A few months ago, I did a post on Domestic Asset Protection Trusts (which shouldn't be confused with traditional discretionary trusts used for asset protection) and why I think they only make sense in very specific situations. That post can be read here. In that post, I focused mostly on arguments involving jurisdiction. Near the end of the post, I glossed over 11 U.S.C. 548(e), intending to do a later post about it. Due to a recent case, now is a good time for that post.
Battley v. Mortensen, 2011 Google Scholar 11958026801002327424 (Bkrpt. D.Alaska 2011) and 2011 Google Scholar 8795756461041061159 (Bkrpt. D.Alaska 2011) involved an Alaska resident who formed a DAPT in Alaska, a state that recognizes DAPTs. He was solvent when forming the DAPT. Based on those facts alone, many would believe the debtor would be in good shape in terms of asset protection.
He wasn't. The court found that the assets of the trust were reachable by the debtor's creditors in bankruptcy under 11 U.S.C. 548(e), which says:
(e)(1) 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.
This provision is commonly known as the 10-year clawback for DAPTs. With regard to DAPTs, subsections A through C are easily proven by a creditor. It is subsection D that the creditor has to prove.
Proving subsection D requires a showing of actual intent. According to the court, "actual intent" for the 10-year clawback is defined the same as actual intent in an UFTA action, as a I described in this earlier post. Actual intent is generally thought of as difficult to prove, especially when the debtor is not insolvent. However, in Mortensen, the court ruled that although the debtor was clearly solvent at the creation of the DAPT he still had actual intent to hinder, delay, or defraud his creditors. The court essentially ruled that formation of a DAPT is basis enough in itself for a finding of actual intent, as DAPTs serve the express purpose of impeding creditors:
[W]hen property is transferred to a self-settled trust with the intention of protecting it from creditors, and the trust’s express purpose is to protect that asset from creditors, both the trust and the transfer manifest the same intent. In this case, I found that the trust’s express purpose could provide evidence of fraudulent intent...
The debtor's DAPT was pierced.
Mortensen is simply a Bankruptcy Court opinion in Alaska, and we will have to wait and see if other courts around the country apply its reasoning. However, it is surely another potential knock against DAPTs. If you have read my previous posts in this blog, while I do draft DAPTs occasionally, I don't always recommend them for my clients. However, more than just having implications for DAPTs alone, Mortensen does have an implication for the type of trusts I often do recommend more often for my clients. On some level, it stands for the proposition that a trust which has as its primary purpose asset protection is at least somewhat vulnerable to a finding of actual intent, which destroys the trust's asset protection benefits. This is why I draft trusts which have explicit "estate planning purposes" of reducing estate taxes (even if the estate is too small to be taxable for federal purposes, it is almost always large enough to be taxable by New Jersey), efficiently managing assets, and providing for beneficiaries. When a trust has an "estate planning purpose" like those listed is it more likely to sustain an attack from creditors. While such an "estate planning purpose" probably wouldn't have helped the Grantor of a DAPT like Mr Mortensen, I believe that in the context of a more traditional discretionary trust such reasons are valid.
As always, if you have any questions about the above, or are interested in a trust hopefully more effective than Mr Mortensen's, feel free to contact me.
[Special thanks to Randall Borkus for alerting me to this case on LinkedIn, and to Jay Adkisson and Chris Riser for writing a great analysis of the case on the Leimberg newsletter.]
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