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Defending The Realm with Asset Protection Planning
- 1. “ Defending the Realm” Asset Protection Planning in Georgia
- 2. Asset Protection Planning : (What it is…) … a means of arranging assets and affairs to preserve and protect property for intended beneficiaries… safeguarding against future risks … should be an integral part of the wealth planning process … advanced planning to position wealth beyond the grasp of potential future creditors
- 3. Asset Protection Planning : (Why?) … an explosion of litigation … continuing increase in the size of jury awards … insurance often inadequate … defendants increasingly paying judgments from personal resources … increased awareness on the part of the wealthy and their advisors
- 4. Asset Protection Planning : (Legitimate Objectives…) … protect assets from future risks from all potential sources … deter litigation over assets … provide incentive for favorable and quick settlement of claims … improve client’s bargaining position
- 5. Asset Protection Planning : (What it is NOT…) … a means by which to EVADE TAXES … a means by which to DEFRAUD CREDITORS … a means by which to HIDE ASSETS
- 12. The Law of Fraudulent Conveyances (Civil) U.S. law of fraudulent conveyances developed from English case law applying the Statute of 13 Elizabeth Transfers of property made with intent to “delay, hinder or defraud” creditors are fraudulent and voidable
- 14. The Law of Fraudulent Conveyances (Civil) “ Badges of fraud” 1. Transfer made or obligation incurred to an insider 2. Debtor retained possession or control after transfer 3. Transfer or obligation was disclosed or concealed 4. Before transfer, debtor sued or threatened with suit 5. Transfer was of substantially all of debtor’s assets 6. The debtor absconded
- 15. The Law of Fraudulent Conveyances (Civil) “ Badges of fraud” (continued) 7. Debtor removed or concealed assets 8. Value of consideration received was not reasonably equivalent to value of asset transferred… 9. Debtor insolvent or became insolvent shortly after transfer… 10. Transfer made shortly before or after substantial debt incurred 11. Debtor transferred essential assets of business to lienor who transferred assets to an insider of the debtor
- 17. The Law of Fraudulent Conveyances (Bankruptcy) Debtors who engage in fraudulent transfers may be denied a discharge in bankruptcy
- 18. Fraudulent Conveyance: Sanctions and Remedies Criminal liability may attach to attorneys and advisors who assist clients in defrauding creditors Under the Georgia UFTA, creditor remedies include: 1. Setting aside the transfer 2. Attachment of the transferred asset 3. Injunction against further transfer 4. Appointment of receiver for property 5. Any other relief the circumstances may require 6. Judgment Creditors may levy execution on transferred asset or proceeds
- 19. Domestic Wealth Planning Bona Fide Business Transactions
- 20. Domestic Wealth Planning Transferring Assets for Estate Planning Purposes
- 21. Domestic Wealth Planning Marital Property Claims and Prenuptial Agreements
- 22. Domestic Wealth Planning Outright Gifts
- 23. Domestic Wealth Planning Charitable Lead and Remainder Trusts
- 24. Domestic Wealth Planning Qualified Personal Residence Trusts
- 25. Domestic Wealth Planning Non-Grantor Irrevocable Trusts
- 26. Domestic Wealth Planning Testamentary Bypass Trusts
- 27. Domestic Wealth Planning Irrevocable Life Insurance Trusts
- 28. Domestic Wealth Planning Disclaimers
- 29. Domestic Wealth Planning Family Limited Partnerships
- 30. Domestic Wealth Planning Limited Liability Companies
- 31. Domestic Wealth Planning Corporations
- 32. Domestic Wealth Planning Retirement Plans
- 34. Sample Spendthrift Language: “… Prior to the actual receipt of such property by any beneficiary, no property (income or principal) distributable under this trust shall be subject to anticipation or assignment by any beneficiary, or to attachment by or to the interference or control of any creditor or assignee of any beneficiary, or taken or reached by any legal or equitable process in satisfaction of any debt or liability of any beneficiary, and any attempted transfer or encumbrance of any interest in such property by any beneficiary hereunder prior to distribution shall be void.”
- 35. Spendthrift Trusts- Validity Spendthrift trusts established for the benefit of beneficiaries other than the settlor are typically upheld as valid…
- 36. Spendthrift Protection: Self-Settled Trusts As a general principle, spendthrift provisions do not effectively protect settlors of self-settled trusts … with possible exception for self-settled trusts having as their situs an asset protection legislation state (Alaska, Delaware, Nevada, Rhode Island) or certain foreign situs trusts
- 44. Questions about “Defending the Realm”? Please direct inquiries to: J. Scot Kirkpatrick, Esq. and William V. McRae, III, Esq. Chamberlain, Hrdlicka, White, Williams and Martin 404-659-1410
Notas del editor
- Speaker introductions Housekeeping items – breaks, lunch, facilities, announcements from NBI staff Questions – If you have questions during the course of the day, please write them down and turn them in to us. Because of the amount of material we’ll be covering today, we will answer questions after lunch and at the end of the day. Time will be reserved for questions at both times. Scot
- At its most elemental, APP is ans should be an integral part of a client’s overall wealth planning. Conducted properly, APP is legitimate planning that complements the other planning routinely conducted by clients. Such planning can be relatively simple, involving careful structuring of common estate planning instruments, or it can be highly complex, involving multinational trust and entity planning. In any case, “clean” APP typically involves structuring affairs and positioning assets to protect against claims of potential future creditors. Bill
- @@ In today's increasingly litigious society, the need to take affirmative measures to protect assets has taken on new importance to wealthy clients. The amount of tort litigation has skyrocketed in recent years, as has the amount of contingent fee litigation. In 1995, the amount of litigation related costs in the U.S. were estimated at $300 billion.@@ In 1999, the top ten jury awards in the U.S. totaled nearly $10 billion. @@ Historically, insurance has been viewed as the principal line of defense against tort and other claims. In recent years, with the nature of litigation changing, and jury awards increasing in size, insurance is often inadequate to cover judgments against defendants with deep pockets. @@Judgments are now more frequently paid, at least in part, from the personal assets of the defendants. Divorce claims have also increased in the past decade. Prenuptial agreements have offered only limited protection against claims of a divorcing spouse, agreements are sometimes overturned by Courts if certain formalities are not met, and frequently no agreement exists between partners to a marriage. Additionally, certain types of claims are not covered by premarital agreements, such as interspousal tort claims (e.g. intentional infliction of emotional distress). The regulatory environment has also changed in our country. The Government imposes liability, at times strict liability (without regard to fault by liable parties) to achieve desired social goals. A prime example is the government's imposition of liability for the cost of cleaning up real property which contains hazardous or toxic substances harmful to the environment. The statute, entitled the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (known as "Superfund" or "CERCLA") gives the EPA broad authority to recover cleanup costs and other costs from owners and/or other parties who have an interest in contaminated sites. @@ With these and many other factors affecting the way our world now operates, there is an increasing awareness on the part of the wealthy and others that asset protection planning needs to be integrated into, or at the very least considered as part of, the wealth planning process. Bill
- Planning to protect assets from future risks is simply sound wealth planning. While it may be virtually impossible, for public policy and other reasons, to effectively shield all assets all the time from the claims of all creditors, exposure to many risks may be effectively reduced or eliminated by taking advantage of commonly accepted tools and techniques. Modest measures carefully applied can be very effective in helping protect clients’ assets. Staying out of court may be a victory in and of itself for many. Because of the financial and emotional toll (and other costs) associated with litigation, taking steps to deter litigation through sound APP will have significant value to many clients. Creditors who face the prospect of litigating matters multi-jurisdictionally, perhaps in remote foreign jurisdictions with laws very different from our own, or who understand that litigation in a particular matter may be an unusually time consuming, costly and possibly uphill battle, may well be inclined to evaluate costs and benefits and settle quickly and on relatively favorable terms. A bird in the hand… A well-crafted wealth plan with thoughtfully drafted asset protection features can, more often than not, place clients in a stronger bargaining position with creditors than those who choose to conduct their affairs without such protections in place. Bill
- Clients who seek advice, counsel and, perhaps, assistance in transferring assets to hide them from the government or other existing creditors, or who seek to move assets offshore to so-called “tax havens” with a view toward eliminating (read: “evading”) income or other tax, are playing with fire. Those who elect to assist clients in such activity will, likely, get burned along with the client. Those who actually follow through with that sort of planning must often make decisions about whether to fully disclose the nature and extent of their activities on annual tax returns, whether to lie under oath in litigation, and whether to ultimately subject their own family members (like their children) to the prospect of lying on death tax returns to cover up the transgressions of their elders. The prudent advisor will help clients steer well clear of activities which could facilitate a slide down those slippery slopes. The prudent advisor does not assist clients with this sort of planning. Bill
- Asset protection planning engagements involve an entirely different set of issues and potential problems than those encountered in pure estate and/or business planning engagements. Remember that one of the principal objectives of ALL asset protection planning ("APP") clients is to position assets outside the grasp of third parties and that, for some who seek your counsel, guidance and assistance, they may be attempting to shield assets from CURRENT creditors who have existing claims against them. Others may be seeking to shelter assets in response to threatened litigation or in anticipation of divorce. Legitimate APP involves planning for a client before the actual need for such planning arises. Planning conducted under other circumstances is likely to be viewed as action taken with intent to delay, hinder or defraud an existing or foreseeable creditor. Under federal and state law, both the client and the professional advisor may be subjected to civil and/or criminal liability for engaging in improper conduct.... More on this later.... In light of the foregoing, the professional who considers undertaking an APP engagement on behalf of a client must exercise great caution before committing to do so, both for the client's ultimate benefit and for the advisor's protection. Bill
- When contemplating undertaking an asset protection planning engagement, there is much information about the prospective client that should be assimilated and evaluated before accepting the engagement. In addition to the typical financial information that one seeks as part of all wealth planning engagements, the practitioner must take extra care to develop information about the client’s family circumstances, financial prospects, intentions, perceived need for protection, sources of concern, creditors (both existing and foreseeable), litigation (pending, threatened and/or foreseeable), recent activities, and other. Having an understanding of client activities which may be violative of state and federal law is critical to properly qualifying the client. As such, we will examine today the law of fraudulent transfers as well as other matters which may have bearing on the propriety of proposed client activities. Bill
- The advisor should obtain and compile detailed current financial information from the prospective planning client, including but not limited to balance sheets, income statements, tax returns and any other information that supports the solvency of the client. Consideration should be given to the client’s reasonably foreseeable cash flow and sources of capital, assets pledged, personal guaranties and contingent assets and liabilities, among other things. If audited financial information is unavailable, such information should be certified by the client as being true, correct and complete. Obtain affidavits of solvency from the client and the client’s CPA if possible. Identify and discuss the merits of pending, threatened and/or expected claims against the client. If claims are meritorious, be particularly circumspect before counseling the client to transfer assets due to the increased likelihood of fraudulent transfer claims being asserted. Ask specific questions and obtain written responses from the client regarding actions previously taken by the client, or which may be taken by the client, which speak to the elements of fraud, constructively fraudulent activity, badges of fraud and the like. Bill
- Determine if previous transfers made by the client were for full and adequate consideration, obtaining documentary evidence supportive of value claims. When evaluating client solvency, be aware that the client may be considered solvent under the UFTA and Bankruptcy Code, but insolvent under the UFCA, due to differences in the way solvency is determined under each set of laws. Be careful! While you may explore with a client all known possibilities for protecting the client’s assets, including those that may be fraudulent or constructively fraudulent, be extremely careful not to counsel the client or assist the client in making transfers of property which could be considered fraudulent or constructively fraudulent. Bill
- Inquire into the client’s future plans, which may provide insights into possibly fraudulent intent or an intention to engage in constructively fraudulent transactions. When counseling married clients, discuss potential conflicts of interest and the ramifications of asset protection planning measures. Bill
- Speaker introductions Housekeeping items – breaks, lunch, facilities, announcements from NBI staff Questions – If you have questions during the course of the day, please write them down and turn them in to us. Because of the amount of material we’ll be covering today, we will answer questions after lunch and at the end of the day. Time will be reserved for questions at both times. Scot
- In the realm of asset protection planning, the advisor must always be cognizant of U.S. law relating to the concept of fraudulent conveyances and fraudulent transfers. Thought the terms are often used interchangeably, fraudulent conveyances were originally intended to relate to improper conveyances of personal property, whereas the term transfer connotes conveyances which may include real property. Early U.S. fraudulent conveyance law grew from the English case law applying the Statute of 13 Elizabeth. That law developed the notion that transfers of property made with the intent to hinder, delay or defraud creditors are fraudulent and, as such, voidable. Bill
- U.S. fraudulent transfer law was first codified in the Uniform Fraudulent Conveyance Act, promulgated in 1918 by the Conference of Commissioners on Uniform State Laws. As previously noted, the Act was based on centuries of English case law applying the Statute of 13 Elizabeth. By 1918, many states in the U.S. had enacted the English Statute in some form. The voidability of fraudulent transfers was, by that time, part of the law of every U.S. state. One important aspect of the UFCA was its treatment of the concept of "badges of fraud." Since direct evidence of fraudulent intent (that is, the intent to hinder, delay or defraud a creditor) was often unavailable and direct proof of such intent was problematic, U.S. courts relied on so-called "badges of fraud", or indicia of fraudulent intent, as evidence of actual fraudulent intent. Different courts gave different weight to such badges of fraud. The UFCA sought to minimize jurisdictional differences in treatment of badges of fraud by providing that proof of certain combinations of facts would conclusively establish fraud. Evidence of actual intent was to be relied on in the absence of evidence of the existence of facts constituting badges of fraud. I’ll discuss badges of fraud in greater detail in a moment. The UFCA also eliminated the requirement that a creditor must obtain a judgment or execution returned unsatisfied before seeking by other means to avoid a transfer as fraudulent. By 1978, bankruptcy law in the U.S. had changed in ways that caused federal bankruptcy law dealing with fraudulent transfers and obligations to be at odds with provisions of the UFCA. Debtors and trustees were able to avoid foreclosure of property interests by invoking fraudulent transfer provisions under the Bankruptcy Reform Act. Additionally, the Uniform Commercial Code had substantially modified rules regulating transfers of personal property by facilitating the making and perfection of security transfers against attack by unsecured creditors. Also, by 1983, the Model Rules of Professional Conduct (for lawyers), adopted in 1983, contained provision forbidding lawyers to counsel or assist a client in conduct that the lawyer knows is fraudulent. For these and other reasons, the UFCA was significantly overhauled by the National Conference of Commissioners on Uniform State Laws in the late 70s and early 80s. The result was the (renamed) Uniform Fraudulent Transfer Act, approved and recommended for enactment in the States in 1984. Bill
- The list of badges or indicia of fraud contained in the UFTA is, according to the Drafting Committee, a non-exclusive catalog of factors appropriate for consideration by courts in determining whether a debtor had actual intent to hinder, delay or defraud…creditors. Proof of one or more factors may be relevant evidence as to debtor’s intent without creating a presumption of fraud, but proof of certain combinations of factors can demonstrate fraud conclusively. Consider these activities: Transfers to insiders- Salomon v. Kaiser, 722 F2d 1574 (2 nd Cir 1983): insolvent debtor’s purchase of houses in spouses name and creation of dummy corp to hide assets held to evidence fraudulent intent Retention of possession- Transfer concealed- Walton v 1 st Nat’l Bank, 13 Colo. 265, 22 P. 440 (1889): agreement between parties to conceal a transfer from public said to be one of the strongest badges of fraud Debtor sued or threatened- Pergrem v Smith, 255 SW2d 42 (1953 Ky): transfer in anticipation of lawsuit deemed to be a badge of fraud; transfer held fraudulent when accompanied by insolvency of transferor who was related to transferee Transfer of substantially all assets- Cole v Mercantile Trust Co., 133 NY 164 (1892): sale of all inventory of insolvent retailer in one transaction held fraudulent Debtor absconded- 1912 NY case held that a debtor who collected money and other property with intent to abscond showed fraudulent intent Bill
- (7) Inadequacy of consideration an indicator of fraudulent intent but typically not held fraudulent without other badges also having been shown I bring these various indicia of fraudulent intent to your attention so that, as you evaluate prospective planning clients, their recent activities and intentions, you will have an intuitive sense as to the propriety of certain client activities. When evaluated in conjunction with the client’s financial affairs and prospects, these indicators often help the advisor paint an accurate portrait of the client BEFORE the client is counseled or assisted. By the way, the case law dealing with the various badges of fraud show different results based on differing facts and circumstances. Typically, in cases where evidence was developed indicating the existence of multiple badges of fraud, the Courts have held that there was a showing of fraudulent intent. In cases where single indicators were found, the Courts often have held that fraudulent intent was not shown. Bill
- Both the UFCA and UFTA provide that transfers made without adequate consideration (or without reasonably equivalent value being given) are constructively fraudulent under certain circumstances. The UFTA follows the Bankruptcy Code’s approach to determining whether adequate consideration has been given as part of a transaction – and eliminates good faith on the part of the transferee as an indicator of whether adequate consideration was given by the transferee. At least one court has stated that the determination of “unreasonably small assets” depends on the intention or reasonable belief of those who direct the debtor, such as corporate managers. (Roxbury State Bank (NJ 1974)). Obtain written opinion from CPA as to client’s ability to carry on biz w/ sufficient capital before engaging in transaction. Determination of insolvency under the UFTA closely follows the approach taken under the Bankruptcy Code. Debtors are insolvent if, at fair valuation, debts exceed assets. Debtors who are generally not paying debts as they become due are (rebuttably) presumed to be insolvent. Assets do not include property that has been transferred, concealed, or removed with fraudulent intent. Debts do not include secured property of the debtor (if lien valid) Conditions 1 and 2 signify constructively fraudulent activity as to PRESENT AND FUTURE CREDITORS. (Section 4, UFTA) Condition 3 signifies constructively fraudulent activity as to EXISTING CREDITORS ONLY (Section 5, UFTA ?) With respect to future creditors, some Courts have drawn a distinction between reasonably foreseeable future creditors and those who are not. Such courts have held that actual intent to defraud can exist only with respect to those creditors who could have been reasonably foreseen by the debtor. While a great deal more time could be spent discussing important details of the UFTA and UFCA, we should also discuss briefly a third source of fraudulent conveyance law, the Bankruptcy Code. Bill
- The Bankruptcy Code was enacted in 1978, effective in 1979. The Code’s fraudulent transfer provisions (Code Sections Roots in the Statute of Elizabeth. The Code carries forward the Statute’s concept of the voidability of fraudulent transfers. (Section 548) The Code also carries forward the concept that transfers made for less than equivalent value are fraudulent if debtor insolvent at time of or rendered insolvent by transfer, or was engaged in business transaction with unreasonably small capital or intended to incur debts beyond ability to repay. A major distinction between the Bankruptcy Code and the UFCA/UFTA is that the Code’s statute of limitations is shorter. (UFTA- 4 years; For transfers made with intent to defraud, hinder… statute is one year after the transfer was or reasonably could have been discovered by the claimant.). Under the Bankruptcy Code, the statute runs one year after filing of the bankruptcy petition (and within 2 years of the earlier of date of trustee appointment or the time the case is closed and dismissed), but the trustee may later avail itself remedies available under state law (with longer limitation periods) Since two principal objectives of prospective bankruptcy debtors are to protect assets from creditors and obtain as broad a discharge of debt as possible, debtors will always want to avail themselves of protections afforded by the Code which provide that certain assets are exempted from creditor claims in bankruptcy. Both federal and state exemptions exist which should be evaluated. Qualified retirement claims are generally exempt from the claims of creditors. In some states, a principal residence is also an exempt asset, though the amount of exemption may vary widely from state to state. In GA, for instance, the homestead exemption in bankruptcy is, I believe, $5,000, while in FL the exemption is unlimited (w/ ½ acre in a municipality or 160 acres elsewhere). Prebankruptcy asset protection planning may focus on conversion of non-exempt assets into exempt assets, and such conversion activities are permissible unless aggregiously conducted with the intent to hinder, delay or defraud creditors. In such cases, the exemption may be denied. There is at times a fine line between permissible and fraudulent conversion activities, and advisors must evaluate prospective actions carefully. Bill
- Those engaging in fraudulent transfers may be subject to prosecution under federal and state law. Fraudulent concealment or fraudulent transfer in a bankruptcy context is a crime (18 USCA Sections 2, 152), and violations of state fraudulent transfer laws may also be a crime. Attorneys may be disciplined, suspended or disbarred for engaging in, or assisting a client to engage in, such prohibited conduct. Those who knowing ly facilitate fraudulent transfers or the hiding of assets from bankruptcy trustees (as agent or principal) may be fined and jailed for up to 5 years. See 18 USC 152(7) . Other potential criminal violations that may arise in conjunction with fraudulent conveyancing activities range from transporting stolen property to evading tax and concealing property, failing to report monetary transactions of over $10,000, defrauding financial institutions and others. Attorneys may be subjected to punitive damages where fraud is shown, though a showing of malice may be required for punitive damages to be awarded. Malpractice insurance usually does not cover criminal or fraudulent acts of an attorney or awards of punitive damages. Creditor remedies available under the UFTA are not exclusive. Creditors may also avail themselves of remedies available under the Bankruptcy Code and/or applicable non-bankruptcy law. Bill
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- Generally, retirement assets (held under qualified plans) are protected from creditors' claims until the assets are distributed. The general rule is riddled with exceptions, however. Retirement assets such as most qualified pension plans are governed by the Employee Retirement Income Security Act of 1974 (ERISA), while non-qualified plans and plans such as IRAs, simplified employee pension(SEP) plans, and single-owner qualified plans are not subject to ERISA. Since IRA accounts and certain other tax-qualified retirement plans to which the employee contributes funds and of which the employee is the sole beneficiary during life are not protected from creditors by ERISA, those assets can only be protected from creditors to the extent of existing state exemptions or if additional asset protection planning takes place. If the plan administrator elects to place plan assets into a single-member LLC, the assets in the plan will have charging order protection and will therefore be afforded some protection from creditors until the assets are distributed. Alternatively, an IRA can be rolled over into a qualified plan (a zero-percent money purchase plan, for example), thereby gaining it ERISA protection. Plan assets may also be afforded protection in a bankruptcy setting pursuant to the provisions of Section 522 of the Bankruptcy Code. Retirement assets can be moved offshore to make it harder for domestic creditors to reach them. In fact, many ERISA plans have the power to transfer assets offshore, so that they function much like offshore trusts. However, it is important to consider all the implications of moving assets offshore before such a dramatic step is taken. One important factor to consider is that naming a foreign trustee for retirement trust assets may cause certain types of plans to lose their tax-deferred status. Scot
- The law favors free alienation of property by owners subject to conditions the owners determine to be appropriate. Assuming no violation of law or public policy, the owners’ desires are generally enforced. A Spendthrift clause in a trust is a restraint on alienation created by the property owner (trust settlor). The clause prevents the trust’s beneficiary from transferring his interest in the trust. Since creditors step into the shoes of the trust beneficiary, the creditors are similarly restrained and, least in theory, cannot transfer and dispose of the interest. Protection does not extend, however, to property already distributed from the trust. Such clauses are consistent with the general notion that owners have no obligation to make their wealth available to their intended beneficiaries’ creditors. Bill
- Although no specific language is required to create a spendthrift trust, the trust instrument must, when examined in its entirety, reflect the settlor’s intention to create a spendthrift trust, and the trust itself must itself be valid under state law. Spendthrift clauses can be customized to fit a range of circumstances and client desires. A spendthrift clause can apply to corpus, or income; it can have a term of years or last for a beneficiary’s lifetime; the term can be modified upon agreement of various parties; it can be drafted to allow the beneficiary to take the property or some portion thereof at the end of the term (and still be valid and protective in the meantime. Practice tip: Spendthrift clauses should not be drafted to pay corpus after the beneficiary’s death to his estate. In so doing, protection against creditor claims may be lost. Restraints on alienation are valid only if protection is afforded the beneficiary. If the beneficiary has no entitlement to corpus at any time, a spendthrift clause seeking to restrain alienation of corpus will be invalid. One must also be cognizant of the fact that, in at least one state (NH), such clauses are considered violative of public policy. That state suggests that it is improper to protect a beneficiary’s interest while, at the same time, allowing the beneficiary to enjoy the fruits of a trust without bearing any responsibility to creditors. Bill
- … and cannot be reached by creditors and is excluded from the beneficiary’s bankruptcy estate (and is therefore protected from creditors in a bankruptcy proceeding) Though protective trusts can shield trust assets from most creditor claims, certain preferred claims can pierce the protective shield, such as: Claims for alimony, federal taxes, child support, reimbursement for necessities furnished to the beneficiary and others Trusts sited in certain foreign jurisdictions will not honor some of these preferred claims. Trusts having beneficiaries who can exercise so much control and dominion over a trust that they can pull assets freely from the trust (at will) will be treated as self-settled trusts. As such, the beneficiaries are not afforded spendthrift protection. So, even in states where spendthrift clauses are generally upheld as valid, care must be taken in the design of trusts not to give beneficiaries so much control that the statutorily afforded protections will disappear. Bill
- Persons who create trusts, acting as both grantor or settlor and beneficiary thereof, or who maintain significant power or control over the trust and its assets, are considered to have created “self-settled” trusts. Bill
- The Georgia Code recognizes generally the validity of spendthrift provisions. Following the majority view, Georgia law does not afford spendthrift protection for the settlors of self-settled trusts (that is, trusts under which the Grantor or settlor is also the beneficiary). Though O.C.G.A Section 53-12-28 recognizes spendthrift clauses, that Code section also contains significant exceptions. Bill
- As previously noted, Georgia is one of only two states in the nation that do not afford spendthrift protection against tort judgments rendered against a beneficiary. Clients considering the use of Georgia trusts who have APP needs must be counseled as to the limitations on spendthrift protection in Georgia. Client circumstances must be carefully evaluated and trust instruments carefully crafted in light of such express limitations. Bill
- While spendthrift clauses are commonly incorporated into trusts as a protective measure, they sometimes do not provide the level of protection needed or desired. Other provisions can be added to trusts to enhance the trust’s effectiveness from an asset protection standpoint. For instance: A trust can be designed so that interests shift on the occurrence of certain events. The trust may shift its terms, its beneficiaries or even its purpose under defined circumstances. Spendthrift trusts may shift into support trusts, blend trusts or discretionary trusts. Discretionary trusts can shift into virtually any other type of trust, and support trusts can shift into discretionary trusts. Of course, if a beneficiary retains less of an interest or no interest after a shift, the greater the ability of the beneficiary to avoid creditor attachment of the interest. It may be possible under certain circumstances for the beneficiary to retain a limited power of appointment over the interest after the shift. One way to protect assets if a spendthrift clause is found to be ineffective is to terminate a beneficiary’s interest on the occurrence of a particular event. In an asset protection setting, the triggering event is often the insolvency of the debtor, or an attempt by a creditor to attach the beneficiary’s interest in the trust. Forfeiture of interest clauses have been found to be effective against tenacious creditor claims, including, in at least one case (9 th Circuit, the Fitzsimmons case), tax liens. (Remember 11 USC 541c2- protected in bankruptcy court if protected from creditors under local law) It may also be possible to enhance protection of a beneficiary’s interest by shifting the interest away from the beneficiary upon the occurrence of a specified event, while affording the beneficiary some retained interest or control. It is important to note that the interest retained must be tenuous in nature- the beneficiary should not be able to compel the trustee to make distributions from the trust. While cases have upheld the validity of trusts which shifted from spendthrift trusts to discretionary trusts under specified conditions, it has also been suggested that where the beneficiary is the ONLY discretionary beneficiary after the shift, no addit’l protection will be afforded. (Trust remained a spendthrift trust which, under local law, afforded no protection- Industrial Natl Bank v Budlong, 106 RI 780). Another case equated the forfeiture mechanism with a spendthrift clause and ruled the trust ineffective against fed tax liens as “offensive and disruptive to federal law”… U.S. v Riggs Natl Bank Bottom line: Be careful to evaluate client circumstances before structuring shifting trusts w/ retained interests. Bill
- A personal trust is one that affords its beneficiary non-assignable rights to use specific trust property. Since the right is specific and limited, and non-assignable, the trust interest may be effectively protected against attack from creditors. While such a right granted in trust may, on its face, appear attractive, its use in practice tends to be limited because of the relative inflexibility of the tool. For instance, the settlor may wish to create a personal trust for the benefit of a child, granting the child the lifetime use of a particular vacation home. If the child later in life desired to sell the vacation home and move to a nearby retirement village, she could not do so under the terms of the protective trust. A blend trust is a trust created for a group of beneficiaries, like members of a family, whose interests are inseparable. Under such a trust, the interests of the beneficiaries are blended in such a way as to make it impossible for a particular beneficiary’s interest to be defined. No beneficiary can ever alienate or claim any particular portion of the trust. Under such a trust, the trustee typically has complete discretion to make distributions to anyone in the class, or may exclude anyone in the class. Under blend trusts, if a beneficiary’s interest can be defined, it can be attached by creditors. If the trust is drafted to look and smell like a self-settled trust, creditors will be able to reach the settlor/beneficiary’s interest. If the trust creates identifiable vested remainder interests, those interests may be attached by creditors of the interest holder. If the class is itself indebted to a creditor, the aggregate interest of the class may be attached. GA Case instructive: Henderson v Collins 245 Ga 776 (1980) Bill
- 1) Trust provisions are often incorporated to facilitate a suspension of distributions under certain circumstances or upon the occurrence of specified events. One provision that we have frequently seen is a provision which permits the trustee to suspend distributions to a beneficiary if the trustee has reasonable grounds to believe that the beneficiary has a substance abuse problem. In this case, the trust is designed to protect the beneficiary not against the claims of third party creditors but against HIMSELF. When circumstances change to the trustee’s satisfaction, distributions may resume. Case law has generally upheld the validity of such provisions, even against the claims of third party creditors. See, e.g., Murphy v Delano, 95 Me. 229 (1901), where the trustee of a trust was given the authority to hold property in trust for the benefit of a beneficiary (until age 30) for so long as the trustee believed it to be in the best interest of the beneficiary and his heirs to do so. The court upheld the validity of such a provision against the claims of the beneficiary’s creditors. Provisions of a trust suspending distributions and later reinstating the beneficiary’s rights can be valid if the trustee’s discretion is broad and distributions may be suspended indefinitely. If the exercise of the trustee’s discretion is limited merely to time and manner of payment, but trustee may not withhold distributions to the beneficiary indefinitely, the beneficiary's interest may be attachable by creditors. 2) Where a trust imposes conditions precedent to distributions being made, the Courts have generally found such clauses to be effective against creditors. Where a beneficiary was required to be solvent before distributions could be made to him, the condition precedent of solvency prior to distribution was found to be valid as not defeating the intention of the settlor in Blardone v. McConnico (a 1980 Texas case) . However, after the condition precedent has been met, creditors may generally attach a debtor’s trust interest. 3) Finally, the power given in a trust document for the trustee (and, preferably, a third party unrelated to the beneficiary) to extend the term of a spendthrift trust may prevent the trust interest of the beneficiary from becoming part of a bankruptcy estate Bill
- Discretionary trusts are trusts under which the beneficiaries may receive distributions only in the discretion of the trustee. Under such trusts, there is no entitlement to distributions, and in theory beneficiaries may receive nothing. Beneficiaries of purely discretionary trusts are dependent upon the broad discretion of the trustee to make distributions to them. As such discretionary trusts should be utilized only where there is a high degree of confidence on the part of the settlor that the trustee will act in the beneficiary’s best interests. From an APP standpoint, properly drafted discretionary trusts can afford a relatively high degree of protection to beneficiaries from claims of their creditors. The high degree of protection derives from the tenuous or speculative nature of the beneficiary’s trust interest. The beneficiary cannot force the trustee to make distributions to him or for his benefit. Creditors stand in the shoes of the discretionary beneficiary. Sale of a discretionary trust interest is, therefore, typically problematic, and the creditor has no remedies against the trustee. A trust qualifies as a truly discretionary trust only if the trustee has the power NOT to make distributions. If the trustee’s power is permissive, that is, exercisable solely in accordance with the trustee’s discretion, property controlled by the trustee will be effectively shielded from creditor claims. If, on the other hand, the trust mandates that the trustee’s discretion be exercised within certain parameters but on a mandatory basis (for example: exercising discretion with regard to the health and support needs of the beneficiary, some or all the protection may be lost. The creditor stands in the shoes of the beneficiary and may demand that distributions be made for, in this example, the beneficiary’s health and support. Debts incurred for such purposes would be obligations the trustee is required to discharge. See, e.g. Martin v Martin, 54 Ohio St. 2d 101 (1978). Factors that weigh on the determination whether powers are permissive or mandatory include: (1) The extent of discretion set forth in the trust; (2) the existence of a definitive external standard by which the trustee’s actions may be judged; (3) The surrounding circumstances; (4) The trustee’s motives; and (5) Evidence of a conflict of interest. Scott & Fratcher, The Law of Trusts Section 188 at 14 (4 th ed 1987). Bill
- Several states have, within the last decade, enacted legislation to permit the creation of domestic self-settled trusts which ostensibly afford spendthrift protection to the settlor. Whether these statutes can provide the same sort of protections available offshore to settlors of certain foreign trusts remains to be seen. Early indications are that they can provide modest protections. Generally, self-settled domestic trusts under which the settlor retains any interest cannot insulate assets from the claims of creditors of the settlor. Recent legislation attempts to provide such insulation, at least from some creditor claims. Each state statute affords protection from creditor claims in the courts of that state. Each state’s protections are limited and should be examined carefully. Several of the states have abolished the rule against perpetuities and all require some or all trust assets to be located in that state and mandate that a local trustee or Co-Trustee be employed. Trust admin should be conducted in that state (in some cases, it’s a requirement). Greater protection exists where the settlor is also a resident of the state. In this latter regard, it should be noted that, while the general rule is that laws of the state of the situs of the trust controls the extent to which interests can be reached by creditors, other states having relevant contacts and jurisdiction may choose to ignore foreign law as violative of their own public policy against affording protections in self-settled trusts. If the forum is federal court in a diversity action, the law (and public policy) of the forum state will control. In a bankruptcy setting, either the law of the forum state or the law of the state having the most significant interest in the litigation will control. In any case, if a trust settlor wishes to enhance prospects that spendthrift protection will be afforded the settlor’s self-settled trust, the settlor should maintain significant contacts with the state of the trust situs and even consider locating his domicile in that state, preferably before trouble arises. Again, these state statutes should be examined carefully by the advisor when evaluating asset protection alternatives for clients. Each affords unique opportunities for protecting client assets domestically and without some of the potential problems, expense and geopolitical unknowns sometimes associated with foreign planning. Notwithstanding the foregoing, the advisor must always remember that federal law preempts state law as a general principal, and reliance on state-created solutions may at times be ill-advised. Absent a treaty, however, federal law will not preempt foreign law…. Bill