About Asset Protection Trusts

Asset Protection Trusts (APT's) can protect your hard worked for assets but only if carefully set up in the right place and at the right time - Read on to find out more!

In view of the topical nature of asset protection trusts (APT's), it has been decided that it should be dealt with separately from general or traditional trusts. In basic structure, an APT is merely a specialist vehicle protecting the assets of those in volatile business and/or professional areas. It is perhaps not surprising that the main market for such structures is in the United States where the litigious nature of its society has resulted in crippling indemnity insurance for doctors and lawyers, an ever increasing spiral of court awards, together with significant and growing probate problems. For these reasons this Chapter has been written with American citizens and residents in mind. However, the basic concepts can be extrapolated to benefit those in other jurisdictions.

A NON-U.S. ASSET PROTECTION TRUST - WHY ?

There is no doubt that the United States is one of the worlds most sophisticated trust jurisdictions. Certainly, trusts can be established to separate a Settlor/Grantor from chosen assets and such a separation may well be valid and of some use. However, it is suggested that even the best thought out indigenous trust will suffer from inherent limitations, including: (i) that local trustees can be subject to direct pressure from United States courts and can be readily subject to a subpoena to supply information on the trust assets, (ii) it is far easier for a U.S. trust under creditor attack to be set-aside than one established abroad, (iii) confidentiality is very difficult to maintain, and (iv) attacking a foreign APT will cause significant difficulties and delays, the cost of which would probably prevent frivolous or vexatious creditor actions. At this stage, it should be noted that foreign APT's should generally not be established to obtain tax advantages. In fact, all Internal Revenue Service rulings are normally rigidly adhered to, with all income received by the named or unnamed beneficiaries being declared on the appropriate tax returns. The reason that such emphasis is given to keeping the tax status quo, is that not to could create severe problems with the IRS, resulting in the legality of the original disposition being called into question. Obviously, if that happened then it is possible that the sought after protection of the trust would dissipate. It should further be noted that all reports to the IRS are strictly confidential and that neither it or the Treasury disclose information to the public.
 
ADVANTAGES

• Protects your assets from unsubstantiated claims.
• Affords a high level of privacy.
• Very difficult for a U.S. court to enforce judgement.
• The fact that the trustees existence is not in the public domain.
• The Trustees' need not be U.S. residents.
• The foreign trustees should be the only legal entities with specific knowledge and control over the trust assets and investments.
• Banking should be outside the U.S. in an area with established confidentiality.
• The offshore trust will be able to create its own foreign investment corporations that need not declare end beneficial ownership.
• The trust could be an ideal mechanism for offshore investments. Such investments providing extra security for the simple reason that the assets will be outside the U.S.
• An offshore trust can have an 'anti-duress' or 'flee' clause to prevent any U.S. based trustee/protector from acting as a catalyst for a U.S. court order.

REQUIREMENTS FOR A VALID DISPOSITION

In most States in the United States it is recognised that there is a clear distinction between probable and possible future creditors. Obviously, if at the time of the settlement it was probable that there would or could be creditor action, it is likely that a U.S. court could seek to set-aside the trust. This would not be the case however, if it was a mere possibility that there could exist a future creditor action but that at the time of the original disposition it could not have been reasonably foreseen or expected. Then a court, subject to sufficient private assets being maintained by the Grantor to meet all reasonably foreseeable debts and/or liabilities, would be very unlikely to ascribe any malfeasance to such an act (See Hurlbert v. Shakleton 560 SoZd 1276, Florida Appeals Court, 1990). Of course, each State must be considered individually, nevertheless, the following are generally considered universal:

(i) There must not be any fraudulent intent at the time of the disposition.
(ii) There must be no future fraudulent intent.
(iii) The Grantor must maintain sufficient assets to meet all existing debts and liabilities, including those that could be reasonably expected in the future.

SEPARATING OWNERSHIP FROM USE

A number of US law firms employ "Limited Partnerships" as a method of providing de facto control to Grantors over transferred APT assets. Of course, it could be argued on basic trust principles that such empowerment will prevent the trust assets from being legally transferred to the trust instrument. However, at present there seems to be little case law to provide any definitive answers. The logic of the law firms concerned appears to rest on a combination of separating "ownership" from "use" and reliance on the anonymity of the structures employed. To many clients these semantics are of little concern provided they feel comfortable and secure with the "veil" of ownership. Nevertheless, many lawyers feel that whilst considerable arguments cold be put forward such structures must go against the "spirit" of trust law.

DIAGRAM - SEPARATING OWNERSHIP FROM USE

TRUST LOCATION

Obviously in establishing a foreign APT one has to be very careful as to which jurisdiction is employed. With the growing use of these mechanisms many countries have introduced special asset protection legislation to attract the APT client. However, it should be noted that it is not merely the APT legislation that should be considered but also the general reputation of the territory concerned. Also, there is an argument that it may be better to use an ordinary discretionary trust in a highly respectable and conservative trust jurisdiction such as Jersey. The logic being that such structures will not immediately draw third party attention to the intended modus operandi. Nevertheless, the general consensus is that it is better to go for areas which have specifically introduced legislation to 'protect' Grantors/Settlors from creditor actions.

EXAMPLE JURISDICTIONS WHERE A.P.T. LEGISLATION EXISTS

THE COOK ISLANDS: The Cook Islands are located in the South Pacific with close historical connections to both the United Kingdom and New Zealand. The legal system is based on English common law whilst company legislation is primarily based on the New Zealand Companies Act, 1970-1971. The population is about 21,000. The capital is Rorotonga (population 8,500) economically and socially stable.
Asset protection trusts are governed by the International Trusts Act, 1984 (Amendments 1989 and 1991). To benefit from this legislation one must either have an existing company (foreign or domestic) registered under the International Companies Act (1981-1982) or a direct trust. The trust must be registered with a local and licensed trust company and have an approved trustee. The beneficiaries cannot include local residents.

TRUST LAW OBSERVATIONS: Indigenous legislation has specifically modified traditional English and New Zealand common law principles in order to make the jurisdiction more attractive to international tax and asset protection advisors. Some of the more interesting of these modifications include:

• It is possible to circumvent the rule against perpetuities for up to 100 years.
• A local trust will not be deemed invalidly settled simply because it has not satisfied the rules and regulations of the Grantors' place of domicile and/or residence.
• A Grantors bankruptcy will not invalidate the trust, unless it can be shown by a creditor 'beyond all reasonable doubt', that the trust was settled with a fraudulent intent AND that as a direct result of such settlement he was unable to meet the creditors demands.

BASIC CHARACTERISTICS OF AN OFFSHORE ASSET PROTECTION TRUST

To ensure the effective operation of an APT, it is vital that the correct people in the correct jurisdictions are instructed to act in the trustee and protector capacities. In particular, it is essential to remember that the Grantor or Settlor should not have any direct control over the trust assets and that trustees are seen to have and actually do have full autonomy and do not slavishly follow the Grantor instructions or a 'Letter of Wishes' (see Introduction Chapter of Section 1). Once again, if one is not careful, it is possible that a court could deem that the trust had not been legally settled. Examples of some of the most important characteristics would include:

• The trust should be registered by a non-U.S. firm to ensure that both the U.S. courts have no jurisdiction and that confidential 'discussion' or 'advice' documents cannot be sequestrated. Remember, that whilst an attorney will benefit from professional privilege, few attorneys have direct connections with foreign trust firms and may use indigenous agents.
• The trustees should be non-U.S. residents to prevent direct pressure being implemented by creditors and/or the U.S. courts. In addition, the foreign trustees must be the only entities with full information on trust assets and investments and with complete and independent control over the aforementioned.
• Any U.S. based 'protector' should be a trusted attorney to ensure 'professional privilege'.
• It is generally recommended that the trust should be of a discretionary nature to allow for flexibility.
• The trust should have an 'anti-duress' or 'flee' clause to ensure that the U.S. courts cannot seek to aPPty indirect pressure on either   the Grantor or protector by holding them in contempt of court. In other words, should a U.S. court try and enforce a disclosure judgement against the above, then the 'anti-duress' clause will come into effect and prevent the trustees from following such instructions. Normally, this would take the form of a specific clause in the trust instrument, preventing the foreign trustees from acting on any advice/instructions that they believe were either made under duress or could cause a breach of their fiduciary duty. The fiduciary duty, of course, being that expected from trustees in their place of residence and/or that of the residence of the trust, but specifically not that expected from a U.S. resident trustee.
• The trust should maintain all bank account facilities outside the U.S., preferably in an area with banking confidentiality. The account need not necessarily be in the same location as the trust.
• Liquid assets should be maintained outside of the U.S. whilst as many investments as possible should likewise be out of the country.
• To keep as much confidentiality as possible Limited Liability Companies are often employed to directly own U.S. based assets. In States such as Delaware it is only necessary to register a Certificate of Formation which need not disclose any 'ownership' details. The only people that will be aware of the trusts ownership and control of the asset(s) will be the I.R.S. The specific reason for a LLC rather than an incorporation is that the I.R.S. treats these entities for tax purposes as 'partnerships' and hence will not create a separate requirement to file accounts at the end of the financial year ( See Delaware Limited Liability Act, 1992, and Revenue Rulings 93-38, 1992 ). Of course, notwithstanding the tax treatment, the LLC is still a genuine limited liability company providing the best of both worlds.

DIAGRAM - BASIC ASSET PROTECTION TRUST

♦ A Grantor can retain wide powers over the transferred assets without fear of the trust being deemed invalid under Cook Islands law. However, note that this very power could cause difficulty if the Grantor resides in the same jurisdiction as his assets. The normal preventative measure would be to introduce an 'anti-duress' clause into the original settlement.
♦ The fact that other jurisdictions do not recognise indigenous trust law or that the employment of the trust could circumvent civil law concepts such as the 'Legitima Portia' Principle will not be cause to set the trust aside.
♦ Even in cases where it can be proved that the trust was established with a fraudulent intent, this will not invalidate the trust, but mean that the proportion of the assets necessary to satisfy the applicable creditor will simply be paid, with the balance continuing to enjoy full trust protection.
♦ All professionals, including bankers and government bodies, are under a strict code of confidentiality.
♦ All APT's with non-resident beneficiaries have no local tax obligations, although government duties are payable.

CYPRUS: The fourth largest of the Mediterranean islands, politically and ethnically divided between Greeks in the South and Turks in the North. However, as a result of the illegal invasion by Turkey in 1974, only the Greek Republic of Cyprus is recognised by the United Nations. It is this part of the island which can afford significant trust benefits. The population is approximately 580,000. The capital city is Nicosia. Since 1974, the island has been relatively stable and is actively seeking membership of the European Union. The legal system is based on English common law, with company law being an almost direct extrapolation from the British Companies Act of 1948.

Asset protection trusts are governed by The International Trusts Law, 1992 and are quite separate from indigenous trust law. To benefit from this legislation neither, the Grantor nor the beneficiary must permanently reside in Cyprus. However, the trust must be registered with a local and permanently resident trustee. Foreign trustees may be appointed, but at all times there must be at least one local involved.

TRUST LAW OBSERVATIONS: As with the Cook Islands, Cyprus has deliberately established APT legislation to attract international tax and trust advisors. The proximity to mainland Europe and it's relative state of development, in comparison to other competing jurisdictions, may prove attractive. Nevertheless, there do not exist the same provisions to allow for the almost direct control of trust assets by the Grantor. Specific benefits afforded by a Cypriot APT would include:

• A trust can exist for a maximum time period of 100 years and, thereby, circumventing the traditional rules relating to perpetuities.
• Unlike indigenous trust law, there are no restrictions on the type of legal investments that can be made,subject only to the standard fiduciary responsibilities.
• A local trust will not be invalidly settled simply because it has not satisfied the rules and regulations of the Grantors' place of domicile and/or residence.
• A Grantors bankruptcy will not invalidate the trust, unless it can be shown by a creditor that within two years of the creation of the trust and 'on the balance of probabilities', that at the time of the transfer or disposal of the trust assets he was a creditor and that there was an intent by the Grantor to defraud.
• The fact that other jurisdictions do not recognise indigenous trust law or that the employment of the trust could circumvent civil law concepts, will not cause the trust to be set aside.
• Cypriot International trusts are completely free of all local taxes, but have to pay an initial registration fee of about US$550.00.
• Cyprus has strict laws relating to confidentiality and any professionals concerned must not release information to any third party, unless so ordered by a Cypriot court.

GIBRALTAR: Gibraltar has been a British Colony since the Treaty of Utrecht in 1713 and is strategically located at the entrance to the Mediterranean between Spain and Morocco. Although it has been part of the European Union since 1973, it is not subject to VAT. The population is 30,000. Gibraltar's legal system is based on English common law, with company law governed by the Companies (Amendment) No.2 Act, 1992. Asset protection trusts benefit from the Bankruptcy Amendment Ordinance, 1990, with amendments thereto by the Bankruptcy (No.2) Ordinance of the same year. As with most similar jurisdictions, tax exemption will only apply if the Grantor and beneficiary(ies) are non-resident and the trust income derives from external sources. In addition, it should be noted that the trustees must be licensed and must register the trust with the Regulatory Bodies, together with a payment of UK£300.00. Also, such trustees are legally obliged to make specific inquiries as to the Grantors solvency and/or anything which may indicate malfeasance. They are required to obtain professional indemnity insurance. The register is not open to members of the public.

TRUST LAW OBSERVATIONS: Whilst Gibraltar has specifically introduced legislation to entice APT's, it is nevertheless trying to protect it's reputation which suffered from a number of scandals in the 1980's. To this end, both trusts and companies are more regulated than in many other jurisdictions. However, it is uncertain what effect this could have on potential clients. Specific benefits afforded by Gibraltar would include:
 

• A trust may have a life span of up to 100 years circumventing the normal limitations as to 'perpetuities'.
• Income from the trust may also be accumulated for a 100 year period.
• A Grantors bankruptcy will not invalidate the trust, unless it can be shown by a creditor that the settlement was made when there existed an actual or contingent liability and that the Grantor had " notice of such a claim or of facts or circumstances which may  render him liable to such a claim ". In Gibraltarese legislation, the   Grantor will not be protected by attesting that   he   had   no   'intent'   to   make a settlement when insolvent or potentially insolvent. The test will be that of the average 'reasonable' man.
• Trustees are under a strict code to protect client confidentiality, unless subject to a court order.
  ? Gibraltar has implemented most of the provisions of the Hague Convention on the law applicable to trusts (1984). In particular,   it   should be noted that Article 15 may prevent
  otherwise valid dispositions from being enforced if it effects: (a) minors, (b) creditors in matters of insolvency, (c) real and personal property relating to marriage, (d) innocent third
  parties acting in 'good faith' and (e) various succession rights.