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For example, about 50% of all physicians will be sued for malpractice at least once. Over half of these suits will seek damages exceeding $1 million, with a median award of over $500,000, according to the U.S. Department of Justice. In 2001 alone, plaintiffs won nearly half a billion dollars in medical malpractice cases, with almost a third of individual jury verdicts topping $1 million.
While medical malpractice insurance provides some protection against patient lawsuits, it's often insufficient or unavailable. Many big carriers have withdrawn from states with histories of high jury awards, such as West Virginia, Pennsylvania, and Florida. Others are refusing to insure certain medical specialties such as emergency medicine, obstetrics, and plastic surgery. Even the physicians who can obtain insurance often cannot afford coverage that protects them completely against large jury verdicts.
And physicians aren't the only ones at risk. Business owners, corporate executives and directors, accountants, financial advisers, and ironically even lawyers themselves are increasingly in the crosshairs of aggressive plaintiff attorneys looking for deep-pocketed defendants. How can financial advisers help their clients avoid a potential litigation nightmare? One option is to establish a self-settled asset protection trust (SSAPT).
As their name implies, SSAPTs are irrevocable trusts wherein the settlor and beneficiary are the same person. "These trusts are created when you place assets into an irrevocable trust for your own benefit," explains Scott Leonard, a CFP and president of Leonard Wealth Management in Redondo Beach, Calif. "The assets are then shielded from creditors in certain foreign and domestic jurisdictions, provided that you appoint an independent trustee and comply with other legal requirements."
OFFSHORE OPTIONS
Although foreign asset protection trusts (FAPTs) have been around for decades, they've increased in popularity as litigation expenses and perceived inequities in the U.S. legal system have prompted many clients to look offshore for protection. In fact, several foreign jurisdictions have established favorable asset protection laws specifically to attract U.S. capital, including Nevis, Cook Islands, Maldives, Belize, Bahamas, Bermuda, Isle of Man, Guernsey, and Jersey.
Creating a FAPT is fairly straightforward. "You first need to pick a country with favorable trust laws and debtor protections, such as the Cook Islands or Nevis," explains Alan Eber, an attorney in Encino, Calif., who specializes in asset protection strategies and offshore planning. "Then choose a reputable independent local trustee, prepare the necessary trust documents, and transfer title of the assets to the trust."
The assets themselves do not necessarily need to be held in the trust jurisdiction, however. In fact, Eber recommends holding them in a bank located in a debtor-friendly country other than where the trust is located, to further shield them from potential creditors.
Because FAPTs are administered offshore, they provide U.S. settlors with many advantages. For example, because U.S. courts lack jurisdiction over a foreign trustee, they can't order the trustee to distribute trust assets. Rather, to collect on a judgment entered against a settlor by a U.S. court, a creditor must have the judgment executed in the jurisdiction where the trustee resides.
Unfortunately for creditors, jurisdictions that cater to U.S. clients rarely recognize judgments in favor of foreign creditors. Instead, the creditor must file suit in the trust jurisdiction and litigate the settlor's liability all over again.
Even then, the creditor may be out of luck. Most well-crafted FAPTs include a "flee clause" allowing the trustee discretion to move the trust to a new country. Unless the creditor is successful in getting the "flee clause" invalidated, the trustee can literally move the trust from country to country, keeping ahead of the creditor and forcing him or her to file multiple lawsuits in multiple jurisdictions with little hope of success.
Further, because most FAPT jurisdictions are in remote locations, the financial burden of prosecuting a lawsuit there can be enormous. Hiring local attorneys who often don't work on a contingency basis, complying with local court requirements, and traveling across the globe to provide witness testimony and attend hearings is a daunting task, even for sophisticated creditors. Robert Mintz, an asset protection and estate planning attorney in Oceanside, Calif., and the author of several books on asset protection planning, says that's the big draw: "They create a huge psychological and financial deterrent to most potential litigants."
Foreign jurisdictions also have shorter statutes of limitations for creditor claims than most U.S courts, as well as heightened standards of proof. This is particularly helpful when determining whether a settlor fraudulently conveyed assets into a trust to delay, hinder, or defraud potential creditors.
"Many of the offshore jurisdictions have a two-year statute of limitations for fraudulent-conveyance claims, versus four years for most U.S. courts," says Scott Farber, a financial adviser with Boston-based Woodstock Corp. (See "Beware Fraudulent Conveyances," below.) "And they may require the plaintiffs to prove any allegations beyond a reasonable doubt, rather than by a preponderance of the evidence as required in most U.S. civil actions."
Creating and administering a FAPT can be expensive. Legal costs can range from $7,500 to $30,000 to create the trust, and trustee fees can add another $2,000 to $6,000 a year depending on the jurisdiction and trust company.
Political stability is also a concern. "Let's face it, four guys in a canoe could do a pretty good job of invading the Maldives," jokes David Ness, president and director of St. Petersburg, Fla.-based Raymond James Trust Co., a subsidiary of Raymond James Financial.
Although a U.S. court has no jurisdiction over an offshore trustee, there is always the risk that a court might require the settlor to instruct the trustee to repatriate trust assets to satisfy a creditor judgment. While this issue is somewhat unsettled and dependent on circumstances, there have been cases where courts have ordered FAPT settlors to issue such instructions and incarcerated them under a contempt order for failing to comply. "FAPTs are very successful when created correctly, but when settlors attempt to retain too much control over the trust, they can get themselves into trouble," Eber says.
Using a FAPT outside the normal business-creditor context can also create problems. For example, there are at least three recent court cases where a husband attempted to use a FAPT to shield assets during divorce proceedings. In each case, the court ruled the FAPT was part of the marital estate and the wife could collect her portion of it from other available marital assets. In fact, one of the courts went so far as to hold "the use of such trusts to avoid alimony, child support, and a fair division of marital property upon divorce is reprehensible to us." And while not all courts may feel the same, the trend, farber notes, "is most clearly toward treating FAPT assets as part of the marital estate to allow an equitable division of all the couple's property."
FRIENDLY STATES
Despite these problems, foreign countries remained the only option for clients seeking to establish SSAPTs until 1997. That's when Alaska became the first state to enact legislation authorizing the creation of self-settled domestic asset protection trusts (DAPTs). Prior to 1997, every U.S. jurisdiction adhered to the long-standing rule that for public policy reasons settlors should not be able to retain beneficiary rights to a trust while also protecting the assets from creditors. Once Alaska broke this barrier, several other states followed suit.
"Most DAPTs are formed under the laws of either Alaska, Delaware, Nevada, Rhode Island, or Utah," explains Dick Nenno, managing director and trust counsel for Delaware-based Wilmington Trust Corp. "South Dakota also may attract its share of trust business, since its statute--which becomes effective in July--is a mirror image of Delaware's. And we'll likely see other states offering self-settled trusts over the next decade."
While each DAPT state retains its own unique rules, their DAPTs share some common traits: they must be irrevocable, be administered by an independent trustee who can exercise discretionary judgment over the assets, and include a spendthrift clause restricting the transfer of the settlor's interests in the trust assets.
DAPTs can be an appealing alternative to FAPTs; they're often significantly cheaper to create and administer, don't involve the same degree of political risk, and can be less burdensome on the settlor. "They also create less personal risk for the settlor, since a court wouldn't need to resort to contempt proceedings or other punitive measures to force the settlor to repatriate assets," Nenno says.
But DAPTs haven't been tested by courts to determine if they provide the same level of asset protection as their offshore counterparts do. Some experts believe that it's only a matter of time until DAPTs are proven equally effective; others disagree.
Also, the U.S. Constitution's "full faith and credit" clause requires states to honor judgments of other states. "We don't know what will happen if a plaintiff obtains a judgment in a Georgia court and tries to have it enforced in Alaska," Ness says. "It's possible that an Alaska court would be bound to enforce the Georgia judgment, even against an Alaska asset protection trust."
Choice-of-law issues are also tricky. If a New York creditor brought suit in his or her home state against the settlor of a Delaware asset protection trust, would the court apply New York or Delaware law? According to Mintz, nobody knows.
Finally, federal courts may not be constrained by any state asset protection laws. In a lawsuit brought in federal court against an Alaska trustee, Eber says, federal law could apply, under the U.S. Constitution's Supremacy Clause.
Some advisers don't view the scarcity of DAPT legal precedent as a problem. "Most plaintiff attorneys aren't challenging these trusts," Leonard explains. "One of the benefits of having an asset protection trust in place is that it discourages plaintiff attorneys from going after you in the first place."
And that may be one of the best reasons to consider self-settled asset protection trusts--their very presence acts as a deterrent to potential litigation. "Much of asset protection is simply taking a pretty asset and making it ugly," Ness says. "To the extent that asset protection trusts and other proactive tools like family limited liability companies make assets ugly enough to discourage lawsuits, they can play a meaningful role in an asset protection strategy."
David A. Twibell, J.D., is executive vice president of Colorado Capital Bank in Colorado Springs, Colo., where he directs the bank's portfolio management and wealth advisory practice. He can be reached at (719) 482-7015, or at dtwibell@bankwest.net.
BEWARE FRAUDULENT CONVEYANCES
A thorny issue for many asset protection trusts is whether asset transfers into a trust constitute fraudulent conveyances--meaning that the transfer was done with the intent to hinder, delay, or defraud a specific creditor. If a court finds that a transfer is fraudulent, it can order the transfer unwound, and the asset will be available to satisfy a creditor judgment.
Virtually every jurisdiction, both foreign and domestic, has some form of fraudulent conveyance statute. But the length of time creditors can challenge a conveyance and the burden of proof they must satisfy to prove their claim vary greatly. For example, most foreign jurisdictions only allow a creditor to attack a conveyance as fraudulent for two years after it's made. And in some foreign jurisdictions, the limitations period is even shorter. This contrasts with most U.S. jurisdictions, which apply a four-year limitations period.
The burden of proof required in foreign and U.S. courts also varies. Many foreign jurisdictions require a creditor to prove a conveyance is fraudulent beyond a reasonable doubt--a tough standard that mirrors the burden of proof in U.S. criminal cases. On the other hand, most U.S. courts only require a creditor prove the transfer was fraudulent by a preponderance of the evidence.
To confuse the issue further, President Bush recently signed into law a bankruptcy reform bill extending the time under which a bankruptcy trustee can set aside a fraudulent transfer into either a foreign or domestic asset protection trust from four years to 10 years prior to a bankruptcy filing.
"It's now imperative for clients to set up asset protection trusts long before they may actually need them to protect their assets against a potential bankruptcy," explains Dick Nenno, managing director and trust counsel for Delaware-based Wilmington Trust. "Clients also need to conduct a solvency analysis and fund the trust with only a portion of their total assets to avoid the perception they are trying to defraud specific creditors. It also helps if they have a purpose for the trust other than just protecting existing assets, like facilitating charitable giving or estate planning." --DAT
