In December 2012, Ohio passed legislation making it the most recent state to jump on the domestic asset protection trust (“DAPT”) bandwagon. Expected to be signed by the governor next month, Ohio’s new law will create the “legacy trust” with asset-protective provisions favoring the use of trustees and banks in Ohio. However, as with DAPT legislation in other states, caveat emptor is the guiding principle here. Clients utilizing Ohio legacy trusts for asset protection purposes are likely to be sorely disappointed with their promised efficacy, and their attorneys could face professional malpractice liability for recommending the Ohio legacy trust as an asset protection planning device.
Ohio Law Ineffective as to Non-Ohio Judgments
To understand why DAPTs such as the Ohio legacy trust are destined to fail, it is important to consider the general criticism leveled at DAPTs since Alaska first brought forth its groundbreaking DAPT legislation many years ago. The most profound weakness of a DAPT is that the Full Faith and Credit Clause of the U.S. Constitution obligates a state court to recognize and enforce the judgments granted by another state’s court. An Ohio court would not be able to refer to protective provisions of the Ohio legacy trust law in the face of another state’s judgment that a transfer to the legacy trust was a fraud on creditors by the trust settlor or the trustee.
In the face of this criticism, many legal commentators have considered that DAPT laws in states such as Nevada, Alaska, or Delaware would only protect residents of those respective states. For example, if a resident of Illinois settled an Ohio legacy trust, an Illinois court could nevertheless ignore Ohio law and grant a judgment against the trustee or the trust assets under Illinois law. In comparison, some lawyers theorize that an Ohio resident settling an Ohio legacy trust would not be less likely to suffer a judgment from a non-Ohio court.
Yet, we all know how easy it is for an out-of-state creditor to obtain diversity jurisdiction against an Ohio resident in Federal court. A number of analysts are convinced that the Ohio legacy trust law can therefore only protect assets of (i) an Ohio resident against (ii) an Ohio-resident creditor where (iii) both the trustee and the trust assets are uniquely situated in Ohio. Threading this needle strains credulity.
No Protection in Bankruptcy
Even assuming the perfect set of facts by which the Full Faith and Credit Clause might not be invoked in a creditor action, recent rulings in Alaska and Hawaii show just how vulnerable DAPTs are to bankruptcy. (See Battley v. Mortensen, Adv. D.Alaska, No. A09-90036-DMD, May 26, 2011; In re Zukerkorn, 2012 WL 6608887 (9th Cir.BAP (Cal.), Dec. 19, 2012)). In the United States, bankruptcy is a Federal law; while each state has its own insolvency and receivership statutes, bankruptcy is strictly a matter of Federal law. Section 548(e) of the Bankruptcy Act includes a 10-year clawback for assets transferred by the bankrupt settlor into a spendthrift trust. Ten years is a very long time to wait and obtain certainty regarding the protection of one’s assets.
Traditional Spendthrift Trusts are Better than DAPTs
In fact, when we line up all the weaknesses with DAPTs, we find that they offer very little advantage to trust settlors. By contrast, trust beneficiaries continue to enjoy all the protections that they have always enjoyed under existing spendthrift trust laws in most states. In other words, DAPT legislation appears to be aimed more at propping up the bogus marketing efforts of trust companies and lawyers peddling vacuous promises of asset protection for trust settlors, when trust settlors could save themselves a lot of money by simply settling traditional spendthrift trusts to protect trust assets from the reach of beneficiary creditors. Because the traditional spendthrift trust offers certain protection for trust beneficiaries, and such trusts are substantially cheaper and easier to manage than DAPTs, we consider the traditional spendthrift trust to be superior to the DAPT. Put succinctly, Ohio’s legacy trust law is a waste of time and money.
Comparing DAPTs with FAPTs
As far as protecting trust assets from the settlor’s creditors, there simply is no substitute under domestic law for the foreign asset protection trust (“FAPT”). Let’s list out the advantages:
- With a DAPT such as the Ohio legacy trust, you may have some arguable protection if you and your creditor are solely Ohio residents, and if your dispute is governed solely by Ohio law, and if your trustee and trust assets are located entirely within the borders of the State of Ohio. With an FAPT such as the Swiss-Belize hybrid trust, you have immediate protection on the very first day that you settle the trust.
- Even if your DAPT satisfies all the conditions listed in #1, above, your DAPT assets are still vulnerable in bankruptcy. If you don’t file for bankruptcy, your creditors may nevertheless file an involuntary petition in bankruptcy against you, dragging your assets into the jurisdiction of the Federal Bankruptcy Court. In the alternative, if you use a FAPT such as the Swiss-Belize hybrid trust, your trust assets are immune to the reach of the bankruptcy court. You may not get a discharge in bankruptcy, but you will still have your assets!
- FAPTs are cheaper to set up and maintain than DAPTs, and they offer as much flexibility as a traditional spendthrift trust.
- How many published court cases feature a “tried and true” DAPT? Count two, and both bode badly for DAPTs. By comparison, FAPTs have been used successfully for generations. The Cook Islands has over two decades of case law confirming the efficacy of FAPTs formed in that country.
- DAPT legislation such as the Ohio legacy trust law contain a built in “bomb” meant to coddle the Ohio banking industry and the Ohio bar. Simply put, you must use an Ohio trustee in order to enjoy the protection (whether such protection actually exists is a separate issue) of Ohio law. If you move to another state, you can forget about replacing your Ohio trustee with someone closer to your new residence. Likewise, if your attorney/trustee picks up and moves out of Ohio, you may be compelled to switch trustees involuntarily. Changing trustees amidst trust litigation is virtually impossible to do, meaning that simply doing nothing could result in the loss of protection under Ohio law.
- In line with the observations in #1 and #5, if you set up an Ohio DAPT, you best not move out of Ohio. Forget about becoming a resident of a warm-weather, low-tax state such as Texas or Florida, or living closer to your grandchildren in Oregon .
- One issue that is not yet ripe, but which we expect to affect the DAPT industry in the coming years, is trustee liability. Under trust law, the trustee is personally liable in the event of a fraudulent transfer. While most domestic trustee companies assume that they will just return the settlor’s assets to the creditor and wash themselves of the liability, that liability may remain unsatisfied if the assets have diminished in value or have been exhausted. For this reason, many domestic trustee companies are extremely particular as to which clients they accept. Still, we have not yet seen a domestic trustee held liable under new DAPT legislation, but it is coming and, when it does, clients in high-risk occupations (e.g., doctors) or with potential claims may find themselves unable to avail themselves of domestic trustee services. We also expect many banks that serve as DAPT trustees to be compelled to withdraw from servicing DAPTs.
Those attorneys who are familiar with our approach to asset protection understand that we favor the approach that utilizes domestic planning whenever possible. We only recommend going offshore when the same result cannot be obtained under domestic law. Unfortunately for even Ohio residents, the Ohio legacy trust law simply does not work, nor do the DAPT laws in any of the other 12 states that offer them. We are great fans of Ohio’s LLC law and believe that Ohio attorneys and their clients would be better served using an Ohio LLC in combination with an FAPT “member” of the Ohio LLC. It produces a superior result to the Ohio legacy trust.
For more information on the Alaska and Hawaii rulings, or to learn about how you can better protect assets with an FAPT, please visit our “Contact” page and drop us a line!