An asset protection trust is a trust agreement established and written by a debtor for the debtor’s own benefit that helps protect the debtor’s assets from potential civil judgment creditors. Learning about an asset protection trusts begins with understanding that legislatures in several states have passed asset protection laws in an attempt to attract investment capital from people looking for legal tools to protect themselves from creditors. Creative attorneys, working with state legislators, have passed statutes that protect assets located within their respective states. As a result, several states have amended their trust and limited liability laws to provide substantial asset protection. These types of asset protection statutes are intended to help residents of all states, not just residents of the state where the laws were passed. These tools include:
- Domestic Asset Protection Trusts, and
- Equity Stripping
Domestic Asset Protection Trusts
A domestic asset protection trust is a self-settled trust that is protected from judgment creditors by state statute. A “self-settled trust” is a trust where the person who creates the trust and transfers the assets to the trust is also a trust beneficiary. A living trust (used for estate planning) is a common example of a self-settled trust. Under Florida law established by a long and consistent line of court decisions, a self-settled trust does not protect the trustmaker’s beneficial interest in the income or principal of the trust from the trustmaker’s creditors.
Offshore trusts provide asset protection benefits mainly because statutes in select foreign countries state that a trustmaker’s beneficial interest in a self-settled trust formed in their country is protected from the trustmaker’s own creditors. These offshore trust statutes include other debtor-friendly provisions to encourage new trust business. Some states in the U.S. have recently enacted statutes which expressly grant these same type of asset protection benefits to self-settled trusts. Trusts created under these state statutes are referred to as domestic asset protection trusts (“DAPT”). These DAPT’s were encouraged by state legislatures in an attempt to provide investors and business owners the protection of offshore trust planning within the United States in order to attract businesses and assets to their states.
Most state DAPT statutes have several common features. The statutes provide that the DAPT is irrevocable so that assets transferred to the trust may not be withdrawn by the trustmaker. The statutes also require at least one trustee to be either a state resident or a corporation doing business in that state and that some trust assets must be located or deposited in the state. The DAPT statutes, like their foreign counterparts, typically provide for a position of “trust protector” who is a person with power to veto the trustee’s decisions to make distributions if such distributions may be vulnerable to the trustmaker’s creditors.
Alaska, Delaware, Utah, and Nevada are states with favorable domestic asset protection trust laws. In Utah, the general statute of limitation for fraudulent transfers to the DAPT is four years, and there is a procedure by which a debtor can shorten the limitations time to only 120 days. In Alaska and Delaware, by contrast, a creditor has four years to challenge a fraudulent conveyance to their states’ DAPTs. Utah’s DAPT law also has relatively flexible trustee provisions under which a trustmaker can appoint himself as trustee as long as there is a Utah co-trustee. The Utah trustee does not have to be a bank or trust company, but it can be any individual who resides in the state. The trustmaker as trustee can retain control of investments and trust distributions.
A DAPT works well in theory, and many qualified commentators have published persuasive legal arguments supporting the DAPT’s asset protection. The legal issue in DAPT planning is referred to as “conflict of law”: If a Florida resident forms a self-settled trust in a DAPT state where these trusts are expressly protected from all creditors, will Florida courts apply the protective laws of the DAPT state which has encouraged self-settled trust protections or the Florida law opposing self-settled trust protection? Resolving the conflict between Florida’s public policy against self-settled trusts and contrary policy in DAPT states is legally complicated and involves a multi-step fact analysis. In general, based upon principles in the Restatement of Trusts, if a Florida debtor establishes a DAPT trust, the more that trust assets, records, and parties are situated in the DAPT state, the more likely the DAPT state laws will apply. However, the more that the DAPT trust assets and parties are in Florida, the more likely Florida courts will apply Florida law. To date, no Florida court has held that a debtor’s interest in a DAPT formed under the laws of another state is protected from a Florida judgment.
There are possibilities to structure estate planning trusts in Florida to achieve asset protection. Although assets in the debtor’s own living trust, a form of self-settled trust, are not protected from the debtor’s creditors, a Florida resident may protect assets in a trust created by another person. There is authority that a debtor’s interest in a trust which the debtor forms or funds with his own non-exempt money will be protected from creditors if anyone other than the debtor is given control over trust assets. Therefore, a properly drafted Florida trust may provide the trustmaker effective asset protection even though Florida has not enacted specific asset protection trust statutes.
“Equity stripping” is a relatively new term in asset protection law describing an old asset protection technique. Equity stripping refers to pledging a non-exempt asset as security for a money loan. In most cases, the debtor obtains a loan from a commercial bank and secures the loan with a mortgage or lien on the non-exempt assets he wants to protect. The bank records the security instruments which gives the bank’s security interest priority over judgments against the debtor subsequently obtained by other creditors. In order for these other creditors to attack the encumbered asset, they would first have to pay off the amount of the lender’s secured loan. Pledging a valuable non-exempt asset to secure a new loan essentially drains the equity from a non-exempt asset and permits the debtor to move the cash borrowed beyond the reach of creditors. Exempt assets, such as a Florida homestead or retirement plan, should not be pledged to borrow new money because these assets are already protected from creditors and cash obtained from a loan secured by an exempt asset may become unprotected.
Equity stripping is useful in certain situations. Business owners or professionals often have large accounts receivable or valuable equipment which cannot be assigned or titled in other names. Banks giving lines of credit almost always ask for a first secured position on a business’s receivables and equipment because these are the most liquid and valuable business assets. The bank’s security interest is established and recorded when the line of credit is established even though no money is lent to the debtor. The business can borrow money on the line of credit if and when it perceives a legal problem. Money borrowed through a line of credit is not protected from creditors, and the business must find other means to protect the borrowed funds such as distributing money borrowed to the business owners to pay principal on their homestead mortgage.
Equity stripping is used by people moving to Florida who mortgage their existing home and use the proceeds to purchase a Florida homestead. Another example is a real estate investor who owns multiple properties with equity. Changing title to multiple properties involves the expense of setting up new legal entities and substantial transfer taxation. An alternative is to buy new properties with loans cross-collateralized by presently owned properties which are otherwise unprotected.