Ryan, Morton & Imms, LLC

999 West Chester Pike
Suite 201

West Chester, PA 19382
Office: 610-430-1425

Asset Protection

By: Kevin J. Ryan, Esquire
Ryan, Morton & Imms LLC

There are a variety of methods available which attempt to protect the assets of an individual or a business from future creditors, law suits, tax problems, and predators in general. Asset protection plans include off-shore asset protection entities, domestic asset protection entities, limited partnerships, limited liability companies, traditional corporations, irrevocable life insurance trusts and charitable trusts. These vehicles should not be confused, generally speaking, with vehicles which will save or lower federal or state income taxation. For the most part, asset protection planning is income tax neutral. Most of these methods are not intended nor should they be used to attempt to shelter income from taxation.

I. Self-Settled Trusts:

In general, under laws that have evolved from Great Brittan and now are honored in most states in the United States and a large number of sovereign countries “self settled trusts” provides no asset protection for the person who formulates that trust.

“Where a person creates for his own benefit a trust with a provision restraining the voluntary or involuntary transfer of his interest, his transferee or creditors can reach his interest.” 

In other words, if you create a trust for yourself, for your own benefit, a revocable trust, the trust under the restatement of trusts does not generally protect the assets of that trust from your creditors.  This is a general trust rule that can be changed by statute.

A. Off Shore Asset Protection Plans/Trusts

Off Shore Asset Protection Trusts (“OSAPT’s”) are governed by the laws of the jurisdiction in which they are formed.  A variety of foreign countries have passed asset protection trust and other laws in order to attract investment without attracting tourists.  Some, such as Lichtenstein and the Isle of Man (as well as to a lesser extent Switzerland) have provided secrecy and asset protection laws for many years while others are fairly new to the game such as Antigua, Belize and the Cook Islands.

“OSAPT’s” generally include some or all of the following features: 

(1)Difficulty for United States creditors to engage local counsel;
(2)Inability of United States Courts to obtain what is known as “personal jurisdiction” over the Trustees;
(3)The lack of recognition by their courts and the judicial systems of judgments secured in the United States;
(4)Provisions that do not allow for the levy of assets in those trusts from a foreign jurisdiction judgment or creditor;
(5)Very narrowly defined fraudulent transfer claims with a very short statute of limitations for bringing claims against the trust; and
(6)Clauses that allow the Trustee or the “Protector” to remove assets to another jurisdiction or change the jurisdiction requirements of the trust in the event of an adverse court result.

OAPTS are anything but invincible. In the 1980’s and 1990’s many US and European citizens formed such trusts. The trusts were funded with real estate in their home countries and/or investments through well known investment companies. The investments were often held in the United States titled in the name of the trusts located in the foreign jurisdiction.  This, in many instances, proved to be fatal – Federal courts (in America) in particular granted jurisdiction to creditors and seized real estate, cash, bank accounts and securities brokerage accounts that were held in the United States despite the fact that they were technically and legally held by a foreign entity trust. 

If an OAPT is to be put in place, the individual transferors have to be made aware of the pitfalls of such a trust. If they are unwilling to allow their assets to physically move from the United States to the foreign jurisdiction the OAPT may be useless to them. In most of these jurisdictions appointment of at least one foreign trustee is mandatory. Therefore the person attempting to protect their assets is taking a certain “leap of faith” that the trustee, the attorneys and the judicial system at the other end to be more friendly toward him and the Trust assets than they are towards his creditors. 

B.        Long Standing Traditional Asset Protection Plans

     1.         The Limited Partnership (“LP”).  Limited Partnerships are still a widely used and highly thought of means of protecting assets.  Forty-nine of the fifty states in the United States recognize limited partnerships (LPs) first having been recognized in the 1850’s in the State of New York.  There is a Uniform Limited Partnership Act that essentially fills in the holes of any limited partnership agreement so that there is never a default no matter how poorly the LP document itself might be crafted. Essentially the LP will always be deemed to have all of the necessary “bells and whistles” under the Uniform Limited Partnership Act as opposed to under a well drafted document.  This is very beneficial in the event that the draftsman are not up to date with the jurisdictional requirements in the state in which it is being drafted or a document is not updated or amended with the changes in laws. 

A Limited Partnership is an entity created under state law.  It must have a general partner who has full liability for all of the actions of the partnership and a limited partner whose liability is generally only to the amount of monies that they have paid into the partnership to the extent of their partnership ownership. Generally the general partner is a limited liability company or a Sub Chapter S corporation although it can be an individual in another partnership, a trust or similar vehicle.

A judgment against a limited partner cannot cause the dissolution of the partnership, does not allow a creditor to actually access the assets of the partnership and with a well crafted document does not allow the creditor to actually sell any interest that they attach in the partnership by reason of a judgment or otherwise.

2.         Irrevocable Life Insurance Trusts

Although an irrevocable life insurance trust (“ILIT”) is not often thought of as an asset protection device, it does have special status.  In most states life insurance is afforded a certain amount of protection from creditors when the Trust is created prior to purchase of the insurance ownership requirement by the ownership from the client’s domain, we add an extra moat and/or drawbridge between the asset and the creditor.

It is difficult in most states to attach the cash value of a life insurance policy.  Given surrender charges and various other items, it may be that a cash value of the life insurance policy, even without a trust, is difficult to assail because  at the policies termination with the reduction from surrender charges results in a zero distribution to the one who owns the policy and who causes the termination/surrender.

Since the trustee technically owns the life insurance policy, a judgment against the insured generally will not have any effect on the ILIT during the life of the client and certainly would have no effect upon his death.

3. Charitable Lead Annuity Trusts

 Charitable Lead Annuity Trusts (“CLATS”) have come into favor with the low interest rates that we are currently seeing.  A CLAT is just the opposite of a Charitable Remainder Unitrust.  With a CLAT the charity receives an income for a period of years and at the end of its term the principal and any accumulated income is distributed out to the heirs of the client.  Once the gift has been made it is in essence a contract with the charity and is not a transfer without consideration.  The CLAT has magnificent estate planning implications and at the same time protects the assets during the lifetime of the client and after the death of the client.  It is not, however, unassailable. 

4.        Corporations and LLC’s

There is always value in having businesses owned and operated through a corporate structure, an LLC structure or as previously mentioned a Limited Partnership structure.  However, this does not necessarily prevent the individual client from being sued.  If he is in fact an owner or the “the” owner of a business entity the protection may be mostly illusory.  Suits against the entities themselves will rarely result in judgments against the individual client unless they do not operate their business in a business like fashion (i.e., paying the babysitter, the vacation, and the girlfriend from the entity check book!!!). 

C.        Delaware Asset Protection Trusts

The author focuses on Delaware Asset Protection Trusts because it is his opinion that the asset protection of Nevada and Alaska are flawed.  Those have certain items within their statutes that the author believes may be subject to attack by reason of public policy such as child support payments, alimony payments and divorce decrees. 

The Delaware laws avoid that pitfall and the writer believes that that is the correct approach.

1.         Federal Income Tax Consequences.  If the Grantor of a Delaware APT retains the right to receive discretionary income and principal distributions, the trust will be a grantor trust with respect to its ordinary income and capital gains unless distributions to the Grantor must be approved by an adverse party.

2.         The Delaware Act specifically permits the trust instrument to authorize the trustee to reimburse the Grantor for income taxes attributable to the trust and, effective in 2008, the Delaware Act authorizes reimbursement of income taxes on a mandatory basis.

  3.         Federal Estate Tax Consequences – Transfer Taxes.  The Grantor of a Delaware APT may prevent the creation of the trust from being a completed gift for federal gift tax proposed by retaining certain powers.  It is possible that such a trust, from which the Grantor may receive distributions only in the exercise of discretion, may be structured to be a completed gift for federal gift-tax purposes and to be excluded from his or her gross estate for federal estate-tax purposes.

4.         The Delaware Act specifically permits the Grantor of a Delaware APT to have the power to:
   a.         Consent to or direct investment changes;
   b.         Veto distributions; and/or
   c.         Replace trustees or advisers.

The Delaware Act also expressly authorizes the Grantor to have:

a.         The ability to receive income or principal pursuant to broad discretion or a standard as determined by Delaware trustees, non-Delaware trustees, and/or advisers;
b.         The right to receive current income distributions;
c.         An interest in a CRT, an interest in a qualified personal residence trust (“QPRT”), or a qualified annuity interest created if a residence in a QPRT ceases to be used as a personal residence.
d.         Up to a 5% interest in a grantor retained annuity trust (“GRAT”), a grantor retained unitrust (“GRUT”), or a total return unitrust;
e.         A non general testamentary power of appointment; and/or
f.          The ability to provide for the payment of debts, expenses and taxes following death.

Under the Delaware Act, the Grantor may not be a trustee and may only have the interests and powers described above.  Furthermore, the Grantor has only the powers and authorities conferred by the trust instrument, and any agreement or understanding purporting to grant or permit the in trust.

-NOTE- A client might want to create a Delaware APT upon the sale of a business to protect the proceeds from claims arising in future ventures.

Delaware APTs might be used to protect the assets of clients (such as those described in the following cases) who are mentally, physically or financially vulnerable.

Given that Delaware APTs are immune from spousal claims in certain circumstances, clients might use them to shield assets from such claims without providing the financial disclosure that is required to implement effective prenuptial agreements.

5.         To create a Delaware APT, the client must create an irrevocable trust that contains spendthrift clause provisions; provides that Delaware law governs the trust’s validity, construction, and administration; and appoints at least one Delaware trustee.

6.         State Income Tax Benefits.  Some states (such as Pennsylvania) require the payment of income tax on undistributed ordinary income and capital gains on a Grantor style trust such as an APT.  As such, a Grantor in Pennsylvania would not be taxed under Delaware law for state income tax purposes in a properly crafted Delaware APT trust.

D.        Fraudulent Transfer Rules Generally

                        All states and virtually all countries allow creditors to set aside fraudulent transfers.  In fact, most states adhere to the Fraudulent Conveyance Act which is set out as follows:

“A transfer made . . . by a debtor is fraudulent as to the creditor, whether the creditor’s claim was before or after the transfer was made . . . if the debtor made the transfer (a) with the actual intent to hinder, delay or defraud any creditor of the debtor, or (b) without receiving a reasonably equivalent value in exchange for the transfer and the debtor (1) was engaged or about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction or (2) intended to incur or believed to reasonably should have believed that he or she would incur debts beyond his or her ability to pay as they become due.”

Simply stated, if you make a transfer for less than adequate consideration (value) this transfer may cause you to become insolvent or in fact makes you insolvent, that transfer is subject to attack for a period of anywhere from two to four years. 

The good news is that there are hundreds if not thousands of cases that deal with fraudulent conveyances. This area of the law is well settled, you can almost always find a case or cases that fit a particular model.  The key is (a) to put all of your assets into an Asset Protection Trust and (b) do it before you run into a problem, sell your business, have a head on collision or get married. 

E.        The Disaster Scenario

   “What if the APT is successfully defeated?

Under Delaware law any action involving a Delaware APT must be brought in the Delaware Court of Chancery.  Any action to actually set aside an APT Trust as to comply with Section 1304 or 1305 of the Delaware Uniform Fraudulent Transfer Act.  These in and of themselves are not insignificant hurdles. 

The Chancery Court is regarded as an extremely competent and effective court worldwide.  The Delaware Bar has been very successful in crafting the rules and regulations regarding a Delaware APT and the rules that govern the Courts and their jurisdiction carefully as well.

However, if one of the exceptions to defeating the Delaware APT is involved, what then happens? 

Under the Delaware Code if a Delaware APT is defeated, it only fails to the extent necessary to pay that particular creditor’s claim and any related costs, including attorney’s fees.  What this means is if there are multiple creditors, each creditor must be successful in his or her action and a single creditor’s defeat of the APT does not benefit other creditors in any way as the APT by statute will be considered to remain in full force and effect as to all other claimants. 

Under Delaware law the trustee may pay for the defense of the trust from trust assets and the only way a trustee is liable is if the creditor provides proof by clear and convincing evidence that the Trustee acted in bad faith in accepting or administering the trust. 

A phenomenal benefit under the Act is that a beneficiary who actually receives a distribution before a creditor brings a successful suit to defeat a Delaware APT, may keep the distribution.  The only exception is if the creditor proves by clear and convincing evidence that the trustee and/or the beneficiary acted in bad faith.

Finally, it is clear under the Delaware Code that an APT will not be treated as fraudulent or otherwise contrary to the law for purposes of any action against the trustee, advisor, protector or otherwise acting under a trust instrument or against an attorney or other professional advisor involved in the establishment of the trust.  This is potent and powerful and gives a great deal of solace to accountants, attorneys and financial advisors in the use and recommendation of a Delaware APT trust.