Fraudulent Transfers

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1 Fraudulent Transfers Governed by the Uniform Fraudulent Transfer Act. The fraudulent transfer rules prevent people from transferring assets after a debt has arisen in order to avoid having to pay the debt from those assets. If a transfer is deemed to be fraudulent, a court can undo the transfer and give the assets back to the donor so that the creditors can access the assets. These rules make asset protection planning difficult and often useless once the debt has arisen. This is important because clients often wake up to the fact that they need asset protection trusts only after they ve been sued or committed some tort, etc.

2 Actual Fraudulent Conveyance This applies to any transfer made with actual intent to hinder, delay, or defraud any entity to which the debtor was indebted to This applies whether or not a lawsuit has already been filed. This applies to family law situations as well. Transferring assets to avoid equitable distribution of marital property or alimony/child support obligations is also a fraudulent conveyance.

3 Constructive Fraudulent Conveyance This applies to any gift (or transfer for less than fair consideration) made while the transferor: Was insolvent (this occurs when the total person s debts are greater than all of his or her assets) Was about to engage in a business or venture for which his remaining property was unreasonably small Intended to incur debts that could not reasonably be repaid Advising clients to intentionally make fraudulent transfers can be unethical and even criminal in some cases!

4 Spendthrift Provisions These provisions stipulate that the creditors of parties relevant to the trust may not access the trust assets to collect the debts. This provision is easiest with regard to the beneficiaries other than the grantor. Spendthrift provisions are standard in trusts with regard to the beneficiaries and are generally valid Spendthrift provisions are often not effective regarding the creditors of the grantor who is also a beneficiary.

5 Protecting Assets from Creditors of the Beneficiaries A typical spendthrift provision should generally do the trick. However, you must be careful not to give the beneficiary any authority that would allow him to distribute assets in a manner that would be reachable by the creditors. Thus, it s best not to give the beneficiaries: A general power of appointment A power to distribute assets to him or herself in a manner that would allow the beneficiary to access the money and give it to the creditors This can be done by requiring the consent of a co-trustee or another beneficiary before trust assets can be spent for a beneficiary

6 Spendthrift Provisions: Other Conerns Creditor protection trusts can also protect beneficiaries eligibility for government assistance benefits. To ensure this, prohibit the trust from paying certain expenses, like healthcare and housing, that government assistance benefits may pay for. Though even this may not be necessary if the discretion is in the hands of someone else. Giving a Crummey right of withdrawal may subject the amount of the withdrawal power to vulnerability to the beneficiary s creditors. The creditor may be able to insist that the right of withdrawal be exercised, etc. Beneficiaries with potential creditor issues may therefore simply not be afforded a right of withdrawal.

7 Self-Settled Spendthrift Trusts In most states, if a grantor is a beneficiary of the trust, then the trust assets are subject to the grantor s creditors, to the extent of the potential interest. For example, if the income may be paid to the grantor, then all trust income can be accessed by the grantor s creditors. This is true whether or not the income is actually paid to the grantor. If a trustee may apply trust principal for the grantor, then the entire trust assets can be vulnerable to the grantor s creditors. In these states a creditor protection trust should not have the grantor as beneficiary in any form whatsoever.

8 Foreign Asset Protection Trust The first alternative is to set up a trust in a country that has more favorable creditor protection rules. This may allow a trust to be protected from the creditors of the grantor even if the grantor is a potential beneficiary. Examples of countries of course include: Bahamas Bermuda Cayman Islands New Zealand

9 Foreign Asset Protection Trust 2 Advantages: Difficult for US courts to gain jurisdiction Host country may not enforce judgment of creditors in U.S. court Disadvantages: Costly and complex to set up; may require assistance of local counsel in the host country Complex U.S. filing requirements for foreign trusts If the US court gets jurisdiction over the trust, it may not respect the laws of the host country Less oversight of banking practices in many countries may lead to greater risk of loss of the assets

10 Domestic Asset Protection Trust Several U.S. states have crafted special rules that protect trust assets from being vulnerable to creditors even when the grantor is a potential beneficiary. For people who live in a DAPT state, establishing one with the grantor as a potential beneficiary is most likely a sound strategy. For residents of other states, whether this strategy is sound is unclear.

11 Domestic Asset Protection Trust - Risks The risks to residents of other states who establish a DAPT in a DAPT state include: 1) If the non-dapt state court can get personal jurisdiction over the trust, it will likely exercise it. This includes other types of jurisdiction like in rem and quasi in rem 2) The court in the DAPT state may be under a responsibility under the good faith and credit clause of the Constitution to enforce the judgment of the court in the non-dapt state. 3) Courts in the DAPT state might determine that choice of law principles indicate that the rules of the non-dapt state should apply. This makes the creditor protection rules of the DAPT state worthless.

12 Domestic Asset Protection Trust Making it (relatively) safe If any out of state resident wants to establish a DAPT in a DAPT state, the following steps are important: The trustee should reside in the DAPT state. Or, at the very least, in a different state than the grantor This can be a professional trustee in the DAPT state The trust assets should be held in the DAPT state or at least have a strong nexus to the DAPT state. A choice of law and choice of forum provision in the trust should designate the DAPT state as having full jurisdiction over the trust. One good strategy is to have an LLC in the DAPT state hold the assets and the trust hold the LLC shares. Holding a DAPT state company gives the trust a nexus to the DAPT state.