The Downsides of Domestic Asset Protection Trusts
The purpose of an asset protection trust is to shield the settlor’s wealth from future creditors, lawsuits, or judgments. Asset protection solutions can help discourage litigation before it begins, by keeping funds within a legal structure that will be difficult to challenge in court. Asset protection trusts are well regarded as the most reliable way to protect your assets from creditors. But not all asset protection trusts are created equal. The location where the trust is settled can make a tremendous difference in the degree of protection offered.
In the world of asset protection, domestic asset protection trusts (“DAPTs”) are the more common, and more economical alternatives to the offshore trusts. A Domestic Asset Protection Trust is an irrevocable trust in which the beneficiary can be the same person that created the trust, and the trust’s assets are managed from within the United States. While some people may be tempted by the convenience of having their trustee located closer to home, domestic trusts are not without their downsides when it comes to protecting wealth.
Unfortunately, everything from federal laws, conflicting state laws, and different states’ public policies seem to count against U.S. based asset protection trusts. This article will discuss the disadvantages of domestic asset protection trusts when compared with their more robust alternative, offshore asset protection trusts.
Limited State Recognition
The most obvious problem with these types of trusts stems out of the fact that laws regarding asset protection trusts do not exist in every state.
Currently, only the following seventeen states allow people to settle an asset protection trust under their jurisdiction: Alaska, Delaware, Hawaii, Indiana, Michigan, Mississippi, Missouri, Nevada, New Hampshire, Ohio, Oklahoma, Rhode Island, South Carolina, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming. Neither the settlor or any of the beneficiaries need to live in one of these states, but the trustee needs to be located there and the trust management needs to take place in the state where the trust is settled.
While these types of asset protection trusts may be gaining recognition in more and more states over the years, the protection offered by these types of trusts is still quite limited. Even for someone living in a state that does recognize them, a U.S. based asset protection trust could be entangled in a lawsuit in a completely different state court. Once this happens, the state court could disregard many of the legal provisions that are meant to provide legal defenses to the trust funds.
The Problem of U.S. Jurisdiction
Instead of being managed from a secure, offshore jurisdiction such as the Cook Islands, or Nevis, domestic asset protection trusts are generally settled in states such as Nevada, Wyoming, or South Dakota. While offshore trusts seek to escape the jurisdiction of U.S. courts by transferring assets abroad, domestic trusts fall squarely under the control of domestic courts, whether state or federal. That means there is little in the way of preventing a local lawsuit against the trust. A plaintiff can engage any number of contingency-based attorneys and go after trust assets in their local state court.
While increasingly more states have been recognizing these legal structures, not every state will respect the integrity of a domestic asset protection trust. Because domestic asset protection trusts operate based on state laws, there is less reliability if facing an out of state lawsuit. Article IV of the U.S. Constitution, states all U.S. states must give “full faith and credit” to the judgements of all other states, which means a lawsuit in any state is equally valid, regardless of whether the jurisdiction recognizes domestic asset protection trusts or not.
In our legal system, the plaintiff is the master of the complaint, and he or she is free to file their suit in any court as long as the minimum jurisdiction requirements are met. This can leave the defendant exposed if they are sued in a state that does not recognize asset protection trusts as legitimate entities. More alarmingly still, the case history in federal courts is also very inconsistent.
Unfavorable Caselaw
Asset protection trusts have existed in the U.S. for a number of years now and attorneys have had numerous opportunities to test the waters when it comes to bringing these trusts to the courts. While domestic asset protection trusts do offer a degree of legal protection to your assets, the results from the courts when defending these types of trusts leaves much to be desired. Instead of providing reliable legal protection, it seems domestic trusts might be offering only a false sense of security to the settlors and their families.
“Battley v. Mortensen” was one of the first cases that resulted in a void transfer to an Alaska asset protection trust. Even though the settlor was solvent at the time the trust was formed, and years passed before he became indebted, the funds held in trust were still included in the bankruptcy estate. Despite the favorable facts, this case proved that the main drawback of domestic trusts was lack of predictability in a result. Since bankruptcy is regulated under federal law, there is no guarantee the courts will give credence to the state laws that recognize domestic asset protection trusts.
In “Toni 1 Trust v. Wacker” an asset protection trust settled in Alaska was the subject of a bankruptcy court proceeding in Montana. While the defendant tried to secure jurisdiction in Alaska, since according to Alaska state laws, only courts in that state have jurisdiction regarding Alaska trusts. The court in Montana conceded that while it is true that Alaska statutes state they have exclusive jurisdiction over Alaska trusts, a state statute cannot have the power to limit other states’ rights with regard to trust property. Unfortunately, while a state such as Alaska may recognize the asset protection trusts and claim they have exclusive jurisdiction, a lawsuit in a different state may still go forward, meaning trust assets can be placed at risk.
“Dahl v. Dahl” is another significant case in the field of asset protection, and one that exposed another important flaw in domestic trusts. The Dahl case is a divorce proceeding in Utah in which one of the spouses had set up a Nevada asset protection trust, and then marital assets were transferred into the trust. Years later, the couple filed for divorce in their home state of Utah. On appeal, the issue was whether the trust should be included as part of the divorce proceedings or whether it should be considered the separate property of the settlor. Despite the trust language stating that the trust should be governed by Nevada law, the Utah Supreme Court applied their own law to the matter and decided to disregard the trust.
These cases prove that even in state court, where there is no federal matter to be resolved or federal law applied, a court in a different state can apply its own state law over a trust formed outside of the state. Domestic trusts can be extremely vulnerable to an unpredictable legal result anywhere in the country, even in state courts. The main lesson arising out of these cases is that domestic trusts simply do not provide the same degree of protection and legal defense that offshore trusts can offer.
Offshore Asset Protection Trusts
Fortunately, the cases discussed in this article do not apply to foreign asset protection trusts. The purpose of offshore trusts is to avoid the reach of U.S. based state and federal courts. With an offshore trust, you avoid the unpredictability of where a lawsuit will arise and what law will be applied. Since offshore jurisdictions are their own sovereign nations, they are not bound by courts in Nevada, or anywhere else in the U.S. That means if a plaintiff wants to reach the trust, they will have to bring their lawsuit in the country where the trust is registered. Fortunately, the countries where offshore trusts are settled also enjoy much more favorable laws towards asset protection trusts.
Naturally, it is much more challenging for a potential plaintiff to bring a lawsuit in a distant foreign nation whether it is Nevis or the Cook Islands. For one, they will have to find a local attorney there who is licensed by the country’s courts. Instead of relying on contingency fees, they will have to pay up front for the associated legal costs, since these types or fee agreements are generally disallowed. Finally, they will have to learn to operate in a legal system that is not nearly as favorable to plaintiffs as the U.S. All these factors give the defendant much more leverage that they otherwise would not have with a domestic trust and can result in a faster and less costly settlement process.
While offshore asset protection trusts tend to be cost more and have additional regulatory requirements, we have found that they more than make up for it thanks to the much higher levels of legal protection they provide.
Blake Harris Law
If you are serious about asset protection, make sure you understand that not all asset protection trusts are the same. Unfortunately, if you have been relying on a domestic asset protection trust to protect your wealth from lawsuits, you may still be at risk. An offshore asset protection trust can make all the difference for someone facing the threat of a lawsuit or creditors in the future. If you are concerned about protecting your assets and believe an asset protection trust might be right for you, speaking with an attorney is the next step.
An experienced attorney can help you determine whether an asset protection trust is right for you and what alternatives are best for your situation. At Blake Harris Law, we recommend the increased legal protection and reliability that offshore trusts can provide. We are very familiar with many of the world’s most secure offshore jurisdictions and have helped hundreds of clients with their asset protection needs. Contact Blake Harris Law today for your no-cost consultation with an asset protection attorney today.
