Several states have adopted asset protection trust statutes that allow a grantor to establish a trust that is protected from the grantor’s creditors, even though the grantor is a discretionary beneficiary. These states include Nevada, Alaska, and Delaware.
We have advised grantors that do not reside in one of these states that if they establish such a trust in one of these jurisdictions that the trust may not be effective for them. One possible line of challenge is that if a judgment is obtained in their state of residence, the Full Faith and Credit Clause of the US Constitution may allow for the enforcement of that judgment against the trust assets in another state, notwithstanding local law provisions in that state. Another line of attack would be to seek to apply the law of the grantor’s state of residence in bankruptcy to reach the trust assets. A recent bankruptcy decision indeed took that later approach, ruling that the assets of an Alaska asset protection trust are exposed to the creditors of a Washington grantor.
The court determined that under Section 270(a) of the Restatement (Second) of Conflict of Laws, the grantor’s choice of Alaska law designated in the trust should be upheld if Alaska has a substantial relation to the trust. Based on the facts, such a substantial relation was found lacking:
Conversely, it is undisputed that at the time the Trust was created, the Debtor resided in Washington; all of the property placed into the Trust, except a $10,000 certificate of deposit, was transferred to the Trust from Washington; the creditors of the Debtor were located in Washington; the Trust beneficiaries were Washington residents; and the attorney who prepared the Trust documents and transferred the assets into the Trust was located in Washington. Accordingly, while Alaska had only a minimal relation to the Trust, using the test set forth in Comment b, Washington had a substantial relation to the Trust when the Trust was created.
The opinion is not a paragon of clarity. Perhaps if the grantor and the trust had established more ties to Alaska, a different result may have obtained. Further, even if the Alaska law was allowed to apply, the trust assets were still exposed under the 10 year rule applicable to asset protection trusts in the Bankruptcy Code. Nonetheless, it is clear confirmation that grantors who do not reside in the asset protection trust jurisdiction in which the trust is established remain open to the risk that they may not be able to benefit by the creditor protection afforded by the asset protection trust jurisdiction.
Waldron v. Huber, 2013 WL 2154218 (Bk.W.D.Wa., May 17, 2013)Follow @RubinOnTax Tweet