EXECUTIVE SUMMARY
A U.S. District Court has ordered the repatriation of assets in two Bahamas trusts that have existed for over 20 years in order to satisfy the beneficiaries’ federal income tax liabilities, ruling that the beneficiaries' ability to replace trustees means that they also have the ability to change the trustees to a U.S. trustee who will then satisfy creditors.
FACTS
Husband and Wife self-settled and funded two foreign trusts – one in Bermuda and the other in Jersey off the coast of England – in 1983 and 1984. Husband was the settlor of one of the trusts for Wife’s benefit, and Wife was the settlor of the other trust for Husband’s benefit.
As settlors of the respective trusts, Husband and Wife were given powers in the trust documents to replace trustees. In the event that one of them died, the other spouse would gain the power to replace trustees “anywhere in the world” for both trusts. The trusts were also drafted so that if one spouse died, the other spouse would become the beneficiary of both trusts.
Two decades later, in 2003, Husband and Wife were hit with a $36 million final judgment for unpaid federal income tax liabilities for tax years 1991 and 1993. As part of its collection efforts, the DOJ moved the court to order the repatriation of the offshore trust assets to satisfy the judgment. Husband died in early 2005, and Wife thus became the beneficiary of both trusts and obtained the ability to replace trustees. Wife argued that the repatriation order violated the laws of the jurisdiction where the trusts were located, and that she did not wish to either repatriate the funds or order the replacement of the foreign trustees.
The court noted that:
"The only issue here is whether for purposes of repatriation, the corpus of a trust is any different than funds held in an ordinary offshore bank account, or for that matter, any offshore asset of a taxpayer. Therefore the query must be: is this a trust over which the beneficiary lacks any control, such that the beneficiary is simply that and nothing more, and regardless of what she does or says, she lacks the power to repatriate these assets to the United States? -- or, does the beneficiary retain such control that she has the power vested in her in some way by the terms of the trust to repatriate the corpus? If she has such power, then this asset is no different than any other asset. * * * Once the power of the person who is either the owner or the beneficiary of the asset to repatriate is established, the court can require that person to repatriate the funds."
The court then looked to the trust document, which gave Wife the "unreviewable discretion" to replace trustees, and rejected Wife's contention that because she had the complete discretion to replace trustees, she could simply refuse to replace the trustee:
"The owner of an asset cannot avoid the impact of a lawful court order requiring repatriation by saying, 'I choose not to do so,' any more than any person can avoid the impact of any court order acting directly against his person by saying, 'I choose not to do so.' The fact that such a person may decide to exercise his will to not make such a choice does not insulate him from the court's power and authority to lawfully order such a choice against the person's desire not to do so. That is the nature and essence of the court's power to act upon the person. The consequences of disobeying such an order are clear. Likewise, if the Defendant here has the power to change trustees or to repatriate assets, she cannot avoid the obligation by saying, 'I choose not to do so,' without incurring the dire consequence of such an avowed choice. The only question at issue is whether [Wife] has the power to effect a repatriation of the trust assets; if so, the court can order her to perform such acts which will in fact result in repatriation, to the same extent it can order any person owning or controlling an offshore account to repatriate the assets to the United States."
The court also ruled that it was totally irrelevant that the trusts were funded a decade before the tax liability even arose:
"[Wife] argues that the trusts were funded prior to any assessment of tax liability . . . and that therefore the court cannot order their repatriation because they are not fraudulent transfers. Such a position has no legal support. While it is true that several of the cases relied upon by the Government involve the repatriation of funds which were transferred within the period in which they would be considered fraudulent transfers, others do not. Moreover, [Wife] has failed to cite any law which holds that funds which are not fraudulently transferred are immune from repatriation. Nor does the law or logic compel such a result."
The court held that since Wife clearly had the power to replace trustees, the court could order her to replace the foreign trustees with a court-appointed U.S. trustee who could marshal assets to satisfy creditors. The court additionally held that despite the language of the trust documents giving her only discretionary distributions, in fact her requests for distributions had never been denied and so therefore it appeared that she had apparent authority – backed up by her power to replace trustees – to require that distributions be made to her.
COMMENTS
In some ways, this decision is just another in what has become a long and relatively consistent line of offshore trust failures – a line that has grown so long that cases such as these have started to become unremarkable. Could the trusts have been better structured? Probably. Would it have made a difference? Who knows. What we do know is that there are some important points that can and should be gleaned from this latest asset protection trust trainwreck.
The first point is that the mere fact that a trust is “old and cold” does not mean that it is immune from repatriation orders. The trusts in this case were formed more than 20 years before judgment was finally entered, and that fact barely merited a passing comment by the court. In other words, the amount of time that has passed since an asset protection trust is hardly relevant to the larger question of whether the trust assets should be available to satisfy creditors.
Don't start thinking that simply because a trust has been around a long time that it is no longer subject to challenge. In fact, older trusts are possibly more dangerous than recently-funded trusts because they probably have not been updated to reflect changes in creditor-debtor law. Which is another way of saying that asset protection planning is not susceptible to "fire and forget"
planning where the documents are forgotten soon after the ink dries, and the client may never been seen after the initial representation is done. Because of changes in creditor-debtor law, it is critically important that key documents be regularly updated, and that the planner should maintain an ongoing relationship with the client with hopefully at least annual reviews.
The second point is that one should not start thinking that an asset protection trust is no longer subject to challenge after the limitations period for fraudulent transfers runs after the initial funding. In entering repatriation orders, courts have not given more than passing thoughts to whether the funding was a fraudulent transfer under either U.S. or foreign law – it just doesn't matter. What the court wants to know is whether the creator or beneficiary of the trust has a current ability to bring trust assets back now, not what happened when the trust was formed. This should especially be true with the 10-year clawback provision for self-settled trusts (both foreign and domestic) in the recent bankruptcy act.
The third point is that if somebody wants to have even a chance of an asset protection trust working, they must actually give up all control of the trust and the assets. A common theme in all of the asset protection trust disasters is that of hidden control, meaning that the settlor has attempted to retain some sort of strings over the assets supposedly given away. No matter how creatively planners have tried to paint these strings, labeling them as "negative powers" or whatever, when the court finds them the arrangement usually comes to grief. Remember: The mere fact that you can articulate an argument doesn't mean that it is a winning argument.
Finally, we are back to the entire concept of the self-settled spendthrift trusts. There is a long line of cases that demonstrate that self-settled trusts don’t work, and very few decisions that even suggest that they might work even in ideal circumstances. Although Husband and Wife attempted to cross-settle trusts for each other, it seems like the court treated Husband and Wife as effectively one unit (certainly this was the case after Husband died) and essentially presumed from the outset that logically the assets should be returned to satisfy the creditor. This does not bode well for the new, and totally untested, domestic asset protection trusts either.
CITES
U.S. v. Grant, U.S.Dist.Ct. So.Fla. Case No. 00-CV-89-86 (September 2, 2005 affirmed December 22, 2005).
