Update of Asset Protection Trust Litigation

“Update of Asset Protection Trust Litigation,” that’s the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is Margaret Van Houten, ACTEC Fellow from Des Moines, Iowa. Over the past year, there have been several court cases regarding asset protection trusts. To give us more information on this topic you will be hearing today from ACTEC Fellow Gray Edmondson of Oxford, Mississippi. Welcome, Gray.

Thank you. And, asset protection trusts, of course, have been around for a while — offshore longer than domestically–and domestically we have had asset protection trusts for a little over 20 years starting with Alaska in 1997. I know there has been a previous podcast that celebrated the 20th anniversary of that legislation a couple of years ago, and in that time we have not had a substantial amount of litigation over the effectiveness of asset protection trusts as a creditor protection tool (Twenty Years of Domestic Asset Protection Trusts in the United States). And increasingly, we are beginning to see more and more of these types of trusts find their way through the court system; and so, we are learning now what we can do, what we can’t do, what best practices and the like. And so, what I would like to do is sort of go through some of these recent opinions and describe some of what happened in those cases as well as what we might be able to learn.

Wacker Opinion

And, the first case I would like to mention is, I refer to as the “Wacker Opinion” out of Alaska, and it dealt with [an] Alaska Domestic Asset Protection Trust, Alaska being one of the 17 domestic US jurisdictions that allow asset protection trusts, which essentially are simply a trust an individual sets up, with their own assets, contributed to the trust and they are a permissible beneficiary of the trust, which under common law has traditionally not been allowed or, I guess better stated, it’s been allowed but your creditors had access to those assets with the theory being that if they were your assets to begin with, they ended up in a trust that you were a beneficiary of, so you still had access to your own assets, your creditors should have access to those assets and that’s been the traditional common law until, as I said earlier, just over 20 years ago in the US, with Alaska beginning this.

So, in the Wacker case, what an individual did, or as a married couple out of Montana, set up an Alaska Asset Protection Trust, deeded some properties to that trust and found themselves in litigation in Alaska over what state’s law applied to the transactions. What the issue was, was that while they were actively deeding these Montana parcels of real estate to their asset protection trust, they were having judgments entered against them in Montana. They ended up getting default judgments in Montana, finding that those transfers were fraudulent transfers under Montana law.

The Alaska statutes, however, say that “only Alaska law could determine whether a transfer to an Alaskan Asset Protection Trust was a fraudulent transfer.” The Wackers, or the creditors in that case, pursued the debtors, the Tangwalls, in Alaska as well. The Tangwalls ended up filing bankruptcy in Alaska and filed for a declaratory judgment in Alaska State Court. It made its way to the Alaska Supreme Court. The Alaska Supreme Court said Alaska, notwithstanding its statutes, can’t determine whether another state has jurisdiction to determine whether a conveyance of property out of that state was a fraudulent transfer. Therefore, the Montana judgment stood. And so, the real issue of that case was whether the Alaska statute could usurp the jurisdiction of another state just by saying we have exclusive jurisdiction, and their Supreme Court found that they could not. That’s really what happened there.

Campbell Case

The Campbell case is an interesting case. It was originally started as a Nevis Asset Protection Trust, an offshore asset protection trust, which was started in 2004 by an individual who put $5 million into that trust at a time when he had a net worth of over $25 million. Between funding the trust with $5 million, and this past year when this litigation found itself in a reported opinion, he invested, Mr. Campbell invested a large portion of his net worth in real estate in the Gulf states, so Louisiana, Mississippi, Alabama. It turned out that Chinese drywall was installed in most of those properties and he lost all of his money.

He owed the IRS around $1.3 million and filed a request for the IRS to accept an offer in compromise paying less than 100 cents on the dollar. His offer in compromise was for $12,000 against a $1.3 million debt and he still had significant assets in his Nevis Asset Protection Trust. So, the issue became, can the IRS consider those assets in the trust as his assets for calculating whether his offer in compromise was an acceptable offer? Because the IRS is supposed to accept an offer in compromise if it represents what the IRS could collect from the debtor.

So, the real turning point in the case was, could the IRS collect this money? And the tax court found that the IRS could not. Mr. Campbell funded this trust before the debts arose. He didn’t become insolvent through the transfer. He had no control over the assets that were currently in the trust; it had a separate trustee. He didn’t have a right to remove and replace that trustee; he didn’t have a right to direct the actions of the trustee and therefore, since he didn’t have access to these funds, the IRS shouldn’t be able to include them and therefore, they had to not count those assets in determining whether he qualified for an offer in compromise. Now, they sent that back. We don’t know whether the $12,000 offer was accepted but we know that those assets in the trust are off the table for the IRS’s calculations.

Cyr Case

The next case I would mention is the Cyr case, C-Y-R is the litigant’s name, and this really isn’t strictly an asset protection trust but it came out of a bankruptcy court in Texas, and the issue became whether a trust is a self-settled trust, being a trust that an individual sets up with their own assets for themselves, which is what asset protection trusts are. Dr. Cyr and his wife transferred a number of assets to a trust. That trust had originally been formed and funded by his parents. Their argument in bankruptcy court was that this was not a self-settled trust. This was a trust that was settled by his parents; they formed it, they funded it, their assets were what made up the original corpus of the trust. The court went back later and through a series of events showed that he had caused assets to find themselves into that trust either by direct transfers or by paying for debts that bought assets that were in the trust and therefore, the reason I bring up this case is just to note that an asset protection trust is a specified vehicle. It’s not something that you can just, I have a trust for myself and therefore it’s protected. It’s not any trust out there and so, we need to be careful in knowing that courts can deem to be self-settled trusts that we don’t intend to be and trusts that we don’t think are.

Rensin Case

The last case I want to mention is the Rensin case, which is a case out of Florida bankruptcy court. Joseph Rensin, who is the founder of BlueHippo computer sales company, that we have all probably seen the late night commercials about, had a Federal Trade Commission judgment against him, a substantial judgment for around $15 million, finding that he never actually ever delivered a computer to anyone but took $15 million from consumers in violation of FTC rules. He then filed bankruptcy in Florida and the bankruptcy trustee sought to set aside assets that were in an asset protection trust that had originally been set up in the Cook Islands — moved to Belize in the interim; it was a Belize asset protection trust. The court found, because Florida has a strong public policy against self-settled trusts, that the trust was invalid under state law, applicable state law, and therefore, the bankruptcy trustee didn’t have to respect the existence of that asset protection trust.

However, the trustee of that trust, shortly before he filed bankruptcy, converted the assets of the trusts into annuities which are largely protected under Florida state law from enforced collection. Therefore, although the trust wasn’t recognized, one of these annuities, the one that was structured appropriately, was recognized as validly protected from creditors, even though, Florida has a statute that says “if you convert non-exempt assets to exempt on the eve of a judgment or creditor issue we can disregard its exempt status.” He didn’t do that; the trustee of his asset protection trust did, and it would actually require the debtor to have been the one that converted the assets.

The other thing that’s interesting here is that although the trust was disregarded, the trustee of the Belize trust went to the Belize Supreme Court and got a judgment that the Belize trustee was not to honor any order of a US court to deliver the assets. The Belize trust was not made a party to that litigation in bankruptcy court. So, the bankruptcy court said, “We are without any jurisdiction or authority to even order them to do this.” And if they had, Belize Supreme Court had said they couldn’t honor our judgments anyway. So there is more litigation to come in this, I am sure, but even though the trust was disregarded he may end up still winning the day because part of the assets in the trust were found to be exempt under Florida law and the other assets, the bankruptcy court may have no effective way to get to those assets just for jurisdictional issues.

Final Thoughts

So, the wrap up in all of this is really what can we learn from these recent cases that we have seen out there. And I think one is certainly, and we learn this from the Cyr case, if you are going to contribute assets to a trust or you are going to pay for assets that originally are titled in the trust but you are going to pay for it with your outside assets, be sure and intentionally set up an asset protection trust in one of these jurisdictions. Don’t rely on the fact that someone else set up a trust and therefore it’s not a self-settled trust. If your assets are going in the trust or if you are somehow paying for assets of the trust, it will be a self-settled trust that needs to be formed in one of these jurisdictions following the requirements.

The second thing is, don’t fund an asset protection trust through a fraudulent transfer–okay? The Wacker case, it would have been a fraudulent transfer under Alaska law anyway. So, regardless of whether the jurisdictional question was resolved one way or the other, these properties were deeded to the trust while judgments were actively being entered against the debtors here, through fraudulent transfers under either state’s laws.

So, when you set up one of these trusts and you form one of these trusts, do it outside of a fraudulent transfer and know that the bankruptcy court has a 10-year statute of limitations on fraudulent transfers. The next lesson we learn is do not file bankruptcy within 10 years of forming and funding one of these trusts either. Bankruptcy is largely voluntary. It can be involuntary, but a lot of these individuals chose Chapter 7, I am sure for other valid reasons, but they potentially lost some of the benefits to their asset protection trusts by doing that.

The last thing that I think is a good thing to learn from all of this is to limit the retained rights of the grantor and the settlor. State laws that allow these asset protection trusts largely allow you to retain a number of powers and a number of rights, but when you read these opinions, they step through the control the settlor had over the trust assets, the control they had over the trustees, the investment management discretion and those types of things. And so, the best practice is probably to avoid retention of some of these levels of control even though state law may allow it because courts have been citing to those as grounds for either respecting or not, these asset protection trusts.

Thank you for giving us more information on litigation in the asset protection world.

Thank you.

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