State Asset Protection Trusts Take Another Hit

Numerous states have statutes that allow for the creation of self-settled discretionary trusts that are protected from claims of the settlor while allowing the settlor to be a discretionary beneficiary. Such trusts are likely valid for settlors who are residents of the particular state, the property in the trust is located in that state, and no other state has jurisdiction over the parties. While these states seek the trust business of persons outside of their borders seeking these benefits, the validity of these benefits to such person has been an unanswered question.

In a recent Supreme Court of Alaska case (Alaska being one of the states that allow for asset protection trusts), judgment debtors transferred Montana property to an Alaska asset protection trust after judgments were entered against them. The judgment creditors brought an action to void the transfer to the trust as a fraudulent conveyance in Montana applying Montana law, and prevailed. A bankruptcy trustee in a Chapter 7 bankruptcy brought in Alaska also sought to have the transfer voided as a fraudulent transfer in federal court, and prevailed.

The debtors sought to have both of these determinations voided because they should have been heard in Alaska state court. This was based on Alaska law that conferred jurisdiction regarding fraudulent conveyance claims involving Alaska asset protection trusts exclusively to Alaska state courts. The Alaska Supreme Court ultimately ruled:

a. The Full Faith and Credit Clause of the U.S. Constitution does not force states to be bound by another state’s law that exclusive jurisdiction to hear matters based on a cause of action even though that state created the cause of action. The court also noted that a fraudulent transfer action is a “transitory” action so that it may be brought in a court having jurisdiction over the parties without regard to where the transfer took place.

b. The Supremacy Clause of the U.S. Constitution prevents a state from depriving federal courts of their jurisdiction.

The U.S. Constitution has always been a concern regarding the enforceability of the protections of state asset protection trust law when the debtor resides in another state or is exposed to the jurisdiction of another state’s law or courts, but given the relative newness of these statutes there was a dearth of case law resolving whether these concerns would be recognized by courts hearing these cases. This case, along with other similar decisions that are springing up, validate these concerns and cast doubt on the ability of asset protection trust states to offer enforceable protection when the debtors reside outside of the state, have property outside of the state, or are subject to the jurisdiction of courts outside of the asset protection trust state.

Note that these constitutional concerns are not an issue when the trust is situated outside of the U.S. in a non-U.S. asset protection (at least when the assets are situated outside of the U.S).

Toni 1 Trust v. Wacker, 2018 WL 1125033 (Alaska 2018)