Reversing the Illinois Court of Appeals, the Illinois Supreme Court has ruled that Illinois law, not Cook Islands law, should be applied to determine that transfers to a Cook Islands Trust were Per Se Fraudulent under Illinois law.
What Happened
In 1994, Mr. Rush W. Sessions created the Sessions Family Trust in the Cook Islands. The trust was an irrevocable self-settled spendthrift trust -- what would usually be called a "Foreign Asset Protection Trust". Mr. Sessions was both the settlor and a lifetime beneficiary. Mr. Sessions named himself the Trust Protector with the power to fire and appoint Trustees, and also to change beneficiaries.
The next year, 1995, Mr. Sessions made an irrevocable pledge of $1.5 million to the Rush University Medical Center ("RushU") in Chicago. Based on Mr. Session's pledge, RushU built a new home for the RushU President, called the "Robert W. Sessions House", and honored him at a public ribbon-cutting ceremony.
A year after that, in 1996, Mr. Sessons sent RushU a letter again confirming his pledge:
"I agree to provide in my will, living trust and other estate planning document * * * that (1) this pledge, if unfulfilled at the time of my death, shall be paid in cash upon my death as a debt and (2) that if this pledge is unenforceable for any reason, a cash distribution shall be made under such will, living trust or other document to Rush University in an amount equal to the unpaid portion of such pledge at the time of my death."
Later, Mr. Sessions executed codicils to his Will which required that the pledge to RushU be completely fulfilled on his death, if not already satisfied.
Fast forward to 2005. Mr. Sessions, who so far had made no payments towards his $1.5 million pledge to RushU, was found to have terminal cancer.
Blaming the good doctors at RushU's medical center for not diagnosing his cancer early enough to do any good, Mr. Sessions revoked his Will and all codicils. Mr. Sessions also gave away $200,000 in various gifts -- but none to RushU.
A month later, Mr. Sessions went on to his reward.
Rounding up all the assets revealed that Mr. Sessions had less than $100,000 in his estate -- not nearly enough to fulfill his pledge to RushU.
But there were assets in the Trust -- a lot of assets. Mr. Sessions had placed a 99% limited partnership interest into the Trust that by 2005 was valued in excess of $16.2 million. The Trust also owned real property in Illinois in excess of $2.7 million.
RushU sued the Trust alleging three things: Fraudulent Transfer, Breach of Contract of a promise that was binding on the Trust, and that Mr. Sessions' transfers of assets to Trust amounted to Per Se Fraudulent and thus the Trust should be voided.
Let's take a second to understand the Per Se Fraudulent claim, as it would feature prominently in the subsequent appellate opinions. Under a 1925 Illinois Court of Appeals opinion called Crane (FN1), and a more recent opinion by a U.S. Bankruptcy Court in Illinois called Morris (FN2), self-settled spendthrift trusts are deemed to be fraudulent and per se void, and their assets are reachable by creditors of the settlor/beneficiary. This theory has since been adopted and used by other Illinois courts. (FN3)
In other words, in Illinois, a self-settled spendthrift trust (a/k/a an asset protection trust) simply does not exist for creditor-debtor purposes -- it is as if such a trust was never created. But let's get back to the case.
After some sparring, the parties then filed competing motions for summary judgment. The court agreed with RushU on its Per Se Fraud theory and found the Trust to be void, stating:
"The Court is going to rule that it was the intent of the decedent to not fulfill his pledge because he did everything to avoid the payment.
* * *
But he never intended to pay the pledge. As all the evidence clearly shows, he did everything that is possible to avoid the payment of the pledge.
* * *
I think the facts are strong and clear that the decedent never intended to fulfill his pledge, and every course of action he took was with the intent to avoid the fulfillment of the pledge.
He even went so far as to defraud the hospital by transferring all of his assets into trusts so they could not be reached by the hospital.
So when he died, he had very little, if any, assets in his name with which to pay the pledge, and he was aware of that and I think he did defraud the hospital in that sense. It's not only the intent but also it's [fraud]."
The Court also denied the Trust's motions for summary judgment. The Trust appealed.
The main thrust of the Trust's argument was that when Illinois adopted the Uniform Fraudulent Transfers Act ("UFTA") in 2006, this law supplanted the common-law Per Se Fraudulent rule. In other words, the Illinois UFTA had the effect of nullifying the Per Se Fraudulent rule to the extent that it no longer existed, and instead a creditor would have to bring the statutory fraudulent transfer action instead.
For the Trust, that was a winning argument before the Court of Appeals:
"We agree with defendants that the Fraudulent Transfer Act and the common law cannot exist in harmony. Crane and its progeny stand for the principle that self-settled trusts are per se fraudulent, but the Fraudulent Transfer Act requires a creditor to satisfy [certain] conditions * * * to bring a successful fraudulent transfer claim. If the legislature intended self-settled trusts to remain per se fraudulent under the common law, it would not have promulgated a statute defining the conditions required to prove a transfer was fraudulent."
Thus finding the Per Se Fraudulent rule to no longer exist, the Court of Appeals further held that RushU had not properly plead a fraudulent transfer and ruled in favor of the Trust.
Thus, onwards and upwards to the Illinois Supreme Court, now also joined by the Illinois Attorney General additionally on behalf of RushU.
Illinois' highest court disagreed with the Court of Appeals, and reversed.
To start, the Supreme Court pointed out that the Illinois UFTA specifically provides may co-exist with other law, or as the law itself states:
"Unless displaced by the provisions of this Act, the principles of law and equity, including * * * the law relating to * * * fraud * * * supplement its provisions."
This is true in most if not all states: Analysis of a creditor-debtor issues cannot both begin and end with the UFTA. Instead, the UFTA is something that a creditor may assert as an alternative to some other theory of relief, in lieu of some other theory, or not asserted at all and the other theory alone pursued. This is one of those things which makes creditor-debtor law, and thus asset protection planning, so darned complicated -- you have to know what other law might apply in addition to the UFTA.
So, the Illinois UFTA and the Illinois Per Se Fraudulent rule could, as the old song goes, exist in perfect harmony.
This now returns us to a discussion of the Per Se Fraudulent rule, which is also referred to as the "Common Law Rule" in this context. It is explained this way by the Illinois Supreme Court:
"The common law rule also has a general purpose of protecting creditors, but it addresses the specific situation where an interest is retained in a self-settled trust with a spendthrift provision. Traditional law is that if a settlor creates a trust for the settlor's own benefit and inserts a spendthrift clause, the clause is void as to the then-existing and future creditors, and creditors can reach the settlor's interest under the trust. And the rule is applicable although the transfer is not a fraudulent conveyance * * * and it is immaterial that the settlor-beneficiary had no intention to defraud his creditors.
"This rule has a 500–year lineage, has been consistently applied as the law in Illinois for over 140 years, at least until the instant appellate court's decision, and remains the law in the vast majority of states throughout the nation . . .."
[Internal quotations and citations omitted.]
In a lengthy and thoughtful analysis, the Illinois Supreme Court rejected the Trust's argument that the Per Se Fraudulent and the Fraudulent Transfer Act were in conflict:
"The common law and the statute are supplementary, not contradictory. Both laws have a general purpose of protecting creditors. But the common law focuses on the additional matter of the interest retained by the settlor of a specific kind of trust, and not simply the fraudulent transfer of an asset or the fraudulent incurring of a debt, as does the statute. Additionally, the Act and the common law rule each operate in some circumstances where the other does not, thus negating any inference that the common law rule would render the Act superfluous. The Act is effective, but the common law rule is not, in a much larger sphere, which includes both situations that do not involve trusts and in connection with transfers into trusts that are not for the settlor's benefit because they permit distributions only to other persons.
* * *
"[I]t could be said that the policy behind the common law rule is not limited solely to deterring fraud, as it prevents the distinct injustice of allowing a person to use a trust as a vehicle to park his assets in a way that preserves his own ability to benefit from those assets, while keeping them outside the reach of his present and future creditors. If the law were otherwise, it would make it possible for a person free from debt to place his property beyond the reach of creditors, and secure to himself a comfortable support during life, without regard to his subsequent business ventures, contracts, or losses.
[Internal quotations and citations omitted.]
Not deaf to the growing DAPT industry, the Court did note that "Alaska and Delaware, motivated in part by a desire to attract trust business otherwise flowing to offshore jurisdictions" had adopted laws specifically allowing self-settled spendthrift trusts. But this did not keep the Court from concluding that the Common Law Rule was alive and well in Illinois, and pointed to certain statutes as further evidence that the Illinois legislature desired to keep the Common Law Rule alive.
As lagniappe, the Supreme Court also ruled that the Common Law Rule was not affected because the Settlor was now dead:
Thus, we believe that if the settlor's interest in a self-settled trust is "void" as to the settlor's creditors, there is no sound reason to treat the creditors' rights as suddenly defeated the moment the settlor dies, thereby giving the commensurate economic benefit to the settlor's heirs.
The Court likewise held that the Common Law Rule could apply to post-mortem creditors as well -- effectively: once void, always void.
My Musings, Such As They Are
In the end, the Trust lost and RushU prevailed. Unfortunately, the Opinion does not of course tell us about the eventual outcome -- what RushU was able to actually recover against the Trust. Presumably, RushU will now be able to execute against the Illinois real estate to satisfy its judgment.
However, RushU probably will not be able to recover against the Trust's other assets in the Cook Islands. The Cook Islands recognizes self-settled trusts, and is not bound by the Illinois Court's judgment. And, unlike the landmark cases involving Foreign Asset Protection Trusts where the settlors were incarcerated, here Mr. Session's biological expiration has placed his soul irretrievably beyond the contempt power of the court.
Which is to say, whether or not foreign asset protection trusts are considered to "work" while the Settlor is still alive and can be hauled to the pokey by the Sheriff or Marshall, there is little doubt that they do in fact work where the Settlor had died -- so long as the assets of the Trust are no longer within the reach of the Courts.
That is the downfall of this case for the Trust -- the real estate located in Illinois. If the Trust didn't have real estate in Illinois, I would be very doubtful as to whether RushU would have made any collection.
But in a bigger sense this is another case where the laws of the location where the trust was located just didn't make any difference. Even though the Trust was domiciled in the Cook Islands, the Court applied Illinois law to penetrate the Cook Islands Trust as to a Illinois settlor and Illinois property.
Of course, the offshore planners will say, quite correctly, "RushU wouldn't have gotten anything if the trust didn't have the property in Illinois." And they would probably would be right.
If anything, this Opinion probably casts a dark shadow on the viability of so-called Domestic Asset Protection Trusts, which -- because of Full Faith & Credit -- do not offer the tremendous advantage of Foreign Asset Protection Trusts that the assets are typically not within the reach of the domestic courts.
In other words, Foreign Asset Protection Trusts do not rely on the U.S. courts finding that the laws of the foreign jurisdiction will apply, and in fact there is an implicit assumption that the U.S. courts will not make such a finding -- those trusts are designed to be effective even in the face of an adverse ruling by a U.S court.
By contrast, with a Domestic Asset Protection Trust, the Debtor/Settlor/Beneficiary and the Trustee may be bound by an adverse ruling of the Court where the judgment is being enforced, even if the Trust is formed in a DAPT state.
The bottom line is that there may be no effective asset protection for assets held in Asset Protection Trusts in those states that have not yet adopted APT legislation, and which still have the Common Law Rule.
Again, and although this case involves an FAPT, this Opinion will likely have far greater impact on DAPTs than FAPTs.
So, let me summarize how I view this area of the law, subject to the General Rule which is that "General Rules Are Generally Inapplicable".
(1) With some exceptions, Foreign Asset Protection Trusts can be effective if the Settlor/Beneficiary and all assets are beyond the reach of the U.S. courts. So long as those two conditions prevail, contrary U.S. law probably will not be of practical benefit to the creditor. But Foreign Asset Protection Trusts might not be effective as to trust assets found in the U.S. (as here), or if the Settlor/Beneficiary remains within the contempt power of the Court.
(2) With some exceptions, Domestic Asset Protection Trusts can be effective if all of the trust assets are held in a DAPT state. But Domestic Asset Protection Trusts might not be effective as to assets held in a non-DAPT state.
(3) While not considered in this Opinion, Bankruptcy Code section 548(e) casts a dark shadow over all "self-settled trusts and similar devices" to the extent that the Bankruptcy Petition is filed within 10 years of the date of transfer.
To summarize as to Domestic Asset Protection Trusts: They "work" so long as your assets are kept in a DAPT state and you can stay out of bankruptcy for 10 years. There is an open question as to whether the courts of a non-DAPT state can compel the return of asset from the DAPT state to the non-DAPT state so that those assets are available to creditors, i.e., the application of "Anderson relief" to DAPTs.
But the real problem with DAPTs is that they are so far significantly untested. We've got a pretty good idea after the Anderson and Lawrence cases what happens with an FAPT, but what will happen with DAPTs is largely a crapshoot. Whether they realize it or not, many clients in DAPTs are the lab rats in a great legal experiment which, in this author's opinion, is not hopeful as far as DAPTs for non-DAPT settlors and their assets are concerned.
This is not to suggest, by any measure, that APTs either foreign or domestic are the only asset protection tools -- they are not. If, for example, Mr. Sessions has not created a self-settled trust but instead just funded a plain 'ol irrevocable trust for the benefits of his children before he made his Pledge, then RushU would have been squarely out-of-luck.
For what it is worth, your writer and his law firm only very rarely use self-settled trusts of any kind for asset protection planning. My advice has long been to "avoid self-settled trusts altogether whenever possible". This Opinion does nothing to dispel the technical basis for that advice.
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Rush Univ. Med. Center v. Sessions, ___ N.E.2d ____, 2012 IL 112906, 2012 WL 4127261 (Ill., Sept. 20, 2012); case below: 2011 IL App (1st) 101,136, 2011 WL 3476645 (Ill.App. 1 Dist., Unpublished, Reversed, Aug. 5, 2011). Found at http://goo.gl/1c2im
FN1. Crane v. Illinois Merchants Trust Co., 238 Ill.App. 257 (1925).
FN2. Barash v. McReady ( In re Morris ), 151 B.R. 900, 906–07 (Bankr.C.D.Ill.1993).
FN3. Dexia Credit Local v. Rogan, 624 F.Supp.2d 970, 976 (N.D.Ill.2009); Marriage of Chapman, 297 Ill.App.3d 611, 620, 697 N.E.2d 365 (1998); Grochocinski v. Kennedy ( In re Miller ), 148 B.R. 510, 519 (Bankr.C.D. Ill 1992).
This Article at http://onforb.es/PBtBJG and http://goo.gl/KrR7I
