In an increasingly litigious society, it is becoming more and more important for wealthy individuals to protect their assets. This is especially true for individuals in high risk professions, such as medicine and construction. Experts consistently name the asset protection trust as the best legal vehicle for asset protection. In this article, we discuss what works best and we look at offshore vs. domestic trusts for legal asset protection.
Introduction to Asset Protection Trusts
Wealth individuals have used trusts to protect the assets for generations. There are many different types of trusts available. Asset protection trusts are unique in we draft them as self-settled spendthrift trusts. This means that they allow individuals to protect their own assets. This is because one individual may act as the settlor of the trust and a beneficiary at the same time. Many also use asset protection trusts to protect assets intended for beneficiaries.
Trustees are in charge of the distribution of assets you hold within your asset protection trust. In some jurisdictions, the settlor of an asset protection trust may act as a co-trustee. However, the settlor can only make distributions of assets to other trust beneficiaries. Thought the trustee can do so, the settlor of the trust may never make distributions to themselves. Doing so would nullify the protection afforded by the asset protection trust. This is because asset protection trusts protect assets by separating the legal and beneficial interest of those assets.
The settlor of a trust does not have the ability demand distributions of the assets held within the trust. As a result, the settlor’s creditors cannot step into his shoes and demand them either. That is, creditor cannot force the settlor to hand over the assets to satisfy a debt. We call this situation an “impossibility to act” defense. Therefore, the trustee must always be in control of distributions of assets the trust makes to the settlor of an asset protection trust.
A number of jurisdictions worldwide offer asset protection trusts. However, the rules and regulations regarding these trusts vary widely by jurisdiction. As a result, the amount of protection afforded by an asset protection trust also varies by jurisdiction. It is critical to choose the right jurisdiction when settling an asset protection trust.
Domestic Asset Protection Trusts
We commonly refer to asset protection trusts in the United States as domestic asset protection trusts. There are currently 17 states in the US which allow for domestic asset protection trusts. We structure domestic asset protection trusts as irrevocable self-settled spendthrift trusts.
There are a number of reasons for establishing a domestic asset protection trust. One reason that some high net worth individuals choose to establish asset protection trusts is to avoid the claims of creditors. Others do so as insurance against the threat of future liabilities derived from litigation. Doctors, lawyers, and those in construction often do so for this reason.
Other individuals may wish to protect their assets from a spendthrift heir. Many people use asset protection trusts in lieu of prenuptial and postnuptial agreements. They do so for asset protection in the event of divorce. This is not possible, however, in all domestic jurisdictions.
The primary objective in settling an asset protection trust is usually to protect assets. However, you may also use one for other purposes. The irrevocable nature of asset protection trusts means you may exclude trust assets from your (the settlor’s) estate. For this reason, they can be beneficial tools for tax planning.
One may use these trusts to protect many different types of assets. These assets may include, real estate, cash, stocks, bonds, jewelry, family heirlooms, and more. The assets held in an asset protection trust may be located anywhere in the world. However, there are advantages to holding offshore trust assets internationally, as we will discuss.
Advantages and Disadvantages
Domestic asset protection trusts offer many advantages for settlors. However, there are also downfalls which are important to be aware of. First and foremost, domestic asset protection trusts are subject to US laws. This means that a US court of law can enforce nearly any judgment against the assets held within the trust.
Another major flaw of domestic asset protection trusts is the existence of exception creditors in many jurisdictions. An exception creditor is a creditor who has the ability to pierce through the protection afforded by the asset protection trusts. These creditors may include the state and federal government for tax purposes, alimony creditors, child support creditors, and tort creditors. For this reason, domestic asset protection trusts in a number of jurisdictions may not prove useful in the event of divorce. They also have significant limitations when it comes to tax planning. Furthermore, the time and cost associated with filing a lawsuit against the settlor of a domestic asset protection trust is not prohibitive. As a result, plaintiff’s attorneys frequently depose and subpoena trustees of domestic asset protection trusts.
Offshore Asset Protection Trusts
The pitfalls of domestic asset protection trusts described above have caused many Americans to seek offshore solutions for asset protection. Compared with domestic asset protection trusts, offshore asset protection trusts offer many benefits.
Many favorable offshore jurisdictions do not recognize foreign judgments. Trustees in the United States are bound by US laws. The courts can legally force them to release assets in compliance with US court orders. The orders of US courts, however do not bind the trustees of offshore trusts. In some jurisdictions, the law obliges the trustees to ignore foreign judgments. They are also prohibited from distributing assets while the settlor of the asset protection trust is under legal duress. Many jurisdictions require that a creditor be physically present in order to bring a claim. Incidentally, there are no exception creditors in favorable offshore jurisdictions.
Even if your creditor files in an offshore jurisdiction, it is unlikely that the creditor will win. In the majority of favorable offshore jurisdictions, only proven claims of fraudulent transfer will be successful. We define fraudulent transfer as a movement or re-titling of assets made with the expressed intent of delaying or defaulting on creditors. However, this is much more difficult for a creditor to prove than it seems, as you will see.
Burden of Proof
The burden of proof related to fraudulent transfer is much higher in many offshore jurisdictions than in US. In the United States, a creditor only needs to provide clear and convincing that a fraudulent transfer was made. In many favorable offshore jurisdictions, the burden of proof for fraudulent transfer claims is beyond all reasonable doubt. A claim of fraudulent transfer in a favorable offshore jurisdiction has to meet the same burden of proof as a murder case. With a Cook Islands Trust, for example, the creditor also must show that the settlor intended to defraud them specifically. Proof that the settlor intended to defraud creditors in general will not be sufficient.
Another reason that many people prefer offshore trusts over domestic trusts is financial privacy. Since domestic trusts are bound by US law, courts can force trustees to release the personal information of the settlors. Many offshore jurisdictions impose strict laws regarding the confidentiality of trust settlors. The name of the settlor of the trust is not even registered in certain jurisdictions. Only the name of the trust, the name of the trustees, and the date of the trust deed must be registered with the government.
Offshore trusts also work incredibly well for multi-entity asset protection structures. Multi-entity offshore asset protection structures provide the best asset protection possible. A creditor looking to make a claim against assets held within a multi-entity structure would have to pierce through all of the various entities.
Multi-Entity Asset Protection
Here is the most common example of a multi-entity structure used for asset protection. We almost always combine an offshore trust with an offshore limited liability company (LLC). In order to use this structure, the settlor of the offshore trust (in the Cook Islands, for example) must also establish an offshore LLC (such as one in the Caribbean island of Nevis). The trust owns 100% of the membership interest in the LLC. Once the LLC is established, the settlor may transfer assets to the LLC. The settlor is able to maintain control of the assets under normal circumstances. This is done by appointing the settlor of the trust as the manager of the LLC.
If the settlor of the trust finds themselves under legal duress, the trustee can step in and protect trust assets via management of the LLC. This provides full access to the settlor while the waters are calm. Then it makes it easy for the trustee to take protective action while a settlor is under legal duress. That said, they do have the ability to pay bills for the settlor of a trust. They may also make distributions to trusted friends or relatives on the settlor’s behalf. As a result, the settlor has access to the assets held in the offshore trust while their creditors do not.
Another common reason for using offshore asset protection trusts is estate planning. Most jurisdictions do not permit trust that last perpetually. They are limited to a certain number of generations. Offshore trusts, on the other hand, are beneficial for estate planning because many foreign jurisdictions do not have rules against perpetuities. This means that settlors of offshore trusts can plan their estates across several generations.
Offshore vs. Domestic Trusts
So, let’s sum up domestic vs. offshore trusts. Generally speaking, offshore asset protection trusts cost a bit more to settle than domestic asset protection trusts. The higher price is warranted, however, because of the significant increase in security that they provide. The most expensive asset protection strategy is one that doesn’t work. So, it is often better to spend more on an offshore asset protection trust. This is because domestic asset protection trusts often do not provide enough protection to keep valuable assets out of the hands of creditors. The cost of settling an offshore trust is almost always lower than the cost of losing the assets held within a domestic asset protection trust.
To get more information about establishing an asset protection trust, fill out the inquiry form on this page or call the numbers located above. General Corporate Services, Inc. the organization behind Asset Protection Planners, was established in 1906.