Foreign asset-protection trusts.

Many high net-worth individuals should consider some sort of asset protection strategy. Having a sound plan reduces the risk of litigation and, in the event of a lawsuit, increases the likelihood of a favorable settlement. To this end, a foreign asset-protection trust is among the vehicles that can be used. However, before implementing this strategy and transferring assets to an offshore trust, it is important to understand the vehicle's basic components, as well as some of its potential limitations.

In establishing a foreign asset-protection trust, the settlor chooses a situs with favorable laws regarding such trusts (e.g., the Cayman Islands, the Bahamas, the Cook Islands or Bermuda). It is important that the jurisdiction not honor foreign judgments, thereby requiring a creditor to litigate a claim in the jurisdiction directly. Generally, the applicable fraudulent conveyance laws require "proof beyond a reasonable doubt" that an entity was established to defraud creditors before a trust will be set aside. Additionally, the fraudulent conveyance laws generally require action within a short period of time (i.e., two or three years).

Often, foreign asset-protection trusts are drafted as grantor trusts for U.S. Federal income tax purposes, due to the retention of the power to appoint either the income or principal or the retention of some reversionary interest. Thus, a trust is ignored for U.S. Federal income tax purposes, so that U.S. grantors are treated as owning the trust's assets and deriving income directly from them. In addition, many jurisdictions with favorable statutes will exempt foreign asset-protection trusts from their own tax system. A trust will normally be irrevocable, have no provisions for payment to a grantor, and, at the end of the term, the trust property will revert to the grantor's estate. Unfortunately, many prospective grantors believe that a foreign asset-protection trust will also permit the deferral or avoidance of U.S. Federal income tax. Rather, a foreign asset-protection trust will generally result in the same U.S. Federal income or estate tax consequences that would result had no trust been created.

To permit a grantor to retain some effective level of control over a trust, many favorable jurisdictions call for a special office of "protector" to be created in connection with the trust. A trust protector is given certain veto powers over trustees for distributions to beneficiaries or investment decisions, or both. A protector may also have the power to change trustees or to move a trust's location. In addition, a trust instrument will often instruct trustees to ignore any court order directed against a grantor, requiring action either to dissolve the trust or to obtain a distribution for the benefit of any creditor.

Prior to implementing a foreign asset-protection trust, the following factors should be reviewed and considered:

1. The cost associated with implementation (generally, should be no more than about $5 per year per $1,000 of assets);

2. Nature of assets to be transferred;

3. Political and economic risks that may be associated with a trust's jurisdiction;

4. Number and type of required trustees (generally, two corporate trustees and an individual trustee are required);

5. Comfort level of a grantor in placing assets into a foreign trust;

6. Experience and competence of U.S. and associated legal counsel with these matters; and

7. Fiduciary responsibilities of other parties in a trust arrangement.

In summary, a foreign asset-protection trust may be a sound basic asset-protection strategy for high net-worth individuals who may be subject to litigation (and who place value on peace of mind) to consider and potentially implement as part of an overall asset protection strategy. (For more information, see Engel, "Integrated Estate Planning with Foreign-Situs Trusts," 31 The Tax Adviser 102 (February 2000).)

FROM RONALD G. WAINWRIGHT, JR., RALEIGH, NC