Many folks talk about "asset protection." What they mean is arranging their business and financial affairs to be insulated from claims of creditors, whether arising from divorce, bankruptcy, personal injury or a civil law suit. There are various techniques to be employed to achieve the result; but, most importantly, all of the techniques require that you make the protective arrangement before there are any known creditors.
The challenge with all these techniques is that most folks want to keep assets away from creditors but also have access to them themselves - the old "have your cake and eat it too." Various trusts are used, some off-shore, to attempt this type of protection where assets are transferred to the trust but a friendly trustee or trust protector can return them to the settlor.
A Domestic Asset Protection Trust (DAPT) is a trust where the settlor can transfer assets to, be a discretionary beneficiary of, but still have the assets of the trust be protected from the settlor's creditors. Alaska, Delaware, and Nevada are three popular jurisdictions for these trusts. Thirteen states altogether have statutes authorizing DAPTs in some form. They have appealed to many U.S. clients because they are in this country - one does not have to rely on a foreign jurisdiction like the Cook Islands - and the states where they can be made have laws expressly authorizing their creation and spelling out the rights of creditors (or lack of rights) under state law. Now the effectiveness of such trusts is put into serious question.
In 2005, Mr. Mortensen transferred real estate valued at $60,000 and $80,000 in cash to an Alaska Domestic Asset Protection Trust. In 2009, Mortensen filed bankruptcy having amassed $250,000 in debt from credit cards, a hospitalization, and investments that went sour. So the question - can the bankruptcy trustee and creditors reach the assets of the trust?
The bankruptcy trustee claimed that because Mortensen created the trust with the intent to protect the trust assets from potential creditors, the transfers to the trust should be voided under the Bankruptcy Code. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 added a provision to the bankruptcy code which provides a 10-year clawback period for pulling back assets "when the property is transferred to a self-settled trust with the intention of protecting it from creditors."
On Motion to Reconsider, the Court said "when property is transferred to a self-settled trust with the intention of protecting it from creditors, and the trust's express purpose is to protect that asset from creditors, both the trust and the transfer manifest the same intent. In this case, I found that the trust's express purpose could provide evidence of fraudulent intent."
The case is Battley v. Mortensen, Adv. D. Alaska. No. A09-90036-DMD (May 26, 2011). According to the holding in this case, an Asset Protection Trust will not protect assets in a bankruptcy for a period of 10 years after it is created if its purpose was to protect assets of the settlor from claims of future creditors. Ouch. Will other courts agree? Mortensen's was a domestic trust. Will the same rule apply to foreign asset protection trusts? Is this the death knell for asset protection trusts unless they are "seasoned" for 10 years?
The decision in the bankruptcy court has been roundly criticized by those who don't like the result. The court gave no effect at all to the provision in the Alaska statute that says the trust language could not be used as evidence of intent to defraud.
Some commentators say that this isn't news - that it was always known that you couldn't file for bankruptcy in the 10-year period after creation of the trust. I wonder if that's what the clients who created these trusts heard?
Perhaps most telling is the fact that Mortensen created the trust himself from forms he found and cobbled together. There are approaches he could have taken that would have avoided the 10-year clawback. He could have transferred the property to an irrevocable trust that was not self-settled. He could have drafted a trust where he was not the initial beneficiary. He could have transferred the property to an irrevocable trust for the benefit of his descendants. But he did not seek advice.
Further, he didn't seek advice about filing for bankruptcy. He did that himself, too. If he had not filed, it is very unlikely that his creditors would have gotten together to force him into involuntary bankruptcy. If he hadn't been in bankruptcy, the 10-year clawback would never have been an issue; and he could have safely relied on Alaska's state law.
It is too early to draw a conclusion from one lower federal court decision, but this definitely is a warning shot. It would be a good time to have your asset protection plans reviewed.
