I.Domestic Asset Protection Trusts v. Prenups: What is Best for Your Client?
What are domestic asset protection trusts?
Domestic Asset Protections Trusts (“DAPTs”) are irrevocable trusts that can be established in states that have special laws for this very specific type of trust. DAPTs allow the settler of the trust to be a discretionary beneficiary while still protecting the trust’s assets from the settlor’s creditors. In reality DAPTs are not solely a tool for protecting your assets during divorce, but have been a way for wealthy families and individuals to shield their assets from creditors. This type of trust can be a useful tool in assisting your clients in protecting their assets. DAPTs also allow clients to transfer property using their annually exclusion gifting ability to take assets out of the estate and freeze them in a trust account. This type of trust account does not require the person creating the trust to be a resident of the state where it is being established. Therefore, for individuals who live in a jurisdiction without DAPTs, they can still benefit from this type of asset protection. DAPTs also act as an alternative for offshore trusts that in the past have been a popular asset protection strategy. There are some drawbacks to foreign trusts that leave them open to being unprotected. One of these is merely not having the ability to accurately predict what will happen with a foreign jurisdiction’s laws or if things will rapidly change due to political unrest or other issues that might be less of a concern on domestic soil.
Prenuptial Agreement: Overview
Prenuptial agreements (“prenups”) are made prior to the marriage. They specifically set out what property or financial assets each spouse is entitled to in the event of divorce. Prenups are often used by a wealthy spouse to protect his or her assets, but can also be used to protect family businesses. In addition, prenups can be used to protect one party from assuming the debt of the other party, determine how property will be passed upon death, clarify financial rights and responsibilities during marriage, and avoid long and costly disputes during the divorce. In most jurisdictions, if you do not have a premarital agreement, your spouse is entitled to share and receive ownership of property acquired during the marriage, receive some of your property upon death, share in any debts acquired during the marriage, and share responsibilities in managing property acquired. Prenups are privately drafted either by the individual or by the party’s attorney. The other spouse can either participate in the drafting with their soon-to-be spouse’s attorney or have an attorney of their own review the agreement. The court does have final review of prenups by closely analyzing them. The judge is analyzing the agreement for fairness and compliance with the state law guidelines. These agreements are a nature of contract law and therefore must be absent duress or fraud in order to be valid. Prenups must also be in writing to be legally valid; and they must be signed voluntarily by both individuals in the presence of a notary public.
DAPTs have many benefits that are unique and helpful for your client and outweigh the benefits of obtaining and getting a prenuptial agreement. One downside to prenuptial agreements is the inability to predict what will happen during the course of the marriage and what gains or losses will be suffered by each person in the relationship. Therefore, this makes drafting a challenge and can lead to harm for your client many years down the road when the assets to the marriage or assets obtained by each individual person is vastly different than when the client sat down with their soon-to-be ex-spouse and created this premarital contract. In addition to the unforseeability of what will happen during the course of the marriage, there can be problems with the actual terms of the premarital agreement. During the drafting phase prior to marriage, the parties are often in the “honeymoon” stage that can lead your client to agree to terms or compromise on certain issues that are not actually in their best interest. While a premarital agreement is intended to protect your client in the case of a divorce, someone who is happy and in love in their soon-to-be marriage is not able to really grasp the concept and the ramifications of an abrupt and traumatizing end to the marriage either through death or divorce.
Unlike a premarital agreement that becomes a contract prior to marriage, a domestic asset protection trust can be set up at any time, including after the parties have married. This is beneficial to your client who may not be able to think about the ramifications of divorce at the outset, but a number of years might be in a different frame of mind regarding the marriage or the potential longevity of the relationship. Your client should be aware that they should set up this type of trust prior to filing for divorce and before it is obvious that the relationship is headed to divorce. Asset transfers while a divorce is pending or immediately before a divorce is filed may lead a court to invalidate the transfer as a fraudulent transfer to intentionally shield assets in which your client’s spouse would otherwise be entitled. Depending on the state that the DAPT is settled in, it might provide for less liability to your former spouse than a prenuptial agreement. While it may sound like a DAPT is the most beneficial option for your client, it may be even more beneficial for your client to also have a prenuptial agreement. Using these asset protection tools in combination may be the best way to protect your client’s assets from an adverse divorce judgment. This is only proper for forward thinking clients who seek asset protection prior to marriage. If only one method of asset protection is being used then the favored one should be DAPTs.
II. General Requirements, Limitations, and Pitfalls of DAPTs.
General requirements will vary slightly with each jurisdiction. Thus, it is imperative to reference the appropriate state statute where the domestic asset protection trust is being settled. One requirement that is universal for DAPTs is that it must be an irrevocable trust. Otherwise, the settlor has control over the trust to modify its terms or dissolve the trust and these are things that have been recognized to leave trusts open to creditor actions against the trust assets. In general, DAPTs must also name a trustee that resides in the jurisdiction being used. Some jurisdictions, like Utah, will allow this to be either an individual domiciled in the jurisdiction or a trustee company or bank located in the jurisdiction. Utah is one of the most recent DAPT jurisdictions and, therefore, is a good case study for what general requirements are common today. As a general requirement, the settlor of the trust must not be insolvent; the trust must include a spendthrift provision; the trust must be irrevocable, the trustee must notify in writing every person who has a child support order or judgment against the settlor thirty days prior to any payout; the trustee must have no discretion over distributions of trust property; the settlor must not be intending to file bankruptcy at the time the trust is funded; and the settlor cannot be intending to defraud by transferring assets into the trust account. This is a non-exhaustive list of DAPT requirements in Utah and other jurisdictions. Check your local jurisdiction for more specifics.
One limitation and pitfall of DAPTs currently is the uncertainty that they have in the law. This is because DAPTs have not been the subject of much litigation and, therefore, attorneys do not have clear guidelines on how these provisions will be protected from family law related creditors. This is potentially dangerous for your client because it could leave their assets unprotected and subject to a court order requiring expensive and time consuming litigation. Ligation in this area of the law holds a significant risk because it is fairly unchartered. There are very few cases at this point that either uphold or reject self-settled trusts under the relatively new domestic asset protection statutes in various jurisdictions in the United States. As time goes on and more of these statutes are challenged by creditors, the benefits of DAPTs or the drawbacks to them might change rapidly.
Conflict of laws is another major concern when dealing with a client living in one jurisdiction with a domestic asset protection trust account in another jurisdiction, which is guided by the foreign law of another state. The threat is that a client will think that their trust account is secure just to have it invalidated by a court in another jurisdiction. Currently, in the United States, the majority of jurisdictions have provisions expressly banning asset protection trusts and, therefore, there is a high likelihood that a case dealing with a DAPT will involve a jurisdiction that has deemed DAPTs against public policy and the likelihood of a state applying the foreign state’s laws when their own state law disfavors the trust accounts is very low. For instance, in the case In Re Huber, a bankruptcy court in Washington invalidated the transfer of assets into a DAPT account not only because they were fraudulent but the court also discussed the case in terms of conflict of law. The conflict of laws issue in this case arose when an individual living and working in Washington State created self-settled trust in Alaska based on an Alaska statute that allows for DAPTs. Washington state law does not allow for self-settled protection trusts and in fact, has a statute banning such trusts. The court analyzed and applied the Restatement Second of Conflicts § 270 which provides that:
An inter vivos trust of interests in movables is valid if
(a) under the local law of the state designated by the settlor to govern the validity of the trust, provided that this state has a substantial relation to the trust and that the application of its law does not violate a strong public policy of the state with which, as to the matter at issue, the trust has its most significant relationship under the principles stated in § 6.
Under this analysis, the court determined that with over 40 years of doing business in Washington state, the settlor’s residence in Washington, and that all of the creditors seeking repayment are located in Washington, that there is no substantial relationship between the trust and Alaska when the only asset that could be considered having connection to Alaska was a $10,000 certificate of deposit. The deposit was de minimis compared to the total amount of assets settled in the trust. The court also found that this trust violates the strong public policy of the state of Washington that has a statute that specifically does not allow or self-settled protection trusts because allowing people to protect their assets in this manner against lawful creditors is a violation of the state’s public policy interest.
Another potential pitfall with DAPTs is the issue of whether the “full faith and credit” clause applies when DAPTs are at issue. For example, in a case involving a defendant who has established a DAPT in one of the jurisdictions that allow for them to sue in the state court of a jurisdiction, has found DAPTs to be against the public policy of the state. Thus, this second state has invalidated a trust transfer by the defendant. Does the state where the trust was settled that allows for DAPTs have to abide by the ruling of the other state’s decision? The answer to this is still uncertain. This leaves your clients assets at risk.
The state statutes themselves can provide limitations for the protection offered by DAPTs. Some state statutes limit protection of assets in an asset protection trust by allowing for exempted creditors who can still bring suit to challenge the trust transfer or to collect from the trust assets. Different jurisdictions allow for different creditor exemptions. Exemption creditors are individuals expressly named in the state statute that allows them to pierce the veil of these domestic asset protection trusts to make claims for debts owed. Some jurisdictions leave very few protections by allowing creditor exemptions for former spouses, creditors associated with maintenance and child support as well as preexisting tort exemption creditors while others, like Nevada, allow for no exemption creditors.
Another potential limitation or pitfall for DAPTs is what legal standards the court applies to the case. Fraudulent conveyance “look back” and fraudulent conveyance burden of proof. The majority of jurisdictions apply a clear and convincing evidence standard to actions brought for fraudulent conveyances. There are only two jurisdictions that differ in their burden of proof requirements. The first is New Hampshire that applies the clear and convincing evidence standard only to actual fraud. The state also applies a preponderance of the evidence standard for constructive fraud. Utah has not addressed what the burden of proof is by statute yet.
Lastly, a tremendous limitation on the protection that DAPTs can provide is the fact that U.S. law governs over state law in this area because asset protection trusts fail to achieve the jurisdictional separation required to be fully protected from federal law.
Therefore, to some extent DAPTs are not always exempt from creditors when being attacked for public policy reasons, as is common in spendthrift trusts. In order to prevent this type of liability, it is important to understand how the law in the state where the settlor lives and the state law allowing for DAPTs to be established differ and in what ways to prevent a conflict of law issue that will end in the invalidation of the trust account. One way to ensure that the conflict of law rises to the level of invalidation is to maintain a substantial connection between the trust account and the state where the trust is settled. This would cover the first prong of § 207 of the Restatement and only leave the question of being against the strong public interest of the conflicted state jurisdiction.
III. DAPT STATES-WHICH JURISDICTIONS ARE MOST FAVORABLE AND WHY?
There are currently twelve states that have adopted domestic asset protection trust laws that allow for this type of trust to be created. Prior to 1997, states viewed it as against public policy to allow an individual to create a trust that they are a beneficiary of while protecting them from creditors. Alaska was the first state to enact into law for DAPTs. Now, there are currently sixteen states with laws allowing for DAPTs. The sixteen jurisdictions that have adopted DAPT laws are: Alaska, Colorado, Delaware, Hawaii, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia and Wyoming. The most recent states to adopt DAPT statutes are Ohio and Mississippi. The Ohio law went into effect March 27, 2013 and the Mississippi statute went into effect July 1, 2014. Currently, the most favorable of these jurisdictions are Nevada, South Dakota, Delaware, and Alaska, but they have significant differences between them. The settlor of a DAPT is able to set it up in a state other than the one they are domiciled by naming a trustee located in the governing-law state.Therefore, a person living in a state that does not recognize DAPTs can still establish one under a state with more favorable law. In that instance, the state where the DAPT is established is the state law that would be applied.
Nevada is the most favored jurisdiction because it does not have any creditor exemptions that would allow creditors or a former spouse to collect from the trust assets. Up until 2013, when Utah updated their asset protection statute to a more comprehensive DAPT statute, Nevada was the only state that did not allow for creditor exemptions. Asset protection trusts in Nevada called NAPTs still have seasoning periods of two years before the assets in the trust are fully protected. This means that creditors can attempt to access the trust assets, but Nevada state statutes make it a difficult burden for creditors. They have to prove that the transfer of assets to the DAPT was fraudulent or violates legal obligations to the creditor under a contract or court order.
South Dakota, like Nevada, has a two-year statute of limitations before assets are protected. This jurisdiction allows divorcing spouses, alimony, and child support creditors as exemption creditors. This means that South Dakota is a poor jurisdiction for people who are planning to get divorced as the very people they are trying to protect their assets from are able to gain access as an exemption creditor provided the required showings are made.Other than this fact, South Dakota is a popular jurisdiction for those establishing DAPTs due to the shorter statute of limitations of two-years.
Delaware has a longer statute of limitations than South Dakota and Nevada. Assets placed into the trust do not become fully protected until four years after it is established for non-preexisting credits. For preexisting creditors the statute of limitations is four years or two years from when the creditor discovers or should have discovered the transfer to the trust. Delaware allows divorcing spouses, child support, alimony and preexisting tort exemption creditors as exemption creditors. This leaves a lot of room open for liability in divorce cases.
Alaska allows divorcing spouses as exemption creditors. Therefore, while it may be a good jurisdiction for DAPTs in general, it would not be the most effective for someone who is attempting to protect their assets from divorce. Like in Delaware, assets become protected after the four year statute of limitations for non-preexisting creditors and four years or one year from the date the creditor discovered or should have discovered the transfer to the trust for preexisting creditors.
Utah is quickly rising up in recent years as a prominent state to settle DAPTs due to a newly enacted law in 2013 that gives even greater protection and corrects errors and loopholes in the earlier 2003 asset protection statute.Utah has one of the shortest time frames for when assets become protected after the trust is settled. Known and unknown creditors can be limited to a mere 120 days from the two years otherwise allowed. This is done by either mailing all known creditors or by publishing a notice that meets the specific publishing requirements for unknown creditors. This timeline gives Utah a slight edge over even Nevada in determining how quickly your client’s assets will be protected. Utah also allows the settlor to act as a co-trustee—meaning that they are able to manage and invest trust funds as long as they do not have discretion over distributions from the funds.
Therefore, clients wanting to establish DAPTs to shield their assets from divorce should consider Nevada or Utah. These are by far the most favorable jurisdictions and offer the most protection. As of yet, there has not been a single Nevada case that allowed a creditor to pierce the veil and access trust assets once the statute of limitations has passed. As an alternative, Alaska provides some protection from child support and alimony creditors, but will not shield the settlor from all creditor claims from the spouse they are divorcing.
Several other states have added some provisions that protect trust assets without enacting full DAPT provisions. For example, the following states have enacted statutes that protect assets in an irrevocable grantor trust from creditor claims: Arizona, Florida, Kentucky, Maryland, Michigan, New Jersey, North Carolina, New York, Oregon and Texas.
IV. REVIEWING KEY PROVISIONS.
a. Standard Clauses.
Standard clauses for DAPTs include clauses regarding the trust being irrevocable and granting all of the assets being placed into the trust in the care and administrative of a named trustee. The trust instrument must make the trust irrevocable by the settlor in order for it to be considered a proper DAPT. The trust instrument must also include a clause about who are the beneficiaries. Typically for DAPTs, the settlor would name themselves as a beneficiary without discretion and their spouse or children. In the case where the settlor is attempting to protect personal assets from an unfavorable divorce settlement, the settlor will not want to put their spouse as a beneficiary. It is not recommended, however, for a settlor to name themselves as the sole beneficiary, to the trust. If the settlor is the only named beneficiary, this might tell a court reviewing the trust during a creditor attack that the trust was created specifically to defraud creditors. The settlor can name other family members or friends as beneficiaries in order to avoid naming their current spouse. However, if a client is setting up a DAPT for reasons other than protecting assets in case of divorce, and your client has a strong relationship with their spousal partner, one of the best ways to protect assets is to name a spouse and any heirs as beneficiaries to the trust. This leaves creditors without much recourse to win on debts owed by the settlor.
Another standard clause that needs to be drafted for the DAPT is the assets that are being transferred to the trust. This can be property, both real property and other property that has to be defined specifically.Some state statutes allow for the settlor to live in a residential property that has been placed in the trust. If this is the case, the provision regarding property should make it clear that the settlor has the right to remain living in the residential property, despite the fact that they do not have control rights over it.
The trust instrument must also grant the trustee sole discretion over the assets in the trust and not leave any remaining control interest in the beneficiaries. The one exception is if your client has formed a limited Family Law Partnership (“FLP”) or a Family Law Limited Corporation (“FLLC”) that would allow the settlor or the settlor’s family members who are also members of the FLP or FLLC to have some control over certain assets. This is one loophole to not being able to have any discretionary authority. Although using a FLP or FLLC does give the beneficiaries some control, it can only be over the non-managerial assets and cannot cover all of the assets in the trust. The trustee maintains control over assets in the trust. Generally, the trustee has full discretion of any assets paid out of the trust.
b. Key Provisions for Maximizing Protection in Divorce Situations.
In order to protect assets during a divorce, the assets must have already been placed in the trust. Therefore, in drafting a DAPT, all individual assets that your client wants to keep separate and prevent from becoming marital assets that their spouse is entitled to must draft these assets into the property provisions of the trust. Additionally, to protect assets from divorce, your client’s spouse should not be one of the discretionary beneficiaries that can benefit from the trust.
Provisions that make the trust completely discretionary maximize the protection a DAPT provides during divorce because if the trustee is the sole decider of whether or not to pay assets out of the trust account then there is less of an argument that the trust asset contributed to fund the marital lifestyle and add to the marital property.
One of the most effective provisions in protecting assets from a divorcing spouse is to have the property ownership interest transfer entirely to the trustee at the time the trust is established. In general, this will protect your client’s assets in states where the court is able to dip into the personal and separate assets of one spouse in order to make the marital division equitable. The court in general will not be able to access assets in the DAPT account that your client does not have any ownership or control over and these assets will not be considered part of your client’s personal and separate property.
c. Clauses Reducing the Exposure of Non-Trust Assets to Equitable Distribution.
Clauses that assign the trust as a grantor trust to the beneficiary—meaning that the settlor/beneficiary would be responsible for paying the income tax on the trust’s earnings every year. This would take money that would otherwise be considered a marital asset or at the very least an asset open to being equitably divided by the court out of the courts discretion. Therefore your client would have over all less assets outside of the trust account that would be available for distribution in an equitable distribution.
d. Provisions Addressing Jurisdiction and Conflict-of-Laws Issues.
Jurisdiction should be addressed in the trust document itself. Jurisdiction is determined by both assigning a trustee in the jurisdiction or one who has ties to the DAPT jurisdiction. Another way to determine jurisdiction is by drafting what jurisdiction’s law shall apply to the administration of the trust. Addressing jurisdiction in the document gives courts in the future a “default setting” for what law to apply in a case brought by creditors attempting to reach the DAPT assets. The court will start with the jurisdiction provisions in the trust document, and as long as the trustee has significant ties to the trust jurisdiction and has not availed himself to the settlor’s jurisdiction routinely, the court should keep the DAPT jurisdiction as the ruling law. This is important because the majority of jurisdictions do not accept DAPT as being within public policy and, therefore, applying an outside state’s law might not be the most beneficial to protect your client’s assets. Often times, if your client is a non-resident of the DAPT state, this is because the jurisdiction they reside in does not allow for domestic asset protection trusts and, therefore, they are benefitting from a jurisdiction’s laws that are more favorable for asset protection. Therefore, it is equally unbeneficial to have a case heard under the law of your client’s jurisdiction if it is unfavorable to DAPTs. The trust instrument should specifically say what jurisdictions laws are to apply for administrative purposes and for conflict of law purposes. Additionally, as much of the trust’s administration as possible should be done in the DAPT state and not the settlor’s state. In order to maintain proper situ, as little contact with the settlor’s domicile as possible should occur.
e. Drafting Dos and Don’ts, Spotting Red Flags.
Drafting can be a challenge due to the unsettled nature of DAPT statutes when a majority of jurisdictions do not allow for DAPTs and consider them against public policy. Be cautious to draft the trust instrument in a way that does not make the DAPT appear to be a sham to the court. Often times, if a DAPT is a sham, it will have certain recognizable characteristics like the settlor is the only named beneficiary or the settlor is a co-trustee or trust protector. Additionally trusts that give the settlor significant control over the trust, if there was a transfer of 100 percent of the settlor’s assets or large asset positions to the trust; or there were implied agreements between the settlor and trustee. If a court deems a DAPT transfer is fraudulent, the court will unwind it, reverse the transfer and put assets back where they were beforehand so that the creditor can attack the asset. Therefore, while drafting make sure that the trust has more than one beneficiary and that the settlor does not have discretionary control over the trust property. Drafting language should also make it clear who the trustee is and establish the settlor’s ties to the jurisdiction in order to avoid a court invalidating the trust as was seen in In re Huber, where the court determined that the settlor had no ties to Alaska as all of his business was in Washington State. It is not necessary to establish ties between the trustee and the jurisdiction where the settlor lives, just that the settlor has enough ties with the DAPT jurisdiction to justify upholding the DAPT account.
In drafting, to avoid a court later dissolving the trust account, it is advised to only draft assets into the trust that are expressly allowed by statute. Therefore, other than claims of fraud the court will not be able to invalidate for improper drafting not allowed by the statute.
After being approached by a client looking to protect their assets through a DAPT, it is a good idea to first have the client draft or sign an affidavit of solvency. The affidavit and further investigation by the attorney in determining if the client truly is solvent combined together can prevent any issues with the court later on. As part of further investigation, you should ask your client about their reasons for wanting to set up a DAPT looking for any warning signs that the client is establishing the DAPT in order to escape creditors. Often, clients who are overly eager to establish a trust already have creditors breathing down their necks and, therefore, are in a rush to have their assets protected as soon as possible.
In drafting and implementing a new DAPT, it is important to leave enough assets out of the trust for the settlor to live on with some cushion to pay future creditor claims without having the assets in the DAPT attacked. This avoids the appearance of fraud. One sign to the court of a fraudulent transfer is when so many assets are put into the trust account that the settlor becomes insolvent. A general rule of thumb for what courts will view as an appropriate transfer to a trust account is between one-third of the settlor’s net assets and half of the settlor’s net assets. Any transfer more than this could raise the court’s suspicion on whether the transfer was fraudulent or not under the rationale that if the settlor transfers assets in the account in excess of what the settlor would need to live off of the individual must know that they will be able to get some assets back if needed.
V. IMPLEMENTATION/ADMINISTRATION ISSUES.
In the administration of the trust, one tip is to make sure that the trustee would not be subject to personal jurisdiction in a court where creditor attacks will occur. This further protects the trust assets from creditors. It is important to understand the way that jurisdiction works in cases by creditors. In order for a creditor to gain access to the DAPT and trust assets the creditor have jurisdiction over the DAPT itself. Jurisdiction over the settlor alone will not allow a creditor to attack the trust assets. When assets are placed in a DAPT, they are no longer considered assets of the settlor and, therefore, are not considered as assets that can be awarded in a creditor claim solely against the settlor. The best case scenario is to implement the trust in a way that leaves little risk that a state other than that DAPT state will have jurisdiction. In general, the DAPT state is going to be more favorable to your client’s case and is the most likely to apply current state DAPT law that protects the settlor from creditors. Implementing the trust account in a way that prevents jurisdiction over the trustee and DAPT account in the resident state of the settlor is one way to ensure that the case will be heard in a jurisdiction favorable to DAPTs and not in a jurisdiction that views them as being against public policy. Limiting the contacts between the trustee and the settlor’s domicile will help prevent not only state law claims in the settlor’s domicile but will also protect that trustee and DAPT account from federal claims in other districts for lack of personal jurisdiction. Implementing the trust in this way will not protect the trustee and DAPT account from claims in Bankruptcy court because U.S. Bankruptcy courts have national jurisdiction. State’s long arm statutes may still allow for personal jurisdiction over a trustee, but the ultimate decision will be up to the court based on an analysis of whether or not the trustee availed themselves to do business in the settlor’s jurisdiction.
Implementation is important because it is one way creditors can attempt to attack a DAPT. Implementation arguments are centered around the argument that the DAPT was not implemented properly according to the statute and, therefore, should be voided for not meeting all of the statutory requirements. There are three main types of implementation arguments: 1) implied agreements between the settlor and the fiduciary; 2) the trust has been implemented so it is merely the “alter-ego” of the settlor; or 3) the trust is a “sham” because of the manner in which it has been implemented. These attacks can be used against both residents and non-residents. Meaning that regardless of whether your client lives in the same state where the DAPT is settled or they are a non-resident to the DAPT state a creditor can argue improper implementation.
The three types of implementation attacks mentioned above can be avoided by maintaining the trustee’s independence. This means ensuring that the trustee has complete discretion over the payout of funds from the trust account. Most spendthrift provisions have exceptions for when the settlor has any discretion or influence over distributions from the trust. These decisions must be the result of an independent trustee in order to be upheld as a valid DAPT. There cannot be any type of agreement either oral or written between the settlor and the trustee, and this includes implied agreements based on a pattern of distribution where the trustee agrees to release funds from the trust account at the settlor’s request. A court will be more likely to assume an implied agreement if there is a prior relationship between the settlor and the trustee such as a family member, close friend, or employee. Therefore, in the interest of protecting the trust accounts a best practice tip is to have a person who the settlor does not have a prior close relationship to administer the trust. This can be accomplished using trust companies at the trustee. Another way to avoid attacks under the theory of ‘alter-ego’ is to establish a FLP or a FLLC and then transfer the FLP limited partnership interest or the FLLC non-managerial interest into the DAPT. This allows the settlor or the settlor’s family to have some control over the FLP or FLLC assets placed into the trust without having a court void the trust altogether. Another reason that a trust can be attacked and invalidated for implementation issues if the statutory requirements of the jurisdiction where the trust is established are not met.
Administration of the trust is guided by whatever state law is assigned in the trust instrument. This will be determined and put into the drafted document. The determination of law governing the trust is also important because it will often act as the default for what jurisdiction controls when creditor claims are brought. Therefore, even if a claim is able to be brought in the non-resident trustee’s state, the courts default would be to apply the law established in the trust document as the governing law. The default is ignored when under a conflict of law analysis the DAPT is against public policy or the DAPT jurisdiction does not have required minimum contacts with the trust account.
VI. DAPT BATTLES IN DIVORCE: EXAMINATION OF CASE LAW.
a. When are DAPT assets factored into a marital division?
Assets in a trust account can be factored into the marital division when a court determines that the trust instrument is voided for fraudulent transfers, implementation or administration issues. Assets in a trust account can be factored into marital division when the court finds that the settlor is a “de facto” trustee. For instance, a Massachusetts court in Caruso v. Caruso, found that when the settlor’s accountant was acting as the trustee for the discretionary trust that the settlor was a de facto trustee who still maintained control over the distributions from the trust. In this case the husband, Mr. Caruso was named as a trustee but he did not have sole discretionary power to pay out of the trust, this ability lied with the accountant trustee. The court found that the accountant was Mr. Caruso’s “yes man” and would not object to any requests for distribution that Mr. Caruso made. This was evidenced by the fact that upon Mr. Caruso’s request, the accountant trustee had released managerial fees from the trust assets that far exceeded normal fees to the point that the trust assets were diminished to the detriment of the trust’s other beneficiaries, mainly Mr. Caruso’s children and their issue.
Another example of a court invalidating a trust which would leave the trust assets open to an equitable marital division is in In Re Huber. This is a Washington case that invalidated the trust asset transfer as being fraudulent. In this case, the court found the transfer to an Alaska Asset Protection Trust was fraudulent when the only contact with Alaska that the trust had was a $10,000 certificate of deposit. The remaining assets in the trust were located in the State of Washington, including Mr. Huber’s businesses and personal assets. The trustee of the DAPT was also Mr. Huber’s son Kevin who was a resident of the State of Washington. Under a conflict of laws analysis, the court applied Washington State law based on the lack of minimum contacts in Alaska. The law in Washington State varies greatly from that of Alaska and does not hold DAPTs to be within good public policy. Despite the unfavorable court jurisdiction for this case, it is likely that the assets would have been fraudulent under and Alaskan law given that the trust was settled when Mr. Huber had creditors already seeking payment including on several personal guarantees that he had outstanding. While this case was not specifically about marital assets, it still makes the point that a DAPT should not be established when your client’s life is in turmoil and this would include immediately prior or after a divorce action has been initiated. A court looking at an equitable marital division will take into consideration the timeline of when the trust was established, and for that reason it is better and safer for your client to establish a DAPT prior to a marriage entirely either along with a prenuptial agreement or in lieu of one.
There are very few cases that have been decided in the specific context of divorce. However, one case where the court upheld the trust against a former spouse is in Dahl v. Dahl where the Utah court held that the wife, the former Mrs. Dahl, was not entitled to assets in the trust account when she was a both a beneficiary of the trust and also a co-settlor. This upheld what is already known about DAPTs, which is the fact that they are irrevocable trusts where the settlor names himself or herself as a beneficiary but does not have the authority and discretion to pay out assets from the trust. Here, while Mrs. Dahl remained a discretionary beneficiary of the trust after the divorce between the two parties she was not entitled to attack the trust account as a third-party beneficiary. This case leaves it open in the future for what might happen when a former spouse, or divorcing spouse attempts to attack an asset protection trust as a third party creditor if the trust account is otherwise formed properly and without fraudulent transfers. One argument made by Mrs. Dahl for why she was entitled to assets in the trust is the argument that the trust was in fact a revocable trust where she would have access to the trust assets as co-settlor and beneficiary. The court, however, looked to the actual trust instrument that deemed the trust to be irrevocable under stated Nevada law. In addition to the actual language of the trust documents the trust was implemented where a trustee besides Mr. Dahl had ultimate discretion for trust distributions while Mr. Dahl as a trustor had the ability to veto decisions made by the trustee without the actual right to determine distributions himself. The court determined that under the law beneficiaries from an irrevocable trust do not have rights to the trust assets unless they are distributed by the trustee within his or her discretion and therefore, while Mrs. Dahl was able to receive distributions from the trust she had no actual claim over the assets if the trustee did not wish to distribute them to her.
b. Impact of Assets/Distributions on Child Support or Spousal Maintenance Calculations.
DAPT assets can be used in calculations for child support or spousal maintenance when a trust is determined to be created through a fraudulent transfer or when it is invalidated for other reasons. This would leave those assets open for the court to distribute in a divorce action. Distributions may also be considered by a court in determining child support and/or spousal maintenance because once they are distributed to the settlor the assets are considered to have left the protection of the trust account and are then in the possession of the settlor again. The assets are only shielded from creditor when they are within the trust account, and therefore any discretionary distribution from the trust account could be considered by the court in a marital dissolution. For instance, in the Caruso v. Caruso case previously discussed, the court awarded Mrs. Caruso alimony in the dissolution of marriage in an amount that reflected trust assets that Mr. Caruso presumed to be protected. This inflated the amount she got in the divorce because it raised his overall yearly income. The assets factored into the courts analysis in this case was both the exorbitant managerial fees that were paid out of the trust by the accountant trustee that the court found to be excess of what was needed to meet the managerial needs as well as the assets remaining in the trust due to the fact that the court deemed Mr. Caruso to be a “de facto” trustee of the trust assets.
c. When Might Distributions Be Subject to Garnishment by Spouse or Children?
Distributions from a DAPT have been held to be subject to garnishment when the beneficiary to the trust has defaulted on alimony payments. This was the case in Berlinger v. Casselberry where a Florida District Court of Appeals affirmed the lower court’s decision that allowed for Ms. Casselberry to garnish the discretionary trust distributions to her former spouse, Mr. Berlinger. The facts of this case were that Mr. Berlinger was ordered to pay $16,000 per month to his former spouse Ms. Casselberry in 2007, after thirty years of marriage. Mr. Berlinger got remarried and stopped paying alimony in 2011 at which time Ms. Casselberry sued for non-payment.The trial level court determined that Mr. Berlinger was supporting his lifestyle, and the lifestyle of his new wife with distributions from a trust he set up and subsequently transferred two-thirds of his property interest into the trust account. The appeals court determined that garnishing distributions was not a violation of Florida law, but reiterated the fact that a court cannot order distributions from an irrevocable trust but that once assets are being distributed a former spouse that is entitled to alimony may “intercept” the distribution to collect alimony owed.