There is No Such Thing as a Delaware Asset Protection Trust

For decades, Delaware has served as a default forum for business planning. Filings are inexpensive, no income tax applies to a business not operating in Delaware, and the legislature has, until recently, been responsive to innovations such as the series LLC.

What is overlooked is that Delaware’s demographics have changed. The bucolic state sandwiched between New Jersey and Pennsylvania has become metropolitan suburbia; the average Delaware voter has become more progressive; and the consequences are bearing out in the legislature. Two forces now diminish Delaware’s viability for asset-protection planning: the plaintiffs’ bar, which has become a dominating influence in the legislature, and the Delaware courts, which have shown no inclination to defend Delaware’s own domestic asset-protection-trust statute.

In 2014 the Delaware Supreme Court approved the use of a fee-shifting provision in ATP Tour, Inc. v. Deutscher Tennis Bund, 2014 Del. LEXIS 209 (Del. May 8, 2014). A pro-business jurisdiction would be expected to recognize the efficacy of such a provision; the court, sitting en banc, did. Soon after, the Delaware Corporate Law Council proposed amendments — supported by the state plaintiffs’ bar — that would prevent the use of fee-shifting provisions in the bylaws of regular stock corporations.

By industry estimates, in 2010 and 2011 some ninety-one percent of mergers and acquisitions involving publicly traded companies were embroiled in litigation shortly after the transaction was announced. Most such litigation settles within three months at little benefit to shareholders, while counsel collect substantial fees. A fee-shifting provision would discourage suits brought for nuisance value. The Delaware legislature’s response was to seek to abolish the very tool the Delaware Supreme Court had just affirmed.

Delaware was an early adopter of asset-protection-trust legislation, enacting the Qualified Dispositions in Trust Act in 1997. 12 Del. Code § 3572 contains the operative provisions purporting to cut off creditor claims once a Delaware trust has been properly established and funded. Section 3572(a) provides that “The Court of Chancery shall have exclusive jurisdiction over any action brought with respect to a qualified disposition.”

In 2002, Glenn Kloiber settled an irrevocable dynasty trust with PNC Bank, Delaware, as trustee. The trust was funded with stock that would later be sold for some $300 million. In 2010, Daniel Kloiber and his wife Beth filed for divorce in Kentucky. The Kentucky court issued status-quo orders identifying the dynasty trust as a marital asset. PNC Bank petitioned the Delaware Chancery Court to grant an anti-suit injunction against the Kentucky orders, citing § 3572(a).

The Chancery Court refused. The judge observed that Delaware code is “riddled with similar provisions concerning the ‘exclusive’ jurisdiction of a court” — and that, properly read, such language only reserves jurisdiction among Delaware courts:

The court then went further, analyzing federal preemption and the Full Faith and Credit Clause — the worst of all outcomes for Delaware-trust practitioners. On the latter, the court was direct:

The Delaware exclusivity clause is drafted to a different effect than the comparable offshore provisions. Section 7(6) of the Belize Trusts Act prohibits a Belize court from varying or setting aside any trust, or recognizing the validity of any claim against trust property, based on the law or court order of a foreign jurisdiction. Section 13D of the Cook Islands International Trusts Act bars the recognition or enforcement of any judgment arising from a foreign jurisdiction. Delaware’s § 3572(a) does not attempt to bar the enforcement of foreign claims; it merely allocates jurisdiction among Delaware courts. The offshore jurisdictions wrote the statute the Delaware bar wishes Delaware had written.

These developments cannot go unnoticed. If the plaintiffs’ bar can move the Delaware legislature to consider banning fee-shifting provisions, it is a function of time before the next set of plaintiff-friendly reforms follows. The defenders of Delaware-trust practice will say the facts of Kloiberwere unique. They were not. People divorce; spouses seek to attach trust assets in divorce; the Delaware Chancery Court appeared to go out of its way to volunteer that a Delaware trust is worthless in out-of-state divorce proceedings. The firm’s own counsel: a lawyer who recommends a Delaware asset-protection trust without disclosing what the Delaware Chancery Court itself has said about it has not yet met the obligation owed to the client.