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ASSET PROTECTION TRUST
Michie Law Firm
DEFINITION of 'Asset Protection Trust'
A vehicle for holding an individual's assets to shield them from creditors. Asset protection trusts allow, if it is difficult for a creditor to seize assets, settle with the debtor on favorable terms instead of engaging in costly litigation. This vehicle has complex regulatory requirements, such as being irrevocable and contains a spendthrift clause. An asset protection trust does provide for occasional distributions, but those distributions must only occur at an independent trustee's discretion.
Domestic Asset Protection Trust
Only a few U.S. states allow asset protection trusts. As of 2012, these include Alaska, Delaware, Rhode Island, Nevada and South Dakota. However, one can establish an asset protection trust in these states without residing there. Offshore financial centers like the Cook Islands and Nevis also allow individuals to establish asset protection trusts. The trust's documents and administration, along with some or all of the trust's assets, must be located in the same jurisdiction where the trust was established.
The trust laws of the offshore world are typically founded on the trust laws of the onshore world. For those jurisdictions which are currently possessions of the UK, or were former possessions of the UK, typically the UK Trustee Act of 1925 is the common starting point. From there, each jurisdiction has sought to develop and evolve the law in a race to develop the most attractive trust environment which maintains acceptable standards, preserves the concepts of a trust, yet is attractive to potential users. Many of these jurisdictions share similar characteristics.
The Commonwealth of the Bahamas have traditionally been associated with offshore planning. However, the Bahamas are probably more noteworthy for offshore banking. The Bahamas do not recognize self-settled spendthrift trusts, unlike the Cook Islands, Nevis, or Belize.
The burden of proof for a claimant to challenge a transfer into a Bahamian Trust has a limitation period of two years, the same as Cook Islands.
The quality of the banking and investment services is reasonable for the uses of a Trustee of an asset protection trust, however, the quality of the judiciary is considered low, as the legal profession is generally closed to the entry of non-Bahamians, and it is therefore difficult bring the knowledge of a specialised trust lawyer to the jurisdiction when needed.
Belize, offers immediate protection from court action initiated by creditors which challenges the settlor’s transfer of property into the trust. However, due to the paucity of credible offshore banks in Belize, many trusts established in Belize hold assets with a second trustee or third-party financial institution in another country.
Cayman Islands trusts are governed principally by the Cayman Islands Trusts Law (2009 Revision), however elements of the Fraudulent Dispositions Law 1989 are relevant when considering the asset protection benefits of Cayman Trusts.
A number of offshore jurisdictions have enacted modern asset protection legislation based on the Cayman Island's Fraudulent Dispositions Law 1989 (the "FDL"). The Cayman Islands FDL states "Every disposition of property made with an intention to defraud, and at undervalue, shall be voidable at the insistence of an eligible creditor thereby prejudiced". The burden of proof is borne by the creditor applying to set aside the trust, and in the case of the Cayman Islands, the creditor/claimant must bring an action in the Cayman Islands courts (not in their home jurisdiction). The bar is set high for a potential claimant to successfully challenge a transfer. They must demonstrate an intention to defraud on behalf of the Settlor, and they must demonstrate they are an "eligible creditor" - meaning that at the date of the transfer, the transferor owes an obligation to the claimant. They must also be willing to bring an action in the Cayman Islands, which by itself is an expensive proposition.
The burden of proof for a claimant to challenge a transfer into a Cayman Trust has a limitation period of six years.
In Cayman it is possible to register a trust as an Exempt Trust however it is voluntary registration regime only, so most trusts remain unregistered. As most Cayman trusts are therefore private arrangements, it is hard to give exact figures for the popularity of AP Trusts governed by Cayman law. However the number of licensed trust companies give us some indication of how the jurisdiction is viewed. As of 30 September 2012 the Fiduciary Services Division of CIMA, the body responsible for licencing and regulating trust companies in the Cayman Islands has supervisory responsibility for 146 active trust licences.
As the Cayman Islands are a British Overseas Dependent Territory, the quality of the judiciary is considered excellent, with the islands able to draw on the services of UK lawyers and solicitors when contentious cases arise and expert lawyers with appropriate experience are required. The quality of banking and investment services are reasonably good.
The Cook Islands claims to be the first country to have enacted an explicit asset protection law, implementing particular provisions in 1989 to its International Trusts Act. Several of these changes have been adopted in one form or another in several other countries and a handful of a U.S. states. The most important of these changes permits the settlor of a trust to be named as a spendthrift beneficiary.
The trust laws of the Cook Islands provide a shortened statute of limitations on fraudulent transfer claims. While most U.S. states have a four year statute of limitations (and the Statute of Elizabeth in some common law jurisdictions has no statute of limitations), the general statute of limitations in the Cook Islands is reduced to two years for fraudulent transfers; in certain circumstances, it may be as short as one year. If the trust is funded while the settlor is solvent, then the transfer cannot be challenged (i.e., there is no time period for the creditor to challenge the transfer)
Several provisions of the Cook Islands law specify the form of pleading that a creditor must establish in order for its claim to be heard in a Cook Islands court. The effect of these provisions is to raise the burden of proof to "beyond a reasonable doubt," something akin to a criminal law standard, in order for a creditor to establish a fraudulent transfer. The "constructive" fraudulent transfer theories are eliminated under Cook Islands law, requiring the creditor to prove that the transfer was made with specific intent to avoid the creditor's claim.
It is believed that the Cook Islands now has more registered asset protection trusts than any other country, although it should be noted that in most jurisdictions a Trust is considered a private arrangement and it is not a requirement to register a Trust. Case law is somewhat lacking in the Cook Islands. However, some landmark decisions show that the Cook Islands Court intends to uphold the asset protection trust law. In 1999 the Federal Trade Commission attempted to recover assets from a Cook Islands Trust. The suit filed by the FTC against a trust company was unsuccessful. The quality of the judiciary and the associated banking and investment services offered from the Cook Islands are considered poor.
Nevis was one of the first countries to follow the Cook Islands, duplicating an older version of the Cook Islands law and naming it the Nevis International Exempt Trust Ordinance, 1994. One distinguishing feature of the Nevis legislation is that a creditor must post a bond of ECB 25,000 (roughly USD 13,000) to lodge a complaint against a trust registered in Nevis.
Very little case law exists in Nevis, which many attorneys interpret to mean that creditors are effectively deterred from bringing suit in Nevis. It has a small offshore banking industry, with St. Kitts-Nevis-Anguilla Bank and Bank of Nevis International as the only licensed offshore banks.
LLC legislation modeled after the Delaware LLC Act was passed in 1996. This has enabled Nevis to distinguish itself as a primary offshore jurisdiction for LLC formations, as opposed to other countries that are well known for IBC formations (British Virgin Islands) or trust formations (Cayman Islands). A Nevis LLC is often used in conjunction with an asset protection trust because it gives the creator of the trust direct control over the assets if the creator is listed as the manager of the Nevis LLC. This gives the creator added security in that it keeps the assets one step removed from the trustee of the asset protection trust. Because the managers and members of a Nevis LLC are not public information, the creator of the trust is able to assume control over the assets without making disclosing his control on any public records.
Channel Islands (Guernsey and Jersey)
The Channel Islands have been long regarded as one of the first small island jurisdictions to develop an offshore finance industry, and is often regarded as being one of the best quality jurisdictions to use. However, modern case law indicates that creditors are routinely able to freeze trust assets in the Channel Islands. Furthermore, tax law initiatives in the UK have largely eliminated the tax advantages of placing assets in trust in the Channel Islands. While the Channel Islands enjoys a modern banking sector, most attorneys do not regard the Channel Islands as appropriate for asset protection planning.
The judicial systems of the Channel Islands are split into two distinct Bailiwicks. The Bailiwick of Jersey, and the Bailiwick of Guernsey (which includes the islands of Guernsey, Alderney Sark, and Herm). The legal system is a dual system based on Norman-French codified law overlaid with elements of English common law. Whilst specialised training is required in order to practice law in the Channel Islands and the Bar is not open to everyone, the quality of the judiciary is generally considered very good, if not very expensive. The related banking and investment services offered from the Channel Islands is also considered good to excellent.
Switzerland and Liechtenstein
Switzerland and Liechtenstein are noteworthy for large banking sectors and sophisticated wealth management services. While both countries now recognize trusts (particularly trusts established under the laws of another jurisdiction, such as Nevis), there is no available case law yet which indicates how the courts of those two countries will enforce offshore asset protection trust laws.
Many attorneys establish asset protection trusts under the laws of another country and deposit the trust assets in Switzerland or Liechtenstein. One question raised by this approach is whether a creditor can seize assets in Switzerland or Liechtenstein without having to bring a claim in the trust-protective jurisdiction. Again, a lack of precedent suggests that this is an open issue in Switzerland and Liechtenstein.
Both countries are also known for offering asset protection annuities, with a six-month statute of limitations on fraudulent transfers into an annuity. Unfortunately for most Americans, these annuities cannot invest in US securities without punitive taxation due to the offshore status of the insurance carriers that offer these annuity products. Furthermore, many lawyers peddling these annuity products to their clients collect commissions from the insurance carriers. These reasons, among others, may help explain why annuities offered in these two countries are not particularly popular with U.S. persons. This does not mean that taxpayers of other jurisdictions may not significantly benefit from holding a Swiss or Liechtenstein annuity. Also, U.S. persons may benefit from holding an annuity issued by a carrier in an asset-protective jurisdiction (such as the Cook Islands), particularly if the carrier is an electing 953(d) carrier (a reference to a provision of US tax law).
Whether such a trust is a spendthrift trust on the U.S. model, a protective trust on the Commonwealth model or another form of discretionary trust, it is more likely to be subject to challenge under the common law doctrine of sham or under specific statutory provisions if any person setting up the trust (or their spouse and their spouse in turn as in a reciprocal trust):
· can benefit under its provisions;
· is the person under risk financially;
· benefits (whether permitted or not) from the trust; or
· if the person setting up the trust is at risk financially, if bankruptcy or divorce occurs soon after the establishment of the trust (fraudulent conveyance).
Offshore trusts and other asset protection vehicles typically do not prevent action against the individual concerned in his or her home country. Orders under divorce and creditor protection laws can typically be made against that individual notwithstanding the alleged independence of such trustees. If a judge determines that the trust settlor controls the assets of the offshore trust, the judge may order the settlor to repatriate the trust assets. Failure to comply with the court's order may lead to a finding of contempt of court and imprisonment. For this reason, a properly established asset protection trust should provide a clear separation between the settlor and those who exercise control over the trust assets.
US v. Grant
The most recent case to rule on the merits of a contempt order is US v. Grant. In 2005, a federal district court in Miami ordered a domestic protector of an offshore asset protection trust, under threat of contempt, to exercise her power to replace the foreign trustee with a domestic trustee chosen by the court. The ruling, U.S. v. Grant Case No. 00-08986-Civ-Jordan (D.C. So. Fla. 2005), threatened to draw into question the viability of an asset-protection trust if a domestic protector could be compelled to appoint a domestic trustee to marshal the assets and bring them within the purview of the domestic court proceedings.
In May 2008, the U.S. government sought to hold the domestic protector in contempt of court for failing to secure the cooperation of the foreign trustee to resign and repatriate the trust assets. The U.S. District Court for the Southern District of Florida ruled against the government, finding that the domestic protector could not be held in contempt for failure to gain the cooperation of the offshore trustee. In denying the government's contempt motion, the judge observed:
"I understand that it has been more than two years since the repatriation order was issued and that the funds had not yet been repatriated. But this failure is not for a lack of effort. I am reluctant to fault Mrs. Grant for her trustees' denial of her requests to repatriate the funds." U.S. v. Grant, 2008 U.S. Dist. LEXIS 51332, 101 A.F. T.R.2d (RIA) 2676 (D.C. So. Fla. 2008).
For years, lawyers have vigorously debated the vulnerability of an asset protection trust with a domestic protector. The Grant case stands for the proposition that no vulnerability exists if the domestic protector complies with the court's orders. While a domestic protector may be required to make an effort to repatriate trust assets, failure to achieve repatriation should not entail any dire consequences to the trust or to the domestic protector. As long as a duress clause permits the foreign trustee to ignore the pleas of a domestic protector acting under threat of a contempt order, the selection of a domestic protector should not jeopardize the integrity of the offshore asset protection trust.
While most attorneys draft trust agreements to limit the domestic protector's powers to those of a negative nature (i.e., the domestic protector may veto trustee decisions, but a domestic protector cannot order a trustee to do anything), the ruling in Grant implies that even positive powers exercisable by a domestic protector may not jeopardize an offshore asset protection trust containing a duress clause. Whether this leads attorneys to be more cavalier in their trust drafting remains to be seen. At least we know that traditional offshore asset protection trust planning works as anticipated.
There are rigorous US tax reporting requirements that apply to taxpayers who establish offshore trusts. While no additional tax is usually imposed, certain forms of asset protection trusts require full disclosure of all trust assets and activities on the U.S. contributor's tax returns. Confidentiality is usually not enjoyed under these arrangements.
Most asset protection trusts established by U.S. settlors are considered "grantor trusts" under U.S. income tax law, meaning that all income of the trust is reportable on the grantor's (i.e., the settlor's) individual income tax return. Asset-protection trusts do not, in and of themselves, offer any tax advantages under U.S. income tax law.