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George F. Bearup, J.D. Senior Legal Trust Advisor

28-Mar-18

Asset Protection Trusts

Take-Away: A recent decision by the Alaska Supreme Court, Toni 1 Trust vs. Wacker, 2018 WL 1125033 (Alaska, March 2, 2018),  created some  anxiety with regard to the viability of self-settled asset protection trusts, much like Michigan’s Qualified Dispositions in Trust Act. This court decision may not be the death-knell to asset protection trusts as some commentators fear it to be, but it may indirectly call into question one feature of Michigan’s Qualified Dispositions in Trust Act, which requires all court proceedings with regard  to a Michigan self-settled asset protection trust to be determined exclusively by a Michigan Probate Court.  The Toni 1 Trust decision is, however, a good reminder in two respects: (i) fraudulent transfers to an asset protection trust will seldom work unless creditors are completely asleep at the switch and miss the statute of limitations; and (ii) if the statutory asset protection trust formalities are not carefully followed, courts are not likely apply a ‘substantial compliance’ analysis and give the benefit of doubt to the debtor-settlor who hopes to create an asset protection trust; if an individual wants to create an asset protection trust, he/she must adhere to all of the rules and statutory preconditions in order to take advantage of that protective legislation.

Background: The facts in Toni 1 Trust were pretty straight-forward. A Montana court and the US Bankruptcy Court both entered default judgments on a lawsuit that claimed the Montana debtor’s transfers of property to an Alaska self-settled asset protection trust he created were fraudulent, thus triggering application of the Uniform Voidable Transfers Act [also adopted in Michigan.] After the default judgments were entered that set aside those transfers of assets to the irrevocable trust, the Trustee engaged in a multi-step forum-shopping game when he ultimately commenced his own a declaratory action in Alaska that sought a judgment that the decisions of the Montana trial court and the US Bankruptcy Court were both void, since Alaska’s asset protection trust statute expressly provides that ‘any court proceeding that relates to transfers to an Alaska self-settled asset protection trust must be determined exclusively by Alaska courts.’ [AS 34.40.110]

Court Holding: The Alaska Supreme Court held that the provision of Alaska’s self-settled asset protection trust statute that required that all legal actions that involved transfers to an Alaska self-settled trust must be decided by an Alaska court was not enforceable when the courts of another state, or the US Bankruptcy Court, have jurisdiction over both the disputed transfer and the parties. In this case the Toni 1 Trust, while created pursuant to the Alaska asset protection trust statute, was nonetheless created in Montana and the transfers were of Montana property to the irrevocable trust by a Montana resident over whom Montana courts had jurisdiction. The Alaska Court’s decision was based on a long-standing US Supreme Court decision, Tennessee Coal, Iron, & R.R. Co. vs George, 233 US 354, 360 (1914), which prohibits the states from creating protective legislation that forces all litigation regarding rights created by state law to take place in the litigant’s ‘home’ state: “The basic principle articulated in Tennessee Coal has not changed in the last century.”

  • Limits on Exclusive Jurisdiction provisions: The Tennessee Coal decision held that the Full Faith and Credit clause of the US Constitution does not require a state to substitute another state’s law for its own, even when the first state created the rights that were litigated. In the Toni 1 Trust case the Alaska Supreme Court held that while Alaska is free to limit its own courts’ jurisdiction, it cannot deprive other state’s courts or the federal government of jurisdiction.
  • Failure to Adhere to Statute Requirements: The Alaska Supreme Court also commented in a footnote that even if that exclusive jurisdictional part of the Alaska statute had been enforceable (it was not) which exclusively limited the legality of transfers to the trust to be decided by an Alaska court, the proper formalities to create the self-settled trust had not been followed  because the settlor had failed to complete an affidavit of solvency which  rendered the Alaska statute’s inapplicable.

Michigan’s Qualified Dispositions In Trust Act: It is not all that clear if Michigan’s Qualified Dispositions in Trust Act attempts to accomplish what Alaska’s statute sought to achieve, which is to force all questions with regard to the self-settled trust or transfers to that self-settled trust into  home-state courts. Michigan’s statute seems to come close. A couple of its provisions follow:

  • Governing Law: Predictably, Michigan’s statute subjects the Qualified Dispositions in Trust to Michigan law. The trust instrument, which requires at least one trustee to be subject to Michigan jurisdiction, must expressly incorporate the law of this state to govern the validity, construction and administration of the trust. [MCL 700.1042(aa)(i)] Note, however, that this statutory provision is limited to questions with regard to the actual trust instrument, and not the transfer of title of assets to that Michigan asset protection trust. It makes sense that only Michigan courts should interpret  Michigan statutes and the public policy presumably behind that legislation, as well as the trustee’s administration of that trust following established Michigan fiduciary duties and laws.
  • Transfers to Trust: Coming somewhat closer to the ‘exclusive determination’ invalid provision of the Alaska statute is the Michigan Qualified Dispositions in Trust provision that gives exclusive jurisdiction to Michigan Probate Courts. The Michigan provides: The [Michigan] probate court has exclusive jurisdiction that addresses [either of] the following questions: (a) whether a transfer is a qualified disposition. [MCL 700.1043] Unfortunately the Michigan statute does not define
  • Disposition: The statute does not, however, define a But it does define a disposition as follows: (g) Disposition means a transfer of property that either creates a new fiduciary relationship… or newly subjects property to a preexisting fiduciary relationship. [MCL 700.1042(g)]
  • Transferor: The Michigan statute’s definition of a transferor is: (i) a person …who.. makes a disposition of the property or causes a disposition to be made. [MCL 700.1042 (y)(i)]
  • Commentary: Combing these definitions suggest that a Michigan Probate Court is intended to have exclusive jurisdiction to determine the validity of a transfer of property to a Qualified Dispositions Trust, i.e. that it is a qualified disposition, meaning not a fraudulent transfer, much like the now invalid Alaska statutory provision. But the exclusive jurisdiction granted to Probate Courts under the Michigan statute does not clearly state, like Alaska, that all questions with regard to the validity of transfers into the trust must be decided by a Michigan Probate Court, but it comes close. So the question is whether Michigan’s Qualified Dispositions in Trust Act, using its exclusive jurisdiction provision, requires that only a Michigan Probate Court can determine if the disposition/transfer to the trust is voidable or not, in effect precluding a comparable determination made by another court, either in Michigan like a circuit court, or an out-of-state court when the transfer of assets purports to be made to a Michigan Qualified Dispositions Trust.

Conclusion: One clear take-away from the Toni 1 Trust decision, equally applicable in Michigan,  is that if a fraudulent or voidable transfer is made by a transferor to what purports to be an asset protection trust, that fraudulent transfer can and most likely will be successfully challenged. A Michigan Probate Court may not be the sole forum where that voidable transfer claim can be litigated if that is the basis of the challenge, not that the trust itself is invalid. The challenge will be made to the transfer itself and not to the validity of the irrevocable asset-protection trust to which title to the asset is transferred. Nor will the challenge to the validity of the transfer implicate the interpretation of Michigan’s Qualified Dispositions in Trust Act.  In sum, it is not clear if a challenge is made to a transfer of assets to a Qualified Dispositions in Trust on the grounds that the transfer is fraudulent, i.e. that it renders the transferor insolvent, or is a deliberate attempt to frustrate and hinder creditors seeking to enforce their judgment, where that set-aside litigation must take place. The Michigan statute states that the Probate Court has exclusive jurisdiction, but Toni 1 Trust implies ‘maybe not’, at least when the court of other states or the US Bankruptcy Court is involved. While the Toni 1 Trust decision dealt with an out-of-state settlor attempting to take advantage of another state’s asset protection trust legislation, advisors need to remember that even resident settlors can face challenges to the transfer of assets to an asset protection trust under the Uniform Voidable Transfers Act, subject to its statute of limitations provisions.