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Domestic Asset Protection Trus...

Domestic Asset Protection Trusts v. Prenuptial Agreements

RANDALL H. BORKUS, JD, JAMES W. COLLINS, JD, AND RICHARD J. SHAPIRO, JD
WEALTHCOUNSEL MEMBERS SINCE 2011

Divorce is an unfortunate reality these days as 40% – 50% of first marriages and 60% of second marriages end in divorce.’ Without appropriate planning, a spouse seeking divorce will likely be entitled to an equitable portion of marital property, which includes business interests, liquid assets, gifts, employment income, and in some cases, inheritances and other assets held prior to the marriage. Therefore, it is important for couples contemplating marriage to find ways to clearly communicate their wishes with regard to their assets and in­come before the wedding day. If the couple fails to adequately address these issues, decisions may be left to the discretion of the judge during the course of what is often an expensive, exhausting, and time-consuming divorce proceeding.

PRENUPTIAL AGREEMENTS

Historically, individuals concerned about protecting assets acquired before marriage used traditional pre­nuptial agreements. Prenuptial agreements are good, but there are numerous personal and legal issues that deter couples from actually executing a prenuptial agreement. In fact, a recent survey found that only approximately 3% of all married or engaged couples have executed a prenuptial agreement.2

 

Even for those relatively few couples who have ex­ecuted a prenuptial agreement, there is no guarantee that the agreement will stand up to a legal challenge if the relationship sours. Statutory and case law im­poses stringent requirements upon prenuptial agree­ments, both technically and procedurally. Absent appropriate care and attention to detail, prenuptial agreements are susceptible to challenges and may be invalidated by the court. Each party should be rep­resented by independent counsel to avoid conflicts of interest as well as accusations of duress or coer­cion in the process. Additionally, a strong prenuptial agreement will include a full disclosure of the assets and liabilities of each prospective spouse on sched­ules attached to the executed prenuptial agreement. Furthermore, the agreement must be fair at the time of execution, and it “may be invalidated if the party challenging the agreement demonstrates that it was the product of fraud, duress, or other inequitable con­duct.”3 Fairness will be determined by a judge or a jury, which may result in a popularity contest in the courtroom. In some states, prenuptial agreements are completely disregarded in divorce proceedings.

 

One common mistake that renders an agreement vulnerable is when a couple waits too long before dis­cussing a desire for a prenuptial agreement. In the most extreme case, the party demanding the prenup­tial agreement thrusts an agreement upon the other party “on the steps of the church or synagogue” on the day of the wedding. While such a scenario is per­haps a bit of an exaggeration, prenuptial agreements are often invalidated if executed too close in time to the wedding ceremony.4

 

As a practical matter, asking a future spouse to enter into a prenuptial agreement often causes discomfort to blossoming love relationships. The person being asked to enter into a prenuptial agreement may well interpret such a request as implying that their future spouse does not trust them, or that their future spouse expects the marriage to fail. As a result, many couples are reluctant to even talk about such agreements5.  Moreover, the requirement for full and accurate finan­cial disclosure deters many couples who might oth­erwise consider a prenuptial agreement from enter­ing into a signed agreement. The bottom line is that while many couples are delighted to share their lives together when entering into a marriage, they may feel uncomfortable sharing information about their net worth.

 

AN ALTERNATIVE: THE DOMESTIC ASSET PROTECTION TRUST

Because of the issues and complications surrounding prenuptial agreements, many couples are looking for alternatives to protect assets obtained prior to mar­riage and protect future inheritances. Asset protec­tion trusts give couples a great alternative to the tra­ditional prenuptial agreement. While asset protection trusts can be formed domestically or off-shore, es­tablishing and administering foreign asset protection trusts has become very expensive. And, in addition to the high cost, most people are uncomfortable with sending their assets offshore.

 

A much better alternative may be a domestic asset protection trust (DAPT) sitused in one of the fifteen states that authorize the use of self-settled asset pro­tection trusts in some form.6 One state offering a par­ticularly favorable statute is Wyoming.7 Wyoming law8 permits the creation of a self-settled trust that pro­vides a more surefire alternative for protecting one’s assets from a claim by a future spouse than the tradi­tional prenuptial agreement.

 

DAPTs are powerful trusts that protect assets from potential unknown creditors, which by definition in­cludes a future divorcing spouse. Moreover, a DAPT allows the creator to name himself or herself as a po­tential beneficiary in many cases—hence the name “self-settled” trust. Unfortunately, some jurisdictions are so pro-creditor — Illinois, for instance — that indi­vidual asset protection is not given consideration in the state’s courts.9

 

BLOODLINE PRESERVATION TRUST

One way to mitigate the negative jurisprudence ap­plied in some states is to utilize a fairly new type of DAPT set up by a third party for the benefit of another individual known as a “Bloodline Preservation Trust” (“BPT”).10 The BPT concept is simple. You choose an asset protection jurisdiction, but unlike a traditional DAPT, the trust creator is not a beneficiary of the trust. The BPT is set up for the benefit of the creator’s spouse, descendants and/or family members. A trust structured in this manner is, by definition, a third-party trust. This allows the creator to avoid the legal uncertainty that is inherent with a self-settled domes­tic asset protection trust formed in jurisdictions that have not enacted statutes permitting self-settled as­set protection trusts.

 

In their various forms, DAPTs are effective against a future divorcing spouse and other creditors, provided that the funding of the trust does not violate the ap­plicable fraudulent transfer law.11 So, to be an effec­tive asset protection tool for a prospective spouse, it is imperative that the DAPT be created and fund­ed before the marriage. Significantly, in establishing a DAPT, there are no requirements that the creator or beneficiary of the DAPT disclose to their future spouse a plan to create a DAPT, or disclose the assets funded in the trust.

 

An individual contemplating marriage can establish a DAPT in a state permitting such trusts and, upon the dissolution of the marriage, shield those assets from any equitable distribution. This technique is appealing to many individuals who desire to protect their assets from their future spouse — and the unpredictability of a judge’s discretion — quietly and with less hassle. Not only is a properly structured and implemented DAPT far less likely to be subject to legal attack than a prenuptial agreement, but the creator also avoids having to engage in “the conversation” with the fu­ture spouse — which at best is uncomfortable, and at worst can lead to the breakup of the relationship when the prospective spouse sputters, “you don’t trust me otherwise you wouldn’t ask me to sign this!”

 

DAPT REQUIREMENTS

As with any estate planning technique, a DAPT must meet certain criteria to be valid. At minimum, the do­mestic asset protection trust:

  • Must be irrevocable;
  • Should appoint a trustee (or trustees) with the discretion to administer the trust;
  • Must appoint a trustee, whether corporate or indi­vidual, that is a qualified trustee of the jurisdiction in which the trust is formed; and
  • Must contain a spendthrift clause, which restricts the transferability of a beneficiary’s interests in the trust property.12

 

Additionally, in exchange for restricting the use of the trust assets, those who establish DAPTs receive sev­eral benefits. First, because the assets gifted to the DAPT constitute trust property, the creator may pro­tect those assets against claims made by future credi­tors of the creator, including a future spouse. Further­more, unlike other types of irrevocable trusts where the grantor gives up all rights to the assets funded to the trust, a grantor or creator of a DAPT retains a beneficial interest in the trust while protecting the as­sets from future unknown creditors. Therefore, a po­tential spouse can establish a domestic asset protec­tion trust that is fully discretionary, receive financial benefit from the trust during his or her lifetime, and protect the trust assets from a bad marriage that is solemnized after the creation of the trust.

 

LAYERED STRATEGIES

Finally, certain individuals contemplating marriage and establishing a DAPT would benefit from further enhancing this already powerful strategy by layering or combining additional levels of asset protection. Individuals with a significant amount of assets, and/ or those holding certain “high-risk” classes of assets such as real estate holdings or business interests, might consider combining underlying entity struc­tures with the DAPT. Specifically, one could create an LLC (Limited Liability Company) under the laws of an asset-protection oriented state (again, Wyoming be­ing a good example). The individual would then trans­fer specified assets into the LLC, with the LLC struc­ture providing the individual with protection against liabilities associated with the assets transferred into the LLC. The individual would in turn have the LLC membership interests owned by the DAPT. The layer­ing and stacking of strategies would present consid­erable additional barriers to a would-be creditor or divorcing spouse.

 

TAKEAWAYS

Given the flexibility and protection afforded by DAPTs, it is essential that professionals discuss the many ben­efits of these trusts with clients who are contemplat­ing premarital planning. If a client combines a DAPT executed before marriage with a prenuptial agree­ment, their personal asset protection is even stronger. Alternatively, if discussing a prenuptial agreement with a future spouse makes a client too uncomfort­able, a DAPT can be a safe and less offensive way to protect one’s assets while simultaneously maintaining the love and trust everyone desires when contemplat­ing nuptial vows.

 

(ENDNOTES)

  1. How common is divorce and what are the reasons?, <http:// www.divorce.usu.edu/htm/lesson-3>; see also American Psycho­logical Association, <http://www.apa.org/topics/divorce/>.
  2. Sanette Tanaka, The Growing Popularity of the Prenup, WALL STREET JOURNAL, October 31, 2013, available at http://www.wsj. com/articles/SB10001424052702303615304579157671554066120.
  3. Cioffi-Petrakis v. Petrakis, 103 A.D.3d 766, 766, 960 N.Y.S.2d 152 (2d Dep’t, 2013).
  4. See, e.g., In Re Marriage of Bernard, 204 P.3rd 907 (Wash. 2009) and Peters-Riemers v. Riemers, 644 N.W.2d 197 (N.D. 2002) (in both cases the courts refused to enforce a prenuptial agreement presented to a spouse just days before the wedding)
  5. Jeff Landers, Skittish About a Prenup? Like It Or Not, You Al­ready Have One, FORBES, July 17, 2013, available at http://www. com/sites/jefflanders/2013/07/17/skittish-about-a-prenup-like-it-or-not-you-already-have-one/
  6. Nevada, South Dakota, Ohio, Tennessee, Alaska, Wyoming, Del aware, Missouri, New Hampshire, Hawaii, Rhode Island, Utah. Vir­ginia, Mississippi, and Oklahoma.
  7. Effective as of July 1, 2007, the Wyoming Legislature enact­ed legislation permitting individuals to establish asset protection trusts in Wyoming, formally known as a Qualified Spendthrift Trust, which can provide certain protection from creditors, liabilities and judgments.
  8. The Wyoming DAPT can be created by anyone living in any ju­risdiction, so long as the trust states that it is: (i) a qualified spend­thrift trust under Wyoming Statute § 4-10-510 et. seq., (ii) expressly incorporates the law of Wyoming to govern the validity, construc­tion and administration of the trust, and (iii) is administered by at least one Qualified Trustee.
  9. Rush Univ. Med. Center v. Sessions, E. 2d                  , 2012 IL 112906, 2012 WL 4127261 (III, Sept. 20, 2012); The Illinois Supreme Court in 2012 held in the Rush University case that a self-settled trust was void as against public policy. Fortunately, this result should be easily averted using the BLOODLINE PRESERVATION TRUST.
  10. BLOODLINE PRESERVATION TRUST, Reg. No. 4,073,124, Reg­istered Dec. 20, 2011, Int. CI.: 36; First used 10-1-2010; Most all prac­titioners agree that Domestic Asset Protection Trusts formed in the states that have Domestic Asset Protection Trust statutes are powerful tools when formed and funded correctly. Despite the high probability of success, there is a way to dramatically increase the odds of success; it is Hybrid form of Domestic Asset Protection Trust known as the Bloodline Preservation Trust (“BPT”).
  11. See, e.g., Wyoming Statute § 34-14-201. “Uniform Fraudulent Transfer Act.”
  12. See, e.g., Wyoming Statute § 4-10-510.

 

ABOUT THE AUTHORS

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Randall H. Borkus is a co-founder and Partner of Borkus Collins Law, PA., a law firm with offices in the Chicago area and Sarasota, Florida. Randall is an attor­ney and consultant with a background in taxation and finance. His primary focus is on family asset preservation planning, income tax planning, estate planning, and providing guidance to entrepre­neurs, financial advisors, accountants, insurance wholesalers, CPAs, business professionals, and other attorneys. Ran­dall enjoys exploring dance steps and traveling with his wife Janis.

 

 

James Wjames-collins-his-res-suit-tie. Collins is a co-founder and Partner in Borkus Collins Law, PA.. Jim is a nationally recog­nized author and speaker in the estate planning field, and his primary focus is on estate plan­ning, estate/gift/income tax planning, asset protection planning, charitable planning, and providing valuable educa­tion and collaboration to financial advi­sors, CPAs, insurance professionals, and other allied professionals. Jim enjoys time with his family and a long history of involvement in distance and endurance/ extreme running events.

 

 

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Richard Shapiro, a partner in the Goshen, New York law firm of Blustein, Sha­piro, Rich & Barone, LLP, concentrates his practice in the areas of estate and business planning, elder law, and spe­cial needs planning. He is a graduate of Cornell University (B.S., 1985) and the University of Pennsylvania (J.D., 1988)

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