Asset Protection Trusts in the United States: What’s the Attraction?

By Alexander A. Bove Jr., Bove & Langa, Boston, USA (02/10/2017)

There must be something attractive about asset protection trusts in the United States.  Just about every year another state adopts a Domestic Asset Protection Trust (DAPT) law.  The latest was Michigan, and months before that, West Virginia.  But exactly who finds this so attractive that so many states (16 last count) are adopting such a law?  It would be one thing if the trend reflected some sort of competition, where the states were vying for new trust business, well, aren’t they?  But a review and comparison of each state’s law doesn’t show that.  What it does reveal is that a few of the 16 states, such as South Dakota, Delaware, Ohio, and Nevada definitely are taking the competitive approach and are seeking new business, but most of the others, such as New Hampshire, Hawaii, Rhode Island and Virginia, seem to have adopted their DAPT law just to have one, and any new business of that sort is a bonus.

            The attraction, therefore, for the first group, appears to be a source of new business for banks, investment firms, accounting, attorneys, and any other service provider in administrating the DAPT.  For the second group, the attraction must be the prospect for ‘local’ business.  For example, perhaps a Virginia resident might feel more comfortable (and loyal?) establishing a Virginia DAPT.  That is, until she found that instead of being required to wait five years for protection in Virginia, she could have obtained the same protection in two years if she had established the trust in Nevada, or South Dakota.

            This is one of the major concerns in planning to establish an asset protection trust in the United States.  We have at the moment 16 (or 17 by some interpretation) states to choose from, each with different laws.  For instance, a number of the states have ‘exception creditors’, who can recover against the trust despite the statutory protection.  These may include claims for child support or claims by creditors who specifically relied on the assets in the trust.  Then there is the degree to which a creditor attacking the trust must prove that the settlor’s transfer to the trust was a fraudulent transfer, which must be the basis for the creditor’s attack.  Several states require proof by ‘clear and convincing’ evidence, while others call for only a ‘preponderance’ of the evidence, a lower burden of proof and thus more advantageous to a creditor. A settlor or advisor must therefore carefully consider these differences.  Commentators who have reviewed and compared all of the states’ DAPT laws have suggested that Alaska, Delaware, Ohio, Nevada and South Dakota offer the best overall features, but one might argue, for example, that South Dakota, with only a two-year period of limitations should be preferable to Delaware, which has a four-year period.  How does one choose?

            As suggested, one of the most important criteria is the period within which the trust is open to attack by creditors (the statute of limitations).  In the early years of the DAPT, the states were simply adopting the prevailing period set by the long established Fraudulent Transfer Act, or four years.  But later, as some states recognized that a shorter open period might attract more new business, states like Nevada and South Dakota cut that in half, adopting a two-year period.  Not to be outdone, Ohio followed with an 18-month open period.  So far, no state has gone lower in this statute of limitations limbo, but that clearly remains to be seen.

            What also remains to be seen is the true test of the U.S. DAPT.  That is, if a creditor in New York, for example, obtains a judgment against a New York debtor who has, more than two years before, established a South Dakota DAPT, may the creditor enforce the New York judgment against the South Dakota trust?  Some argue that the U.S. Constitution, public policy, and other arguments would support an invasion of the trust, while others insist that the judgment was rendered against the debtor, individually, and not against the trust, so that once the limitations period has passed, the creditor is out of luck.  To date, however, no case has confirmed either result.  But this should not necessarily discourage a person considering a DAPT.  It is widely acknowledged that one of the essential ingredients of an asset protection plan is to build obstacles that a creditor must overcome before collecting on a claim.  The multiple lawsuits and related time and considerable expense that would accompany pursuit of a claim against a DAPT present a considerable obstacle to creditors and with no guarantee of success.

            The same reasoning applies, and even more so where the U.S. DAPT is established by a non-resident of the U.S., where an offshore creditor and offshore debt are involved.  In that case, the creditor would be faced with the daunting task of attempting to enforce the foreign judgment in the U.S., assuming he is within the allowable period of limitations.  And if the U.S. debtor and the trustee of the U.S. DAPT are still worried, there is always the option to exercise the ‘flee’ clause, moving the assets out of the targeted trust and into a new trust, much farther away.