Despite decades of hoopla, ballyhooing, and collective singing of praises at asset protection seminars about the theoretical benefits of the offshore trust, a/k/a Foreign Asset Protection Trust ("FAPT"), what has remained conspicuous by its absence -- the Elephant in the room -- is any case law that actually validates these benefits as to U.S. settlors.
But after years of criticism, and including no shortage of the same from Yours Truly, it seemed that such a case had been found -- the Arline Grant case as I shall now relate. Raymond Grant, before his passing, was married to Arline Grant. In 1983 and 1984, Raymond settled an offshore trust in Bermuda and another one in the Isle of Jersey, with one trust benefitting himself and the other benefitting Arline.
The evidence was overwhelming that Raymond managed the trusts and their affairs, and that Arline had little to do with them. Raymond also mis-managed the couple's tax affairs, leading to a $36 million tax judgment in favor of the United States. By then, Raymond didn't really care, as he had gone off to that great Tax Shelter in the Sky that no mortal revenue agent can touch. The U.S. tried a variety of strategies to get at the money in the Grants' offshore trusts, including trying to force Arline to appoint a new Trustee. None of this worked, and finally the U.S. moved to hold Arline in contempt of Court until the money came back to the U.S.
Such contempt orders have been routinely granted by the Courts, see, e.g., FTC v. Affordable Media LLC, 179 F.3d 1228 (9th Cir. 1999) (a/k/a "Anderson"); In re Lawrence, 279 F.3d 1294 (11th Cir., 2002). But it was not granted against Arline Grant, mostly since there was little evidence that she had anything to do with the trusts set up by Raymond. Thus, the Court:
I understand that it has been more than two years since the repatriation order was issued and that the funds had not yet been repatriated. But this failure is not for a lack of effort. I am reluctant to fault Mrs. Grant for her trustees' denial of her requests to repatriate the funds.
Accordingly, I find that Mrs. Grant has sufficiently established that she is not able to repatriate the offshore funds and deny the motion for an order to show cause.
U.S. v. Grant, 2008 WL 2894826 (S.D.Fla.), 101 A.F.T.R.2d 2008-2676 (S.D.Fla., May 27, 2008).
Despite the outlier facts unlikely to be often seen -- Raymond had died and Arline had little connection to the Trusts -- the Arline Grant case was immediately trumpeted by Foreign Asset Protection Trust proponents as a triumph of the offshore trust; it's first real, verifiable victory over a determined creditor.
As will now be shown, these celebrations were premature.
The thing about creditors is, even if a debtor stymies one attempt to get at assets, the creditor doesn't have to give up. Instead, the creditor can just linger, letting interest grow on the judgment, and look for other ways to get at the moneys -- or at least keep the debtor from getting the moneys so as to put as much pressure on the debtor. That is exactly what happened here. The U.S. never gave up in its collection efforts against Arline. To the contrary, as creditors are wont to do, the U.S. sat back for a few years and let water pass under the bridge, then started to go after their Debtor again.
What the U.S. found, in 2011, was that although Arline had previously disclaimed any control over the Trusts, she had since received $221,000 from the Trusts, which were paid into her children's bank accounts. Bingo!
On January 13, 2012, the U.S. filed a second contempt motion against Arline for violating the earlier Repatriation Order by not turning these moneys to the U.S. Arline protested that her reading of the Repatriation Order did not prohibit her from receiving funds from the Trusts. But the U.S., and, more importantly, the U.S. District Judge, fervently disagreed, and by March 22, 2013, had held the "frail and aging" (according to her counsel) Arline in contempt of the Repatriation Order. Rejecting her pleas that she desperately needed the money to live on, the Court slammed Arline:
That Mrs. Grant has since been able to repatriate funds to her children’s bank accounts in the United States, but failed to expressly and timely inform Plaintiff’s counsel or the Court of that fact, brazenly flouts the authority of the Court. * * * [T]he Court could not have been any clearer: repatriated funds were to “pay down” the Grants’ tax liability to the Plaintiff. The use of repatriated funds for other purposes, including for Mrs. Grant’s “general sustenance” . . . runs plainly afoul of the Court’s Order.
Order, March 25, 2013, Doc. #169.
The U.S. also moved for a permanent injunction against Arline, to keep her and her children from receiving any more moneys from the Trusts, or if they did to turn them over to the U.S. In an order dated April 22, 2013, the Court considered the injunction, as will now be discussed. Arline fought the injunction on the basis that the U.S. could not levy against the offshore trusts, and she had no "discernable assets that are subject to execution". This was basically a repeat of her previously-successful argument that because she had no control over the Trusts, she could not be held in contempt.
But things had changed -- she had received money, and this made all the difference. The Court now rejected Arline's claim that she had no control over the trusts: "Since 2008, Mrs. Grant has demonstrated such control by having over $221,000 in trust funds deposited into her children's accounts."
Indeed, the Court indicated that it had reached its limits with Arline:
During and since the pendency of the Plaintiff's prior post-judgment motions, Mrs. Grant has engaged in a scheme to avoid collection of her liabilities by having trust funds directly deposited into accounts in her children's names. Altogether, since December 22, 2005 when the Court ordered Mrs. Grant to repatriate the assets of the trusts, no money has been paid toward the judgment against her while $506,630 has been transferred from the trusts into accounts held in the names of her children and used to pay expenses at her direction. Through this scheme, Mrs. Grant has dissipated hundreds of thousands of dollars of assets to which federal tax liens attach.
The Court also indicated that its sympathies for "the little old lady" defense had reached the limits of its success:
That Mrs. Grant is ill, is eighty-four years old, and will no longer be able to use trust funds to "pay for her immediate living expenses and attorneys' fees" or "provide for [herself] in a very modest fashion" . . . means little with respect to either factor—the record shows Mrs. Grant continues to receive the exempt portion of her Social Security benefits, and that she has children who care for her, or at the very least, follow her instruction.
Suffice it to say that "the exempt part of her Social Security benefits" probably doesn't go a long way in Southern Florida. So, there may be millions in the Trusts, but Arline can survive on cat food as far as this Court is now concerned. Thus, the Court entered an Injunction, and a doozy of an Injunction it is, as shown by its terms:
Paragraph 1 requires that every quarter Arline request from the Trustees to pay to the U.S. whatever money is available to her or her children (apparently successor beneficiaries).
Paragraph 2 requires that Arline and her children pay over the $221,000 and any future moneys they receive from the Trusts to the U.S.
Paragraph 3 requires Arline and anybody acting on her behalf to transfer the Trusts' assets to the U.S.
Paragraph 4 prohibits Arline or anybody else from receiving the Trusts' assets without immediately turning them over to the U.S.
Paragraph 5 prohibits Arline or anybody else from dissipating the Trusts' assets.
Paragraph 6 provides, well, here is the exact text:
6) Arline Grant and anyone acting in concert and/or participation with her, either directly or indirectly, or under her direction or control, or anyone seeking to help Arline Grant shield her assets from going toward the payment of her tax liabilities, are prohibited from communicating to the trustees of the trusts or in a manner calculated to reach the trustees of the trusts the existence of this injunction or any other order in this case or the suggestion that distributions requested are being compelled.
In other words, Arline and her children have to hand over the $221,000 to the U.S., they can't receive any more money from the Trusts in the future without giving it to the U.S., they can't do anything that would help the Trust withhold money from them, and to the contrary Arline has to quarterly demand that the Trusts make distributions to her for the real benefit of the U.S. This is a very bad outcome for Arline by any standard.
ANALYSIS
If asset protection is just about protecting the assets from creditors, that's easy -- give the assets away to charity, put them on a rocket and launch them into deep space, or sink them into the depths of the Marianas Trench. Of course, that's not what asset protection is about.
What asset protection is about is protecting assets from one's creditors while still having the realistic possibility of lawfully enjoying those assets now or in the future if the need arises.
Measured by that standard, the Foreign Asset Protection Trusts in this case are a miserable failure. While the assets themselves might be protected, Arline now has no way to lawfully enjoy those assets without violating the injunction, other than to herself move overseas and outside the contempt power of the U.S. courts. Even then, when she passes, her children will not be able to enjoy the Trust assets either, without themselves violating the injunction.
I'll leave it to other to guess as to whether, if Arline passes and the children become beneficiaries, whether the children can then become liable for taxes on the income generated by the Trusts, but without being able to receive the Trusts' assets so as to pay those taxes, unless they disclaim. But suffice it to say, that this is not an enjoyable circumstance for them either, since they are now jointly liable with Arline to return the $221,000 previously received through their accounts. Arline herself is probably not going to make that up quickly with the exempt portion of her Social Security payments, so it will likely be her children who cough up the $221,000.
Chalk this one up also to yet another instance of where children to help a Debtor parent and themselves gets into trouble. Aiding and abetting a Debtor will rarely lead to anything positive (particularly since a child is included as an "insider" under the Uniform Fraudulent Transfer Act, although that didn't come into play here). Yet, time and time again, we see children dragged into a bad creditor-debtor situation and come out worse than they were before. You'd think that parents would care enough about their children not to get them involved, but this particular movie apparently has endless sequels.
Also note another important lesson of the Grant case: Just because a debtor fights off contempt once, doesn't mean that a debtor is then home-free to start taking money from the trust. To the contrary, the debtor can't take any more money from the trust ever without risking contempt, as exactly what happened to Arline in this case. She fought off the contempt in 2008, but then after receiving money from the trust, the U.S. second motion for contempt was successful. Whatever good she thought she had accomplished in 2008 was unwound in 2013.
The bottom line is that Foreign Asset Protection Trusts usually only "work" in the sense of both protecting assets and giving the settlor the beneficial use of those assets, for those persons who can reasonably leave the jurisdiction of the U.S. courts should creditor difficulties arise. They would work for, for instance, an immigrant to the U.S. who could return to his or her home country if things got bad enough in the U.S. For purely domestic persons and their families who are not going to leave the U.S., it is difficult to see why a Foreign Asset Protection Trust would ever be recommended as a possible asset protection solution in light of the existing case law.
But even more importantly, this case highlights that with asset protection trust planning, the creditor can keep the debtor from benefitting from the trust. While the creditor must sit and stew without recovery, at the same time the debtor must sit and stew without access to the assets -- it is a standoff. (Notably, it is the same type of standoff as when a creditor obtains a charging order against an LP or LLC being used to shield a debtor's assets -- the creditor can't get at the assets, but the debtor doesn't have access to them either.).
This is very important, because a fundamental strategy of creditors is to simply inflict so much financial pain on the debtor that the latter's checkbook comes out. Thus, creditors will often force the debtor to repeated examinations, and require the debtor to show where they are getting money for living expenses to pay their grocery bills, phone bills, insurance payments, and the like, or to fund their business operations. Even if the creditor cannot get at assets because they are protected, the creditor can work to seal the debtor off from receiving any money and put the debtor in considerable pain.
I myself have used this technique to pursue debtors both at the individual and corporate level. A few years ago, I forced the settlement of a multi-million dollar case between a corporate creditor and debtor by putting charging orders, assignment orders, and other things in place that ultimately had the effect of financially strangling the debtor -- to the point where they had to either settle with my client or file for bankruptcy protection and risk losing everything; they settled. At the outset of the case, I devised my "Anaconda Plan" to financially squeeze the debtor, and in less than a year it had worked like a charm.
This is what creditors do, and now they have definitive authority to do it with offshore trusts, thanks to this Arline Grant case.
As I have previously written, offshore trust planning only works if all the client's assets are outside the U.S. If they are in the U.S., they are exposed to creditors even if they otherwise might have been protected by some exemption. The reason for this is that a court may "surcharge" the exempt assets of a debtor if they refuse to turn over non-exempt assets (such as are in an offshore trust). For example, if a debtor has $1 million in an IRA or in a residential homestead, the creditor may seek the court to "surcharge" these otherwise exempt assets if the creditor cannot otherwise collect because the debtor has intentionally put other assets outside the creditor's reach.
The upshot of surcharging is that other assets will not be available to the debtor to fund living expenses, etc. If the debtor thinks that they can use an offshore trust to thumb their nose at creditors, and in the meantime live off their qualified accounts, they may be sadly mistaken.
Asset protection planners, however, seem to rarely take these things into account in their planning. Instead, there is a marked tendency of planners to believe that creditors will settle quickly (not a good presumption) and therefore they do not need to worry about a client's ability to obtain living funds in the meantime. The same is also true for funding a debtor's defense -- if the debtor cannot get money to pay their defense attorneys, they can be put in a bad way very quickly. Creditors know this, and so they put down judgment liens and related things early to try to cut the debtor's attorney off from the spigot of fees. (In California, for instance, it is becoming increasingly common for a creditor to levy on the debtor's attorney's trust account to at least tie up those funds and keep the debtor's attorney from being paid.).
Clients should be asking, "How will I live in the meantime?", but sadly they might not hear any good answer with regard to a particular plan. Or, more likely, they will hear glib but unrealistic promises from their planners, such as "Oh, we'll just run money through your children's accounts," as happened here in the Grant case, and was a awful failure.
Note that "the meantime" could practically be forever. No law requires a creditor to take a settlement less than the full amount, interest continues to accrue on the judgment (10% or so in most states -- creditors will joke, "I can't get that at a bank!"), and the creditor may just sit back and let the years pass, just renewing the judgment every 10 years and re-calculating the interest periodically so that it compounds. Then, as in this case, when the debtor dies, the Repatriation Order prevents the debtors' kids from getting the money either (and, again, query whether the kids may become responsible for the trust's taxes such that they are forced to disclaim). Maybe someday there will be a settlement; but the debtor may not live to see it. Just ask Raymond Grant, who passed before he could clear up this mess which has since plagued his family, and left his widow penniless.
Note that most of the foregoing should apply with equal force to a Domestic Asset Protection Trust ("DAPT"), which is a domestic, self-settled, irrevocable trust, i.e., a trust that you set up for yourself and then stand behind when creditors appear. While DAPTs are currently the flavor-of-the-day in asset protection planning and very heavily marketed, the use of DAPTs has been a curiosity to me, since (1) no court case anywhere has yet to validate their benefits; (2) the assets of self-settled trusts are part of a bankruptcy estate outside those states that have adopted DAPT laws; and (3) even in states that have enacted DAPT laws, there is a 10-year clawback period for transfers to "self-settled trusts and similar devices" in Bankruptcy Code Section 548(e).
I'm itching to see a trial where a planner set up a DAPT, it failed for one of the reasons above, and the planner has to explain to a jury why in light of the foregoing, he or she advised a DAPT to their client -- it's not going to be pretty. But of course, none of this has stopped the trust companies from marketing them, often with little or no disclosure of these seemingly glaring defects. Planners themselves rarely disclose these potential flaws to their clients, or, when they do, they attempt to gloss over them.
The point is that a creditor could get a similar injunction that keeps the settlor and beneficiaries of a DAPT from receiving assets from the trust. There is no reason why a DAPT is any better in this regard, and the courts of the state where a DAPT is domiciled would probably be required to give Full Faith and Credit to such an injunction.
I had better caveat that just as FAPTs have their limited uses for persons who can immigrate outside of the U.S. and thus avoid the contempt power of the Court, DAPTs similarly have their uses for persons who are domiciled in a DAPT state and are not engaged in any conduct whereby they are likely to end up in bankruptcy, i.e., a retiree or a professional worried about an outlier excess negligence judgment. For clients who are not resident in a DAPT state, however, the use of DAPTs lies somewhere on the continuum between aggressive and insane.
This leads me to my final point, one that I have argued for the last 15 years: Self-settled trusts of all varietals should be avoided in all except a few limited circumstances where they might make sense, as set forth above. Self-settled trusts, whether FAPTs or DAPTs, are scalpels to be delicately used in particularly fine situations, and not hammers to be indiscriminately swung as if everything were nails. There are some situations where they work, but they are nothing like the solution of general application that many asset protection planners make them to be.
The Grant case is a good example. Let's say that before Raymond Grant entered into the tax shelters that caused him trouble, Raymond and Arline instead funded a good old-fashioned domestic irrevocable estate planning trust (non-self-settled, i.e., not a DAPT) for the benefit of the Grant children. Into this plain-vanilla trust, Raymond and Arline gifted the bulk of their assets -- not so much as to render them technically insolvent, but a goodly amount. In such a case, the assets that Raymond and Arline would probably have been protected from their later creditors, and then presumably distributions could have been lawfully and transparently made to their children, who then provided Raymond and Arline with support if their world turned upside down. As it is, Arline is trying to get assets to her children so that they can support her, but with the bad results described above.
So why isn't basic plain-bread planning like this done more often? One word: Marketing.
There is a false mystique to asset protection planning that has often allowed planners to charge premium prices for selling cutting-edge strategies to their clients at premium prices, when boring and inexpensive solutions probably would have worked better. This is largely driven the trust companies, both offshore and onshore, that promote FAPTs and DAPTs with little or no discussion of their downsides. Lately, the marketing has been driving by a few states competing for DAPT business, with each trying to trump the other's laws by offering the most creditor-unfriendly laws, but the presumption that a particular state's laws will apply at all is at best an unsound one.
Asset protection is best done by following the old military acronym "KISS", for "Keep It Simple, Stupid." Common and ordinary things which can be easily explained to a judge and jury are better; things which are obviously aggressive, overly-complicated carry, or are hard to explain with a straight face, carry with them their own seeds of defeat.
And don't let the fact that everybody else is running for the latest flavor-of-the-day planning technique, whatever it is, make you think that it must ipso facto be good -- hard experience has shown that more often than not, it is just the herd which is headed for the cliff.
CITE
U.S. v. Grant, 2013 WL 1729380 (S.D.Fla., April 22, 2013). Opinion posted at http://goo.gl/Dvidf
This article at http://onforb.es/YVIsT1 and http://goo.gl/0JZOg
