Asset Protection Trusts: Update on Recent Litigation

Offshore and domestic asset protection trusts (“APT”) have been around for a while. Currently, there are seventeen states¹ that allow a person to contribute assets to trust for their own benefit (i.e. a self-settled trust) and exempt those assets from claims of their own creditors subject to certain statutes of limitations and exception creditors. Other than the 10-year window applicable in federal bankruptcy matters², assets can be well protected generally within a 2-4 year window. Domestically, Alaska was the first state to provide this planning option with the passage of legislation in 1997.³ Offshore APTs have been an option for much longer.⁴

Over the years, however, there has been only limited litigation involving APTs. This has led to speculation about the application of the Full Faith and Credit Clause of the U.S. Constitution and the enforceability of choice of law provisions. In Addition, litigation involving APTs has been limited. This leaves a number of the questions unanswered. Beyond these issues APTs can be subject to other challenges, especially under the Uniform Fraudulent Transfer Act and the Uniform Voidable Transfer Act.⁵

Recently, there have been a handful of cases which deal with APTs. I have written about some of these cases.⁶ The purpose of this article is to summarize recent cases relating to APTs.

Wacker  ⁷

In 2007, Mr. and Ms. Tangwall filed a lawsuit against William and Barbara Wacker in Montana state court. Counterclaims were filed against the Tangwalls. During the period of time when judgments were being entered against them on the counterclaims, the Tangwalls conveyed parcels of Montana real estate to an Alaska APT. Following those actions, the Wackers filed a fraudulent transfer action seeking to recover the Montana property from the APT. The Tangwalls failed to contest this action resulting in default judgments being entered against them in Montana on the fraudulent transfer action.

Before the Wackers could recover on their default judgments, Bertran Tangwall filed Chapter 7 bankruptcy in Alaska. In the bankruptcy court action, following a fraudulent conveyance complaint filed by the bankruptcy trustee, Tangwall took the position that only the Alaska state court has jurisdiction to determine whether conveyance of the Montana property to the APT was a fraudulent conveyance. In support of this position, Tangwall cited to Alaska statutes which purported to assert this exclusive jurisdiction. After a default judgment was entered against Tangwall in bankruptcy court, Tangwall filed a declaratory judgment action in Alaska state court seeking a judgment that the Montana judgments were void. The declaratory judgment action found its way to the Alaska Supreme Court which rendered the relevant opinion in this matter.

Ultimately, the Alaska Supreme Court decided that Alaska cannot limit the ability of other states to render judgments when they have an independent basis for jurisdiction. As such, the Montana judgments finding a fraudulent conveyance were valid and enforceable. The Full Faith and Credit Clause to the U.S. Constitution did not limit Montana to respecting Alaska’s assertion of exclusive jurisdiction. Likewise, the Alaska statute cannot limit the scope of the bankruptcy court’s authority to enter judgment against the trust’s property. Ultimately, Tangwall lost the property in Montana to his creditors.

Although some have argued that this case is the end of asset-protection protections for residents of states without APT statutes⁸, it really is not that clear. Fraudulent transfer laws apply to transfers to asset protection trusts just as they do to other transfers. Arguments may be raised as to what state’s fraudulent transfers apply. However, as illustrated in Wacker, it is not advisable to fund an APT through fraudulent transfers under the laws of any state with potential jurisdiction (as a minimum, do not fund the trust while judgments are actively being entered). Here, Tangwall made yet another mistake by filing bankruptcy subjecting himself to bankruptcy’s fraudulent transfer laws and 10-year statute of limitations period. In effect, Wacker likely does not significantly change valid use of APTs for those who properly form and fund them.

Campbell  ⁹

John Campbell formed a Nevis APT in 2004, funding it with $5 in a transaction which did not make him insolvent or otherwise unable to pay his debts. In 2010, the Tax Court entered a decision against Campbell finding he owed approximately $1.3 million of income tax and penalties as a result of his participation in the CARDS tax shelter in 2001.¹⁰ In the intervening years, Campbell experienced a significant loss of net worth following investing in properties constructed with Chinese drywall. After the Internal Revenue Service (“IRS”) issued a notice of intent to levy on Campbell’s assets, he sought a collections due process hearing pursuing an offer in compromise (“OIC”). Campbell offered to pay $12,603 in full satisfaction of his income tax liabilities.

Given Campbell’s loss of personal wealth, the critical question was whether assets in the APT should be considered as available to Campbell. The reason is that a taxpayer’s OIC which reflects the IRS’ reasonable collection potential generally should be accepted by the IRS. If the $12,603 offer reflected all the IRS could collect against Campbell, then his OIC should be accepted.

After analyzing factors set forth in the Internal Revenue Manual, the Tax Court determined that the APT assets do not constitute dissipated assets, would not be collectible by the IRS, and are not available to Campbell. Critical in the analysis and referenced by the Tax Court are that Campbell’s funding of the trust did not make him insolvent, the APT was formed and funded well before IRS debts were final, and Campbell did not retain control over trust assets or distributions. As a result, the Tax Court recognized the APT assets as being unavailable to Campbell (under Connecticut law) and not to be included in calculation of Campbell’s OIC. On these facts, the APT accomplished its goal.

Cyr  ¹¹

This case is not strictly an APT case. However, it is included in these materials to illustrate how a self-settled trust can be created outside of intentional APTs and the importance of complying with APT formalities. At issue in this opinion were assets held in a trust created by Steven Cyr’s parents. The nominal settlors of the trust were Cyr’s parents. However between 2009 and 2017, Cyr purchased properties he transferred to the trust, the trust purchased property paid for by Cyr, Cyr directed that certain payments he was receiving be made to the trust, and Cyr’s wife transferred LLC interests to the trust. As such, while Cyr was not the original settlor of the trust, he and his wife made substantial transfers to or for the benefit of the trust.¹²

After Cyr filed Chapter 7 bankruptcy on June 15, 2018, the bankruptcy trustee filed a complaint seeking to have the bankruptcy court determine that assets of the trust were available for Cyr’s creditors in bankruptcy.  A motion to dismiss the bankruptcy trustee’s complaint was filed andthe relevant litigation commenced. The court’s opinion is difficult to read, addressing multiple legal issues, with respect to multiple transfers. However, the most important results of the case are fairly clear.

While the court found the trust not to be a sham, it also found that Cyr was a settlor of the trust under Texas law (making the trust self-settled). That determination allowed the court to disregard the spendthrift provision as to the trust with respect to any assets contributed by Cyr. Despite arguments by the bankruptcy trustee, the court did not find the entire trust to be self-settled but rather required a tracing of assets which were contributed by Cyr. Only to the extent of such assets would the trust be self-settled.

Beyond determining Cyr to be at least partial settlor of the trust, the court addressed situations that may be covered by the bankruptcy self-settled trust and fraudulent transfer statute.¹³ One issue is important because not merely self-settled trusts are subject to being set aside in bankruptcy during the 10-year statute of limitations period, but also any “similar device.” While the court did not substantially analyze what would constitute a “similar device,” the court indicated the term is to be given “broad application.” Regarding fraudulent conveyance, the court generally found that facts were not present to show that Cyr had an actual intent to hinder, delay, or defraud present or future creditors which would be required to prove a fraudulent transfer.

Ultimately, what may be important in this case is to know that one can be deemed to be the settlor of a trust even when he or she did not form or initially fund the trust. Without compliance with state-specific APT requirements, assets of any trust subject to this treatment under state law may be subject to creditors. Bankruptcy courts may be allowed to liberally look not only strictly at such state law classification but also at what may constitute a “similar device.” Even when that is not found, a bankruptcy court may reach assets funded into trusts through fraudulent transfers.

Rensin  ¹⁴

The founder of BlueHippo, Joseph Rensin, after a series of asset transfers and a change in residency, filed Chapter 7 bankruptcy in February 2017. In 2008, the FTC obtained a ruling that resulted in a $13.4 million judgment against Rensin. This judgment was non-dischargeable in bankruptcy. Relevant for this discussion, Rensin had established a Cook Islands APT in 2001. At the time he formed and funded the trust, Rensin was not insolvent. Rensin did not retain the right to remove or veto the trustee. Also, he had no power to select a replacement trustee unless there was no trust protector or the trust protector failed to act. Nonetheless, during litigation with the Federal Ttrade Commission, Rensin received 14 distributions totaling approx. $8.7 million used to pay his creditors and legal fees. Also during this time, and before the bankruptcy filing, the trust situs moved to Belize.

In 2015, after the FTC judgment but before filing bankruptcy, Rensin transferred $350,000 to the APT which used the funds to purchase a deferred annuity. At the same time, the trust purchased a fixed annuity with the trust’s remaining $1.7 million in cash. Those annuities were the only assets held in the APT, with the fixed annuity at the time paying Rensin $15,000 per month. In August 2017, the trust obtained an order by the Belize Supreme Court not to pay the FTC with assets in the APT. The bankruptcy trustee sought to obtain all trust assets.

A few primary issues were considered by the court: (1) whether Florida or Belize law applied; (2) whether trust assets were available to Rensin’s creditors; and (3) whether the annuities were exempt from execution under Florida law. As to applicable law, the court quickly found that Florida law applied to determine a Florida debtor’s property rights.

Regarding the trust, after having determined that Florida law applies, the court cited to Florida’s strong public policy disfavor of APTs. Therefore, the court disregarded the spendthrift protection and found that any creditor protection afforded Mr. Rensin by the trust should be disregarded. In analyzing the annuities, the court cited to Florida exemption statutes noting that the fixed annuity would be protected¹⁵ absent an exemption for a fraudulent conversion of a non-exempt to an exempt asset.¹⁶ Since the fixed annuity had already commenced payment, it constituted an exempt asset under Florida law. The variable annuity did not. The bankruptcy trustee argued the fixed annuity should be found non-exempt as a fraudulent conversion of non-exempt to exempt assets, that statute requires a “conversion by the debtor.” Here, the trustee converted cash into a fixed annuity. As such, the debtor, Rensin, was not the party converting the assets and, therefore, the exception did not apply. The court discussed that Rensin would have to hold the legal power to force conversion for it to deem the conversion by the trustee to have been made by Rensin.

In the end, the court disregarded the APT and determined one of the annuities to be non-exempt from execution. However, Rensin still came out ahead in this case versus if he had not planned using his APT. First, the fixed annuity would likely not have been creditor protected if he had purchased it himself. Second, the trust was not a party to the litigation. As such, the court was without jurisdiction to order the trustee to take any action with respect to the variable annuity (its only other asset). While there may be future litigation, without jurisdiction to issue a binding order on the trustee, the court’s view of Rensin’s property rights may be irrelevant.

Conclusion

A few conclusions may be reached from these recent opinions. Some of the advice I take from them include:

• Take care not to inadvertently create a self-settled trust. If someone may be deemed to be the settlor of a trust under controlling state law (or potentially any state’s laws which could apply), then another solution needs to be determined. This could involve the sale to the trust, creation of an intentional APT (domestic or offshore), or a number of other alternatives. Could Cyr have turned out differently had they been more intentional with their asset protection planning? It seems at least possible.
• Do not fund an APT through a fraudulent transfer. Any good asset protection plan, including formation and funding of an APT, needs to occur well in advance of any known creditors. Transfers to an APT should not cause the settlor to become insolvent. When that is the done (and the bankruptcy 10-year statute of limitations passes if bankruptcy is filed), there may be little that can be done by a creditor to get to APT assets. In the Wacker case, had the trust been funded other than through a fraudulent transfer, it may have worked. In Campbell, funding well before the IRS debt matured and at a time when the debtor was not insolvent were significant factors in the court’s conclusion to respect the APT.
• Do not file bankruptcy during the 10-year statute of limitations. Of course, there can be involuntary bankruptcies. However, as in Wacker and Rensin¸ we see voluntary bankruptcy filings which likely cost the debtor much more than if they had simply avoided filing.
• Limit the settlor’s retained rights. In each of these cases, the courts discuss powers held by the relevant debtor regarding trust assets. While APT statutes may allow liberal retention of rights by a settlor, courts clearly look to retained rights in rendering their opinions (is the trust a sham, alter ego, nominee, etc.). Therefore, notwithstanding what may be permitted, perhaps it is a best practice to limit the settlor’s rights to the extent feasible. Likewise, it would be wise to avoid having a settlor direct the trustee to take action even when such control is not retained in the trust instrument.

Beyond this list, I question what these cases tell us about whether it is safer to establish an APT domestically or offshore. Most of these cases did not appear to turn on the trust’s jurisdiction. Therefore, perhaps it does not matter where the trust was formed. However, in Rensin, the fact that the trustee was not a party to the litigation, likely due to the Belize residency of the trustee, may allow Rensin to retain assets otherwise reachable by creditors. In such case, there may be some advantage to having an offshore trustee which may be outside the jurisdiction of a US court.

In the end, while there have not been a significant number of reported cases involving APTs, we have begun seeing more recently. As we advise clients, it is important that we learn from how courts interpret the various legal and practical decisions that are made. These cases give us some helpful guidance.

S. Gray Edmondson, J.D., LL.M.

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1. Alaska, Delaware, Hawaii, Michigan, Mississippi, Missouri, New Hampshire, Nevada, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Virginia, and West Virginia.
2. 11 U.S.C. §548(e). Bankruptcy courts also have national jurisdiction. See 28 U.S.C. § 1334(e); Bankruptcy Rule 7004(d).
3. 1997 Alaska Laws Ch. 6 (H.B. 101).
4. Jurisdictions include the Bahamas, Belize, Bermuda, Cayman Islands, Cook Islands, Liechtenstein. Nevis, Channel Islands, and Switzerland.
5. The Uniform Voidable Transfer Act (“UVTA”) has been adopted by 18 states and has raised particular concern for planners. See UVTA Comment 8 to Section 4. See also Karibjanian, Wehle, Jr., and Lancaster, History Has Its Eyes on UVTA—A Response; Steven Leimberg’s Asset Protection Planning E-mail Newsletter, dated April 18, 2016; Richard Nenno and Dan Rubin, Uniform Voidable Transactions Act: Are Transfers to Self-Settled Spendthrift Trusts by Settlors in Non-APT States Voidable Transfers Per Se?; Steven Leimberg’s Asset Protection Planning Newsletter, August 15, 2016; Kettering and Smith, Comments to Uniform Voidable Transactions Act Should Not be Changed, Steven Leimberg’s Asset Protection Planning Newsletter, August 25, 2016; George D. Karibjanian, The Uniform Voidable Transactions Act Will Affect Your Practice, 155 (5) Trusts & Estates 17 (May 2016); George D. Karibjanian, Richard W. Nenno & Daniel S. Rubin, The Uniform Voidable Transactions Act: Why Transfers to Self-Settled Spendthrift Trusts by Settlors in Non-APT States Are Not Voidable Transfers Per Se, Bloomberg BNA Tax Management Estates, Gifts, and Trusts Journal, Vol. 42, No. 4, July/Aug. 2017.
6. “Alaska Supreme Court Takes a Wack at Their Domestic Asset Protection Trust Statute,” March 14, 2018, https://esapllc.com/alaska-supreme-court-takes-wack-domestic-asset-protection-trust-statutes/ and “Asset Protection Trust Protects Assets from Income Tax Liabilities,” February 26, 2019, https://esapllc.com/asset-protection-trust-protected-from-income-tax/.
7. Toni 1 Trust v. Wacker, 2018 WL 1125033.
8. Jay Adkinsson, Alaska Supreme Court Hammers Last Nail In DAPT Coffin For Use In Non-DAPT States In Toni 1 Trust, FORBES (March 5, 2018, 10:08 PM) https://www.forbes.com/forbes/welcome/?toURL=https://www.forbes.com/sites/jayadkisson/2018/03/05/alaska-supreme-court-hammers-last-nail-in-dapt-coffin-for-use-in-non-dapt-states-in-toni-1-trust/
9. Campbell v. Commissioner, T.C. Memo 2019-14.
10. See Sage, Josh, “Playing with a Loaded Deck: CARDs and The Economic Substance Doctrine, July 18, 2018, https://esapllc.com/playing-with-a-loaded-deck-cards-and-the-economic-substance-doctrine/.
11. In re Cyr, 2019 WL 1495137 (Bankr. W.D.Tex., April 1, 2019).
12. Note that this could be deemed to treat them as settlors of the trust under Uniform Trust Code §103(15) as well as Restatement (Third) of Trusts §§ 10 and/or 58.
13. 11 U.S.C. 548(e)(1).
14. In re Rensin, 2019 WL 2004000 (Bankr. S.D.Fla., May 3, 2019).
15. Fla. Stat. § 222.14.
16. Fla. Stat. § 222.30.