How Offshore Trusts Work in Bankruptcy

Offshore Trusts in Bankruptcy

There are three crucial things to know about offshore trust protection in bankruptcy:

1. Your offshore trust may be destroyed in a bankruptcy proceeding.
2. Your creditor may force you into bankruptcy by filing an involuntary bankruptcy petition.
3. There are things you can do to prevent involuntary bankruptcy and preserve offshore trust protection.

How Offshore Trusts Work

Offshore trusts provide asset protection by placing your assets in a foreign country that is outside the jurisdiction of U.S. civil courts.

The trusts employ a foreign trustee, which is also beyond U.S. court jurisdiction. The trustee is not required to obey U.S. court orders, and U.S. courts cannot enter an order that affects trust assets geographically beyond the court’s jurisdiction.

Bankruptcy Can Blow Up Your Offshore Trust Protection

Bankruptcy Courts Have Worldwide Jurisdiction

The general legal principles that make offshore trusts effective in state and federal courts do not work in bankruptcy court.

Bankruptcy courts have jurisdiction over all your property and equitable interests “wherever located” and by whomever held. Courts have interpreted this principle to extend the bankruptcy judge’s jurisdiction and powers to assets and persons located outside the United States, specifically including offshore trusts.

The bankruptcy court may properly order the repatriation of assets held in offshore trusts. Therefore, transferring assets to an offshore trust does not necessarily place the assets beyond the reach of all U.S. federal courts.

Courts May Apply Your Local Law to Your Offshore Trust

Another promoted advantage of offshore trusts is that legal actions to interpret or enforce the foreign trust must be administered under the laws of the trust jurisdiction.

Offshore trust agreements typically include a “choice of law” clause that attempts to subject collection actions against the trust to the laws of the offshore trust jurisdiction, or any new jurisdiction where the trust protector decides to relocate the trust.

Many bankruptcy courts have rejected offshore trusts’ choice of law provisions and tied offshore trusts to the laws of the debtor’s residence.

Most states have decided that choice of law provisions are inapplicable if they offend the state’s public policy. These courts then explain that self-settled trusts, particularly offshore trusts, are contrary to public policy.

Here are two examples: one case in Florida, and another Connecticut.

As a result, bankruptcy creditors can ignore the laws of the offshore trust country and employ domestic law to attack the trusts in courts where the debtor resides.

Bankruptcy Law Has a 10-Year Statute of Limitations For Fraudulent Transfers

U.S. state and federal fraudulent transfer statutes typically have a four-year statute of limitations applicable to fraudulent transfers. Creditors can attack as fraudulent conveyances your transfers within the previous four years. Older transfers cannot be reversed under fraudulent transfer laws.

Promoters of offshore trusts often point to a shorter, two-year statute of limitations in many offshore trust jurisdictions such as Cook Islands and Nevis, W.I.

Yet bankruptcy law ignores the short statute of limitations of foreign trust jurisdictions. Bankruptcy courts may avoid your transfers to any self-settled trust, or similar device, within the 10 years prior to the beginning of your bankruptcy if the transfer was made with the intent to hinder, delay, or defraud your creditors.

The bankruptcy judge may remedy a fraudulent transfer by ordering the debtor to bring back offshore trust assets and turn over the assets to the bankruptcy trustee for distribution to creditors.

How Bankruptcy Courts Enforce Turnover of Offshore Trust Assets

Offshore trust salesmen promise that no U.S. court can force the dismantling of an offshore trust because the U.S. court, even the bankruptcy court, does not have personal jurisdiction over the foreign trustee and trust protector.

This is not true in bankruptcy court. A bankruptcy court having personal jurisdiction over the debtor may, and has often, ordered the debtor to either reverse fraudulent transfers to an offshore trust or to turn over the assets of the offshore trust to be included in the bankruptcy estate.

Debtors who fail to comply have frequently been held in contempt of court, and many have been incarcerated until they dissolved their trust.

The Defense of “Impossibility” Does Not Work in Bankruptcy

Some offshore trust salesmen brag that a court cannot compel you to repatriate offshore trust assets because you have relinquished control over the trust to a foreign trustee and trust protector.

The sales pitch is that only the offshore trustee can transfer trust assets, and the trust agreement forbids the trustee from transferring assets to a U.S. court under duress of a bankruptcy court order. Therefore, it is impossible for a bankruptcy debtor to comply with a court’s turnover order.

U.S. law holds that a debtor cannot be held in contempt for failure or refusal to do acts that are impossible for the debtor to accomplish. This legal defense to turnover orders and contempt citations is known as “the impossibility defense.”

The impossibility defense may sound convincing, but it has not been effective in bankruptcy courts. Most bankruptcy courts have refused to recognize impossibility hurdles built into an offshore trust structure because the debtor created their own impossibility.

Bankruptcy courts have been reluctant to excuse debtors from compliance with turnover orders of offshore trust assets when the alleged impossibility was both self-created and self-serving.

Bankruptcy Courts Use Common Sense To Demolish Offshore Trusts

Whether you, as a debtor in bankruptcy, can comply with court orders to repatriate your offshore assets is a question of fact in each bankruptcy case. Judges may properly assess your history of financial transactions with your offshore trustee, and the judges typically judge the credibility of your own testimony in court.

Despite what is written in your offshore trust agreement, bankruptcy judges employ their own common sense to determine your control and powers over the trust and trust assets.

Bankruptcy judges are skeptical of many self-serving terms of offshore trust agreements. In one prominent example, the judge found that no rational person would give nearly all his assets to a stranger in a foreign land without retaining some means of control.

Other courts have found debtor control based on a history of numerous exchanges of money between the offshore trustee and the debtor to cover the debtor’s living expenses.

Contempt of Court and Incarceration of Bankruptcy Debtors

What happens if a bankruptcy judge orders you to dissolve your offshore trust and turn over all trust assets to a bankruptcy trustee because either the trust funding was a fraudulent transfer or because your beneficial interest is part of the bankruptcy estate?

If you do not comply with the court’s turnover order, the court can hold you in civil contempt.

Contempt of court is punishable by incarceration. A bankruptcy judge has the right to put you in jail until you comply with a court order to dissolve your offshore trust. In these cases, compliance means causing the offshore trustee to send your offshore trust assets to you and your bankruptcy trustee. The debtor in contempt holds the keys to their own release.

Many Bankruptcy Debtors With Offshore Trusts Have Been Sent to Jail

Many individuals with offshore trusts have been incarcerated by bankruptcy judges. The facts recited in court decisions suggest that these unfortunate debtors were sold offshore trust plans by promoters that promised invincibility from U.S. courts, including the bankruptcy courts.

The debtors believed the promoter’s promises that the written provisions of their trust insulated them from bankruptcy.

In court, the debtors acted stubbornly and contemptuously toward the bankruptcy judges. The judges then sent these people to jail until they unwound their offshore trust and turned over the assets to the bankrupt trustee.

Involuntary Bankruptcy Destroys Offshore Trusts

Few people would choose to file for bankruptcy if their assets are held in an offshore asset protection trust. An offshore trust that effectively protects you from state court debt collection will likely fail to protect your assets in bankruptcy court for all the reasons explained in this article.

But bankruptcy is not solely your decision. Section 303 of the Bankruptcy Code provides a means by which just one of your creditors can force you into bankruptcy by filing an involuntary bankruptcy petition.

In our experience, there is usually only one aggressive creditor that considers or files involuntary bankruptcy petitions against offshore trust debtors after that creditor has been frustrated in state court collection efforts against the offshore trust.

The ability of an aggressive creditor to force you into bankruptcy court depends mostly on how many other parties have claims against you. If you have a total of 12 or more creditor claims, then it takes three such creditors to file a successful involuntary petition.

Rarely will two creditors join with the one aggressive creditor to support an involuntary bankruptcy because of potential sanctions against all petitioning creditors for unsuccessful creditor petitions.

If, however, you have fewer than 12 creditors, any one aggressive creditor can send you to bankruptcy court. The number of creditors is determined as of the date of the involuntary petition. Whether you and your trust are forced into bankruptcy court depends on whether the creditor accurately counted your other creditors.

A bankruptcy court may sanction a creditor that files an involuntary petition based upon a miscalculation of the number of existing creditor claims.

How To Prevent Involuntary Bankruptcy

You can prevent one creditor from forcing you into bankruptcy by accumulating more than 12 creditors. That is the simple answer, and the probable response you will get from an internet search or AI inquiry.

However, we have learned through our client experiences that the defenses against involuntary bankruptcy are much more technical.

Who Is A Creditor in Involuntary Bankruptcy?

The definition of a creditor or claimant for creditor counting is complicated.

The involuntary bankruptcy statute defines a qualifying claimant as a creditor that holds a claim against the debtor that is not contingent as to liability or the subject of a bona fide dispute as to liability or amount. ”

Not all creditor claims are qualified claims, and only “qualified” claims count toward the 12-claim threshold. A party does not need a judgment or lawsuit against you to have a “claim.” If any claim is subject to a “bona fide” dispute, then the claim is not a qualifying claim.

Definition of a Qualifying Claim For Involuntary Bankruptcy

Bankruptcy courts in different parts of the country define and count qualifying claims differently.

The law is evolving, so the definition of a qualifying claim for involuntary petition purposes changes in different bankruptcy jurisdictions as new judicial precedent is established.

A petitioning creditor must show that you have less than 12 total qualifying claims. If the petitioner miscounts qualifying claims, then the petitioner is open to dismissal and court sanctions for filing a false petition.

What Types of Creditors Count Toward the 12-Claim Threshold?

The classes or types of creditors that can hold “qualifying claims,” which are subject to the 12-claim cutoff, differ among federal circuits and bankruptcy courts. There has been much litigation in involuntary bankruptcy cases revolving around what type of creditor can qualify as a petitioning creditor or be counted in the court’s creditor count.

Courts are divided over whether small, recurring claims, such as utilities, rent, and insurance, should be counted. Most, but not all, bankruptcy courts find that small and recurring claims do not qualify as petitions or claimants for purposes of claim numerosity.

Here are some sample issues in these bankruptcy court cases:

• Do monthly credit card bills qualify as claims?
• Are both secured and unsecured debts qualifying claims?
• Are landlords and mortgagees claimants?
• Can bills owed to your own CPA and attorneys be qualifying claims?
• When are debts to your business qualifying claims?
• If small and recurring claims do not count, what claim amount is considered too small to be counted?

Is a Claim Subject to a Bona Fide Dispute?

Claims subject to a bona fide dispute are not qualifying claims. Not every dispute you have with a creditor is a bona fide dispute. You must show a genuine issue of fact or law that bears upon your liability to the creditor. Here are a few points to consider:

• If you acknowledge a debt or obligation to a party, but the amount of debt is not finalized, then there remains a bona fide dispute, and the party is not a qualifying claimant.
• If there are unresolved appeals as to liability or amount, then there is a bona fide dispute. The party is not a qualifying claimant.
• An unresolved counterclaim is a bona fide dispute, even if your counterclaim involves matters not directly related to the underlying debts.

Counting the number of qualifying claims against you to evaluate an involuntary petition involves an examination of each potential claim. You, as the offshore trust settlor, must convince the court that you are subject to at least 12 qualifying claims to defeat a single aggressive creditor’s involuntary bankruptcy petition.

Summary: Key to the Success of Your Offshore Trust

An offshore trust, particularly in the Cook Islands, can provide very effective asset protection. To succeed, your trust must be able to defend itself against all your creditors in state court and bankruptcy court.

Bankruptcy court is the gravest threat to your offshore trust, and involuntary bankruptcy is your creditors’ ultimate collection weapon. Make sure the offshore trust attorney that you hire is also an experienced bankruptcy attorney who can evaluate the number of your qualifying creditors to be sure that you are not vulnerable to an involuntary bankruptcy petition that could threaten your offshore trust.

Effective offshore trust planning requires an attorney with expertise in both offshore trust law and bankruptcy law.

Sources

Cases Where Self-Created Impossibility Was Not a Defense

• SEC v. Solow, 682 F. Supp. 2d 1312 (SD Fl 2010)
• In re Lawrence 279 F 3d 1294 (11^th Cir 2002)
• SEC v. Yun 208 F. Supp 2d 1279 (MD Fla 2002)
• Advanced Telecomminiction Network, Inc v.. Allen, D.C. Docket No 05-00770CV- ORL- 19-  JA – DA (11^th Cir 2011)
• SEC v. Greenberg, 2015 WL 2450500 (S.D.Fla., May 21, 2015). 

Common-sense Approach Found That Debtors Had Actual Control Over the Trust

• In re Lawrence 279 F 3d 1294 (11^th Cir 2002)
• In re Brooks, 217 B.R. 98 (D.Conn. Bkrpt. 1998) 

Bankruptcy Judge Put Debtors in Jail for Contempt for Refusal to Dissolve Offshore Trust

• FTC v. Affordable Media, LLC, 179 F.3d 1228 (9th Cir. 1999)
• SEC v. Bilzerian, 131 F. Supp. 2d 10 (D.C. 2001)
• In re Lawrence 279 F 3d 1294 (11^th Cir 2002)
• Bank of America v. Weese, 277 B.R. 241 (D.Md. 2002) (Debtors paid a settlement of over $12,000,000 to avoid incarceration).
• BankFirst v. Legendre, bankruptcy case M.D. Florida (2002)
• U.S. v. Plath, 2003-1 USTC 50,729 (U.S. District Court, So. Dist. Fla. 2003) 
• FTC v. AmeriDebt, Inc., 373 F. Supp. 2d 558 (D Md. 2005) (
• Morris v. Morris, Case Nos. 4D04-3812, 4D04-4621, 4D04-4763, aff’d Appeal No. SC05-1166 (Fla.S.Ct. April 13, 2006);
• Morris v. Wroble, Case No. CIV-O6-80479 (S.D. Fla.) aff’d Appeal No. 06-80452-CV-DTKH (11th Cir. Nov. 16, 2006).
• Barbee V. Goldstein, 2006 U.S.Dist. LEXIS 82945
• SEC v. Solow, 682 F. Supp. 2d 1312 (SD Fl 2010)
• Advanced Telecomminiction Network, Inc v.. Allen, D.C. Docket No 05-00770CV- ORL- 19-  JA – DA (11^th Cir 2011)