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“Domestic Asset Protection Trusts Can Fail” says Estate Planning Expert

January 27, 2014 2 Comments

A battle is raging between US-based attorneys over the use of Domestic Asset Protection Trusts (DAPTs) or their offshore counterparts (Foreign Asset Protection Trusts or FAPTs). Fifteen states (and counting) have enacted some form of asset protection trust legislation, but the efficacy of these DAPTs has been called into question since inception.

At the 48th Annual Heckerling Institute on Estate Planning, a panelist noted that DAPTs can fail. [1]

Critics of FAPTs argue that they too can fail, and point to a handful of published cases where assets were recovered by creditors, or settlors were held in contempt for failing to repatriate the assets. However, all of these infamous cases have one common element – the trust was improperly drafted or implemented. Therefore, to compare the reliability of DAPTs and FAPTs, a key distinction is necessary:

When it comes to offshore trusts, only improperly drafted or implemented FAPTs fail.

With domestic trusts, even properly drafted and implemented DAPTs can fail.

Why are domestic asset protection trusts unreliable?

Most states that have enacted DAPT legislation have also included loopholes for certain classes of creditors. Some also require a long statute of limitations to expire before the transferred asset is considered exempt from creditors.
Moreover, the strength of a DAPT relies on the cause of action being limited to a state court. The debtor and the creditor may end up in a federal court, and when they do, the United States Code is not as obliging as the DAPT statutes. In 2011, a federal bankruptcy court reversed asset transfers to an Alaska DAPT, choosing to follow federal law in determining bankruptcy exemptions instead of the debtor-friendly Alaska DAPT statutes (In re Mortensen). This landmark case was considered the first real test of domestic asset protection, and the DAPT failed entirely. A DAPT can be “undone” for up to ten years after its establishment by a bankruptcy court.

Common Misconceptions about DAPTs vs. FAPTs

The misconceptions about offshore planning are numerous. Some believe that the only use for offshore planning is tax evasion (categorically false). Others believe it to be a utilized by only the unscrupulous or illicit type (also false). Here are some of the most common misconceptions:

There are more cases where FAPTs have failed, so they must be less reliable.

WRONG. FAPTs have been used for decades, so there are naturally more published cases involving FAPTs. But only in those instances where a FAPT has been improperly drafted or implemented has the creditor reached the assets. There are fewer published cases regarding DAPTs because DAPTs are relatively new, and, until 2011, were untested.

The settlor can be held in contempt for setting up a FAPT, but not a DAPT.

WRONG. The US Supreme court has ruled that civil contempt is only available to compel an action which is within the power of contemnor. This applies equally to FAPTs and DAPTs. Where a trust is improperly drafted with the result that the settlor retains control over the assets, a court may compel the settlor to act or hold him/her in contempt for failing to comply. When FAPTs are properly drafted and implemented, the settlor retains no control over the assets, and therefore cannot be held in contempt for failing to repatriate them.

Offshore trust companies are less reliable than domestic trust companies.

WRONG. For this answer we need only look at an additional domestic asset protection disaster – In re Donald G. Huber (another Alaska trust that failed to protect the settlor’s assets). The creditor predictably sued the Alaska trust company, ‘Alaska USA Trust Company’. The trust company cut and ran. To remove itself from the lawsuit, the trust company settled with the creditor for just over $5,000 and a promise to fully assist in the creditor’s case.

There are many experienced domestic trust companies, but asset protection trusts are a relatively new product for them. There are also many experienced offshore trust companies which have successfully defended asset protection trusts for decades.

Offshore trusts companies charge more than domestic trust companies.

WRONG. There is no known relationship between cost and location.

Offshore planning is only for the über-rich.

WRONG. There is a recommended minimum level of assets to be eligible for asset protection planning. Asset protection should be considered by those with more than $500,000 in cash or securities outside of retirement plans. This recommendation doesn’t change based on the use of a domestic or foreign trustee.

The bottom line: offshore asset protection planning, utilizing FAPTs, is a safe, tested, reliable, and legitimate practice which can and should be utilized by Americans seeking to protect their assets.

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[1] The Heckerling is the leading conference for estate planning attorneys, CPAs, and other professionals, and is the largest of its kind.  It is sponsored by the University of Miami School of Law, and held annually in Orlando, Florida. Exhibitors and speakers include the nation’s leading experts on DAPTs and FAPTs.