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Estate Planning Newsletter

Asset Protection Planning Using Offshore Trusts

In today’s litigious society more individuals are inquiring about asset protection planning, especially those individuals with a high risk of potential exposure to liability, such as business owners, doctors, or those involved in high risk occupations. Asset protection planning involves the use of legal entities and techniques to protect one’s assets from the claims of potential creditors. One asset protection planning strategy is the “asset protection trust” (APT).

Spendthrift Trusts

A trust may entail transfer of legal title to real or personal property to an individual or entity as the “trustee”. A trustee is a fiduciary who is bound by the instructions in the trust instrument regarding the management and distribution of the trust assets. In almost all U.S. states, under certain circumstances a trust can protect assets from the creditors of a trust beneficiary. The use of a “spendthrift clause” in a trust bars the trustee from allowing or recognizing any attempted encumbrance, sale or other transfer of an interest in the trust prior to distribution to the beneficiary.

Domestic APTs

An APT attempts to extend this same kind of protection to the person forming the trust (the “settlor”), i.e. the settlor transfers assets into the APT and continues to derive the use and benefit of the assets as a beneficiary of the trust, while creditors are barred from pursuing the assets of the trust. The APT serves to frustrate creditors, since creditors cannot force distributions or payments from the trust, but are only able to pursue collection from the debtor beneficiary after a distribution or payment is made to the debtor beneficiary.

The idea of allowing a debtor to establish a trust and retain the use and benefits of trust assets while preventing creditors from accessing trust assets to satisfy debts seemed unfair to most states, and for many years the laws of nearly every state prevented this. However, in the 1990’s a handful of states, including Alaska and Delaware, changed their laws to permit the formation of APT’s to provide protection from the settlor’s creditors. There are, however, limits to such APTs and serious questions about their effectiveness in protecting assets from creditors.

Foreign APTs

Even prior to these changes in U.S. laws, APTs were authorized and enforceable under the laws of certain foreign jurisdictions, such as the Cook Islands, Belize and Gibraltar. Aggressively marketed in the U.S., foreign APTs (FAPTs) were (and still are) often touted as providing significantly greater asset protection than domestic APTs. The laws of each foreign jurisdiction vary, but common provisions include:

  • The settlor may be a beneficiary, or even the sole beneficiary, of the FAPT. In contrast, under the laws of the U.S. states that allow APTs, the settlor can only be one “discretionary” (as opposed to “mandatory”) beneficiary out of a number of beneficiaries; the settlor may not be the sole beneficiary in a domestic APT.
  • Spendthrift clauses are enforced, even against creditors of the settlor. In some foreign jurisdictions, a creditor may be able to reach FAPT assets if the transfer to the FAPT was intended to defraud that creditor, making the settlor unable to pay the debt. However, foreign laws make it much harder to prove intent to defraud.
  • The FAPT may be revocable by the settlor. In U.S. jurisdictions that recognize domestic APTs, they must generally be irrevocable.
  • The FAPT does not have to pay local taxes.
  • The FAPT may contain provisions for a “trust protector,” someone (even the settlor), to oversee administration of the FAPT and remove trustees, thus enabling the settlor to retain some control of the FAPT.
  • U.S. judgments against FAPT assets are not recognized or enforced, meaning that a creditor may have to travel to the foreign country and hire a local lawyer to procure a new judgment against the FAPT. In addition, the foreign laws may make it much more difficult for the creditor to obtain a judgment against the FAPT.
  • The trustee of a FAPT does not have to follow the instructions of a settlor or protector who acted under “duress.” A settlor who is ordered by a U.S. court to make FAPT assets available to a creditor would be under “duress,” and the trustee of the FAPT could refuse to act as ordered by the court.
  • The FAPT may be transferred to another jurisdiction and have that jurisdiction’s laws apply retroactively . Thus, if the FAPT assets are at risk in one jurisdiction, they may quickly be transferred to another jurisdiction.
  • Bankruptcy of the settlor will not invalidate the FAPT.

Effectiveness of Foreign APTs

Foreign APTs have been touted as offering comprehensive asset protection, but there are risks and limitations. The trustee of the FAPT is generally required to be located in the foreign jurisdiction, and thus not subject to U.S. jurisdiction. There have been cases of foreign trustees charging exorbitant fees or even embezzling trust assets.

Several cases have undermined the protection claims. In the “Anderson case,” husband and wife set up a FAPT. The couple was involved in a telemarketing scheme that the Federal Trade Commission (FTC) attacked as fraudulent. A judge agreed and issued a preliminary injunction, ordering the Andersons to return to the U.S., or “repatriate,” all of the funds in their FAPT.

The Andersons duly told the trustee of their FAPT to transfer the assets to the U.S., but because the Andersons were acting under court order and were therefore under “duress”, the trustee refused to comply. The Andersons were then jailed for contempt, a decision which was upheld by the federal 9th Circuit Court of Appeals. Some commentators have suggested that FAPTs may only be effective when the settlors are prepared to ultimately leave the U.S. to avoid turning over their assets to a court.

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