WALTER H. DIAMOND
DOROTHY B. DIAMOND
BARRY A. KAPLAN

VOLUME 1

WARREN, GORHAM & LAMONT

1000] ASSET PROTECTION PLANNING THROUGH THE FOREIGN SITUS ASSET PROTECTION TRUST—THE CASE FOR

Engel & Rudman, P.C., Englewood, Colorado

Barry S. Engel is the President of the Isle of Man-based Offshore institute, a multi-disciplinary professional body founded in 1989. He is a member of the International Bureau of London-based Offshore Investment magazine, Consulting Editor of the International Offshore and Financial Centres Handbook, a member of the Board of Editorial Advisors for London-based Trusts & Trustees and International Asset Management, and Editor of Shore to Shore, the official newsletter of the Offshore Institute. He received his B.S. degree from the University of Colorado, at Boulder in 1976 and his law degree from the University of California, Hastings College of the Law, in 1979.

Asset protection planning (APP) through the asset protection trust (APT) may be defined as the process of planning in advance for the protection of assets against risks to which they would otherwise be subject. While the label "asset protection planning" is relatively new, there is really nothing original about APP as a concept.

For example, buying liability insurance, a form of APP, is not a novel concept. The same can be said about planning for the mitigation of taxes, whether income, gift, estate, or excise. Again, a parent company operating through a number of underlying brother-sister entities provides another well-known example of APP.

What is new, however, is the fact that APP has fast become a regular component of overall client planning. Today, an increasing number of professionals are integrating this type of planning into their practices. This introduction will cover the following topics:

Motivation for APP .................¶1001
What APP is not .....................¶1002
APTs as planning tool ..............¶1003
Advantages of APTs ...............¶1004
Choice of governing law .......... ¶1005
Location of trust assets ............ ¶1006
Risk considerations .................. ¶1007
Effective of APP ......................¶1008

[¶1001] Motivation for APP

Worldwide concern over liability. The risks that motivate an individual to engage in some form of APP are indeed diverse. For example, the litigation risks associated with being a business owner, a professional, or a property owner are of foremost concern to many U.S. citizens and increasingly to persons in other common law jurisdictions. [Both the current literature on APP and the popular press are replete with examples of how these risks play out, and many readers probably have a story or two of their own.] Persons living under civil law or other legal systems may also have concerns about liability exposure. For example, the author has encountered clients living in Italy and Spain who are equally concerned about this problem.

Testamentary freedom. Other considerations may require this type of planning. Regardless of whether or not individuals who are domiciled in a civil law jurisdiction are concerned about liability exposure, they may still find themselves, depending on the jurisdiction, subject to the forced heirship laws of their home country. Thus, APP may be motivated in this case by a desire to achieve testamentary freedom.

Political stability. APP may also be motivated by fear of an oppressive government or by political or social instability. Whatever the motivating factor may be, the goals of, and approaches to, APP are very much the same.

[¶ 1002] What APP Is Not

Having described what APP is, it is equally important to describe what APP is not. APP is not planning that is effective only if cloaked in secrecy.

Protecting the client. The planning should perform so that, if one day put to the test, it will prove to be a legally sound structure. Planning should never be so weak that it depends on a client willing to commit perjury either on the witness stand or when signing a tax return.

No illegitimate tax benefit expectations. APP is not planning that would cause the client to expect any tax benefit other than those legitimate tax benefits already generally familiar to planners (for example, marital deduction/credit shelter planning and family or charitable gift giving). Conversely, properly implemented, the planning should not result in any tax detriment to the client either.

No fraud. Last but certainly not least, APP should not be used as a means to defraud creditors. Given the civil, and in some cases criminal, interdictions of fraudulent conveyance law, planners may not be able to do as much (if anything) for the client who already has a pending, threatened, or anticipated legal matter as the planner can do for a client with no clouds on the horizon. In view of this, APP may be described as planning for "one day what if" possibilities. Similarly, it may be described as a vaccine, not a cure.

[¶ 1003] APTs as Planning Tool

The asset protection planner has many planning tools available. These tools range from the simple, such as gift giving and exemption planning, to the more involved, such as family limited partnerships, to the sophisticated and complex, such as the foreign situs APT. As one might expect, an inverse relationship exists between the simplicity of the planning and its ultimate effectiveness.

Unique trust purposes. To a great extent the phrase "asset protection trust" is redundant, for all trusts by their nature entail the protection of assets to at least some extent. This fact notwithstanding, the APT label has come to be identified with a foreign trust that is not principally established for any of the more traditional reasons for trust creation, but rather for one of the reasons described above. While APTs are also sometimes referred to by a number of other names, such as "protection of assets trusts," "creditor protection trusts," and "family security trusts," they are all essentially the same.

Achieving diverse goals. It should be pointed out that, whereas the creation of an APT is often motivated by one of the reasons described above, a number of planning goals can be simultaneously achieved through an APT. These goals often influence the client's decision to proceed with APT planning. For example, the APT can provide the client with the means to avoid probate, plan for a marital deduction, facilitate the global diversification investment of a portfolio, and protect financial privacy.

Impervious but flexible. In the context of APP, the APT is the most impervious, yet flexible, APP tool available. If properly drafted, the creator of the trust (the settlor) experiences only minimal disruption of his or her personal and financial affairs while at the same time preserving the settlor's assets for the family in the event an unanticipated creditor problem later surfaces.

[¶ 1004] Advantages of APTs

Although domestic trusts are frequently used in the planning process, there are four distinct reasons why APTs are clearly superior to domestic trusts when it comes to APP:

• Enhanced ability to retain benefits and control. The nature and extent of the benefits under a trust and the control over a trust that a settlor can retain following settlement are generally restricted under domestic trust laws. A maxim of domestic law is that property is not out of a creditor's reach if the property has not been placed out of the client's own reach. Thus, a trust settled at a time when the seas are calm may nevertheless remain vulnerable for the settlor's lifetime to the extent benefit or control is retained by the settlor. Substantial trade-offs are thus involved when a client uses a domestic trust for APP purposes because most "asset protection" oriented clients balk at surrendering all benefit and control.

Not automatic targets. A domestic trust remains subject to local process and jurisdiction. Thus, a domestic trust with a substantial or otherwise attractive principal is a vulnerable target for litigation against the settlor. It would not take too much creativity on the part of plaintiffs counsel, hoping for a settlement, to craft a theory by which a domestic trust could be subjected to the same legal shake-down and exposed to the same hazards of litigation to which the settlor may be exposed. On the other hand, given jurisdictional and comity considerations, such as whether the judgments and orders of a domestic court will be recognized by the relevant foreign court, an APT is as not as likely as a domestic trust to be the same automatic defendant in litigation against the settlor.

• Practical barriers. The mere fact that the APT is a foreign entity will have a definite impact on a creditor's decision whether to institute suit in the first place and on how far the creditor is willing to go to chase assets. Factors, such as the psychological barrier of dealing with foreigners and foreign legal systems, the costs of pursuing litigation overseas (particularly if a new suit must be brought against the defendant in the foreign court due to the absence of comity), the added uncertainty of prevailing under foreign law, and the increased time factor, serve to substantially enhance the protection the trust assets will enjoy should a legal problem develop some day.

Most seasoned litigators know and appreciate that it is one thing to obtain a judgment and quite another to collect a judgment. The procedural quagmire created by a foreign APT gives new meaning to this practical fact of litigation life.

• Added protection of certain foreign jurisdictions. The trust law of certain select jurisdictions is simply more specific, thorough, and protective than is the trust law in other jurisdictions when it comes to the all-important question of when and under what circumstances a creditor of the settlor can access assets settled in trust. Accordingly, even if a creditor is not dissuaded by the many hurdles and barriers erected by a properly designed and implemented APT, the determined suitor will be confronted with a very tall and wide brick wall on the other side of the last obstacle. The bricks in the wall are the properly selected jurisdiction's protective statutes relating to trusts and the narrow circumstances under which a trust governed by its law can be invaded in satisfaction of the separate indebtedness of the settlor. An APT will ultimately work because it is legally sound, not because of smoke and mirrors or secrecy.

[¶1005] Choice of Governing Law
Persons who live in common law jurisdictions generally have the freedom to select the law that will (1) govern a business transaction, (2) control a corporation and its affairs, or (3) apply to the administration of a trust. One example of the freedom to select governing law is the incorporation in Delaware of companies transacting no business in Delaware. Selecting the law of a jurisdiction other than the state of the settlor's domicile to govern the administration, validity, and interpretation of a settlement of trust is another example. Choice of law principles would thus permit a settlor to settle a trust to be governed by the laws of his or her home state, a neighboring state, or another country. Given that one is free to choose law in this regard, why should a client limit his or her choice of applicable trust law to that of the client's home jurisdiction?

Factors for selecting appropriate jurisdiction. There are a number of factors to be considered when choosing the foreign jurisdiction whose laws will govern an APT:

  • the existence of favorable, definite, and protective trust laws
  • the political, economic, and social stability of the jurisdiction
  • the jurisdiction's reputation in the world financial community
  • the tax laws of the jurisdiction
  • the existence of language barriers
  • the presence or absence of modem telecommunications facilities in the jurisdiction
  • the availability of adequate legal, accounting, and financial services in the jurisdiction

 Certainty in the law. A number of offshore financial centers satisfy these factors to varying degrees. Countries, such as Anguilla, the Bahamas, Belize, Bermuda, the Cayman Islands, the Cook Islands, Cyprus, Gibraltar, the Marshall Islands, Mauritius, Niue, and the Turks & Caicos Islands, all have statutory provisions specifically designed for, and relating to, APTs. To varying degrees, all these jurisdictions, clarify through their trust legislation the myriad of issues relating to when and under what circumstances a trust's assets can be accessed by a creditor of the settlor. A fair amount of uncertainty in this area exists under U.S. law and to a great extent under English law. Persons desiring to set aside assets for the benefit of their family and themselves have a right to as much certainty in their planning as possible. One of the goals of APT legislation is to provide this certainty.

A number of other offshore financial centers are considering APT legislation in one form or another. While these other jurisdictions presently have some level of trust law, the provisions of their trust law do not specifically cover APTs and the many and diverse issues associated with them.

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[¶1006]Location of Trust Assets

A properly drafted APT will allow the trustees of the trust to invest trust assets in any part of the world. Accordingly, the location of trust assets need not necessarily change from the city where the settlor resides, and the asset protection structure need not interrupt or disturb relationships that the client may have with his or her legal, accounting, insurance, or financial advisors. Through the concurrent use of one or more entities to underlie the APT, such as a family limited partnership, a limited liability company, or a controlled corporation, the settlor can be given direct management and control over trust assets without being a trustee of the APT and without compromising the protection ultimately afforded.

Safety valve needed. Experience has shown that when APTs are challenged they have generally proven to be a tremendous deterrent to litigation. The clouds and issues created by the structure have in most cases been sufficient to, at a minimum, force an early and inexpensive settlement. Other cases, however, have involved angry, overly emotional, and tenacious creditors who have been undeterred by the trust barriers. While a domestic court should recognize the choice of foreign law and other bona fide aspects of the planning, a safety valve is needed in the event a court nevertheless applies domestic law. The APT's ultimate safety valve is its ability, as an international instrument, to invest and reinvest assets in any part of the world. Thus, while the APT's assets can remain domestic, the option exists for the trustees to diversify the assets out of any jurisdiction where a problem may be brewing thus forcing the battle over the assets into the foreign court.

[¶ 1007] Risk Considerations

Clients and their advisors frequently inquire about the risks associated with having assets held by trustees of an APT. A properly structured APT will not leave a client in the position of having to make a choice between risking the assets to a future creditor or risking the assets to the trustees of the APT. Checks and balances will be incorporated into a well-crafted trust deed. Moreover, as an international entity, the APT can hold assets in any part of the world. The trust assets need not be physically held in the jurisdiction whose laws govern the APT's administration, interpretation, or validity.

Importance of underlying entity. For as long as and to the extent that assets are held in an entity underlying the APT, the person who manages the underlying entity, and not the trustees, will have direct control over, and management of, the protected assets.

Trustee selection. Careful selection of the trustees understandably plays a major role in the settlor's comfort and security.

"Contempt of court" issues. Another customary question is whether the client may someday be in the awkward position of having to either repatriate assets or be held in contempt of court. Under these circumstances, a properly drafted APT would make it impossible for the client to repatriate assets held by the trust. If compliance with a court's order is not possible, then under the law of contempt one cannot be cited for the contemptuous act of noncompliance. Impossibility of performance is thus a complete defense to civil contempt.

Exception. An exception to this general rule is self-created impossibility. If the party claiming the defense of impossibility of performance is responsible for the creation of the impossibility, then the defense will not be available to that party. However, for this exception to the general rule to apply, there must be a nexus in time between the order of the court and the act that was done to render performance impossible.

Nexus-in-time factor. To illustrate this extremely important point, assume two business partners have a falling out. One partner destroys certain records immediately after "the last straw" but well before any suit is commenced by the other. In this case, the requisite nexus in time would be lacking if and when the first partner is ordered to produce the records.

Contrast this with the indefensible situation of the records being destroyed not immediately after the falling out but immediately after the court orders production of the records by week's end.

In the context of APP through an APT, the critical nexus-in-time factor would not exist if the APT is properly drafted and is established and funded at an appropriate time.

Court's disregarding the trust Another frequently presented issue is whether a domestic court can be expected to recognize the foreign-based planning when assets remain in the settlor's home jurisdiction. While a sound structure will have its international "i"s dotted and its international "t"s crossed, the planner must hope for the best yet plan for the worst. In the context of an APT, the worst would be a domestic court disregarding the trust and determining that its assets would indeed be available to the creditor. The answer is that the foreign trustee, in the course of exercising its fiduciary duty to protect trust assets, would be well-advised to diversify trust assets out of the jurisdiction where the settlor's problem is unfolding. Through this protective step the battle over the assets can be forced into the foreign court where the assets are held or where the trust is established, which would be bound to apply its protective legislation.

Caution to planners and trustees. Finally, it should be stated that clients are not the only ones concerned about risks, and rightfully so. The planner as well as the trustees of an APT could find themselves on the defensive side of the "v." in a complaint if proper care is not exercised in both accepting the client's planning and drafting and funding the APT.

[¶1008] Effectiveness of APP

Potential clients and their advisors will often inquire whether APP through APTs "works." Whether planning of this nature "works" must be defined by reference to what the client's position would have been had the client not engaged in APP through an APT. The ultimate goal of APP can be said to have been achieved if the client weathers a legal storm at least moderately better than the client otherwise would have done without this planning. To date, however, in the author's experiences, the "moderately better" standard has been consistently surpassed.

Seminars & Events:

April, 2017 - CELESQ
“An Asset Protection Planning Primer for Estate Planning, Tax and Creditors Rights Lawyers”
Live Web Cast
May 31 – June 1, 2017 - 

SOUTHPAC TRUST OFFSHORE PLANNING INSTITUTE CONFERENCE 2017, “Asset Protection in a Changing World” (31 May 2017) and “Questions & Answer Panel on Industry Challenges to Asset Protection Structures” (1 June 2017)
Las Vegas, Nevada

 

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Contact Information

Barry S. Engel
Email: info@engelreiman.com