The Bloggers are having a heyday. The first case to test Section 548(e) of the Bankruptcy Code, In re Thomas William Mortensen, was decided in an Alaskan Bankruptcy court on May 26, 2011. The court held that Mr. Mortensen’s transfer to an Alaskan asset protection trust in 2005, while Mr. Mortensen was solvent, which occurred within the statutory 10 year period prior to the filing of his bankruptcy petition, was made with actual intent to hinder, delay or defraud his future creditors. The Judge concluded that a settlor’s expressed intention to protect assets placed into a self-settled trust from a beneficiary’s potential future creditors can be evidence of an intent to defraud. On this basis he allowed Mortensen’s creditors to reach the assets of the trust. Commentators are weighing in on the effect of this decision on Domestic Asset Protection Trusts. Some are predicting that the decision may be the death warrant for this planning strategy. This author believes that the decision should have only a minor effect on the continued use of DAPT’s.
Our typical DAPT client is an individual seeking to protect assets from future creditors. Careful due diligence is performed to satisfy our firm that the proposed transfer does not constitute a fraudulent transfer. We also are not concerned with unknown, unexpected and nonexistent potential future creditors. Neither Michigan nor Delaware (an example of a DAPT state) fraudulent transfer law protects unknown, unexpected and/or nonexistent potential future creditors. The judge in Mortensen however concluded that just such creditors are protected under Section 548(e)(1)(D) of the Code. How is it then that we continue to be so confident of the benefits of the DAPT in light of Mortensen.
Let’s assume we have a similar client to Mr. Mortensen and the facts are identical. We would advise our client not to file for bankruptcy if the trust had been established within the 10 year period prior to the date of filing his petition. Involuntary bankruptcies in individual bankruptcy cases are very rare indeed so it is the debtor who controls the decision. Sure it would be nice to obtain a discharge of what might be some large debts but the inability to do so demonstrates how the DAPT strategy is so effective. Our client, weighed down by enormous debt, can live in a beautiful home owned by the DAPT which pays the mortgage, utilities and upkeep. The DAPT can provide or guaranty payment of a credit card. The DAPT can own but let our client use a luxury automobile and pay for his foreign travel. All of this while the creditors are unable to access the assets of the DAPT. Considering these advantages, how has the DAPT really been hurt by the Mortenson decision? The debtor client continues to live well untouchable by his creditors. And once the 10 year period runs a petition can be safely filed.
Of course, we are not unmindful of the high earning debtor whose earnings will now be subject to garnishment. Worse case scenario, 25% of the earnings go to the creditors. But there are many sophisticated strategies where the debtor, if previously the owner of a business, can convert from owner, officer, director and/or CEO to employee where his wages are considerably less leaving the creditors with a much smaller garnishment.
And let’s not forget one of the overall objectives of asset protection planning ….. placing the debtor client in a position where the creditor is much more likely to negotiate a favorable settlement. It is clear to me that the creditors squeezing out monthly garnishment payments that may not even cover the interest on the debts will be quite receptive to a lump sum settlement which ultimately has the effect of a discharge. We have accomplished these results for many clients. Ironically, the creditors are often delighted that they can finally close their file.
This is not to say that offshore asset protection trusts should not now be given greater consideration. The offshore venues are not subject to the judgments of a US Bankruptcy court. While each case and client is different and the factors need to be carefully analyzed, we think DAPT’s are still viable and provide an excellent planning opportunity for many clients.