Someone once said, “Believe none of what you read and half of what you see,” or something like that. I guess the message is to be cautious and rely only on what you can prove to your satisfaction. A recent article that caught my attention in a popular professional journal (name withheld) is an excellent example of the need to be cautious.
The article’s premise, in no uncertain terms, warns practitioners that “self-settled offshore trusts are increasingly ineffective (emphasis added) in protecting assets from creditors of US citizens, residents, and those settlors with US connections.” The article suggests that in many, if not most, cases, unless the settlor is willing to transfer the trust funds over to the court, establishing such trusts is likely to result in the settlor of the trust being jailed.
In my opinion, this information is quite misleading, if not downright false, and does a considerable disservice to practitioners who may not have more than a bit of experience with “offshore trusts.”
Who Goes to Jail?
The gist of the article is that more and more US courts are punishing US settlors of offshore trusts through a combination of contempt charges and actual imprisonment when the trust funds are not readily available to the court. Unfortunately, the few occasions where this has occurred have all dealt with settlors who have either committed criminal acts or openly defied court orders that they could otherwise have obeyed to avoid incarceration. None of them was your typical doctor, dentist, contractor, or other person simply trying to protect assets from future creditors.
One case of criminally liable settlors who thought they could lie to the court and get away with it was Fed. Trade Commission v. Affordable Media, 179 F.3d 1228 (9th Cir. 1999). It is a rare US trust and estate lawyer who hasn’t heard of Michael and Denyse Anderson, the Colorado couple who spent six months in jail for failing to obey a court order to repatriate funds they placed in a Cook Islands offshore trust. When the court discovered the Andersons were not only protectors of their own trust (and therefore had control), but that they had the power to repatriate the funds, the judge reportedly said, “When you return to court next week, bring the funds from the trust or bring your toothbrush.”
Why the court order of incarceration? Because the Andersons were found guilty of conducting a criminal scam, and most of their illegal proceeds were deposited in their offshore trust. In addition, they lied to the court, falsely alleging that the terms of the trust would not allow them to comply with the court order. Their outright lie and refusal in light of their criminal behavior left the court no alternative. Would it be fair to conclude from these facts, however, that every person who established a trust to hold funds he wished to set aside and protect for his retirement should spend time in jail because someone suing him for a bad business deal couldn’t reach the funds?
The journal article highlights a number of the more popular bad-guy cases. This type of case, made conspicuous and noteworthy by the settlor’s aggressive and uncooperative behavior, often leads to a contempt charge, sometimes jail, and news coverage. Although the more prominent and more notorious cases of thieves and tax evaders have made the news with their offshore trusts and, on the way, have spent time at the crowbar hotel, the more significant fact is that many hundreds, if not thousands, of trusts have been successfully established in various offshore (and onshore) jurisdictions successfully protecting funds without adding at all to the United States prison population.
The Contempt Threat
In all of the more commonly highlighted cases where the settlor-beneficiary of the trust is jailed for contempt (i.e., for refusing to comply or falsely claiming to be unable to comply) with the court’s order, it is “civil contempt” on which the order is based, the idea being that the settlor-defendant may thereby be convinced to come up with the money rather than sit in a jail cell for an indeterminate time. Thus, jailing the settlor for civil contempt is a form of coercion rather than punishment, because the settlor “holds the keys to his cell.” The other form of contempt is criminal contempt, a form of punishment for committing an act and not for discussion here.
In the case of civil contempt, the settlor would be released on payment of the subject amount or after a period of time that indicated to the court that the settlor may never pay. An example is the Florida case of Stephan Lawrence, who transferred millions to an offshore trust just after a significant judgment was issued against him. In re Lawrence, 279 F.3d 1294 (11th Cir. 2002). Of course, the transfer was fraudulent. After making false statements and being unresponsive to a court order to repatriate the fraudulently transferred funds, Lawrence sat in jail for over six years until the court finally recognized he would never pay and released him. But Lawrence is not an exemplary case, as most would agree.
It is crucial to note that in the case of civil contempt, it is well-established that the settlor’s impossibility of performance is a complete defense to a contempt charge. See, e.g., U.S. v. Rylander, 460 US 752 (1983). Thus, if the settlor can convince the court that he is factually unable to comply with the court’s order (e.g., because he relinquished all control over the trust), he cannot be held in contempt. Although this may occur in many cases, it is often not that simple. One problem that typically arises, specifically in these self-settled asset protection trust cases, is that the terms of such trusts typically take away control of the settlor to dispose of the funds. Thus, it is a “self-created impossibility” of performance. The obstacle to compliance is of the settlor’s own making. Furthermore, the timing of the settlor’s transfers is critical to the asset protection issue. As noted below, the proximity of the transfers to the subject claim may be the most important concern.
There are cases where claims arise several years after the trust was established or where there was no evidence that the settlor anticipated or knew of the claim, whenever it arose. In these cases, absent any other problematic issues, the terms of the trust would likely be upheld, and the impossibility defense would be valid. Generally, transfers made close to or in anticipation of the claim are known as fraudulent transfers and may be voidable by the court.
Those who argue against the propriety of self-settled asset protection trusts suggest that virtually every offshore asset protection trust settled by a US person is a per se fraudulent transfer and thus is an automatic exposure to be jailed for contempt if a US court is unsuccessful in obtaining repatriation of the trust funds.
This result may be likely for defiant defendants such as those covered in the subject article, but there is no support for this position in the case of good faith planning. On the other hand, like the Andersons, or like Paul Bilzerian, who was convicted of securities fraud and transferred millions to his offshore trusts despite owing millions to the US government (SEC v. Bilzerian, 112 F. Supp.2d 12 (D.D.C. 2000) (finding Bilzerian in contempt)), or like Stephan Lawrence, who transferred millions to his offshore trust in the very face of a judgment against him and who “lied through his teeth” in the words of the judge who sentenced him, or the number of others who flaunted the rules, ignored court orders and the law, and blatantly lied to inquiring judges, leaving no choice to the courts but to incarcerate them, there is a pretty consistent record of the courts agreeing that the recalcitrant settlors may need time to think. So the court provides room and board for them while they are thinking.
Defending a Contempt Charge
What often gets pushed aside by reporters in reviewing the outrageous facts and behavior in the above egregious cases is that the impossibility defense is alive and well and has been successfully used as a defense to a contempt charge if the settlor plays by the rules. The courts have repeatedly recognized that if a debtor truly does not have control over the funds or property that the court has ordered them to produce, they should not hold them in contempt, let alone punish them. Unfortunately, the possibility of going to jail just for setting up this type of trust has become a familiar scare tactic for those who oppose the concept of self-settled asset protection trusts (those where the settlor is also a beneficiary). To those individuals, the underlying concept of such trusts is morally wrong, and that “wrong” is exacerbated to the highest degree when the settlor pleads the impossibility defense because the settlors themselves created the impossibility by establishing the trust. Nevertheless, courts recognize that this can happen without losing the protection offered by the trust, and relevant cases have found many rules that support such a defense, even though the settlor created the impossibility.
Accordingly, when faced with such a situation, the courts will consider the following:
- whether the debtor/settlor acted in good faith in establishing the trust;
- whether the debtor/settlor acted in anticipation of an existing, threatened, upcoming, or imminent claim against him;
- whether the debtor/settlor retained adequate assets to cover regular expected expenses and reasonably anticipated claims; and, importantly,
- whether the debtor/settlor’s acts in rendering the funds or property beyond their reach were proximate to the creditor’s claim or the court’s order.
Suppose we review the facts of the devious debtor cases noted above, whose own exceedingly aggressive behavior brought them into the legal spotlight. In those cases, it is evident that none satisfied a single criterion that might constitute a defense to the self-created impossibility. So there is no mystery to their fate.
Where to Go from Here
Another essential and seemingly inescapable aspect of this whole moral question is the nature of and motivation behind the asset protection trust transfer. Suppose the law discourages such transfers or provides recourse to a creditor harmed by a person’s transfer. When would establishing a self-settled asset protection trust be for any reason other than to make it difficult or impossible for that person’s creditors to reach the trust assets? Never, and if so, aren’t they inherently morally wrong? And if so, why aren’t corporations, limited liability companies, and similarly protective arrangements also morally wrong? At the same time, strict adherence to this result would make every gratuitous transfer subject to the fraudulent transfer charge when a creditor comes along, even years later. But the courts have agreed that asset protection planning is entirely permissible and, in some instances, is encouraged by the state and federal governments, as in creditor-protected retirement plans, which one could argue is a self-settled asset protection trust. In one often-cited case, the court of appeals said, “…as a prudent move, he (the debtor) sought to protect his assets from unforeseen adversity….. That is not legal fraud.” Hurlbert v. Shackleton, 560 So. 2d 1276, 1280-81 (Fla. 1st DCA 1990, Barfield, dissenting).
In one view of the preceding, there may be a pretty strong argument, not in favor of jail, but in favor of limiting the use of, or in some cases prohibiting, self-settled asset protection trusts altogether, in light of the hundreds of years of precedent in the US and other common law jurisdictions. This long-standing precedent is based on the principle that it is against public policy for persons to have their wealth available for personal use and benefit but unreachable by their creditors. Accordingly, the terms of trusts that attempted to accomplish that result were routinely ignored by US courts, and the maximum amount payable to the settlor under the trust would be made available to the settlor’s creditors. But all that changed abruptly in 1997 when Alaska and Delaware enacted the first US self-settled domestic asset protection trust (DAPT) legislation allowing settlors to establish their own self-settled asset protection trusts whether or not they resided in the DAPT state.
Asset Protection Trusts in the Good Old USA
As of this writing, 18 more states have followed suit and adopted DAPT legislation (almost 40 percent of the country and growing). One reason this “trend” by the states has taken hold so firmly is not that the DAPT is a benefit to society, but rather that so many US individuals have transferred so much money to offshore asset protection trusts that more and more of our states have decided to “relax” their moral frame of reference and abandon 400 years of precedent so that they can attract some of that money.
The DAPT states seem unbothered by the prospect that, if carefully planned, settlors of a DAPT can run up huge debts beyond their ability to pay (outside of their DAPT) and legally escape payment while enjoying their wealth as beneficiaries of the trust. The “you could go to jail” warning does not harm this because there are no “Do Not Pass Go” decisions involving a US DAPT.
Nevertheless, it will be interesting to see how far US courts will go if they come across a Lawrence-type settlor who did not commit a crime and carefully followed the anti-contempt rules but ran out of non-trust money to pay his legal debts. At the same time, his comfortable lifestyle continues, and his Delaware DAPT is protecting his money.