use the clause for this purpose throughout the nineteenth century. See, e.g., Sturges v. Crowninshield, 17 U.S. 122 (1819); Ogden v. Saunders, 25 U.S. 213 (1827); Bronson v. Kinzie, 42 U.S. 311 (1843). However, the clause fell into obscurity during the Court's "substantive due process" era, because "substantive due process" gave the Court greater discretion in passing on the constitutionality of state legislation. Thereafter, the contract clause was considered of little or no importance until its revival in 1977 in United States Trust Co. v. New Jersey, 431 U.S. 1 (1977). The next year, it was used by the Court to invalidate a statute for unreasonable interference with private contracts in Allied Structural Steel v. Spannaus, 438 U.S. 234 (1978), and the Court has continued to use a contract clause analysis for this purpose. See, e.g., Exxon Corp. v. Eagerton, 462 U.S. 176 (1983); Energy Reserves Group, Inc. v. Kansas Power & Light Co., 459 U.S. 400 (1983); Keystone Bituminous Coal Assoc. v. DeBenedictis, 480 U.S. 470 (1987); General Motors Corp. v. Romein, 503 U.S. 181 (1992). 189One reason would be transfer tax planning. For a discussion of possible planning opportunities, see Blattmachr, Blattmachr, and Rivlin, A New Direction in Estate Planning: North to Alaska, Trusts & Estates, September 1997. 190See note Error: Reference source not found. 191See 4 below. 192See Hayton, "When is a Trust not a Trust?", presented at the IBC Conference on Strategic Uses of International Trusts, London, Dec. 1993. See U.S. v. Grant, Civil Case 00-CV-8986 (S.D. Fla. 2005). Because the beneficiary of a Bermuda trust had full discretion to remove and replace the trustee, the magistrate concluded that the beneficiary essentially controlled the corpus of the trust and recommended that the beneficiary be ordered to repatriate trust assets so that they would be subject to U.S. law. 193See, e.g., Uniting and Strengthening of America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA Patriot Act), Pub. L. No. 107-56, 115 Stat. 272. For general discussion of fraudulent transfers, attorney liability and ethics, and relevant criminal statutes, see Osborne & Schurig, Asset Protection: Domestic and International Law and Tactics, Ch. 2, 4, and 26 (1995). 19418 U.S.C. § 1956. 195See, e.g., United States v. Ramsey, 785 F.2d 184, 189 (7th Cir. 1986), cert. denied, 476 U.S. 1186 (1986). 196See U.S. v. Evseroff, 2006 WL 2792750, 98 A.F.T.R.2d 2006-7034 (E.D.N.Y.) (giving great weight to the defendant’s companion motives, i.e., his problematic relationship with hiswife and his estate planning goals with respect to his sons). 197See Duncan E. Osborne and Bradley G. Korell, Converting an Asset Protection Trust into a Tax-Efficient Wealth Reserve, U.S. Taxation of International Operations (Warren, Gorham & Lamont, 2003) §§ 6011-6011.5. 198 Richard W. Nenno, Domestic Asset Protection Trusts (2002) [unpublished, available from Wilmington Trust Company]; John A. Warnick and Serio Pareja, Selecting a Trust Situs in the 21st Century, 16 Probate & Property 53 (March/April 2002). 199See, e.g., U.S. v. Levine et al., 951 F.2d 1466 (6th Cir. 1991) (Mr. Levine had an account at a branch of a Swiss bank in the Bahamas, and despite Bahamas bank secrecy laws, U.S. authorities gained access to information about the account by exerting pressure on the U.S. branch of the Swiss bank). 200See, e.g., the British Overseas Territories Report, Secretary of State for Foreign and Commonwealth Affairs, Partnership for Progress and Prosperity, British Overseas Territory, March 1999. 201See Chart C for an illustration of this structure. 202See Charts D, E and F. Another structure involves a corporation controlled by the settlor (see Chart G). 203Federal Trade Commission v. Affordable Media, Inc., 179 F.3rd 1228 (CA-9, 1999). 204In the Anderson case, the settlors were jailed for contempt when they failed to repatriate the assets, and the court's opinion discusses at length the extent of the Andersons' control and the fallacies in the use of a duress clause. (A duress clause directs the trustee to refuse to make distributions to a beneficiary if the beneficiary, or another party in control of the trust, is under a court order to repatriate trust assets). See also David C. Lee, Offshore Asset Protection Trusts: Testing the Limits of Judicial Tolerance in Estate Planning, 15 Bankr. Dev. J. 451, 464 (1999). 205See Chart C for an illustration of this structure. 206See Chart F for an illustration of this structure. 207See Chart D for an illustration of this structure. 208See Chart E for an illustration of this structure. 209See Chart G for an illustration of this structure. 210This concept was suggested in M. Grundy and J. Briggs, Asset Protection Trusts, Appendix IV (1990). 211Gideon Rothschild, Asset Protection Planning – Current Strategies and Pittfalls, Tax Mgm’t Est., Gifts and Tr. J., Sept./Oct. 2005, at 251. 212The following discussion is based, in part, on Osborne and Schurig, Asset Protection Trusts: Impact of Recent Case Law, 5 J. of Asset Prot. No. 2 (Nov/Dec 1999). 213In re Brooks, 217 B.R. 98 (Bankr. E.D. Conn. 1998); In re Larry Portnoy, 201 B.R. 685 (Bankr. S.D.N.Y. 1996); In re Lawrence, 251 B.R. 630 (Bankr. S.D. Fl. 2000). See also Securities and Exchange Commission v. Brennan, 230 F3rd 65 (CA-2, 2000), Bank of America v. Weese, 277 B.R. 241 (Bankr. D. Md. 2002), and Legendre v. Henkel, Case No. 01- 06482-6J7 (Bankr. M.D. Fl. Orlando Div. 2002). 214Federal Trade Commission v. Affordable Media, Inc., 179 F.3d 1228 (CA-9, 1999). See also Federal Trade Commission v. Ameridebt, Inc., et al., 373 F. Supp. 2d 558 (D. Md. 2005). The FTC is aggressively pursuing this case against Andres Pukke, accused of defrauding consumers with debt problems by structuring repayment plans which, not coincidentally, included huge fees to Pukke. Knowing full well he was under investigation by the FTC, Pukke nonetheless executed a deliberate plan to transfer (without consideration) nearly $24,000,000 of assets to relatives, friends, and asset protection trusts established in Delaware, Nevis, and The Cook Islands. Thus far, the FTC has obtained a freezing order, a preliminary injunction, an order to repatriate assets, and appointment of a receiver to marshal Pukke’s assets. If Pukke fails to comply, the court made clear it will entertain a contempt motion from the FTC. 215William C. Symonds, Offshore Trusts: Not So Watertight, Businessweek, July 26, 1999; Lynn Asinof, Ruling in West May Chill Use of Offshore Trusts, Wall St. J., July 12, 1999 at A24. 216Civil contempt is imposed solely to force (coerce) the contemnor to do a particular act--such as turn over assets. The contemnor must be released when he complies. Criminal contempt is punitive. The contemnor is sentenced and must serve the term, much as in any criminal proceeding. 217In re Larry Portnoy, 201 B.R. 685 at 697 (Bankr. S.D.N.Y. 1996). 218David C. Lee, Offshore Asset Protection Trusts: Testing the Limits of Judicial Tolerance in Estate Planning, 15 Bankr. Dev. J. 451, 464 (1999). 219Id. at 452. See United States v. Rylander, 460 U.S. 752 (1983). 220Osborne and Schurig, Asset Protection: Domestic and International Law and Tactics, § 26:06 (1995); Cf. Chadwick v. Janecka, Case No. 02-1173 (CA-3, 2002). Contemnor has been held in confinement for more than seven years for refusing to comply with an order in a matrimonial proceeding directing him to pay over $2.5 million into an escrow account. Held, there is no federal constitutional bar to indefinite confinement for civil contempt so long as contemnor retains the ability to comply with the order requiring him to pay over the money at issue. See In re Lawrence, 279 F.3d 1294 (11th Cir. 2002). On December 12, 2006, Stephen Jay Lawrence was released from confinement for civil contempt after serving more than six years due to his refusal (according to the court) or inability (according to Lawrence) to repatriate $7 million from his Jersey (later Mauritius) trust for inclusion in his bankruptcy estate. The court determined that the contempt order had morphed from coercive to punitive in nature, in violation of Lawrence’s due process rights. Apparently, concluding that Lawrence valued his money more than his liberty, the court granted him both. 221In re Lawrence, supra note Error: Reference source not found; see also Commodity Future Trading Commission, et al. v. Armstrong, 2002 WL 416448 (2d Cir. N.Y. March 18, 2002); Commodity Future Trading Commission, et al. v. Armstrong, 269 F.3d 109 (2d Cir. 2001); Securities and Exchange Commission v. Princeton Economic International LTD., et al., 152 F. Supp. 2d 456 (S.D.N.Y. 2001). 222Eulich v. United States (N.D. Tex. Case No. 99-CV-01842, August 18, 2004). “Eulich made a conscious decision to set up the Trust in the Bahamas … Eulich cannot benefit from a situation that he himself created.” The court ruled that Eulich could have filed a lawsuit in the Bahamas to compel disclosure of the requested documents and, not having done so, failed to exhaust all avenues for obtaining the documents. If this ruling gets much traction in U.S. courts, it will set a high standard for the impossibility defense. Settlors might have to file expensive lawsuits in foreign jurisdictions (and lose) before they can claim impossibility of compliance in a U.S. court. 223In Nastro v. D’Onofrio, 263 F. Supp. 2d 446 (D. Conn. 2003), a debtor fraudulently transferred Connecticut corporation stock shares to a Jersey trust. Although the court held that it had no jurisdiction over the Jersey trust or its trustee, it found jurisdiction over the Connecticut corporation and ordered the corporation to cancel the stock held in the offshore trust and issue new stock certificates as equitable relief for the fraudulent transfer. 224Osborne and Schurig, Asset Protection: Domestic and International Law and Tactics, § 20:08 (1995). 225Id. at § 20:07. 226Id. at § 20:04. 227Riechers v. Riechers, 679 N.Y.S.2d 233 (Sup. Ct. 1998). See also 267 A.D.2d 445, 701 N.Y.S.2d 113, 1999 N.Y. App. Div. LEXIS 13303 (N.Y. App. Div. 2d Dep't 1999), 95 N.Y.2d 757, 734 N.E.2d 761, 2000 N.Y. LEXIS 1859, 712 N.Y.S.2d 449 (2000). 228Judgment of January 6, 2003, CA 8/02 [Cook Islands Court of Appeal held at Auckland, New Zealand], para. 14. 229Morganroth & Morganroth, et al v. Norris, McLaughlin & Marcus, et al, No. 02-2087, 2003 U.S. App. LEXIS 10808 (3rd Cir. May 30, 2003). See also J.W. v. Allvest, Inc. (Alaska Sup. 3rd Dist. No. 3AN-97-7192-CIV, 2002). Settlor’s corporation suffered a judgment, and settlor attempted to drain the corporation of assets by a series of transfers to an offshore trust. Creditor sued everyone involved (including the attorneys who created this “plan”) for civil conspiracy and fraud. 230Compare Engel, Does Asset Protection Planning Really "Work"?, 4 J. of Asset Prot. No. 1 (Sept/Oct 1998).