Domestic Asset Protection Trusts

A well-structured trust may be an insurmountable obstacle to creditors.  The trust is structured properly if (1) it is irrevocable (the settlor has not retained the right to take back his assets), (2) has a spendthrift clause (prohibits beneficiaries from demanding distributions or assigning their interests), and (3) is for the benefit of a third-party (like children).  The “settlor” is the person transferring his assets to the trust.

A number of U.S. states (including Alaska, Delaware, and Nevada) permit the so-called self-settled trusts as effective asset protection shields.  A trust is self-settled if the settlor is also the beneficiary of the trust.  For example, Delaware trusts must comply with the following requirements: (i) the trust must be irrevocable and spendthrift; (ii) at least one Delaware resident trustee must be appointed; (iii) some administration of the trust must be conducted in Delaware; and (iv) the settlor cannot act as a trustee. Self-settled trusts established in one of these states are commonly referred to as DAPTs (domestic asset protection trusts).

How well do Domestic Asset Protection Trusts work?  They are unlikely to work for a person who is not a residence of one these states.  If, say, the trust owns California real property, then California law will govern any collection action on the real property and the asset protection of the trust jurisdiction will not apply. This problem may be remedied to some extent by having a DAPT own California real estate through a limited liability company or a limited partnership organized under the laws of another jurisdiction. This way the trust no longer owns California realty, but owns an intangible asset governed by the laws of the DAPT jurisdiction.  Even this structure does not give us any certainty, as a California judge is likely to do whatever he can to ensure that a self-settled trust is afforded no protection in California.

Even residents of the DAPT jurisdictions may not want to use self-settled trusts.  The transfer of assets to a self-settled trust has a 10-year look back under bankruptcy law, and a judge is more likely to allow the piercing of the veil of a self-settled trust.

In our asset protection practice we use a great many domestic trusts.  We never use self-settled trusts, even for clients in the DAPT states.

Asset protection trusts come under many names and guises.  Look at the three requirements (irrevocable, spendthrift clause, third-party beneficiary) and see if the trust meets them. If yes, you have a good asset protection trust. Whether the trust is called a residence trust, a Fortress trust, a Bridge trust, a qualified personal residence trust (QPRT), an intentionally defective grantor trust (IDGT), or any other name is irrelevant.