Self-Settled Trusts: From the Restatement Rule to the Modern Statutes

Scope of the chapter. A self-settled trust is a trust in which the settlor is also a beneficiary. The settlor transfers the settlor's own property to a trustee and retains the possibility of receiving distributions. For five centuries the common law has held that the settlor's creditors may reach whatever the trustee could distribute to the settlor, whatever the trust says. Since 1997, a growing number of American states have enacted statutes that reverse the rule for trusts meeting statutory requirements, and offshore jurisdictions reversed it earlier still. The domestic asset protection trust, or DAPT, created under these statutes is now a standard planning tool. Its effectiveness against a creditor depends on where the creditor sues, where the settlor lives, whether the settlor files for bankruptcy and how the trust was funded and administered.

This chapter examines the common-law rule (see infra ¶ 1810), the domestic statutes (see infra ¶ 1820), the main differences among them (see infra ¶ 1830), the conflict-of-laws problem that arises when a resident of one state creates a trust under the law of another (see infra ¶ 1840), the ten-year avoidance power of the Bankruptcy Code (see infra ¶ 1850), other theories creditors use (see infra ¶ 1860), and hybrid structures designed to obtain the benefits of a self-settled trust without the settlor's being a beneficiary at the outset (see infra ¶ 1870). It closes with the design and administration of the trust (see infra ¶ 1880) and its place in the Threat Matrix (see infra ¶ 1890). The offshore self-settled trust, which shares the statutory premise but adds distance from American courts, is examined in Parts IV and V (see infra chs. 21–25, 30).

The policy debate. The self-settled trust divides the profession. Its opponents argue that it allows a person to keep the benefit of property while placing it beyond the reach of those to whom the person owes money, and that it invites abuse by debtors who create trusts after claims arise. Its defenders argue that the statutes protect only transfers made without intent to defraud, after a limitations period, and that a person who sets aside property while solvent, against future and unforeseen claims, should be allowed to do so in the same way that the law allows homestead, retirement and insurance exemptions (see supra chs. 12–14). They also argue that Americans who would otherwise create offshore trusts are better served by domestic trusts subject to American courts. The debate has shaped the statutes. Every domestic statute preserves voidable transfer claims, and most preserve the claims of some exception creditors. None protects a debtor who transfers property to defeat a known claim.

The settlor's three questions. A client considering a self-settled trust should be given clear answers to three questions before proceeding:

1. Will the trust protect against creditors who sue me in my home state? If the client lives in a state that has not enacted a DAPT statute, the answer is uncertain, and the conflict-of-laws analysis in ¶ 1840 governs.
2. Will the trust protect against a bankruptcy trustee? For ten years after each transfer, the answer is no where the transfer was made with actual intent to hinder, delay or defraud (see infra ¶ 1850).
3. Will the trust protect against my existing and foreseeable creditors? No. The trust protects only against creditors whose claims arise after the transfer and after the limitations period, and against existing creditors only if the limitations period runs before they sue (see supra ch. 5).

A client who hears those answers and proceeds has made an informed choice. The planner should document the advice (see supra ch. 3).