Integrated estate planning with foreign-situs trusts.

EXECUTIVE SUMMARY

* IEPTs should not be used to hide assets, defraud creditors or evade taxes.

* Asset protection planning is the process of organizing assets and affairs in advance to safeguard them from loss or dissipation.

* A number of factors need to be considered when selecting which jurisdiction (domestic or foreign) will govern a client's IEPT.

For the client who needs to protect assets, estate planning may include the use of asset protection trusts (such as foreign-situs trusts) that will put assets safely out of reach. Although there are potentially many reasons to use such vehicles, their use is not for everyone; many factors must first be considered. This article explores the world of the "Integrated Estate Planning Trust," discusses why and when it is used and offers a model planning structure.

Today, asset protection planning is generally a concept familiar to wealth-planning professionals worldwide. However, while it has become more familiar and accepted, too often, such planning is done in a vacuum and without regard for its effect on the client's overall estate plan.

The same can be said for conventional estate planning; the emphasis tends to be on tax mitigation at death, the smooth transition of property, probate avoidance and ensuring that intended beneficiaries receive the intended property in the intended fashion. Unfortunately, the lifetime side of the estate plan has typically been ignored--particularly, planning to preserve the client's estate during his life.

The collective thinking of the planning community has evolved tremendously over the past 10 years. The time has come for asset protection planning and estate planning to be joined into a new concept--integrated estate plan(ning) (IEP).

Asset Protection Planning

Asset protection planning recognizes that preservation and protection of a client's estate during his life is at least as important (and in the view of many, more important) than preserving and protecting it after death.

The financial uncertainties stemming from (1) engaging in business or a profession or (2) being an entrepreneur or property owner and (3) economic and social factors have caused many successful people to adopt strategies to safeguard their accumulated wealth. A number of factors have contributed to the growing interest in and recognition of the asset protection component of an IEE including (1) expanding theories of legal liability, (2) threat of litigation, (3) result-oriented judges and juries, (4) the unavailability of affordable, adequate or appropriate insurance coverage and (5) the continuing national increase in the volume of litigation. Of course, other reasons may serve as motivating factors to persons of means who reside (or have assets) in other jurisdictions, as discussed below.

Definition

Asset protection planning may be defined as the process of organizing assets and affairs in advance to safeguard them from loss or dissipation.

Stated another way, wealth may be more or less vulnerable to risk, depending on the nature of the property and the manner in which it is held. Thus, at least in part, the asset protection component of an IEP involves reorganizing how property is held so that it is less vulnerable to threat than it otherwise would be (e.g., converting joint tenancy property to a tenancy by the entirety or placing property in trust for the benefit of third parties or the settlor).

Asset protection planning is broader than simply planning for the possibility of future litigation. Clients will be motivated to plan for different reasons, not necessarily tied to the possibility of litigation. Thus, a client in a civil-law jurisdiction may desire to achieve "testamentary freedom" and avoid the forced heirship provisions applicable in his home country; a client residing (or with assets) in a politically or socially volatile part of the world may seek to protect his accumulated wealth from the various threats posed by such instability. However, the asset protection component of an IEP is not to be used to:

Hide assets: Planning to or "hiding" assets can be dangerous; the dangers arise from the likelihood that a client will have to choose between protecting assets and committing perjury if he becomes involved in litigation. Whether or not litigation ever arises, a client may face difficult decisions each year in filing his Form 1040; full disclosure on a return is inconsistent with planning based on concealing assets. Further, hiding assets may result in criminal prosecution. Finally, the tangled web that often results from such planning is inconsistent with the goal of creating a user-friendly IEP.

While many clients appreciate the confidentiality that can be obtained through an IEP, a proper plan will not rely on secrecy for its efficacy.

Defraud creditors: There is some uncertainty as to when asset protection planning can be implemented (and the extent to which it can be implemented, if at all) when a client has a pending or expected legal threat. This uncertainty is much less prevalent today than in the past.

The easy clients are those with neither pending nor threatened claims who seek to protect against the unexpected. The difficult clients are those on the brink of bankruptcy (although pre-bankruptcy planning may help). There is a vast gray area in between.

Fraudulent conveyance law varies by state; there is also some Federal fraudulent conveyance law. For the client's (and planner's) sake, any asset protection planning must take into account applicable fraudulent conveyance law.

Our common-law system favors the free alienability of property; an individual without creditor concerns is free to dispose of his property as he sees fit, whether in the form of charitable gifts or gifts to children, to a spouse or in trust. Fraudulent conveyance laws tend to focus not on the transferee, but on the transferor's intent at the time of the transfer.

Fraudulent conveyance law generally protects present and subsequent creditors from transfers made by a person who is (or foreseeably will become) their debtor. However, "subsequent creditors" does not include every person who becomes a creditor in the future; there is also a "future potential" class of creditors. The distinction is clarified by a Florida decision,(1) which stated that asset transfers are permissible as to one's possible creditors, but not as to one's probable creditors. The operative inquiry is whether the client has any outstanding judgments, and whether he has any litigation or investigations pending, threatened or expected.(2)

Evade taxes: Some U.S. clients and their advisers are attracted to foreign-based planning by hoped-for tax advantages. As relatively few tax maneuvers involving foreign entities exist today for the global investor, a well-designed IEP will have no particular income, gift or estate tax advantages other than those that can be accomplished through conventional inter vivos or testamentary planning. Importantly, a well-designed IEP will have no particular income, gift, excise or estate tax disadvantages either, whether from a domestic or foreign standpoint. Both the planner and the client should be aware on an ongoing basis that certain tax issues will exist in the IEP setting; these tend to be not much different from (nor much more involved than) those associated with other types of entities that clients and planners are familiar with. Although there may be additional government reporting obligations (depending on the nature and design of the overall planning structure), neutrality in terms of tax liability will generally prevail under an IEP.

Practical Applications

Some of the practical applications of the asset protection component of an IEP may be summarized as follows:

1. When coordinated with the estate plans of other family members, an IEP can be very useful in protecting an inheritance that otherwise may be at risk when distributed to the beneficiary. For example, it would make little sense for an inheritance to be received by an IEP client from his parent to be exposed to the risks the client seeks to avoid.

2. A number of jurisdictions have "forced heirship" laws dictating the percentage of an estate that certain heirs must receive, and the timing of such distributions. IEPs have proven quite useful for clients who desire testamentary freedom as to the ultimate disposition of their property.

3. It is not uncommon for a person who sells his business or professional practice to be concerned with protecting the sales proceeds. One concern is that the buyer may not be as successful with the business or practice as was the seller; the buyer may reappear several years later to claim that the purchase price was excessive.

4. IEPs have been used as a replacement or supplement to liability insurance (e.g., professional malpractice insurance, tail coverage, errors and omissions insurance, or directors' and officers' liability coverage). A professional (e.g., a physician) may be able to eliminate or reduce liability coverage once an IEP is in place.

5. Many people believe that a large insurance policy serves as a magnet for litigation, IEPs have allowed such individuals to either eliminate or reduce coverage.

6. IEPs have been used for covering periods during a lapse in insurance coverage.

7. Many insurance policies contain coverage exclusions and exceptions; an insurance carrier could itself suffer economic reversals. IEPs may provide back-up insurance coverage.

8. Many business people and professionals are often involved in business or investment activities outside the scope of their main area of work. An IEP affords protection against risks that can arise from these other activities. For example, an architect or surgeon who is a general partner in a real estate investment may be surprised to learn that he is 100% liable for all partnership debts. This sort of risk may pose a greater problem for this investor than his professional activities.

9. Many wealthy people believe that their financial profile may encourage litigation. IEPs have been used to reduce one's financial profile to discourage lawsuits.

10. IEPs have been used as an alternative to a prenuptial agreement. They can be particularly attractive to a client who is facing a second (or higher) marriage and does not wish a marital agreement with his intended.

11. IEPs have been used as a back-up to a prenuptial agreement.

12. When an individual or a business signs for a loan or otherwise fakes on a financial obligation, an owned assets may become subject to the loan or obligation. IEPs have been used to segregate wealth into various pockets before the loan or transaction is negotiated, so that not all is at risk in a particular transaction.

13. Certain principles can be applied to protect retirement plan and benefit interests.

14. A person with creditor problems may be able to use an IEP to increase his strategic position in creditor negotiations. However, this is fraught with traps for the unwary. For example, an individual might transfer a small apartment building owned for many years to a planning structure as a creditor threat looms. The individual is left solvent following the transfer. The creditor would be hard-pressed to complain, given the transferor's remaining solvency. By protecting this parcel of real property, the debtor would be spared the taxable gain recognition that would result from the creditor proceeding against the property.

15. IEPs have been used to rebuild wealth free from a client's past or current financial problems. This "business opportunities approach" involves a planning structure designed to exploit business opportunities the client otherwise might exploit personally.

Ladder of Planning Tools

Exhibit 1 on p. 105 lists, in ascending order of efficacy, the tools used in the asset protection component of an IEP. An IEP will often use a combination of these tools.

Some of the planning tools are relatively simple, such as family gift-giving or planning based on creditor exemptions available under state law. Other techniques are more involved, including the use of a family limited partnership (FLP) or domestic trust (i.e., a trust settled under the laws of the client's (settlor's) country of citizenship or residency). Still others are quite sophisticated and complex, such as use of a trust governed by the laws of a country other than the settlor's home country (a foreign-situs trust or IEPT).

Foreign-Situs Trusts

Foreign-situs trusts are not a new concept; what is new is their use by U.S. persons to protect assets from future potential creditors as part of an IEP. This use is an extension of older protective purposes (e.g., to safeguard against threats such as monetary exchange controls, the forced repatriation of assets, confiscatory tax rates, etc.).

Why use a foreign-situs trust instead of a domestic trust as part of an IEP? In an effort to attract U.S. trust business that would otherwise go offshore, in 1997, Alaska enacted statutory asset protection trust (APT) provisions, followed by Delaware that same year and Nevada and Rhode Island in 1999. Why not use an Alaska trust? A settlor has this option; however, a better one may be for the settlor to appoint an Alaska trustee as the domestic trustee in a multijurisdictional IEE This is discussed below under "Selecting the Appropriate Jurisdiction(s)." There are numerous reasons why a foreign-situs trust is widely regarded in wealth-planning circles as more protective and flexible than a domestic trust.

Increased Ability to Retain Benefits and Control

Domestic trust law generally restricts the trust benefits and control that the settlor can retain following trust settlement. This is due to a general rule under American trust law against self-settled spendthrift trusts. Under the law of most states, a trust is "self-settled" if the settlor is a beneficiary, controls the trust or has a general power of appointment over it. A spendthrift trust prevents the beneficiary's creditors from accessing trust assets to satisfy the beneficiary's obligations. Thus, while such a trust created for the settlor's benefit is valid, it is ineffective as to his creditors. The laws of Alaska, Delaware, Nevada and Rhode Island (and to a lesser extent, Colorado) contain exceptions to the general rule against self-settled spendthrift trusts; the trust laws in a number of offshore financial centers (OFCs) are even more permissive.

Not Automatic Targets

A domestic trust remains subject to the jurisdiction of the U.S. courts; thus, it can reasonably be expected to be a target in litigation against the settlor if it holds a corpus of any significance. A properly drafted, implemented and administered foreign-situs trust is not as likely to be an automatic defendant; the reasons relate to the practical barriers described below.

Erect Practical Barriers

The mere presence of the foreign element in a foreign-situs trust will have a definite effect on a creditor's decision to either institute suit or pursue assets. The following factors will likely deter a creditor from pursuing IEPT assets:

No comity: Many OFC trust laws provide that judgments foreign to the OFC are not to be given force and effect. Thus, a new trial on the merits under the OFC's law may be required to adjudicate the settlor's liability and the trust's liability for the settlor's separate debt.

Burden of proof: The trust law in a number of OFCs provides that the burden of proof in challenging asset transfers to a trust is always on the party making the allegations, and does not shift to the transferor.

Standard of proof: The trust law in a number of OFCs provides that the standard of proof to be met by the party making the allegations is the American criminal standard of "beyond a reasonable doubt."

Statute of limitations: The trust law of many OFCs provides that the statute of limitations (SOL) for challenging asset transfers to the trust begins to run from the transfer date. Unlike American law, there is no separate SOL that begins to run from the date the transfer is "discovered" by someone with a claim against the transferor. Additionally, a number of OFCs have SOLs shorter than the typical four-year statute found under American law.

Costs and fees: It is expensive to pursue a claim out of state, let alone in a foreign country, particularly when there is no comity (i.e., recognition of foreign judgments or court orders) and the exchange rate favors the foreign jurisdiction. In addition, there may be a requirement to post a large bond before proceeding.

Psychological barriers: The psychological barriers of dealing with foreigners and foreign legal systems, the added uncertainty of prevailing under foreign law, the increased time factor, the geographical factor and the like serve to substantially enhance the protection of trust assets should a threat against the settlor one day materialize. It is one thing to obtain a judgment, and quite another to collect it. The procedural quagmire created by a foreign-situs trust just makes the collection process more difficult.

Foreign trusts ultimately more protective: The trust law of certain foreign jurisdictions is simply more specific and protective than U.S. state trust law; accordingly, even if a creditor is not dissuaded by the many hurdles erected by a proper foreign-situs trust, protective foreign statutes make it difficult to pierce a trust to satisfy the settlor's separate debts. A proper foreign-situs trust will ultimately succeed because it is legally sound, not because of secrecy. An overview of protective features available through the trust law of select OFCs is discussed below under "Selecting the Appropriate Jurisdiction(s)."

Sovereign status/no preemption: While most of us do not expect to experience bankruptcy, Federal investigation or the like, reliance on the trust statutes of Alaska, Delaware or Nevada may result in otherwise protectable assets being exposed. In the absence of a treaty or similar agreement, while Federal law preempts state law, it does not preempt foreign law.

Choice of Law

Individuals who reside in a common-law jurisdiction such as the U.S. generally have the freedom to select the law that will govern a business transaction, a corporation or trust (e.g., incorporating in Delaware, but transacting no business there, or selecting the law of a jurisdiction other than the state of the settlor's domicile to govern a trust). Choice-of-law principles permit a trust to be governed by the laws of the settlor's home state or any other state. If a settlor can so choose trust law, why should he limit his choice to the trust laws of the 50 states?

Selecting the Appropriate Jurisdiction(s)

A number of factors should be considered when choosing which foreign jurisdiction(s) will govern an IEPT, including: (1) whether its trust law is favorable, well-defined and protective; (2) its political, economic and social stability; (3) its reputation and credibility in the world community; (4) its tax laws; (5) whether there are language barriers; (6) whether it has modern telecommunications facilities; (7) whether it offers adequate legal, accounting and financial services; and (8) whether there are exchange controls. A number of OFCs satisfy these factors to varying favorable degrees, such as the Bahamas, Belize, the Cook Islands, Gibraltar, the Isle of Man, Jersey and Nevis.

Through the enactment of modern trust law, various OFCs have addressed when and the circumstances under which a settlor's creditor can access trust assets. Exhibit 2 on pp. 108-109 compares the protective nature of the trust law of these OFCs versus some U.S. states. From the standpoint of statutory specificity, jurisdictions that score highly include the Cook Islands, Labaun, Nevis, and St. Vincent and the Grenadines.

[TABULAR DATA NOT REPRODUCIBLE IN ASCII]

One of the advantages of practicing in the offshore arena is that there is no shortage of OFCs or available law. Depending on classification, there are more than 60 OFCs worldwide, but no "perfect jurisdiction" Different jurisdictions have different attributes; each brings something different to the discussion. Various OFCs should be used in the overall plan, depending on what each has to offer.

A multijurisdictional approach should be used for an IEPT. This may involve, for example, the use of three trustees: one would be in a jurisdiction with specific and protective trust law (e.g., the Caribbean country of Nevis), the law of which would be designated as the IEPT's governing law. The second trustee would be in an OFC known for its credibility, stability and reputation in the offshore industry and world community, and for its favorable trust law (e.g., the Isle of Man in the British Isles). The third trustee could be U.S.-based if the settlor seeks to trade a degree of ultimate protection for an increase in ease of administration (such as classification of the IEPT as a domestic trust under Sec. 7701(a)(30)). The trust would need to be designed consistent with this approach.

In selecting the U.S. trustee, the asset protection component of the IEP would be well-served by considering a trust company based in Alaska or Nevada. Thus, if a challenge to the IEPT does develop in the future, and the U.S. court refuses to apply the foreign law as the governing law, much could be gained through protective domestic trust law being applied by default. A "three-headed multijurisdictional trust structure" of this nature is the preferred approach for an IEPT.

Location of Trust Assets

A properly drafted IEPT will allow its trustees to invest trust assets in any part of the world. Accordingly, the location of trust assets need not necessarily change from the city in which the settlor resides, and need not be confined to the trust's governing jurisdiction. Importantly, the IEP need not interrupt or disturb relationships the client has with his advisers, whether legal, accounting, insurance or financial. Of course, the IEPT trustees could change this if and when the threat of a claim arises against the settlor.

Through the concurrent use of other planning techniques (such as an underlying FLP), the settlor can be given direct control and management over the protected assets without being a trustee. This can be done so as not to materially compromise the protection ultimately afforded, but rather to enhance the overall protection afforded by the IEP.

FLPs have become a popular tool in the IEP process. They can be used for gift giving at values discounted for Federal gift tax purposes or while retaining control over the assets gifted. FLPs also provide an additional element of protection for assets. Almost all state partnership law provides that a creditor's remedy against a limited partnership interest held by a debtor is to obtain a "charging order" (typically, a rather limited and unattractive remedy). In some states, a charging order is a creditor's sole remedy.

Under Federal tax law, a creditor who has obtained a charging order against interests in a limited partnership runs the risk of receiving phantom income from the partnership under Rev. Rul. 77-137.(3) This means that a creditor with a charging order will be taxed on all or a portion of the FLP's income, whether or not the FLP distributes any income to its partners. This factor alone could very well dissuade a creditor from ever seeking a charging order.

FLPs are useful not only in rendering attractive assets unattractive, but also in separating ownership from control in an IEP. Under the typical IEP, either the IEPT settlor or a third party retains control over FLP assets, by holding a small (1%) interest as a general partner. The IEPT holds the balance of the interests as a limited partner. As a result, the IEPT is the equity, noncontrolling partner; the general partner is the minimal equity, controlling partner. The IEPT receives the equity interest by transfer from the settlor when he has no outstanding judgments nor claims pending, threatened or expected. Thus, the settlor no longer owns the property; a judgment creditor cannot obtain assets the settlor no longer owns.(4)

Distance

Of course, while control and flexibility can be integrated into an IEP, settlors must continue to be mindful of the "distance factor." The greater the distance between the settlor and the assets, the more the assets are protected. The trustees or FLP general partner needs to recognize the wisdom of forming relationships at the outset with one or more foreign institutions and foreign fund managers, and of funding a managed account. The comfort level of those involved (including the IEPT beneficiaries) will be exponentially increased if such a relationship already exists, and if subsequent events cause the trustees to diversify assets from the jurisdiction in which held and into the institutions' and managers' hands.

Federal Tax Considerations

As mentioned earlier, "tax neutrality" generally prevails in the IEP world. In general, neither favorable nor unfavorable Federal tax consequences should arise, except to the extent favorable gift and estate tax planning techniques are used in an IEP.

Income Tax

Due to the retention of certain degrees of benefit and control by the settlor, the IEPT will be a grantor trust for Federal tax purposes. If an IEPT is designed to be a foreign trust for Federal income tax purposes, Sec. 679 ensures grantor trust treatment; thus, all items of income, gain, loss, deduction and credit will flow through to the settlor's individual tax return. There will also be a flowthrough of tax attributes when other tax-transparent vehicles are used (e.g., FLPs and limited liability companies).

Moreover, a foreign-situs IEPT can be structured either as a foreign or domestic vehicle for Federal income tax purposes, under Sec. 7701(a) (30) (E)'s two-part test. The IEPT can be drafted either to intentionally satisfy both parts of this test or to intentionally fail.

Gift Tax

Gift tax implications are typically avoided, as the settlor retains a limited power of appointment. Under Regs. Sec. 25.2511-2, a gift is not completed for gift tax purposes until the limited power of appointment either lapses, is exercised or the settlor dies.

Estate Tax

If transfers to the IEPT are incomplete for U.S. gift tax purposes, when the settlor dies, the value of the IEPT will be included in his estate for U.S. estate tax purposes.

Sec. 684 Gain

Sec. 684 provides that gain or loss is recognized when property is transferred to a trust that is foreign for U.S. tax purposes. This section does not apply, however, to transfers to grantor trusts and trusts that are domestic trusts for U.S. tax purposes. A grantor trust loses such status on the settlor's death; the issue then arises as to whether Sec. 684 gain applies if the trust is a foreign trust for tax purposes at that time. Until this issue is settled, an IEPT should be drafted to avoid the application of Sec. 684. One way is to design the IEPT as a domestic trust for Federal income tax purposes, as was discussed; another is to maintain grantor trust status after the settlor's death by designating another "grantor" under Sec. 678.

Foreign Tax Considerations

A properly drafted foreign-situs IEPT governed by an appropriately selected OFC will not be subject to income, gift, estate, transfer, excise or like tax in the selected jurisdiction. Generally, OFCs that have enacted protective trust provisions treat trusts settled by nonresidents as exempt trusts as long as none of the beneficiaries is resident in the OFC.(5)

Risks

Trusting the Trustees

Clients or their advisers frequently inquire about the risks associated with having assets held by trustees of an IEPT. A client will not be forced to choose between risking assets to a future potential creditor or to the APT trustees, because of the checks and balances inherent in a properly structured, well-drafted IEPT. Moreover, as earlier mentioned, as an international vehicle, an IEPT can hold assets in any part of the world; thus, such assets need not be physically held in the jurisdiction whose laws govern the IEPT's administration, interpretation or validity. Finally, for as long as (and to the extent that) assets are held in a FLP, the general partner (not the trustees) will have direct control over and management of the protected assets.

Contempt of Court

Another common question is whether the client may someday have to either repatriate assets or be held in contempt of court. A properly drafted IEPT would make it factually impossible for a client to repatriate trust assets. Impossibility of performance is a complete defense to a civil contempt charge. An exception is if the party claiming impossibility of performance is responsible for creation of the impossibility. However, for this exception to apply, there must be a nexus in time between the court order and the creation of the impossibility. This nexus would be lacking if the APT was properly drafted, established, administered and funded.

For example, in Blaine,(6) the defendant claimed he was unable to comply with a court order to produce documents for a corporation of which he was president, because he had transferred the documents to his attorney five months before being served with a subpoena. When the order to produce the documents was issued, the attorney returned the documents to the defendant, but several files were missing.

After the attorney and defendant testified they did not know the whereabouts of the missing files, the court denied the motion to hold the defendant in contempt. The court reasoned that the impossibility of performance defense was a complete defense to a contempt charge; the defendant was not responsible for the documents' unavailability. The court found that the defendant had disposed of the documents in good faith before the issuance of the order to produce; thus, he could not be held in contempt because he could not produce them.

In Goldstein,(7) a physician's claim of inability to comply with a subpoena for the production of documents was ineffective. He had disposed of the documents in question 11 days before the subpoena was issued and had reason to know the subpoena would be issued when he disposed of the documents. The Second Circuit determined that the defense of impossibility of performance was unavailable.

However, the Federal Trade Commission (FTC), in Affordable Media(8) (the Anderson case), successfully sought to jail the Andersons, settlors of a Cook Islands trust, for contempt of court. The Andersons had argued that they could not repatriate trust assets, when in fact, because of inartful trust drafting, they maintained such power.

Concerning the Andersons' control over the trust they settled, which continued even as they were ordered to repatriate trust assets, the Ninth Circuit stated:

After the Andersons claimed that compliance with the repatriation provisions of the temporary restraining order was impossible, the [Federal Trade] Commission revealed to the court that the Andersons were the protectors of the trust. The Andersons immediately attempted to resign as protectors of the trust. This attempted resignation indicates that the Andersons knew that, as the protectors of the trust, they remained in control of the trust and could force the foreign trustee to repatriate the assets.(9)

The court described the fatal flaw in the design of the Anderson trust as follows:

[T]he trust agreement makes clear that the Andersons, as protectors, have the power to determine whether or not an event of duress has occurred ... Moreover, the very definition of an event of duress that the Andersons assert has occurred makes dear that whether or not an event of duress has occurred depends upon the opinion of the protector ... Therefore ... it is clear that the Andersons could have ordered the trust assets repatriated simply by certifying to the foreign trustee that in their opinion, as protectors, no event of duress had occurred.(10) (Emphasis added.)

When an IEPT trust is poorly designed, a contempt of court order may not be far behind. A properly drafted, implemented and administered IEPT should avoid this result. However, all a planner can do is to draft an IEPT consistent with applicable law, including contempt law; he cannot protect against a judge who decides to violate due process and hold a client hostage in exchange for assets. In extreme cases, emergency appeal procedures exist.

While some practitioners predicted the end of protective trusts (onshore or offshore) after Anderson, each situation turns on its facts and circumstances. Anderson is simply a matter of bad facts leading to the appropriate result. Proper asset protection structures are designed to take contempt law into consideration; such was not the case with the Anderson trust.

The Anderson trust remains intact. In an unreported decision, not only was the FTC unsuccessful in bringing proceedings in the Cook Islands to "bust the trust," the Cook Islands court assessed costs against the FTC. While the overall plan did not work well for the Andersons, their trust continues to protect the subject assets.

Choice of Law

A final consideration is whether a domestic court can be expected to recognize foreign-based planning when and if assets remain in the U.S. Generally, U.S. law requires that a proper choice-of-law decision be respected. The possibility exists that a court could decline to apply foreign law. If so, three alternatives exist. First, generally, the asset that would be made available to the creditor would be the IEPT's limited partnership interest in the FLP, which would still afford the client protection and bargaining power through charging order protection and the threat of phantom income. Second, the foreign trustee(s), in exercising his fiduciary duty to protect trust assets, would likely diversify them out of the jurisdiction in which the threat is arising. Through this protective step, the battle over the assets can be forced into the foreign court (which would apply its protective legislation); a contrary decision by a domestic court will likely matter very little. Finally, should a domestic court decline to recognize the settlor's choice of applicable law, the favorable provisions of one of the states that has enacted protective trust provisions should be applied (rather than the less favorable provisions of some other state). This approach, if drafted into and administered as part of an IEP, would serve to make the best of an incorrect decision and a bad situation.

Does It Really Work?

The goal of the asset protection component of an IEP is realized if the client weathers the storm at least moderately better than if he had not engaged in such planning. Generally, foreign-situs trusts in IEPs do meet that goal.(11)

The many variables under any given IEP prevent blanket statements about the efficacy of IEPTs; these variables include: (1) a client's particular facts; (2) the client's goals and the way and extent to which they can be incorporated into the IEPT's design; (3) the skill with which the IEPT was crafted; (4) the nature of the asset(s) transferred to the IEPT; (5) the skill with which the IEPT is attacked; (6) the skill with which the IEPT is defended; (7) the thoroughness and protectiveness of the IEPT's applicable law; (8) whether the opposing party is a governmental instrumentality; (9) whether criminal sanctions would result from the trustees (or others involved) exercising certain options they would otherwise be free to exercise if all the litigants were private parties; (10) the law of the forum court; and (11) any biases of the presiding judge.

A number of reported cases involve foreign trusts used to protect assets. These cases have been cited by some to support the proposition that foreign-situs trusts are not as effective as they once were in protecting assets. However, when the facts of each of these cases are considered, it can be seen why the results in each were not as hoped for by the settlors:

* In the Orange Grove Case,(12) the debtors were making property transfers to a Cook Islands trust until a few weeks before their trial date.

* In Brown vs. Higashi,(13) the debtor's trustees in Belize were unfamiliar with the settlor and had no record of the trust; the debtor did not complete property transfers to the trust he settled.

* Portnoy(14) involved a debtor who transferred virtually all of his assets into a trust in Jersey, Channel Islands, when he knew his personal guarantee was about to be called.

* In Grupo Torras,(15) Kuwaiti Sheik Fahad obtained assets through fraud, then sought protection for them through offshore masts.

* Colburn(16) involved a debtor who lied on his bankruptcy schedules and was denied a bankruptcy discharge. No decision was rendered as to the foreign trust in Bermuda that the debtor had previously established.

* In Brooks,(17) the debtor had fraudulent intent and settled two foreign trusts within 18 months of bankruptcy.

* In Anderson, as previously discussed, the debtors controlled trust funds at the time the court ordered them to produce them. They were incarcerated for contempt of court for failing to repatriate the assets they controlled.

* In Lawrence,(18) the debtor transferred assets to Mauritius a few days after a $20 million judgment was entered against him.

* In Papson, the settlor of a Cayman Islands revocable trust made transfers to it while under a restraining order barring such transfers, and while he was in arrears on child support, tuition and other court-ordered payments.(19)

There are no surprises in these results; it would have been a surprise had the results desired by the settlors been fully obtained. The facts described in these circumstances are not those under which offshore planning should be used with any realistic hopes. These cases are the exceptions. Planning under the proper facts and circumstances makes all the difference in the world, particularly in the offshore world.

Conclusion

Exhibit 3 on pp. 112-113 is an overview of a model IEP using an IEPT as the core. A few points should be stressed: (1) the planning concepts presented in the model have been oversimplified for discussion purposes; (2) an IEP is implemented when the client has no claims pending, threatened or expected, nor outstanding judgments; (3) following all property transfers, the client remains solvent and able to pay his reasonably anticipated debts as they become due; and (4) the IEP depicted in the model is only a sample structure. The design of any given IEP is a function of the client's goals and needs; the plan must be tailored accordingly.

[ILLUSTRATIONS OMITTED]

(1) See Opal G. Hurlbert v. John N. Shackleton, 560 So.2d 1276 (Fla. Dist. Ct. App., 1st Dist., 1990).

(2) See Engel, "When is a Subsequent Creditor Not a Subsequent Creditor?," 3 J. Int'l Tr. & Corp. Plng. 105 (1994).

(3) Rev. Rul. 77-137, 1977-1 CB 178.

(4) See Engel, "Does Asset Protection Really `Work'?," 4 J. Asset Prot'n 18 (September/October 1998).

(5) For example, Section 43 of the Nevis International Exempt Trust Ordinance, 1994, exempts trusts registered under the Ordinance from all income, transfer and stamp taxes.

(6) Federal Trade Comm'n v. Sol Blaine, 308 F Supp 932 (N.D. Ga. 1970).

(7) Hyman Goldstein, 105 F2d 150 (2d Cir. 1939).

(8) Federal Trade Comm'n v. Affordable Media, LLC, 179 F3d 1228 (9th Cir. 1999).

(9) Id. at 1243.

(10) Id., n. 13. Compare this result with that of 1995 contempt proceedings (still ongoing) involving a trust settled by a client of the author's firm. The Federal court concluded that to hold the client in contempt for a failure to comply as ordered would be a violation of due process, because it was impossible for the client to comply. It further stated that putting a person in prison does not compel compliance when he does not have the ability to comply.

(11) See Engel, note 4 supra, pp. 24-26.

(12) 515 S. Orange Grove Owners Ass'n v. Orange Grove Partners, High Ct. Rarotonga, Civ. Div., No. 208/94 (11/6/95).

(13) Brown v. Higashi, 4 Ak. Br. Rpt. 279 (Bankr. DC Alaska 1995).

(14) In re Portnoy, 201 B.R. 685 (Bankr. S.D.N.Y. 1996).

(15) Grupo Torras, S.A. v. S.F.M. Al-Sabah, Bahamas Sup. Ct. (9/1/95).

(16) In re Colburn, 145 B.R. 851 (Bankr. E.D. Va. 1992).

(17) In re Brooks, 217 B.R. 98 (Bankr. DC Conn. 1998).

(18) In re Lawrence, 227 B.R. 207 (Bankr. S.D. Fla. 1998).

(19) See Hambett, "Husband Used Trust to Hide Marital Assets," NY Law J. (8/24/98), p. 1.