Offshore Fortress Or House of Cards: Use Of Foreign Trusts In Asset Protection Planning

In asset protection planning, not all trust instruments are created equal. For example, living trusts and other self-settled trusts, while excellent estate planning devices, are generally useless when it comes to asset protection planning. Domestic Asset Protection Trusts (“DAPTs”), which are only available in certain states (Alaska[1], Delaware[2], Nevada[3], Missouri[4], and Rhode Island[5]), are also not perfect. Enforcement of a DAPT’s key principle (the application of spendthrift clauses to self-settled trusts) is not guaranteed if the trustor (or real property owned by the trust) resides in a non-DAPT jurisdiction[6]. The non-DAPT jurisdiction could refuse to honor the laws of the DAPT jurisdiction and issue judgments against trust[7]. Conversely, the DAPT jurisdiction may refuse to honor any non-DAPT jurisdiction judgment against the trust. This legal merry-go-round does not always provide the security expected in asset protection planning either for the debtor or creditor. Furthermore, even if the trustor of a DAPT and all its assets reside in the DAPT jurisdiction, the efficacy of the DAPT may still be challenged under: the Supremacy Clause of the U.S. Constitution, various fraudulent transfer statutes, or because the trustor retained some prohibited control over the trust.

The only possible way of avoiding all these obstacles when performing asset protection planning with trusts is through the means of a foreign trust—a trust governed by the laws of a foreign nation.

A foreign trust instrument, per se, does not have any unique asset protection benefits. The benefits derive from the jurisdictions that governs the trust. In addition to the practical protection of requiring claims to be litigated in a foreign jurisdiction at substantial cost, from a legal perspective, several offshore jurisdictions have enacted trust laws that are particularly favorable to debtors either as beneficiaries or trustors. The Cook Islands[8], Nevis[9] and St. Vincent[10] are several such jurisdictions.

The offshore jurisdictions trust laws typically contain some variety of the following: a) there is no recognition of foreign judgments with respect to trusts; b) there is a very short statute of limitations for fraudulent transfers; c) to establish fraudulent transfer the creditor must show that the debtor was insolvent and that they had the intent to hinder delay or defraud beyond a reasonable doubt; d) the trust need not hold any assets in the jurisdiction[11]; and e) spendthrift protection is extended to self-settled trusts. Of these, the non-recognition of foreign judgments is the most important.

However, usage of foreign trusts is not without its own unique set of risks. Because U.S. courts cannot reach the foreign assets of a foreign trust or exercise jurisdiction over the foreign trustee, they focus on the domestic trustor-debtor.

In a foreign trust situation, a U.S. court may attempt to coerce the debtor into repatriating the money or assets, through civil contempt. The debtor defends this by establishing that it is impossible for him or her to do so, and therefore the contempt charge cannot stand.[12] The debtor’s choice of law should not factor into the impossibility analysis. The only question is whether the debtor retained control over the assets in a way that repatriation is not impossible[13]. If there is no finding of control, impossibility exists, and contempt should not stand.

This illustrates the importance of one of the cardinal rules in asset protection planning—plan ahead before there is a claim. If the trust structure and transfers were set up without the proper legal analysis, the trustor may end up retaining sufficient control to allow for a contempt charge. Conversely, if due diligence and care is taken so that the trust is irrevocable, with spendthrift clauses, as much discretion as possible conferred to the trustee, and the trustor does not act as co-trustee, trust protector or have any power to remove or appoint a trustee, then it will be hard for a contempt charge to stand.

Asset protection planning is a complicated process that requires legal advice by someone who not only knows the intricate nuances of all of the applicable tools but is well-versed in the laws of various domestic and foreign jurisdictions.

—By Douglas M. Hanchar, Esq., Barnes Law

Douglas M. Hanchar is an associate attorney with Barnes Law, licensed to practice law in California.

The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Alaska Stat. § 34.40.110.

[2] 12 Del. Code § 3572

[3] Nev. Rev. Stat. Ch. 166.

[4] Mo. Ann. Stat. § 428.005 et seq.

[5] R.I. Gen. Laws §§ 18-9.2.

[6] Rest. 2d conf. of Laws § 280

[7] Rest. 2d conf. of Laws § 187, subd. (2)

[8] Cook Islands International Trusts Act, 1984.

[9] Nevis International Exempt Trust Ordinance, 1994.

[10] Saint Vincent and the Grenadines International Trusts Act, 1996.

[11] Unlike most DAPT jurisdictions (see, e.g., Ala. Stat. § 13.36.035(c)(1)), the foreign trust jurisdictions do not require that the trust hold any assets in the jurisdiction of its domicile. Consequently, a Saint Vincent or Cook Islands trust can hold assets located anywhere in the world.

[12] Even if compliance is impossible, contempt charges will stick if the impossibility is self-created.  Impossibility will be deemed self-created if the foreign trust is funded in close proximity to the timing of the court’s order. In re Lawrence (11th Cir. 2002) 279 F.3d 1294, 1300.

[13] F.T.C. v. Affordable Media, LLC (9th Cir. 1999) 179 F.3d 1228