Asset Protection

Through the Use of Irrevocable Trust

“Offshore" trusts have traditionally been used as asset protections trusts. In the last decade, however, both Alaska and Delaware have modified their trust law to provide asset protection in certain cases. In legal terminology, what these trusts attempt to do is to provide that self-settled trusts that do not provide for a pay out to the settlor cannot be used to satisfy creditor claims.

Throughout virtually all of the United States such as California, creditors of the grantor of a trust can attach its assets if the trustee can distribute trust property back to the grantor. For example, California Probate Code §15304 provides:

(a) If the settlor is a beneficiary of a trust created by the settlor and the settlor's interest is subject to a provision restraining the voluntary or involuntary transfer of the settlor's interest, the restraint is invalid against transferees or creditors of the settlor. The invalidity of the restraint on transfer does not affect the validity of the trust.

(b) If the settlor is the beneficiary of a trust created by the settlor and the trust instrument provides that the trustee shall pay income or principal or both for the education or support of the beneficiary or gives the trustee discretion to determine the amount of income or principal or both to be paid to or for the benefit of the settlor, a transferee or creditor of the settlor may reach the maximum amount that the trustee could pay to or for the benefit of the settlor under the trust instrument, not exceeding the amount of the settlor's proportionate contribution to the trust.

The Alaska Trust Act made significant changes to Alaska law relating to trusts created under that state's law, intended to be of interest to individuals throughout the United States. Alaska law now provides that the assets in such a trust are not subject to the claims of the grantor's creditors, unless the original transfer to the trust was intended to defraud known creditors of the grantor, the grantor is in default on child support payments, the grantor retains the right to revoke the trust or the grantor retains the right (as opposed to the mere eligibility) to receive distributions from the trust.

Hence, an individual may transfer assets to an irrevocable Alaska trust and be a beneficiary to whom the trustee (other than the grantor) can distribute trust property. Yet, the trust assets will not be subject under Alaska law to the claims of the grantor's creditors. (The protection does not apply if the trust mustdistribute income or other assets to the grantor.) This protection from creditor claims applies even if the grantor is the only person to whom the trustee may distribute trust assets and income. If there are beneficiaries in addition to the grantor, this protection from claims of creditors also applies even if the grantor retains the right to veto distributions to other beneficiaries of the trust. The creditor protection also applies even if the grantor retains the right to control where the trust property is to pass upon his or her death. By retaining these veto and control powers, transfers to the trust will not be subject to gift tax when the trust is created. However, retaining either of these powers will cause the trust assets to be includable in the grantor's tax estate at death.

An illustration of the problem arises from a 1999 federal case in the Ninth Circuit, Federal Trade Commission vs. Affordable Media, LLC, 1999-1 Trade Cas. §72,547. The Ninth Circuit includes California, although this case arose out of a Nevada court. In that case, the Ninth Circuit took great pleasure in quoting from an article on offshore trusts.

"Finally, the settlor should be aware that, although his trust will probably prove unassailable by domestic creditors, he may fact minor hassles while defending his trust in court. In particular, if a creditor attacks an offshore trust in United States court, the settlor may face contempt of court orders during the proceedings . . . There is a possibility that the court will . . . order the settlor to collect his assets from the trust an turn them over to the court. If the settlor does not comply with these orders, a court may hold him in contempt. However, there are ways around such a conflict . . . The settlor could comply with the court order and 'order' his trustee to turn over the funds, knowing full well that the trustee will not comply with the court's order, escape contempt of court charges, and still rest assured that his assets will remain protected." [emphasis added]

The Andersons did just that. As stated by the court, the Andersons notified the trustee to turn over the funds. The trustee, as instructed under the terms of the document when he received that request, terminated the settlor's involvement with the trust and declined to turn over the assets.

Then, in the closing words, the Ninth Circuit stated:

"Given the nature of the Andersons' so-called 'asset protection' trust, which was designed to frustrate the power of United States courts to enforce judgments, there may be little else that a district court judge can do besides exercise its contempt power to coerce people like the Andersons into removing the obstacles they placed in the way of a court. Given that the Andersons' trust is operating precisely as they intended, we are not overly sympathetic to their claims and would be hesitant to overly restrict the district court's discretion, and thus legitimize what the Andersons have done."

The offshore trust companies, in reaction to the Affordable Media case, have noted that debate over asset protection and most of them provide a check list of post-Anderson dos or don'ts.

The “Grant Case” (U.S. v. Raymond Grand and Arlene Grant) suggest following the dos and don’ts
may work. In that case the court refused to hold Ms. Grant in contempt noting that she had made significant attempts to repatriate the assets. Illustrative of her attempts the court quotes a letter from the trustee’s attorney which said in part “That any attempted exercise by you of your right to remove our Client as Trustee of the Trust and appoint a U.S. Resident Trustee in this place would not be a valid exercise and would therefore be voided and of no effect, which means that our client would remain the Trustee of the Trust notwithstanding your attempted exercise of your power”.


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