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Asset protection and dynasty trusts
Real Property, Probate and Trust Journal, Summer 2002 by Fox, Charles D IV, Huft, Michael J
Editors' Synopsis: Historically, settlors of trusts were not permitted to remain trust beneficiaries while obtaining spendthrift protection from creditors; however, recent legislation in several states has purportedly permitted this result. This Article examines domestic protection trusts permitted under Alaska, Delaware, Nevada, and Rhode Island Additionally, this Article examines the possibility of creating perpetual dynasty trusts under the law ofseveral states that have abolished the rule against perpetuities or permit trusts to opt out of the rule.
I. INTRODUCTION
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Asset protection in some respects has been a part of estate planning for as long as an estate planning discipline has existed. After all, people create trusts for family members in most instances to preserve and protect property for the future use and benefit of the family members. From this perspective, asset protection is really just an integral part of the primary goal of the estate planner-to provide a structure to pass property, either during life or at death, to a client's designated beneficiaries, while reducing transfer taxes and avoiding other costs and delays.
In today's increasingly litigious environment, however, asset protection planning is becoming increasingly significant as a separate area of focus within the field of estate planning. The essence of asset protection planning is the use of advanced planning techniques to place assets beyond the reach of future potential creditors! In this way, the client can preserve the assets to pass to family members or other beneficiaries through traditional estate planning techniques.
Creditor and liability problems can arise from a variety of sources: (1) Contract Creditors
Creditor threats can arise from contractual relationships such as consumer debt, bank debt, guaranties, and partnership liabilities.
(2) Tort Creditors
The amount of tort litigation in the United States has increased tremendously in recent years.2 Moreover, the potential costs to a party found liable may be dangerously severe. In 1999, for example, the top ten jury awards in United States alone totaled $9.6 billion. In addition, annual litigation-related costs in the United States have been estimated at $300 billion.4
(3) Regulatory Liability
Government has imposed liability on various groups to achieve desirable social goals. One of the best examples of this practice is the liability imposed for the cost of cleaning up environmentally damaged property by the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 ("CERCLA" or "Superfund"),6 as well as other federal and state environmental statutes. CERCLA, for example, gives the Environmental Protection Agency ("EPA") broad powers in the identification and cleanup of contaminated sites and in the recovery of cleanup and related costs from private parties.
Subject to certain limited defenses, liability is imposed without regard to fault on any or all of the liable parties. The liability is not necessarily based on the degree to which the party contributed to the problem, if at all.
The potential costs to a party on whom liability is imposed are staggering. As of August 2001, the EPA counted a total of 1,235 Superfund sites,' and the average Superfund cleanup has been estimated to cost more than $20 million! Significantly, general liability policies commonly exclude environmental liability.
(4) Divorce
(5) Disabled Beneficiaries
A growing topic of concern for many clients with a disabled parent, spouse, or child is how to create a trust to provide for the needs of that disabled relative, without having the trust assets included among the disabled beneficiary's assets for the purpose of determining whether the beneficiary is eligible for Medicaid or other public assistance."
Historically, trusts have been one of the most important, regularly used and accepted asset protection tools available to an individual who seeks to make assets available to a third person beneficiary, but wishes to protect those transfers from the beneficiary's creditors. With respect to the transferor's creditors, for reasons set forth below, trusts have until very recently not been viewed as a useful technique for creditor protection.
II. TRADITIONAL ASSET PROTECTION METHODS
A. Outright Gifts of Property
Outright gifts are a simple way for a client to protect assets from the claims of creditors. Assets that the client gives away are no longer subject to seizure by the client's creditors. However, if the client is insolvent, or would become insolvent by making the gift, the Fraudulent Conveyance statutes, discussed in Part IV of this Article, may impose consequences.
B. Transfer in Trust
Trusts may be the most important, regularly used, and accepted asset protection tool available. For transfer of property by gift, using a trust can alleviate the client's concerns about the beneficiary's imprudent use of the property. In the case of a transfer to a spouse, a trust will provide some protection in case of later divorce. Of even greater importance is the creditor protection that a trust provides to the trust beneficiaries. In most states, a beneficiary's creditors cannot reach trust assets if the trustee's power to distribute trust assets is subject to the trustee's discretion, and the trust has been created, in good faith, by, or the fund so held in trust has proceeded from, a person other than the beneficiary. In many states, the statutory protection from creditors provided by a trust created by another is automatic. In other cases, the trust agreement must specifically prohibit attachment by, or assignment to, a beneficiary's creditors. A spendthrift provision is ineffective in most states where the settlor is also a beneficiary of the trust. In general, the settlor's creditors can reach the trust assets to the extent that the trustee could make permissible distributions to the settlor, whether or not the settlor has the power to compel the distribution.
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