The Early Demise of the Domestic Asset Protection Trust

Foreign asset-protection trusts have enjoyed three decades of success since the codification of the first asset- protection-trust law in the Cook Islands. With time, one or more U.S. states could have been expected to enact competing legislation. Alaska and Delaware led; the criticisms followed almost immediately. Among them: the Full Faith and Credit Clause requires that a judgment obtained against a debtor or trustee in another state be enforced in the trustee’s DAPT state; the Bankruptcy Act’s ten-year clawback for transfers into spendthrift trusts (§ 548(e)) bars practical use of a DAPT in bankruptcy; a court in the debtor’s home state, where DAPTs are not recognized, may decline to apply another state’s DAPT law as void against public policy.

In Waldron v. Huber (In re: Huber), 2013 WL 2154218 (Bk.W.D.Wash., May 17, 2013), a Washington-resident debtor settled an Alaska DAPT in anticipation of a personal-guaranty liability. The settlor, beneficiaries, and trust assets were located in Washington — except for a $10,000 certificate of deposit placed by the trustee with an Alaska bank.

The bankruptcy court applied § 270 of the Restatement (Second) of Conflict of Laws. Section 270 ordinarily respects a settlor’s choice of law, so long as the chosen law does not violate “a strong public policy of the state with which, as to the matter at issue, the trust has its most significant relationship.” The court contrasted the minimal Alaska contacts (the modest CD) with Washington’s strong public policy against the use of self-settled spendthrift trusts to avoid creditors. The transfers were voided.

Separately, the court applied the ten-year clawback under § 548(e) and held that the contributions to the trust were fraudulent transfers, taking particular aim at the selection of Alaska law as evidence of specific intent to evade, defeat, or hinder a creditor.

DAPTs are folly. The DAPT is now demonstrably vulnerable in the federal court system. Even had Huber resided in Ohio (a DAPT state) rather than Washington, the outcome on § 548(e) would have been the same: a ten-year fraudulent-transfer reach.

Counsel recommending DAPTs ought to expect malpractice exposure. The firm has voiced this concern since Ohio enacted its statute. The analysis after Huber does not change.

The FAPT vehicle is itself maturing. Foreign asset-protection trusts have enjoyed unparalleled success over several decades; that very success has prompted creditors’ counsel to refine their attack. FAPTs are designed with the understanding that the trust and the trustee will, in all likelihood, be disregarded in a U.S. court — and that the trust assets are nevertheless outside the reach of U.S. judgments because they sit offshore. Creditors increasingly respond by looking for trust-related accounts at U.S. banks and brokerage firms that can be reached domestically.

LLCs continue to rise as the planning vehicle of choice. The firm has counseled for some time that the FAPT contains an optical vulnerability: Kilker and now Huber indicate that courts increasingly treat the establishment of an asset-protection trust as per se evidence of intent to defraud. The asset-protection LLC, properly capitalized as part of a documented business plan, presents a number of additional defenses that a trust cannot assert — the business purpose for the contribution, the shared rather than gratuitous nature of the consideration, and the protective architecture of jurisdictions such as Belize and Nevis.