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of
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Law Review
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ARTICLE:
OFFSHORE ASSET PROTECTION
TRUSTS: HAVING YOUR
CAKE AND EATING IT
TOO
Elena
Marty-Nelson
SUMMARY:
I.
Introduction
Amid
questioning by the
United States Senate
Judiciary Committee
over his
controversial
writings in support
of limits on freedom
of speech, Judge Robert
Bork
quipped, "Sometimes I wish I had confined myself to writing about
spendthrift
trusts. . . ." n1 For over a century, U.S. spendthrift trust law has
indeed
led a fairly quiet
existence. n2 Judge
Bork might be dis [*12]
appointed
to learn, however,
that in the last decade
at least one mutation
of
the
once staid spendthrift
trust has become controversial.
n3 That variant is
a
type
of spendthrift trust
commonly referred to
as the offshore asset
protection
trust
("OAPT"). n4
Generally,
OAPTs are trusts n5
created under the laws
of certain foreign
jurisdictions
in order to shield
the assets transferred
to the trust from future
creditors.
n6 Numerous devices
fall under OAPTs. Typically,
however, an OAPT is
established under laws
of a foreign jurisdiction
with trust legislation
supportive
of OAPTs. n7 Once framed,
the trust is irrevocable.
n8 The
[*13]
trust may terminate
in a relatively short
time period, such as
ten
years,
with the settlor retaining
a reversionary interest.
n9 Alternatively, the
trust
term may be tied to
the lives of the settlor
n10 or one or more
beneficiaries.
n11 Beneficiaries of
the trust are members
of the settlor's
family,
such as spouse and
children, and may include
the settlor. n12 The
trustee
is a foreign trust
company or financial
institution. n13 Ordinarily,
the
trust
vests the trustee with
unfettered discretion
over distribution of
income
or
principal among the
designated beneficiaries.
n14 The settlor, however,
typically
reserves some measure
of control over the
trust either through
membership
in a "committee of advisors," n15 or as a self-designated "protector"
of
the trust with authority,
among other things,
to replace the trustee.
n16
OAPTs
are utilized primarily
for two reasons: (1)
they offer added
protection
from creditors when
compared with domestic
spendthrift trusts;
and
(2)
they offer this added
protection without
the settlor divesting
total control
over
the transferred assets.
n17 For these reasons,
OAPTs have become the
most
popular
vehicles for foreign
asset protection planning.
n18 In
[*14]
fact, current estimates
suggest that the staggering
amount of $ 1
trillion
of foreign trust funds
are held in asset protection
trusts. n19 One
reason
behind the explosion
in OAPTs is that the
class of OAPT settlors
has
expanded
from its traditional
base of the "super-rich" to include less
well-heeled
newcomers whose professions
or businesses leave
them vulnerable to
potentially
devastating litigation
risks. n20 These trusts
are now popular among
professionals
such as doctors, n21
lawyers, n22 and accountants
n23 as ways to
shield
their assets from runaway
malpractice claims.
Recently, they have
also
been
suggested as a way
to insulate officers
and directors of companies
that
face
potential environmental
tort liability. n24
Virtually
all of the legal literature
on offshore asset protection
trusts
n25
has been contributed
by practitioners specializing
in the field. n26 As
such,
the literature paints
a fairly rosy picture
of OAPTs. n27 OAPT
specialists
tout
them as a panacea
[*15]
against virtually all
creditor risks. n28
Proponents of OAPTs
cite their
heightened
protection as an important
and desirable improvement
over the
vagaries
of U.S. trust law.
n29
The
controversy surrounding
OAPTs arises from a
point often glossed
over in
those
articles: the degree
to which OAPTs, in
practice, often defeat
deep-seated
precepts
of U.S. trust law.
Not least of these
precepts is that one
ought not
control
and benefit from property
and at the same time
shield it from one's
creditors.
This Article aims to
focus attention on
the fact that, although
not
all
OAPTs raise concerns,
many appear to be designed
to defeat, or certainly
have
the effect of bypassing,
U.S. trust law. As
such, the policies
underlying
those
laws ought to be carefully
reevaluated by the
judicial and legislative
interests
in this country to
determine whether they
are worthy of preserving,
or
doomed
to be sacrificed at
the altar of OAPTs.
The question raised
is: if the
protection
against creditors and
the control reserved
for the trust settlor
is
far
greater under OAPTs
than that tolerated
under U.S. trust law,
is this
expanding
loophole a development
recognized and approved
by U.S. lawmakers?
Having
broadly outlined the
purpose of this Article,
it is important to
note
what
the Article does not
attempt. This is not
an article that judges
whether
U.S.
spendthrift laws reflect
good public policy.
Nor does the Article
take a
stand
on whether OAPTs are
good public policy.
Rather, the Article
compares the
two
systems to identify
ways in which OAPTs
frustrate U.S. trust
policies. In
particular,
the Article explains
that although U.S.
law varies widely from
state
to
state in certain areas
(e.g., the propensity
for granting "special creditor"
status),
state laws uniformly
outlaw self-settled
spendthrift trusts.
OAPTs
challenge
that long-held public
policy.
The
degree to which OAPTs
undermine U.S. trust
law is made clear by
a
careful
comparison of U.S.
and offshore trusts.
Thus, Part II of this
Article
lays
the foundation for
this comparison by
setting out conventional
U.S. trust
law
from the standpoint
of creditor access
to assets held in U.S.
trusts. Part
III
maps out the structure
of OAPTs and examines
how they offer creditor
protection.
Part IV sets forth
a methodology by which
to compare the two
systems.
It examines ethical
and policy considerations
raised by the greater
protection,
flexibility, and control
offered OAPT settlors
versus settlors of
domestic
trusts. Part V concludes
that in substance,
if not in form, some
OAPTs
defeat
well-settled U.S. trust
doctrine. n30
II.
U.S. Trust Law--Creditor
Access to Domestic
Trusts
Weighing
whether clients must
go offshore to protect
their assets from the
vagaries
of U.S. trust law requires
both an understanding
of the typical
domestic
trust structure and
an understanding of
creditor access to
U.S. trusts.
Thus,
Part A describes the
common asset protection
features of domestic
trusts
and
explains the theories
by which the different
trust structures or
provisions
therein
shield assets from
creditors. Part B explains
how creditor access
to
domestic
trusts is a function
of at least three variables:
(1) the particular
asset
protection features
with which the trust
is imbued; (2) whether
the
creditor
is pursuing the settlor
as opposed to the beneficia
[*17] ry; and
(3)
the status of the creditor.
A.
Typical Domestic Trust
Arrangements that Limit
Creditor Access
A
fundamental purpose
of virtually all trusts
is to ensure the financial
security
of the trust beneficiaries
for the duration of
the trust. n31 For
that
reason,
trust settlors labor
to protect trust assets
from dissipation by
beneficiaries
and their creditors.
Several protective
mechanisms curtail
creditor
access to trust assets.
These restraints operate
either separately or
they
can be combined to
heighten creditor protection.
Creditor
access can be thwarted
in two different ways.
First, the trust
instrument
could contain a clause
that restricts a beneficiary
(and a
beneficiary's
creditors) from the
trust assets. Second,
the beneficiary's
interest
could be conditioned
on some standard or
be dependant on the
trustee's
n32
discretion. Examples
of the former are spendthrift
clauses n33 and
forfeiture
clauses. n34 Examples
of the latter include
support trusts n35
and
discretionary
trusts. n36
...
Thus, in discretionary
trusts, creditors or
assignees of a beneficiary
cannot
compel the trustee
to transfer trust assets
to them or reach any
part of
the
trust assets. n75 This
curb on creditors has
withstood challenges
even in
jurisdictions
in which spendthrift
trusts are not recognized.
n76 Courts reason
that
since the beneficiary
himself cannot compel
the trustee to pay
over any
part
of the trust, his creditors
stand in no better
position. n77
III.
Offshore Trust Law--Creditor
Access to Offshore
Asset Protection
Trusts
Advocates
of OAPTs often justify
them as a rational
response to the national
litigation
and malpractice explosion.
n212 Increasingly,
high damage awards
and
new
legal tactics designed
to reach into "deep pockets" continue to spread tort
litigation
to more defendants.
n213 Mounting malpractice
liability has promoted
larger
plaintiff recoveries
and a wary and
[*57]
weary class of professionals.
n214 It is this class
of professionals who
have
found new interest
in this particular
field of estate planning.
n215
Specialists
in OAPTs insist that
they offer a solution
for safeguarding
assets,
provided the law of
a friendly foreign
situs, such as the
Bahamas or the
Cook
Islands, applies. n216
This protection comes
from key features of
these
foreign
laws. For example,
as discussed in detail
below, the settlor
who
creates
a trust in one of these
havens is afforded
protection from U.S.
judgments.
n217 Creditors seeking
to reach the assets
must often embark on
independent
legal proceedings in
the foreign jurisdiction
in which the trust
is
located.
n218 For example, assume
a creditor wins a malpractice
claim in the
United
States against a doctor/settlor
of an OAPT. The courts
of the OAPT
jurisdiction
would not honor that
judgment. Rather, the
claimant would have
to
re-litigate
her claim in the OAPT
jurisdiction to obtain
a judgment that would
be
recognized in that
jurisdiction. n219
Even a favorable foreign
judgment may
be
a hollow victory. The
creditor still may
not be able to satisfy
that judgment
from
the assets held in
the trust unless she
proves that the transfer
to the
trust
constituted a fraudulent
conveyance. n220 Proving
this is nearly
impossible
in many of these jurisdictions
due to lax fraudulent
conveyance and
trust
creation laws. n221
Thus, while OAPTs may
offer a method of evading
U.S.
creditors,
in some cases they
also raise public policy
concerns. n222
[*58]
OAPT
formation may be inspired
either by legitimate
n223 estate planning
concerns,
or by a desire to shelter
personal assets n224
from creditors, or
on
some
combination thereof.
The motivation for
protecting one's assets
may arise
from
the settlor's desire
to retain assets for
the future benefit
of others, or
from
the settlor's desire
to retain his assets
for his own current
and future
benefit.
n225 United States
trust law, as discussed
above, legitimizes
the
former
purpose, but prohibits
the latter. n226 U.S.
courts will not recognize
a
self-settled
trust. If the law were
otherwise, then future
creditors would be
unable
to collect from solvent
debtors who still controlled
their assets. n227
The
key motivation of settlors
of self-settled OAPTs
is
[*59]
to preserve their assets
for their own current
and future benefit.
n228
By
contrast, OAPTs designed
for estate planning
protect assets primarily
for the
purpose
of ensuring future
support for others.
The two categories
of OAPTs
represent
the extremes; most
OAPTs fall somewhere
between these versions.
Before
addressing the public
policy concerns raised
by OAPTs, it is vital
to
understand
how OAPTs offer additional
barriers against creditors,
while
reserving
in settlors greater
control of the transferred
assets.
A.
OAPTs Present Practical
Barriers Against Creditors
Suppose
that after time-consuming
and costly litigation
in U.S. courts, a
creditor
finally receives a
favorable judgment
against a debtor. When
the
creditor
tries to collect, however,
he discovers that the
debtor's assets are
tied
up in an offshore trust,
governed by the unfamiliar
laws of an alien land.
Upon
pressing his claim,
the judgment creditor
will likely face an
unknown
foreign
legal system replete
with laws designed
to frustrate creditors.
As a
noted
New York trust and
estate planning specialist
sees it: "These trusts are
probably
immune. Creditors of
the person who created
the trust probably
can't
collect
against it or foreclose
it. The island countries
tried to make sure
of
that
when they rewrote their
laws to protect these
trusts from attachment." n229
1.
Foreign Judgments not
Respected
The
first hindrance to
the U.S. creditor will
come when he travels
to the
offshore
jurisdiction to enforce
his judgment. He will
quickly learn that
these
OAPT
havens do not recognize
foreign judgments,
notwithstanding contrary
rules
of
law or equity. n230
The hardy creditor
must make his case
anew--this
[*60]
time, in a land protective
of settlors and unsympathetic
to creditors.
2.
Foreign Legal Systems
Less Sympathetic to
Creditors
The
first step in bringing
the creditor's suit
in the OAPT jurisdiction
entails
enlisting the services
of a foreign attorney
well-versed in such
litigation.
Unlike some American
lawyers who take clients
on a contingency
basis,
foreign attorneys often
charge fees up front.
n231 Moreover, even
if the
creditor
finds an attorney willing
to take his case, the
creditor may well have
to
come up with defendant's
estimated trial and
court costs in advance.
n232
a.
Burden of Proving a
Fraudulent Conveyance
is Higher
If
a creditor obtains
a favorable foreign
judgment, he still
must prove that
the
transfer into the trust
was fraudulent. In
OAPT jurisdictions,
however, this
is
a formidable task.
For
example, the Cook Islands,
which is nursing a
reputation as one of
the
most
popular offshore trust
havens, recently amended
its trust laws, virtually
foreclosing
all fraudulent transfer
suits against transfers
of assets to Cook
Islands
trusts. n233 Although
the Cook Islands has
its own fraudulent
conveyance
law,
it requires proof of
actual intent to defraud;
this standard is almost
impossible
to meet. The badges
of fraud applied by
American courts to
prove
fraudulent
intent circumstantially
have no bearing on
a Cook Islands fraudulent
conveyance
proceeding. As long
as the settlor-debtor
has legitimate grounds
for
setting
up the trust, such
as estate planning,
a creditor will be
hard pressed
to
prove actual intent
to defraud. n234 The
plaintiff's standard
of proof is
notably
severe;
[*61]
the plaintiff must
prove his pleadings
beyond a reasonable
doubt,
instead
of the "preponderance of the evidence" standard adopted in U.S. civil
proceedings.
n235
Interestingly,
some foreign nations
provide even more settler-friendly
OAPT
regimes
than that provided
by the Cook Islands.
One noted bankruptcy
watcher
recently
commented on the new
trust law in Belize: "The Cook Islands adopted at
least
some version of fraudulent
conveyance law; Belize
. . . did not even
try."
n236
b.
Short Statute of Limitations
In
addition to the substantial
hurdles previously
addressed, the creditor
must
initiate his action
within the applicable
statute of limitations.
This time
frame
often proves difficult
to meet. The Cayman
Islands is the most
accommodating
to creditors; a creditor
must institute proceedings
against the
trust
or settlor within six
years of the date of
transfer. n237 The
law of
Cyprus
and the Bahamas, on
the other hand, narrows
the window of opportunity
to
two
years. n238
Stronger
trust protection is
offered in the Cook
Islands. Under its
law, a
creditor
must commence suit
against the settlor
no later than two years
after
the
creditor's cause of
action has accrued,
or within one year
of the transfer
of
assets. n239 As one
attorney cynically
noted: "The practical effect is that
by
the time you find out
where the money is
and file your action,
the statute of
limitations
bars the suit." n240
B.
Offshore Trusts Allow
for Stronger Settlor
Controls Than Lawful
in the
United
States
Offshore
trusts invite settlor
control far beyond
that tolerated in domestic
trusts.
For example, the OAPT
settlor: (1) may be
a beneficiary; (2)
may be a
"protector" or
an "advisor"; and (3) may include a "letter of wishes" with the
trust
giving nonbinding instructions
to the trustee. n241
1.
Settlor as Beneficiary
Proponents
of OAPTs candidly acknowledge
that settlors seek
a degree of
protection
and control unavailable
in domestic trusts.
The "true desire" of an
individual
who seeks to protect
his assets through
an OAPT has been described
as
"not
to make a transfer
into a trust for the
benefit of spouse or
children, but
rather
to make a transfer
into a trust that he
or she controls and
of which he
or
she is a beneficiary." n242 This is an option unavailable in the United
States;
courts refuse to protect
a settlor who is also
a beneficiary of a
self-settled
spendthrift trust.
n243
The
offshore asset protection
trust is seen as the
solution to this domestic
rule
of law. Properly chosen,
a trust-friendly offshore
jurisdiction will honor
spendthrift
clauses in self-settled
trusts wherein the
settlor is a beneficiary.
Although
a settlor may frame
a trust for his own
benefit, he is nonetheless
shielded
from his creditors.
For this reason, the
Bahamas, Belize, Cayman
Islands,
Cook Islands, Cyprus,
Gibraltar, and the
Turks and Caicos Islands
are
some
of the most popular
jurisdictions with
U.S. settlors. n244
While
many designers of OAPTs
avoid naming the settlor
as a beneficiary,
n245
such practice is not
uncommon. n246 For
[*63]
example, in an Internal
Revenue Service (IRS)
private letter ruling,
93-32-006,
counsel to settlors
of an OAPT n247 represented
to the IRS that
creditors
of the settlors could
not reach the assets
in the trust, even
though
the
settlors themselves
were beneficiaries.
The
private letter ruling
addressed certain income,
estate, and gift tax
issues
involved in the creation
and transfer of assets
to an OAPT. n248 The
facts
of the letter ruling
can be distilled to
the following. The
dispute
involved
two U.S. citizens,
A and B, who were siblings
and trust settlors.
n249
A
and B created a 100
year irrevocable trust
in a foreign jurisdiction.
n250 The
trust
beneficiaries included
the two settlors, one
of their parents, and
the
settlors'
heirs. n251 An unrelated
protector was authorized
to channel trust
distributions
for the benefit of
either settlor. n252
To resolve the gift
and
estate
tax questions raised
by the facts, the IRS
relied on claims of
the
settlors'
representatives that "under the laws of [the situs country] neither a
beneficiary
or sic any creditor
of any beneficiary,
including the Settlors,
may
compel
the trustee to distribute
the Trust's assets
to or for their benefit."
n253
The settlors' attorneys
were confident that,
under the laws of the
foreign
jurisdiction,
creditors of the settlor
could not reach the
assets even though
the
settlors themselves
were beneficiaries.
By comparison, if the
same trust
were
tested under U.S. trust
laws, the trust would
most likely be condemned
as a
self-settled
trust, and creditors
of the settlors would
be able to reach the
maximum
trust amount distributable
to the settlors. n254
[*64]
At
least one OAPT jurisdiction
has confronted the
self-settled trust
question
directly in its legislation.
Belize's new trust
law proclaims that "any
rule
of law or public policy
which prevents a settlor
from establishing a
protective
or a spendthrift trust
of which he is a beneficiary
is hereby
abolished." n255
2.
Settlor as Protector
Also
unique to foreign trusts
is the role of the
protector. n256 The
protector
may be granted broad
powers by the settlor,
including the right
to:
(a)
oversee the activities
of the trustees; n257
(b)
remove and replace
trustees; n258
(c)
authorize payouts to
beneficiaries; n259
(d)
vary beneficiaries;
n260
(e)
change jurisdictions
n261 or applicable
law. n262
In
the recent past, the
post of protector was
not filled by the settlor.
Instead,
a trusted family member,
n263 friend, or professional
would be named by
the
settlor. However, this
practice may be changing.
At least two jurisdictions,
the
Cook Islands and Belize,
now allow the settlor
to name himself protector
without
adversely affecting
his creditor protection
status. n264
[*65]
As protector, a settlor
has virtually unlimited
power over the trustee,
and
thus, over the trust
itself. Before, there
was some semblance
of divesture
of
control; the settlor
had to name someone
other than himself.
Although this
person
was arguably a strawman,
even that illusory
safeguard may now be
disappearing.
3.
Settlor's Letter of
Wishes
An
OAPT often takes the
form of a discretionary
spendthrift trust.
However,
the
settlor of an OAPT
commonly provides the
trustee with a non-binding "letter
of
wishes" expressing the settlor's intentions as to the disposition of
property.
n265 In practice, the
fact that the letter
of wishes has no legal
effect
is of no real significance.
n266 The letter of
wishes carries clout.
Although
the trustee may disregard
the settlor's expressed
intent, this almost
never
happens, as "the trustee rarely strays outside the settlor's chalk
circle."
The
combined authority
of the protector and
the letter of wishes
does not
affirmatively
direct the trustee's
actions. It could,
however, be perceived
as
indirectly
guiding the trustee's
discretion in making
trust distributions.
Consider,
for example, the protector's
right to remove and
replace the trustee.
The
magnitude of this power
over the trustee is
significant. As one
commentator
has
observed, the role
of the protector is
to ensure that "if by any chance the
trustee
did ignore the letter
of wishes, the protector
would step in." n268
Viewed
in this light, it is
questionable whether
these OAPTs are, in
substance,
truly
discretionary trusts
or whether they are
more similar to support
trusts or
mandatory
distribution trusts
with spendthrift clauses.
Examined in their
entirety,
OAPTs bear a striking
resemblance to support
trusts or mandatory
distribution
trusts.
Before
analyzing OAPTs based
on their economic substance,
it is important to
briefly
illustrate some of
the risks and costs
[*66]
inherent in establishing
an OAPT.
C.
The Risks and Costs
of OAPTs
From
the standpoint of individual
settlors blind to global
public policy,
OAPTs
sound almost too good
to be true. The considerable
trust-friendly
legislation
notwithstanding, settlors
who consider establishing
offshore trusts
need
to weigh the attendant
risks and costs.
1.
Political Instability
Many
potential OAPT settlors
face tremendous risk
by investing large
sums of
money
in volatile foreign
countries. While many
trust settlors deem
U.S. trust
law
as the enemy, at least
the enemy is predictable.
When investigating
OAPTs,
though,
a settler need consider,
among other factors,
the potential of a
military
coup in the situs nation,
and the subsequent
consequences to the
trust
assets.
Fortunately for OAPT
settlors, flight clauses
and the fact that the
assets
need not be physically
situated in the offshore
situs in which the
trust
is
created vastly minimize
these risks.
a.
Flight Clauses
A
flight clause (also
known as a "Cuba clause") provides that the trustee
can
relocate the assets
to another foreign
situs if any event
threatens the
trust
or its assets. n269
The clause effectively
renders trusts ambulatory,
able
to
be spirited away to
safety when trust assets
are jeopardized. Flight
clauses
are
a creditor's nightmare; "imagine the creditor's dismay when it discovers
that
the foreign trustee
has been removed and
the APT has 'fled'
to another
foreign
jurisdiction pursuant
to a clause in the
trust which allowed
it to do
so." n270
Nearly every OAPT contains
a flight clause. n271
The
flight clause may enumerate
particular situations
in which the trust
may
be
removed to a safer
location. Some such
situations include:
(1) political or
economic
unrest in the situs
[*67]
nation; (2) proposed
enactment of unfavorable
gift, income or estate
tax
laws
by the situs nation;
(3) pending litigation
against the trust by
creditors;
n272
or (4) the prospect
that the situs nation
may enter into a treaty
with the
United
States which undermines
the security of the
trust. Since these
flight
clauses
appear to cover all
potential situations,
wary settlors can take
solace
in
the knowledge that
the trustee or protector
is empowered to change
jurisdictions
when warranted.
b.
Location of Assets
With
respect to location
of assets, OAPT settlors
have several options.
The
assets
need not be located
abroad, so long as
the trust is established
and
administered
in the foreign situs.
n273 Many settlors
feel more comfortable
knowing
their assets are close
by. There is, however,
an inherent risk to
not
