First Place Winner 2006

Domestic Asset Protection Trusts: The Risks and Roadblocks Which May Hinder Their Effectiveness
Michael A. Passananti
DePaul College of Law
Chicago, Illinois
  Rick Stangizt, a 45-year-old restaurant entrepreneur, owns 10 restaurants in Chicago, Illinois. Rick protected his restaurants under 10 separate limited liability corporations (“LLC”). The restaurants are located in different areas and carry diverse menus. Rick’s business has been growing rapidly, and everything he touches seems to explode. Rick plans to sell two of his restaurants within the next year and to open five additional restaurants in the western suburbs of Chicago over the next three years. Rick strictly imposes safety and healthcare requirements; however, last month there was a fatal food poisoning at one of his restaurants. Rick feels terrible about the tragedy. The estate of the deceased customer filed suit against the LLC that owns the restaurant and against Rick as the owner and sole shareholder of the LLC. Rick realizes that if a judgment is rendered against him personally, it will wipe out his net worth because the multi-million dollar judgment will exceed his insurance coverage. An adverse judgment would make it impossible for Rick to recover financially, thus inhibiting his future goals within the restaurant business.
  Although Rick realizes the potential liability he faces, he is not necessarily concerned. Rick feels comfortable because he understands, from his lawyer’s advice, that most of his assets are protected. About five years ago, Rick consulted Cliff Harrigan, an estate planning attorney, about how to effectively protect and preserve his wealth. Cliff utilized a newly created asset protection device called the Domestic Asset Protection Trust (“DAPT”) to help Rick reach his goals. DAPTs allow settlors to set up self-settled spendthrift trusts. Settlors can keep their assets within the United States and continue to enjoy the benefits of the assets while being immune to almost any creditor’s claim. DAPTs are only offered in eight states and Cliff chose Delaware law to govern Rick’s DAPT.   Knowing that Rick is in a business which increases his exposure to liability, Cliff thought that a DAPT was the best way to protect the assets Rick had worked for years and years to build from any judgments against him.
  A year after the tragedy the case went to trial. After a 15-day trial, the jury rendered a judgment against Rick for $5,000,000. The LLC which owned the restaurant was dropped as a defendant after it declared bankruptcy. Plaintiff’s family members were relieved as the judgment against Rick helped attain closure to the tragedy. Soon after the trial, the estate attempted to enforce the judgment against Rick. To its surprise, its efforts were unsuccessful. The estate was able to garnish $20,000 from Rick’s personal checking account, but all his assets were protected in a Delaware DAPT. As justice seemed to prevail, plaintiff’s estate was left empty-handed.
  The result devastated the family members but allowed Rick to continue to grow his restaurant business. Depending on the point of view, this result may seem totally reasonable or terribly inequitable. Regardless of the point of view, an outcome like this is not unrealistic when DAPTs are used as an asset protection vehicle.
  What are the legal characteristics of DAPTS (Section II)? Are these asset protection tools a violation of public policy (Section III)? Will DAPTs be able to withstand attacks from aggressive creditors (Section IV)? This article will address these issues and evaluate whether DAPTs are a stable asset protection vehicle.
  The DAPT is a spin-off of the Foreign Asset Protection Trust (“FAPT”). Approximately 60 nations worldwide have asset protection trust statutes.[1] High net-worth clients transfer their assets to offshore trusts to: (1) take advantage of transfer tax savings and (2) insulate their assets from potential claims of their creditors.[2] FAPTs make it nearly impossible for U.S. creditors to reach the underlying assets because they are not subject to the jurisdiction of the States. Thus, in order to enforce the judgment, the creditor must file suit in the offshore jurisdiction (e.g., Bermuda, the Isle of Man, the Cook Islands, or the Bahamas) and then try the case in the foreign jurisdiction.[3] Foreign law will apply and the creditor and witnesses must travel across the globe to try the case.[4] A U.S. judgment will not be respected by these foreign courts. Needless to say, winning a case within a foreign country poses enormous obstacles for the U.S. creditor.
  Similarly, DAPT statutes allow the settlor to retain a beneficial interest in the trust, while removing it from the reach of future creditors.[5] DAPTs were first adopted in the United States in 1997. Alaska and Delaware were the first to offer DAPTs, but over the last eight years, Utah, Rhode Island, Nevada, Missouri, and Oklahoma have also enacted DAPT legislation.[6] Legislative authorization of asset protection trusts marks a major change in centuries-old law. The Restatement (Second) of Trusts states that “where a person creates for his own benefit a trust for support or a discretionary trust, his transferee or creditors can reach the maximum among which the trustee under the terms of the trust could pay to him or apply for his benefit.”[7] Thus, the DAPT legislation contradicts the Restatement (Second) of Trusts, which has been the guiding authority for years. Although the DAPT statutes vary in detail, they share many of the same common characteristics.
  A. Common Characteristics of DAPTs
    Typically, DAPTs require: (1) a transfer to an irrevocable trust; (2) a resident trustee; (3) specific incorporation of state law; (4) inclusion of a spendthrift clause; (5) grantor’s/settlor’s retained interests; and (6) a bar against creditors reaching trust assets, except in specific circumstances.[8]
    1. Transfer to Irrevocable Trust
      The transfer must be to an irrevocable spendthrift trust either from the settlor to the trustee or from the settlor’s exercise of an inter vivos power of appointment under an existing trust.[9]
    2. A Resident Trustee
      All DAPT statutes require that an individual, trust company, or bank acting as trustee be a resident in the DAPT state. The settlor must not serve as trustee of the DAPT, but may serve as an investment advisor with specific veto powers. Most DAPT statutes also require that a percentage of the trust assets be held within the respective state.
    3. Incorporation of State Law
      The trust instrument must expressly provide that the DAPT state’s laws govern the trust. This requirement protects the validity and construction of the DAPT in an effort to ensure the DAPT state’s laws will apply if a dispute regarding the DAPT arises.
    4. Spendthrift Clause
      The trust instrument must include a spend­thrift provision prohibiting attachment or assignment of any beneficiary’s interest in the trust. This clause establishes that the settlor has created a trust for his/her own benefit.
    5. Settlor’s Retained Interests
      Most DAPT statutes allow the settlor to retain the following interests: (1) discretionary distributions of income; (2) discretionary distributions of principal; (3) veto power over distributions of income or principal; and/or (4) special testamentary powers of appointment.[10]
    6. Creditors Bar from Recovery and Limited Exceptions
      In general, creditors cannot pierce the DAPT to reach DAPT assets in satisfaction of any judgment. However, most DAPT statutes provide for a few exceptions. First, any creditor who proves that assets have been fraudulently transferred into the DAPT may be entitled to recovery.
      Next, DAPT statutes provide exemptions for creditors who are: (1) spouses and children or (2) existing tort claimants. Trust assets will not be protected against child support claims or claims for alimony by a plaintiff who was married to the settlor on or before the time assets were transferred to the trust. Furthermore, trust assets are not protected against tort claimants (death, personal injury, or property damage) on or before the date of the transfer to the trust. Thus, only three types of creditors (fraudulent transfer, spouse or child, and tort claimants) have the statutory authority to attempt to pierce the DAPT and reach its assets.
    7. Fraudulent Transfer Exception
      Most U.S. jurisdictions follow the 1984 Uniform Fraudulent Transfer Act (“UFTA”), which allows creditors to set aside a fraudulent transfer. In other words, a creditor who proves that a debtor, like Rick, made a fraudulent transfer to the DAPT could ignore the protection of the DAPT and enforce the judgment against the assets as if the original transfer never took place. 
      With respect to present creditors, Section 5(a) of the UFTA provides[11] :
        A transfer made by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made if the debtor made the transfer and the debtor was insolvent at the time or the debtor became insolvent as a result of the transfer.
      With respect to present and future creditors, Section 4(a) of the UFTA provides[12] :
        A transfer made by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made, if the debtor made the transfer:
        (1) with actual intent to hinder, delay or defraud any creditor or the debtor, or
        (2) without receiving a reasonably equivalent value in exchange for the transfer and:
          (a) the debtor intended to incur, or believed or reasonably should have believed that he/she would incur debts beyond his/her ability to pay as they became due; or
          (b) the debtor was engaged or was about to engage in business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction.
      The UFTA provides 11 “badges of fraud” to determine if the debtor had actual intent to defraud under Section 4(a)(1) of the UFTA.[13] Some of the relevant tests include whether the settlor has been sued, whether the settlor was threatened with suit, or whether the settlor incurred a debt shortly before transferring assets to the DAPT.[14] Under Section 4(a)(2) of the UFTA the court will apply an objective test which examines the assets exchanged and the debts or business ventures the debtor engaged in.[15]
    8. Tail Periods for Fraudulent Transfers
      Most DAPTs incorporate “tail periods” that begin to run upon the settlor’s transfer of assets to the DAPT. After the “tail period” has run, the enforcement of future creditor claims is barred regardless of whether the original transfer was fraudulent. Most DAPT statutes provide that a plaintiff, who is a creditor before the settlor’s assets are transferred (or an existing creditor) to the trust must bring an action within the later of: (1) four years after the transfer is made; or (2) one year after the transfer is or reasonably could have been discovered by the creditor. Future creditors, or those who become a creditor subsequent to the transfer into trust, must bring their claims within four years from the date of the transfer.
      The tail period included in most DAPT statutes reduces the period in which claims for fraudulent transfers could normally be brought under state or federal law. Even if the transfer is proven to be fraudulent, a settlor may be able to dismiss the claims if the four-year tail period has run.
  Many scholars and experts clash on whether DAPTs are a healthy asset protection device. There are ways in which a DAPT certainly can act as a valuable tool to assist the right client; however, DAPTs also provide for an opportunity to abuse the integrity of our economic system. Below are the pros and cons relating to the policy considerations of DAPTs.
  A. Policy Arguments Supporting DAPTs
    DAPTs are helpful to entrepreneurs and business owners who do not have the opportunities to protect their assets by other means. Some individuals who work for large corporations may protect their assets by placing them in “creditor proof” retirement accounts. Other asset protection vehicles include tenancy-by-the-entirety property, family limited partnerships, limited liability companies, homesteads, life insurance policies, annuity contracts, and transfers to cooperative friends or family members.[16]
    Entrepreneurs or small business owners who do not have the opportunity to set up these types of asset protection tools should be provided with alternatives to protect their assets in the same manner. 
    DAPTs also offer entrepreneurs and business owners, whose profession or business exposes them to liability, protection from our tort system. Our tort system fosters thousands of meritless claims per year and DAPTs can help “shield the settlor’s properties from ever-expanding theories of liability and ever-expanding risks of litigation that arise from a dysfunctional legal system.”[17] DAPTs allow for entrepreneurs and business owners to take advantage of opportunities without worrying about being financially drained from a meritless lawsuit. Under this theory, more business owners will explore new deals, helping to stimulate our economy. 
    Furthermore, DAPTs may be viewed as a positive alternative to FAPTs. FAPTs, which are created and administered in foreign countries, typically are thought of as abusive or fraudulent asset protection tools because they are governed by the foreign jurisdictions. Many believe that creating asset protection trusts within the United States will limit the abuse because the trusts will be administered here and our laws will apply.[18] DAPTs provide settlors with a chance to limit the risk of abuse or fraud by keeping their assets within the United States and within their control. In addition, DAPTs will help stop the flow of assets out of the United States into foreign jurisdictions. Although the volume of FAPT transactions is uncertain, in recent years reports estimated that:
    (1) 100,000 Americans have set up offshore trusts.[19]
    (2) The United States Treasury Department estimates that assets worth “tens of billions of dollars” are currently in FAPTs, with the amount growing each year.[20]
    (3) 10,000 United States physicians have created an offshore entity as part of an asset protection or financial plan.[21] 
    Thus, by refusing to adopt similar statutes, our economy would continue to lose billions of dollars per year. DAPTs provide an economic boost to many industries within the state because: (1) all DAPTs require at least one trustee from the DAPT state, and (2) require that a percentage of trust assets be managed within the state. Thus, many professions within the respective economy benefit from the adoption of DAPT legislation.
  B. Policy Arguments Against DAPTs
    There are also many reasons why DAPTs are against public policy. Many scholars believe that DAPTs will impair settlors’ moral duties to pay their debts.[22] After setting up a DAPT, some contend that settlors will continue to control and enjoy their trust property while “thumbing their noses at their creditors.”[23] Our economy is able to grow because lending allows business to develop while the underlying debts are legally guaranteed. However, by allowing a DAPT settlor to ignore his/her creditors may discourage the extension of credit by financial institutions.[24] Lenders will be forced to do extensive due diligence and loan transaction costs will likely rise. Our economy will be adversely affected if financial institutions cannot operate efficiently due to the fear that DAPT settlors may never repay substantial debts. In addition, DAPTs undermine our liability system. Creditors will be deterred from using the court system because they know that a judgment against a DAPT settlor is unlikely to be enforced.
    Furthermore, DAPTs can cost between $50,000 to $100,000 to set up, making them available only to the rich. This allows the wealthy an avenue to avoid their debts, which is not available to the poor or middle class. “Such unequal availability violates the normative standard of uniform application of the laws to similarly situated persons.”[25]
    Although DAPTs allow bona fide business owners to explore certain risks that they might not usually take, DAPTs may also promote hazardous conduct. For example, a financial advisor may promote an offshore hedge fund to his clients. The advisor knows that the fund has no track record and the management team is inexperienced. In his professional judgment, the advisor knows that this fund is extremely risky. However, the advisor realizes that he and his client stand to make a substantial amount of money if the fund appreciates. Since the financial advisor has professional liability insurance and a DAPT, he figures he can take the risk, without being subject to personal liability. Thus, DAPTs will provide incentive for morally unstable business owners or professionals to push the envelope, acting with reckless disregard for their customers or clients.
  After analyzing DAPTs in connection with the Full Faith and Credit Clause, the Supremacy Clause, and the new federal bankruptcy laws, DAPTs appear to be a vulnerable asset protection vehicle. After eight years of existence, DAPTs do not have any track record in our courts. However, after exploring the different outcomes, the weaknesses of the DAPTs are exposed.
  A. Full Faith and Credit      The Full Faith and Credit Clause of the United States Constitution states that Full Faith and Credit shall be given in each state to the public acts, records, and judicial proceedings of every other state and the congress may by general laws prescribe the manner in which such acts, records and proceedings shall be proved, and the effect thereof.[26] In other words, all states are required to enforce judgments that have been properly rendered in sister states. The Full Faith and Credit Clause presents DAPT states with a potential problem when faced with whether or not to enforce against DAPT assets judgments rendered in non-DAPT states. For example, if the suit against Rick is successful in Illinois state court, the plaintiff’s estate is entitled to enforce the judgment against Rick. A majority of Rick’s assets are in his DAPT, which he set up in Delaware. Thus, plaintiff’s estate must go to a Delaware state court to enforce the Illinois judgment against Rick’s assets. The Delaware court must then decide whether to enforce the judgment against Rick or deny the judgment and uphold its DAPT statute.
    1. Enforcing a Foreign Judgment in a DAPT State
      Although no court within a DAPT state has been faced with this issue, many experts agree that the DAPT state would reject a foreign judgment of a non-DAPT state. Most of the DAPT statutes have a choice of law provision, which allows them to apply their own law.[27] It is unlikely that a court within a DAPT state will allow the foreign creditor to enforce the judgment against DAPT assets, unless the creditor proves that the DAPT statute violates public policy. 
      However, it is unlikely that a creditor’s public policy argument will succeed. Most DAPT states have enacted these statutes to boost their respective economies and DAPT courts likely will support the legitimacy of these statutes. For example, in Gibson v. Speegle, a Delaware court refused to permit a creditor of a trust beneficiary to reach the beneficiary’s interest in a spendthrift trust even though the beneficiary had committed a willful tort against the creditor.[28] A court will do all within its power to protect a trust instrument that provides significant benefits to the state. 
    2. Enforcing a Foreign Judgment in a Non-DAPT State
      If a creditor is not confident he/she will be able to enforce the judgment within the DAPT state, the creditor may try to enforce the judgment in a non-DAPT state. There are many scenarios that allow the creditor to attack the DAPT assets by enforcing the judgment in a non-DAPT state, essentially destroying the DAPT as an effective protection tool. 
      In order to enforce a judgment in a non-DAPT state, the plaintiff must: (1) establish jurisdiction within the non-DAPT state and (2) persuade the non-DAPT state to apply its own law, rather than the DAPT state’s law. For example, plaintiff’s executor may attempt to enforce the judgment against Rick in Illinois because he or she knows it is unlikely that Delaware will respect the judgment. Thus, plaintiff’s estate will have to establish jurisdiction within Illinois state or federal court and then persuade the court to use Illinois law, instead of Delaware law.
      a. Establishing Jurisdiction
        A creditor can establish jurisdiction over the settlor, trust property, or the trustee.
        i. Jurisdiction Over Settlor
          Plaintiff’s estate could gain jurisdiction over Rick in Illinois state court because Rick is an Illinois resident. However, Rick technically does not own the property within the trust so establishing jurisdiction over the settlor might prove to be ineffective. Thus, the plaintiff would have to assert in rem jurisdiction over trust property or personal jurisdiction over a nonresident trustee.
        ii. Jurisdiction Over Trust Assets
          The creditor will be able to obtain in rem jurisdiction over the trust if some of the trust assets are located within the jurisdiction.[29] A trust may include real property, bank and brokerage accounts, and shares of stock issued by corporations. If a trust holds real property throughout the country and/or stock in many different corporations, the DAPT is subject to jurisdiction in several states.[30] For example, in Bank of America v. Weese[31] a Maryland court obtained jurisdiction over a Cook Islands FAPT because the trust was funded with Maryland real estate. Thus, Rick’s trustee must hold all of his assets in Delaware, where the trust was created, to prevent being dragged into court in other jurisdictions. Assuming that Rick’s DAPT is funded with stock in two closely-held businesses in Illinois, a condominium complex in Florida, and rental property in Nevada, Rick’s DAPT is subject to three different jurisdictions.
        iii. Jurisdiction Over Trustee
          To establish jurisdiction over the trustee, the plaintiff must show that the trustee established “minimum contacts” with the forum state by proving that the trustee purposefully availed itself of the privilege of conducting business within the forum state while enjoying the accompanying benefits provided by the state.[32]
          The guiding case regarding jurisdiction over a nonresident is International Shoe Company v. Washington.[33] In International Shoe, the defendant was a Delaware corporation with its principal place of business in St. Louis, Missouri.[34] Plaintiff brought suit against the defendant in Washington to force the defendant to contribute to its unemployment compensation fund.[35] Although defendant did not have any offices in Washington or maintain any merchandise within the state,[36] the Supreme Court determined that the Washington court had proper jurisdiction over defendant by establishing “minimum contacts.”[37] Defendant established “minimum contacts” with Washington because it consistently sent salesmen into the state to solicit one retail product.[38] During this time, defendant was protected by the state law, including the option to resort to the courts for the enforcement of its contractual rights.[39] The Court determined that defendant’s presence within the state was continuous and systematic and also gave rise to the liabilities sued upon.[40] Since the defendant had: (1) minimal contacts with the forum state and (2) the assertion of personal jurisdiction did not offend traditional notions of fair play and substantial justice, Washington had proper jurisdiction over the defendant.[41]
          Thus, a plaintiff must meet the “minimum contacts” test in order to establish jurisdiction over the trustee in any non-DAPT state. If the trustee is an individual, it is unlikely that plaintiff will be able to establish jurisdiction, unless, of course, the individual trustee has a residence in the forum state or he/she consistently conducts business within the state. However, most DAPTs are comprised of significant assets and are managed by corporate trustees such as trust companies or banks.
          The paramount case for establishing jurisdiction over a corporate trustee is Hanson v. Denckla.[42] In Hanson, the United States Supreme Court held that a foreign state could not establish proper jurisdiction over two Delaware trust companies.[43] Decedent, Dora Browning Donner (“Mrs. Donner”) was a Pennsylvania resident who executed two trusts in Delaware, naming two Delaware trust companies as trustees.[44] Mrs. Donner’s will directed that the balance of her property be paid in equal parts to the two trusts, created for the benefit of her two daughters.[45] There was a suit brought by legatees claiming that the residual clause of the will was not executed properly.[46] A judgment in favor of the legatees was rendered in the Supreme Court of Florida.[47] The judgment was then brought to Delaware, where plaintiff’s attempted to enforce the judgment against the trust.[48] The Supreme Court of Delaware refused to honor the judgment, concluding that the Florida courts never established in rem jurisdiction over the trust res or in personam jurisdiction over the two Delaware trust companies.[49]
          The United States Supreme Court upheld Delaware’s decision. First, the Supreme Court held that since no trust assets were located in Florida and no administration of trust assets took place in Florida, the Florida court lacked jurisdiction over the trust res.[50] Second, and more importantly, the Supreme Court held that the Florida court never obtained proper jurisdiction over the Delaware trustees.[51] The Delaware trust companies had no offices in Florida and transacted no business there.[52] The trust was executed in Delaware by a trust company incorporated in Delaware for a settlor who was domiciled in Pennsylvania.[53] Mrs. Donner eventually moved to Florida several years after the trust was established.[54] In Florida she carried on bits of “trust administration” and received statements and other updates via mail from the Delaware trust companies.[55] However, the record disclosed no solicitation of business in Florida on behalf of the Delaware trust companies in person or by mail.[56] Thus, the Supreme Court held that since the Delaware trust companies’ interaction with the settlor and the beneficiaries within Florida never amounted to solicitation, the trust companies never established “minimum contacts” in Florida.[57]
          Hanson has clearly established that a trustee that does not have any offices within the jurisdiction and does not solicit any business there, cannot be hauled into court in the forum state. However, the question remains as to how courts will interpret what constitutes “solicitation.”
          In Rose v. Firstar Bank[58] the court held that the Ohio trustee did not establish jurisdiction in Rhode Island even though the trustee sent statements and periodic mailings and occasionally called the beneficiary.[59] The court held that the Ohio trustee did not solicit any new or additional trust business in Rhode Island.[60] Furthermore, the court held that the Ohio trustee did not solicit or deliberately seek out the beneficiaries in Rhode Island for the purpose of initiating business or soliciting them to continue to do business with the bank.[61] When the Ohio trustee assumed its trusteeship, neither the trust nor applicable law required it to solicit or obtain the beneficiaries’ approval.[62] Thus, the court concluded that the Ohio trustee’s communication via mail or telephone did not amount to solicitation of a business relationship.[63]
          However, in McGee v. International Life Insurance Co.,[64] the United States Supreme Court held that the defendant solicited business and concluded that a California court had jurisdiction over a Texas-based insurance company. In McGee, the insured purchased a life insurance policy after he received a letter from the insurance company offering him a new life insurance policy.[65] Like Hanson, the life insurance company never maintained any offices in California or had any agents within the state.[66] In fact no evidence was introduced that the company ever did any business within California.[67] However, the Court held that the letter sent to the plaintiff constituted solicitation and was enough to establish minimum contacts with California.[68]
          In light of McGee, it follows that trust companies and banks that make a simple marketing effort or contract offer directed towards an individual within a forum state may have established “minimum contacts.” But what about advertising or marketing that is not necessarily aimed at individuals? For instance, will the trustee of Rick’s DAPT establish “minimum contacts” in multiple states by running a national advertising campaign in an estate planning journal circulated in every state? Case law throughout the U.S. establishes that general national advertising is insufficient to establish jurisdiction, even if residents within the state respond to the advertising campaign.[69] For example, in NAPA Development Corp. Inc. v. Pollution Control Financing Authority, the court stated that a nonresident defendant’s general advertising does not, by itself, satisfy the “systematic and continuous conduct of business” requirement for general personal jurisdiction.[70]
          However, as in Weintraub v. Walt Disney World Co.,[71] a corporation can be subject to jurisdiction within the forum state if the advertisements of the corporation are aimed at attracting business from the residents of a specific state and not the general public. In Weintraub, the Pennsylvania court held that jurisdiction over Walt Disney World was proper in the forum state because Disney: (1) made promotional visits to the forum state to attract business; (2) engaged in advertising specifically aimed at the forum state’s market, not the general public; and (3) maintained a toll free telephone number specifically for the forum state’s travel agents.[72] Thus, if Rick’s trust company directed its advertising efforts specifically to the Illinois market and not the general public, jurisdiction over his trustee in Illinois would be proper.
          Furthermore, as internet marketing continues to grow, trust companies and banks may subject themselves to the jurisdiction of many states. If the trust company or bank’s website enters into contracts or performs estate-planning services over the internet, it is likely that it will be subject to the jurisdiction where its client resides. For example, in Zippo Manufacturing Co. v. Zippo Dot Com, Inc.[73] the defendant, a California corporation, was subject to jurisdiction in Pennsylvania because defendant conducted electronic commerce with 3,000 Pennsylvania residents and seven internet access providers in Pennsylvania. The court held that although Pennsylvania residents comprised only 2% of its total subscribers, the defendant had done more than generally advertise on the internet. The court reasoned that if the defendant had not wanted to be amenable to jurisdiction in Pennsylvania, then it could have simply chosen not to sell its services to Pennsylvania residents.[74] As estate planning grows more and more interactive, it is not unreasonable for trust companies and banks to offer DAPT services over the internet. Doing so could possibly expose corporate trustees to jurisdiction in a majority of states.   
          Case law has established that corporate trustees that pursue estate and trust business nationwide through marketing campaigns aimed at specific states or specific individuals will establish sufficient contacts with many states, increasing the likelihood of being hauled into foreign jurisdictions.
      b. Choice of Law Application
        Assuming that an Illinois court has established proper jurisdiction over the trustee of Rick’s DAPT, the Illinois court must then determine whether Illinois or Delaware law applies. If Illinois law applies, then the DAPT statute is unenforceable, allowing Rick’s judgment creditor to penetrate the trust. Alternatively, if Delaware law applies, then the “creditor proof” clause of the DAPT must be respected. Thus, the non-DAPT forum state must apply conflict of law analysis to determine which state’s law governs.
        Section 270 of the Second Restatement of Conflict of Laws[75] provides:
          An inter vivos trust of interests in movables is valid if valid…under local law of the state designated by the settlor to govern the validity of the trust, provided that this state has a substantial relation to the trust and that the application of its law does not violate a strong public policy of the state with which, as to the matter at issue…
          Thus, a DAPT choice of law provision will be respected only if: (1) the law of the state designated has a substantial relation to the trust and (2) application of DAPT laws does not violate a strong public policy of the state with which, as to the matter at issue, the trust has its most significant relationship.[76] A “substantial relation” exists if the state whose law is chosen is: (1) the state where the trust is to be administered; (2) the state of the trustee’s business or domicile at the time of the creation of the trust; (3) the location of the trust assets; (4) the domicile of the trust maker; or (5) the domicile of the beneficiaries.[77]
        Many commentators believe that a non-DAPT forum state will probably apply its own law and refuse to enforce the spendthrift provision of the DAPT.[78] For example, in Rick’s situation, it is likely that Illinois law would have a closer relation to the trust with respect to the matter at issue. Assuming that an Illinois court established proper jurisdiction over the trust assets and/or the trustee, Illinois has developed a substantial relationship with the trust. Furthermore, many believe all non-DAPT states will conclude that DAPTs violate their public policy[79] as nearly all non-DAPT states have statutes expressly stating that creditors are allowed to reach all the assets within self-settled spendthrift trusts.[80] Thus, many non-DAPT courts that obtain jurisdiction over the trust assets or trustee may simply choose to ignore the governing law and substitute their own state laws.
        Assuming the non-DAPT forum cannot apply its law, the creditor may still be able to attack the validity of the DAPT. A creditor may allow the forum court to apply DAPT law but attempt to invalidate the trust on the basis that it is a “sham” or “alter ego” of the settlor.[81] Creditors may argue that the settlor is a beneficiary who retains significant control over the trust and is not a “discretionary beneficiary.”[82] In fact, discovery may show that many DAPT settlors still control a majority of the trust assets, thus increasing the likelihood that the DAPT is simply a sham or alter ego of the settlor. If the non-DAPT court accepts the creditor’s argument, the transfer of such assets to the trust will be void, resulting in full ownership and possession of the trust assets by the settlor, free of any trust, and subject to the creditor’s claims.[83]
      c. Enforcement
        It is apparent that there are many ways in which the trust assets or the trustee can be exposed to jurisdiction of courts throughout the country. However, if the creditor has obtained proper jurisdiction and non-DAPT law is applied (or alternatively the DAPT law is invalidated), the creditor must also enforce the second judgment against the assets of the DAPT.[84]
        If jurisdiction is based on the trust assets, then the court may simply enter an order to force the turnover of those assets to the judgment debtor.[85] Such an order will force the judgment debtor to turn over the trust assets or face criminal contempt charges. If the court had jurisdiction over the trustee, the court may issue a similar order to the trustee to turn over assets.[86] However, if the trustee does not comply, the creditor will be forced to take the judgment to the DAPT jurisdiction where the trust assets are located to enforce the judgment.[87] If the creditor obtained jurisdiction in the forum court, the DAPT court will be forced to respect its judgment under the Full Faith and Credit Clause of the U.S. Constitution.
  B. Supremacy Clause
    Under the Supremacy Clause[88] of the United States Constitution, federal courts are not bound by state law. A federal district court can assert in rem jurisdiction over the trust or personal jurisdiction over the trustee under federal question jurisdiction[89] or diversity jurisdiction.[90]  Once federal jurisdiction has been established, federal courts essentially have the power to ignore the DAPT state statutes, thus destroying the effectiveness of the DAPT.
    In the past, federal courts have exercised their contempt powers to force the turnover of assets by disregarding laws governing FAPTs. Although there is no federal case law regarding DAPTs, it is likely federal courts will not hesitate to disregard DAPT statutes the same way or simply hold the DAPT statutes are against public policy.
    For example, in Lawrence v. Goldberg,[91] the Eleventh Circuit held the settlor of a FAPT in contempt for failing to turn over trust assets, notwithstanding the fact that the FAPT was “creditor proof.” In 1991, the defendant settled an offshore self-settled trust valued at $7 million.[92] Two months later, an arbitration judgment was issued against defendant for $20.4 million.[93] After the judgment, defendant filed a voluntary bankruptcy petition.[94] However, the bankruptcy court objected to the defendant’s discharge and ordered the defendant to turn over the assets of the trust in satisfaction of the judgment.[95] Defendant claimed that after he set up the FAPT, he no longer had the authority to turn over the assets according to the terms of the trust.[96]
    The Eleventh Circuit held that in order to succeed on an “inability defense,” the debtor must go beyond a mere assertion of inability and establish that he has made in good faith all reasonable efforts to meet the terms of the court order he is seeking to avoid.[97] The court held that the defendant created the FAPT in an obvious attempt to shelter his funds from an expected adverse judgment and did not make the requisite “reasonable efforts” to avoid the court order.[98] The court upheld the district court’s decision that the turn over order was appropriate and affirmed the incarceration of the defendant until he complied with the court order.[99] Defendant was jailed in August of 2000 and remains jailed today.[100]
    Similarly, in Federal Trade Commission v. Affordable Media[101] (“FTC”) the Ninth Circuit upheld the district court’s contempt order against settlors who refused to turn over their assets within an offshore trust pursuant to a court order. Defendants were involved in promoting a telemarketing venture which promised investors a 50 percent return in just 60 to 90 days.[102] After the scheme failed, the FTC brought a civil action to recover as much money as possible for the defrauded investors.[103] The profits from the defendants’ scheme were in a FAPT within the Cook Islands.[104] The district court ordered the defendants to turn over the assets, but as in Lawrence, the defendants claimed the defense of impossibility.[105] Specifically, the defendants claimed that compliance with the court order was impossible because the trustee, in accordance with the terms of the trust, would not repatriate the trust assets to the United States.[106]
    The Ninth Circuit stated that:
      with foreign laws designed to frustrate the operation of domestic courts and foreign trustees acting in concert with domestic persons to thwart the United States courts, the domestic courts will have to be especially wary of accepting a defendant’s assertions that repatriation or other compliance with a court’s order concerning a foreign trust is impossible. Consequently, the burden on the defendant of proving impossibility as a defense to a contempt charge will be especially high.[107]
    In light of the heightened standard, the court concluded that it was not impossible to comply with the turn over order because the defendants remain in control of their FAPT and even obtained in excess of $1 million from the trust to pay their taxes.[108]
    Lawrence and FTC are examples of the power that federal courts possess when the court determines that a trust is being used to shelter funds. It is important to note that Lawrence and FTC essentially dismissed the defendants’ impossibility defenses in the context of a FAPT as a weak defense. It has yet to be seen whether a federal court will apply the heightened standard to a DAPT defendant’s impossibility defense. However, it is not unreasonable to conclude that a federal court would simply laugh at an impossibility defense raised by a settlor: (1) who resides in the United States; and (2) who still retains the benefits of the trust assets, which are located within the country.
    Furthermore, federal courts may order the individual or corporate trustee of the DAPT to turn over the assets of the trust. If the trustee is an individual, the federal courts could easily enforce their contempt power over him/her. Unlike FAPTs, whose trustees are usually located in foreign countries and nearly impossible to reach, individual DAPT trustees are located in the United States and within the jurisdiction of the federal courts.
    Federal courts also have the power to enforce civil contempt orders against corporate trustees or banks. For example, in U.S. v. Bank of Nova Scotia,[109] the Eleventh Circuit affirmed an order of civil contempt against a Canadian-based bank for $1,825,000.[110] The Bank of Nova Scotia (“Nova Scotia”) was headquartered in Toronto, with over 1,200 branches, offices and agencies in 46 countries.[111] In 1983, Nova Scotia’s Miami office was served with a subpoena to produce financial documents pertaining to two individuals and three companies.[112] The court recognized that the district judge was extremely patient with Nova Scotia for months despite almost no efforts to produce the requested documents. Nova Scotia eventually produced a small fraction of the documents.[113] Despite Nova Scotia’s production of some documents, the Eleventh Circuit was not satisfied with Nova Scotia’s weak efforts and upheld the district court’s imposition of civil contempt.[114]
    Furthermore, the federal court may decide to go directly after the assets within the DAPT without dealing with contempt orders against the settlor or the trustee. The federal court may seize the assets, place a constructive trust over the assets, or order a lien against the assets.
    The stability and the effectiveness of FAPTs have been adversely affected in light of Lawrence, FTC, and Bank of Nova Scotia. Federal courts have established that they have the power to reach assets within FAPTs even though they are located outside the country. Unlike their foreign counterpart, DAPT assets and trustees are located within the United States, making it easier for federal courts to reach them. Thus, it only takes one federal judge with slight hostility against DAPTs and a debtor who is sheltering his/her assets to ruin the protective nature of the DAPT.
  C. Federal Bankruptcy Laws
    A recent bankruptcy decision and the incorporation of a provision in the new Bankruptcy Code have also called into question the strength of DAPTs as an option for asset protection. In In re Brooks,[115] the court held that plaintiff’s property in Bermuda and Jersey FAPTs were property of his bankruptcy estate. Originally, settlors who set up FAPTs or DAPTs expected to continue to enjoy their assets even if they were forced to declare bankruptcy because most creditors’ claims were barred. In re Brooks held that plaintiff was forced to include his FAPT in his bankruptcy estate and thus the assets within the trust could be used to satisfy creditors’ claims. The case sets a precedent which, if other bankruptcy and federal courts follow, would prohibit protection for those settlors who plan to hide millions of dollars in their DAPT while avoiding creditor’s claims by filing for bankruptcy. The court realized that such behavior is wholly inequitable and will be eliminated if all courts include asset protection trusts within the bankruptcy estate of the debtor.
    Furthermore a new subsection was added to the new Bankruptcy Code[116] addressing fraudulent transfers within the context of self-settled trusts. As discussed in Section II, most DAPTs bar any claims for fraudulent transfers occurring four years after the original assets are transferred. However, subsection (e)(1) of Section 548 of the new Bankruptcy Code extends the limitations period for fraudulent transfers to 10 years before the date the debtor files for bankruptcy.[117] Section (e) provides:
      In addition to any transfer that the trustee may otherwise avoid, the trustee may   avoid any transfer of an interest of the debtor in property that was made on or within 10 years before the date of the filing of the petition, if
        (A) such transfer was made to a self-settled trust or similar device;
        (B) such transfer was by the debtor;
        (C) the debtor is a beneficiary of such trust or similar device; and
        (D) the debtor made such transfer with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made, indebted.
      (2) For the purposes of this subsection, a transfer includes a transfer made in anticipation of any money judgment, settlement, civil penalty, equitable order, or criminal fine incurred by….
    This 10-year limitations period only applies to self-settled trusts or similar devices and extends the limitation period for fraudulent transfers much longer than DAPT state law.[118] For example, under the old Bankruptcy Code, if Rick fraudulently transferred assets to the DAPT in 1995 but did not go bankrupt until 2005, his creditors would be barred from raising such a claim. However, under the new subsection of the Bankruptcy Code, Rick’s creditors would be able to pierce the DAPT because the fraudulent transfer was made within 10 years from the date he filed for bankruptcy. Like the Brooks court, Congress has taken affirmative steps to avoid debtors’ inequitable actions in bankruptcy.
    In light of In re Brooks and the new Bankruptcy Code section, DAPTs are simply ineffective for those settlors who file for bankruptcy and hope to preserve their wealth. The four-year tail period which made DAPTs so attractive to some settlors has been trumped by the new provisions of the Bankruptcy Code, and it is possible that at some point in the near future all DAPT assets must be incorporated in the debtor’s bankruptcy estate.
  DAPTs offer settlors an opportunity to set up a self-settled trust for their own benefit. Settlors are able to enjoy the trust assets, while maintaining control over the management of the trust. DAPTs help to stop the flow of assets offshore and in return provide a boost to our economy. On their face they provide settlors a safe nest to place their assets.
  However, after analyzing DAPTs within the context of the Full Faith and Credit Clause, the Supremacy Clause, and the new bankruptcy laws, the weaknesses of the DAPT as an asset protection vehicle are exposed. Unfortunately, there are many situations whereby the “creditor proof” provisions of the DAPT will be ignored or at least weakened. There are many scenarios where jurisdiction may be obtained over the trust assets or the trustee. First, if jurisdiction has been properly established, the creditor has three arguments: (1) the DAPT statute is inapplicable because it is against public policy of the forum state; (2) the DAPT was simply a sham or alter ego of the settlor; or (3) the transfer was fraudulent. If the forum court accepts one of these arguments, the DAPT is unenforceable and allows creditors to reach the settlor’s assets.
  Second, if a judgment has already been rendered against the debtor, the creditor may attack DAPT assets by establishing jurisdiction over the trust assets or the trustee in a non-DAPT state. Assuming the non-DAPT state will apply its own law, the judgment will be enforced, and the DAPT will provide no protection.  
  Third, if the creditor can establish jurisdiction in federal court, the federal courts may use their contempt power to make sure the settlor or trustee produces assets or relevant documents. Therefore, once a creditor enters federal courts, the DAPT statutes are in essence meaningless, and the decisions lie in the hands of the federal district or circuit court judge.
  Fourth, recent bankruptcy decisions and laws make it increasingly difficult for a settlor to set up a DAPT and then establish protection by filing for bankruptcy. Bankruptcy courts may include the DAPT as part of the bankruptcy estate, thus exposing DAPT assets to creditors. Furthermore, Congress extended the limitation period for filing a fraudulent transfer made on or within 10 years before the date of the filing.
  Although there is no case law that has tested the enforceability of DAPTs, these are at least four circumstances that make DAPT a risky form of asset protection at this point.
Copyright 2006. Michael A. Passananti. All rights reserved.
[1] See Domestic Asset Protection Trust, at onlineAUS, http:/
[2]  Id.
[3] Maurice Offit, The Truth About Offshore Asset Protection Trusts, Society of Financial Services Professionals,
[4] Id.
[5] J. Alan Jensen and Janene Sohng, “The Use and Abuse of Asset Protection Trusts,” Holland & Knight Private Wealth Services Newsletter, Summer 2004, Volume 2.
[6] Deborah L. Jacobs, “Going Under Cover,” Bloomberg Wealth Manager, March 2005 at 82.
[7] Restatement (Second) of Trusts § 156 (1959).
[8] See Alaska Stat. §§ 34.40.110, 13.36.035, 13.36.043, 13.36.310, 13.36.320, 13.36.330, 13.36.390; Del. Code Ann. Tit. 12, §§ 3570-71, 3573-75; Nev. Rev. Stat. §§ 166.015, 166.020, 166.025, 166.040, 166.050, 166.120, 166.140, 166.170, 166.190, 166.230; R.I. Gen. Laws §§ 18-9.2-2 through -6; Utah Code Ann. §§ 7-5-1, 25-6-14, 75-2-205, 75-7-601, 75-7-602.
[9] J. Alan Jensen and Janene Sohng, “The Use and Abuse of Asset Protection Trusts,” Holland & Knight Private Wealth Services Newsletter, Summer 2004, Volume 2.
[10] Id.
[11] UFTA § 5(a) (1984).
[12] 4(a) (1984).
[13] UFTA § 4(a) (1984).
[14] Id.
[15] J. Alan Jensen and Janene Sohng, “The Use and Abuse of Asset Protection Trusts,” Holland & Knight Private Wealth Services Newsletter, Summer 2004, Volume 2.
[16] Richard W. Nenno, “The Domestic Asset Protection Trust Comes of Age,” American Law Institute, SK069 ALI-ABA 283.
[17] “Domestic Asset Protection Trusts, Irrevocable Trusts: Analysis with Forms,”Irrev. Tr.: Analysis Forms ¶ 14.09, 2004 WL 2652603.
[18] Id.
[19] Id.
[20] Id.
[21] Id.
[22] Id. at 535.
[23] “Domestic Asset Protection Trusts, Irrevocable Trusts: Analysis with Forms,” Irrev. Tr.: Analysis Forms ¶ 14.09, 2004 WL 2652603.
[24] Henry, J. Lischer Jr., “Domestic Asset Protection Trusts,” (Fall 2000), 35 Real Prop. Prob. & Tr. J. 479, 546.
[25] Id.
[26] U.S. Const. amend. IV, § 1.
[27] See, e.g., Alaska Asset Protection Trust Act, Alaska Stat. § 34.40.110.
[28] Gibson v. Speegle, C.A. No. 134 (Del. Ch. May 30, 1984).
[29] Richard W. Nenno, “The Domestic Asset Protection Trust Comes of Age,” American Law Institute, SK069 ALI-ABA at 330-31.
[30] Duncan E. Osborne and Jack F. Owen, “Asset Protection: Trust Planning,American Law Institute, SK069 ALI-ABA 2029, 2063 (2005).
[31] Bank of America v. Weese, No. 03-C-01-011892 (Md. Cir. Ct. Baltimore County, July 30, 2001).
[32] See World-Wide Volkswagen Corp. v. Woodson, 44 U.S. 286, 100 S. Ct. 559 (1980).
[33] International Shoe Company v. Washington, 326 U.S. 310, 66 S. Ct. 154 (1945).   
[34] Id. at 313.
[35] Id.
[36] Id.
[37] Id. at 315.
[38] Id. at 320.
[39] Id. at 320.
[40] Id. at 319-20.
[41] Id.
[42] Hanson v. Denckla, 357 U.S. 235, 78 S. Ct. 1228 (1958).
[43] Id. at 235.
[44] Id. at 239.
[45] Id.
[46] Id. at 240.
[47] Id.
[48] Id. at 243.
[49] Id. at 244-48.
[50] Id. at 246-47.
[51] Id. at 251-52.
[52] Randall J. Gingiss, “Putting a Stop to ‘Asset Protection’ Trusts,” 51 Baylor L. Rev. 987, 1022 (1999).
[53] Id. at 252.
[54] Hanson at 252.
[55] Id.
[56] Randall J. Gingiss, “Putting a Stop to ‘Asset Protection’ Trusts,” 51 Baylor L. Rev. 987, 1022 (1999).
[57] Hanson at 256.
[58] Rose v. Firstar Bank, 819 A.2d 1247 (2003).
[59] Id. at 1252.
[60] Id.
[61] Id.
[62] Id.
[63] Id.; see also In the Matter of the Estate of Ducey, 241 Mont. 419, 787 P.2d 749 (1990). The Supreme Court of Montana held that the state court did not have personal jurisdiction over a Nevada corporate trustee. The trustee did not conduct any business in the forum state (Nevada) availing itself of the benefits and protections of Montana’s laws. The Nevada corporate trustee: (1) made payments of trust income to the beneficiary in Montana; (2) responded to requests made by the beneficiary; and (3) participated in negotiations initiated by and at the request of the beneficiary. Although the Nevada corporate trustee had contact with a beneficiary in Montana, the trustee did not perform any acts which lead to solicitation of trust business within Montana. Thus, the court held that the Montana court lacked jurisdiction over the Nevada trustee.  
[64] McGee v. International Life Insurance Co., 355 U.S. 200, 78 S. Ct. 1999 (1957).
[65] Id. at 200.
[66] Randall J. Gingiss, “Putting a Stop to ‘Asset Protection’ Trusts,” 51 Baylor L. Rev. 987, 1022 (1999).
[67] Id.
[68] Id.
[69] See NAPA Development Corp. Inc. v. Pollution Control Financing Authority, 346 F. Supp. 2d 730 (E.D. Pa. 2004); see also Gehling v. St. George’s Sch. of Med., Ltd., 773 F.2d 539 (3d Cir. 1985); Salem v. Circus Hotels, 1997 WL 102481 (N.D. Tex.).
[70] NAPA Development at 733.
[71] Weintraub v. Walt Disney World Co., 825 F. Supp. 717 (E.D. Pa. 1993).
[72] Id. at 720-21.
[73] Zippo Manufacturing Co. v. Zippo Dot Com, Inc., 952 F. Supp. 1119 (W.D. Pa. 1997).
[74] But see Bensusan Restaurant Corp. v. King, 937 F. Supp. 295 (S.D.N.Y. 1996). The operator of a New York jazz club sued a Missouri jazz club for trademark infringement. The internet web site at issue contained general information about the defendant’s club, a calendar of events and ticket information. If a user wanted to go to the club, he would have to call and then pick up the tickets at the club on the night of the show. The New York Court lacked jurisdiction because Missouri club owner’s web site contained general information and advertising.
[75] Restatement (Second) of Conflict of Laws § 270 (1971).
[76] “Domestic Asset Protection Trusts, Irrevocable Trusts: Analysis with Forms,”Irrev. Tr.: Analysis Forms ¶ 14.05, 2004 WL 2652599.
[77] Id.
[78] Id.
[79] Id.
[80] Duncan E. Osborne and Jack E. Owen, “Asset Protection: Offshore and Onshore,” American Bar Association, RPPT Section Meeting, Chicago, Illinois (September 11-13, 2003).
[81] Duncan E. Osborne and Jack F. Owen, “Asset Protection: Trust Planning,” American Law Institute, SK069 ALI-ABA 2029, 2063 (2005).
[82] Id.
[83] Id. at 2064.
[84] Id.
[85] Id.
[86] Id. at 2065.
[87] Id.
[88] U.S. Const. amend. VI § 2.
[89] 28 U.S.C. § 1331.
[90] 28 U.S.C. § 1332.
[91] Lawrence v. Goldberg, 279 F.3d 1294 (11th Cir. 2002).
[92] Id. at 1296.
[93] Id.
[94] Id.
[95] Id. at 1297.
[96] Id. at 1298.
[97]  Id.
[98] Id. at 1300.
[99] Id. at 1294.
[100] Jay Adkisson and Chris Riser, “Asset Protection: Concepts and Strategies for Protecting Your Wealth,” Chapter 13, Domestic Asset Protection Trusts Neutered by Bankruptcy Reform
[101] Federal Trade Commission v. Affordable Media, 179 F.3d 1228 (9th Cir. 1999).
[102] Id. at 1231
[103] Id.
[104] Id.
[105] Id.
[106] Id. at 1239.
[107] Id. at 1241.
[108] Id. at 1241-42.
[109] U.S. v. Bank of Nova Scotia, 740 F.2d 817 (11th Cir. 1984).
[110] Id. at 817.
[111] Id. at 820.
[112] Id. at 820.
[113] Id. at 832.
[114] Id. at 826.
[115] In re Brooks, 217 B.R. 98 (Bankr. D. Conn. 1998).
[116] 11 U.S.C.A. § 548.
[117] Id.
[118] Jay Adkisson and Chris Riser, “Asset Protection: Concepts and Strategies for Protecting Your Wealth,” Chaper 13, Domestic Asset Protection Trusts Neutered by Bankruptcy Reform. http//