Cook Islands Trust vs. Domestic Asset Protection Trust

Asset protection planning involves a choice between Domestic Asset Protection Trusts (DAPTs) established in U.S. states such as Nevada, South Dakota, or Delaware, and offshore structures, primarily the Cook Islands Trust.

While domestic trusts offer convenience and lower initial costs, they are subject to the Full Faith and Credit Clause of the U.S. Constitution. Conversely, Cook Islands Trusts operate under a separate sovereign legal system that does not recognize foreign judgments, providing a higher degree of asset insulation.

Constitutional Limitations of Domestic Trusts

The primary legal vulnerability of a Domestic Asset Protection Trust (DAPT) is Article IV, Section 1 of the U.S. Constitution, commonly known as the “Full Faith and Credit Clause.” This clause mandates that “Full Faith and Credit shall be given in each State to the public Acts, Records, and judicial Proceedings of every other State.”

The Jurisdictional Conflict

For residents of non-DAPT states (e.g., California, Florida, Texas, New York), a domestic trust in a jurisdiction like Nevada relies on the premise that the Nevada courts will ignore a judgment from the debtor’s home state. However, constitutional reciprocity requires enforcement.

1. The Judgment: A creditor obtains a judgment in the debtor’s home state (e.g., California).
2. Domestication: The creditor registers that judgment in the DAPT state (e.g., Nevada).
3. Enforcement: Under the Full Faith and Credit Clause, the DAPT state courts are constitutionally required to recognize the valid judgment of the sister state, potentially bypassing the DAPT state’s asset protection statutes.

Conflict of Laws and Public Policy

Domestic trusts frequently face challenges under the Conflict of Laws doctrine. While trust documents may designate a specific state’s law to govern the trust (Choice of Law), federal and state courts often set this designation aside if it violates the “strong public policy” of the jurisdiction where the debtor resides.

Case Law Precedents

• In re Huber (Washington/Alaska): A Washington resident established an Alaska DAPT. The bankruptcy court ruled that Washington law applied because the debtor lived and earned revenue in Washington. As Washington has a public policy against self-settled asset protection trusts, the court invalidated the trust’s protections.
• In re Mortensen (Alaska): Similar rulings have established that a debtor cannot utilize the laws of a foreign state solely to defeat the claims of creditors in their domicile state.

The Cook Islands Advantage: Jurisdiction

The Cook Islands is a sovereign nation independent of the United States. It is not subject to the U.S. Constitution, and no “Full Faith and Credit” requirement exists between the two jurisdictions.

Statutory Non-Recognition

The Cook Islands International Trusts Act governs offshore trusts in the jurisdiction. Specifically, Section 13D of the Act explicitly prohibits the recognition or enforcement of foreign judgments.

If a U.S. creditor obtains a judgment against a settlor, the Cook Islands trustee is statutorily barred from honoring that judgment. To pursue the assets, the creditor cannot domesticate the U.S. order; they must initiate new litigation within the Cook Islands High Court.

Evidentiary Burden of Proof

In the event of litigation, the burden of proof required to seize assets differs significantly between U.S. and Cook Islands courts.

Domestic Standard: Clear and Convincing Evidence

In most U.S. jurisdictions, a creditor alleging fraudulent transfer must prove their case by “clear and convincing evidence.” While rigorous, this standard is frequently met in civil litigation.

Cook Islands Standard: Beyond a Reasonable Doubt

Under Section 13B of the International Trusts Act, a creditor must prove that the assets were transferred with the specific intent to defraud that creditor “beyond a reasonable doubt.”

This is the standard applied in U.S. criminal proceedings. If the settlor can demonstrate any legitimate purpose for the trust—such as estate planning, investment diversification, or business succession—reasonable doubt exists, and the creditor’s claim fails.

Case Study: FTC v. Affordable Media (The Anderson Case)

The efficacy of the Cook Islands statute was tested in Federal Trade Commission v. Affordable Media, LLC, commonly known as the “Anderson Case.”

• Facts: The Andersons were sued by the FTC and ordered to repatriate assets held in a Cook Islands Trust.
• Trustee Action: The Andersons instructed the trustee to return the funds. The trustee, adhering to the trust’s “Duress Clause,” refused the instruction, determining that the request was made under court compulsion.
• Outcome: The U.S. court held the Andersons in civil contempt, resulting in incarceration. However, the Cook Islands trustee refused to release the assets. The funds remained secure despite the maximum pressure exerted by the U.S. legal system.

Hybrid Trust Structure

The “Hybrid Trust” (or Bridge Trust) is utilized by settlors seeking a balance between domestic simplicity and offshore protection.

• Phase 1 (Domestic): The trust is established and compliant with U.S. laws. Assets remain in the U.S., and tax reporting is streamlined (Form 1041).
• Phase 2 (Trigger Event): Upon the threat of litigation, the trust contains a specialized clause allowing it to migrate to the Cook Islands.
• Phase 3 (Offshore): The trust becomes a foreign entity. Assets are moved to an offshore custodian, and the protective statutes of the International Trusts Act engage.

Cost Analysis and Comparison

The cost differential between domestic and offshore trusts reflects the scope of legal protection.

Cost Category	Domestic DAPT (NV/DE/SD)	Cook Islands Trust
Initial Setup Fee	$3,000 – $6,000	$14,000 – $20,000
Annual Maintenance	$1,500 – $3,000	$4,000 – $6,000
Legal Defense Cost	High (Must litigate in US courts)	Low (Creditors often walk away)
Total 5-Year Cost	~$15,000	~$40,000

While the Cook Islands Trust requires a higher initial investment, it mitigates the substantial costs associated with defending a DAPT in U.S. courts, where litigation is prolonged and outcomes are uncertain due to conflict of laws issues.

IRS Compliance and Taxation

A Cook Islands Trust is generally tax-neutral for U.S. persons but entails strict reporting requirements.

Tax Status: Grantor Trust

Under Internal Revenue Code § 679, a foreign trust with a U.S. beneficiary is classified as a “Foreign Grantor Trust.”

• Tax Liability: The trust is a disregarded entity. All income is reported on the settlor’s personal Form 1040.
• No Tax Advantage: The structure is an asset protection vehicle, not a tax minimization strategy.

Reporting Requirements

Compliance requires the filing of informational returns. Failure to file can result in penalties up to 35% of the gross value of trust assets.

• Form 3520: Filed by the settlor to report the creation of the trust or transfers to it. Due April 15.
• Form 3520-A: Filed by the trustee to report annual trust activity. Due March 15.

Note: As of late 2024, the IRS has revised penalty procedures, ending automatic assessments for late filings and allowing for “Reasonable Cause” reviews prior to penalty issuance.