In trust law, an asset-protection trust is any form of trust which provides for funds to be held on a discretionary basis. Such trusts are set up in an attempt to avoid or mitigate the effects of taxation, divorce and bankruptcy on the beneficiary. Such trusts are therefore frequently proscribed or limited in their effects by governments and the courts.
The asset-protection trust is a trust that splits the beneficial enjoyment of trust assets from their legal ownership. The beneficiaries of a trust are the beneficial owners of equitable interests in the trust assets, but they do not hold legal title to the assets. Thus this kind of trust fulfills the goal of asset protection planning, i.e. to insulate assets from claims of creditors without concealment or tax evasion. A creditor's ability to satisfy a judgment against a beneficiary's interest in a trust is limited to the beneficiary's interest in such trust. Consequently, the common goal of asset protection trusts is to limit the interests of beneficiaries in such a way so as to preclude creditors from collecting against trust assets.
Such trusts must be irrevocable (a revocable trust will not provide asset protection because and to the extent of the settlor's power to revoke). Most of them contain a spendthrift clause preventing a trust beneficiary from alienating his or her expected interest in favor of a creditor. The spendthrift clause has three general exceptions to the protection afforded: the self-settled trusts (if the settlor of a trust is also a beneficiary of a trust), the case when a debtor is the sole beneficiary and the sole trustee of a trust, and the support payments (a court may order the trustee to satisfy a beneficiary's support obligation to a former spouse or minor child). The first general exception, which accounts for the majority of asset protection trusts, no longer applies in several jurisdictions. The laws of certain jurisdictions including Alaska, Bermuda, and the Cayman Islands allow self-settled trusts to afford their settlors the protection of the spendthrift clause.
History of trusts
Trusts were developed at common law in England originally to minimize the impact of inheritance taxes arising from transfers at death. The essence of the trust was to separate "legal" title, which was given to someone to hold as "trustee", from "equitable title", which was to be retained by the trust beneficiaries.
In the United States and England, a practice developed whereby trust settlors began to use "spendthrift" clauses to prevent trust beneficiaries from alienating their beneficial interests to creditors. Over time, courts were asked to determine the efficacy of spendthrift clauses as against the trust beneficiaries seeking to engage in such assignments, and the creditors of those beneficiaries seeking to reach trust assets. A case law doctrine developed whereby courts may generally recognize the efficacy of spendthrift clauses as against trust beneficiaries and their creditors, but not against creditors of a settlor.
Domestic asset protection trust
Alaska was the first US jurisdiction to enact laws allowing protection for self-settled trusts (in 1997) and was shortly followed by Delaware, Nevada, South Dakota and a few others. These trusts are known as Domestic Asset Protection Trusts (DAPTs). Usually, a DAPT must comply with the following requirements: the trust must be irrevocable and spendthrift; at least one resident trustee must be appointed; some administration of the trust must be conducted in respective state; the settlor cannot act as a trustee.
Trusts are generally governed by the laws of the jurisdiction that is designated by the settlor as the governing jurisdiction. There are two exceptions to the general rule, which may create conflicts of law: (i) states will not recognize laws of sister states that violate their own public policy, and (ii) if the trust owns real property, such property will be governed by the law of jurisdiction that is the property's situs. Additionally, the Full Faith and Credit Clause of the Constitution provides that each state must give full faith and credit to the laws of every other state. This means that if a court from another state refuses to recognize the protection of a DAPT and enters a judgment for the creditor, the creditor may be able to enforce the judgment against the trustee of the DAPT, even if that trustee was located in the DAPT jurisdiction. The efficacy of a DAPT may also be challenged under the Supremacy clause of the U.S. Constitution, under the applicable fraudulent transfer statute, or because the settlor retained some prohibited control over the trust.
These jurisdictions are also known as United States Asset Protection Trusts (USAPTs), from the point of view of the non-US settlors. The issues that would seem to apply on a USAPT established by a non-US settlor are: 1) whether a non-US court has jurisdiction over the USAPT; 2) the conflict of US versus non-US laws (i.e., which jurisdiction's laws will apply to the trust and the protection it purports to offer); 3) which fraudulent transfer law would apply; and 4) whether the US state court will recognize the non-US judgment.
The context of a non-US settlor has a few advantages over that of a US settlor. The issue of the Full Faith and Credit clause doctrine of the US Constitution would not apply to a non-US settlor facing a non-US judgment. Creditors of non-US settlors would have to first obtain a judgment in their home jurisdiction and then attempt to enforce that "foreign" judgment in the US against the trustee of the USAPT, who was not a party to the original action. Therefore, except in unusual cases, this would mean that the only issues to litigate would be whether a fraudulent transfer has taken place, and in turn, which jurisdiction's fraudulent transfer laws would apply. Despite that, the non-US creditor must still seek to first have the foreign judgment recognized, because without formal legal acknowledgment of the judgment in the US court, there would be no basis on which to question the transfer.
U.S. jurisdictions
South Dakota
South Dakota was one of the first states (1983) to allow a trust to endure perpetually, essentially jumping outside the onerous federal transfer (gift, estate and generation-skipping) tax system theoretically forever. Currently, twenty-four other states have joined the ranks of offering a long-term trust. Nineteen of these states, including South Dakota, allow a trust to continue in perpetuity.
South Dakota does not impose any form of state taxation on the assets that comprise a trust located there. This includes, but is not limited to: no state income, capital gains, dividend/interest and/or intangible's taxes. Additionally, South Dakota has the lowest insurance premium tax of any state (i.e., 8 basis points or 8/100ths of 1%) and also offers other very favorable insurance legislation. South Dakota also has both excellent self-settled trust as well as third party discretionary trust statutes, both allowing for domestic asset protection planning with trusts.
South Dakota is the first and only state in the US with a third party discretionary trust statute for asset protection, which states that a discretionary interest in third party trust, limited power of appointments, and remainder interests are not considered property interests. South Dakota also has Asset Protection statutes for LLCs and LPs based upon a "sole remedy charging order statute". Consequently, many trust strategies for the wealthy involve trust administration in South Dakota without the necessity of having the trust's family reside there.
Offshore jurisdictions
The trust laws of the offshore world are typically founded on the trust laws of the onshore world. For those jurisdictions which are currently possessions of the UK, or were former possessions of the UK, typically the British Trustee Act of 1925 is the common starting point. From there, each jurisdiction has sought to develop and evolve the law in a race to develop the most attractive trust environment which maintains acceptable standards, preserves the concepts of a trust, yet is attractive to potential users. Many of these jurisdictions share similar characteristics.
Bahamas
The Commonwealth of the Bahamas have traditionally been associated with offshore planning. However, the Bahamas are probably more noteworthy for offshore banking. The Bahamas do not recognize self-settled spendthrift trusts, unlike the Cook Islands, Nevis, or Belize.
The burden of proof for a claimant to challenge a transfer into a Bahamian Trust has a limitation period of two years, the same as Cook Islands.
The quality of the banking and investment services is reasonable for the uses of a Trustee of an asset protection trust, however, the quality of the judiciary is considered low, as the legal profession is generally closed to the entry of non-Bahamians, and it is therefore difficult bring the knowledge of a specialised trust lawyer to the jurisdiction when needed.
Belize
Belize, offers immediate protection from court action initiated by creditors which challenges the settlor's transfer of property into the trust. However, due to the paucity of credible in Belize, many trusts established in Belize hold assets with a second trustee or third-party financial institution in another country.
Bermuda
Bermuda, entry to follow
Cayman Islands
Cayman Islands trusts are governed principally by the Cayman Islands Trusts Law (2009 Revision), however elements of the Fraudulent Dispositions Law 1989 are relevant when considering the asset protection benefits of Cayman Trusts.
A number of offshore jurisdictions have enacted modern asset protection legislation based on the Cayman Island's Fraudulent Dispositions Law 1989 (the "FDL").Cayman Islands Fraudulent Dispositions Law 1989 The Cayman Islands FDL states "Every disposition of property made with an intention to defraud, and at undervalue, shall be voidable at the insistence of an eligible creditor thereby prejudiced".STEP Diploma in International Trust Management Course Notes Module 11 The burden of proof is borne by the creditor applying to set aside the trust, and in the case of the Cayman Islands, the creditor/claimant must bring an action in the Cayman Islands courts (not in their home jurisdiction). The bar is set high for a potential claimant to successfully challenge a transfer. They must demonstrate an intention to defraud on behalf of the Settlor, and they must demonstrate they are an "eligible creditor"—meaning that at the date of the transfer, the transferor owes an obligation to the claimant. They must also be willing to bring an action in the Cayman Islands, which by itself is an expensive proposition.
The burden of proof for a claimant to challenge a transfer into a Cayman Trust has a limitation period of six years.
In Cayman it is possible to register a trust as an Exempt Trust Cayman Trusts Law (2009 Revision - Part VI - Section 74(1)) however it is voluntary registration regime only, so most trusts remain unregistered. As most Cayman trusts are therefore private arrangements, it is hard to give exact figures for the popularity of AP Trusts governed by Cayman law. However the number of licensed trust companies give us some indication of how the jurisdiction is viewed. As of 30 September 2012 the Fiduciary Services Division of CIMA, the body responsible for licensing and regulating trust companies in the Cayman Islands has supervisory responsibility for 146 active trust licences.CIMA website: http://www.cimoney.com.ky/Stats_Reg_Ent/stats_reg_ent.aspx?id=298
As the Cayman Islands are a British Overseas Dependent Territory, the islands are able to draw on the services of British lawyers and solicitors when contentious cases arise and lawyers with appropriate experience are required. The quality of banking and investment services are reasonably good.
Cook Islands