Monday night I had the opportunity to listen to a speech with regard to  Michigan’s new asset protection trust act [The Qualified Dispositions in Trust Act] by one of its principal draft-persons, Rob Tiplady, an Ann Arbor attorney.  What follows are a summary of my notes taken during Rob’s presentation that described Michigan’s newest trust legislation.

Take-Away: One of Rob’s most interesting comments with regard to this new Act was the shared observation of the drafters that when the proposed bill was being submitted to the Legislature, many of the drafting attorneys  thought that one group that would benefit from the adoption of the asset protection legislation would be northern and western Michigan estate planning attorneys. Their  reasoning is that many of the wealthy Chicago area folks who have summer homes and cottages in western and northern Michigan will travel to Michigan for their asset protection trusts. Since Illinois does not have an asset protection trust act, those Chicago residents who feel the need for the benefit of an asset protection trust will likely come to western or northern Michigan where their cottages and retirement homes are located to adopt trusts and meet with their Michigan based trustees. In short, Michigan is easily accessible for the settlor to meet with his/her asset protection trust trustee close to their home. While I am not quite as optimistic as Rob described this possible business boom for estate planners and professional trustees in western Michigan, apparently the drafting attorneys thought a lot of new business might come from this legislation.

My notes from Rob’s presentation follow, in no real order of importance:

Key Features of the Qualified Dispositions in Trust Act(APT):

  1. The statute expressly replaces Michigan’s historic  common law that prevented self-settled irrevocable trusts as mechanisms to defeat the settlor’s creditor claims
  2. It is permissible for the settlor to retain several rights in the irrevocable under the APT- but Rob cautioned to not retain all of these permissible retained rights [he used the ‘pigs get fat, hogs get slaughtered’ admonition]:.
  3. Some of those retained rights permissibly held by the settlor under the APT include:  control of investments, the right to receive all income, the right to receive, per the trustee’s exercise of discretion, trust principal distributions pursuant to an  ascertainable standard,  a testamentary limited power of appointment over the corpus, and the right to have the APT assets used to pay estate taxes and estate administration expenses [since the APT assets will be taxed, generally, in the settlor’s estate by virtue of either IRC 2036 or 2038.]
  4. The settlor must use a Michigan domiciled trustee for the APT- Rob strongly recommends use of a professional trustee for the APT, as individual trustees may be less inclined to follow all of the technical rules imposed by the APT statute or more prone to overlook the trust’s distribution restrictions, possibly jeopardizing the goal for establishing the APT to begin with
  5. There are a very limited number of exception creditors– child support arrearage is the only creditor that the APT statute protects at time assets are transferred by the settlor to the APT [ for a comparison, note that in the Trust Code’s exception creditors for a support trust, creditors who can access the beneficiary’s interest, include those for child support,  spousal support, governmental agencies, and those who provided services to the support trust]
  6. There is a very short 2 year statute of limitations (SofL) for claims to set aside transfers to the APT by creditors [other statutes of limitations usually are 4 or 6 years]
  7. The burden of proof standard imposed on creditor is very high to set aside the settlor’s transfer to the APT- clear and convincing of insolvency and the intent to hinder, delay or defraud that specific creditor [not other creditors who were defrauded, just the creditor who attempts to set-aside the transfer of assets to the APT must show that he/she was defrauded]

Likely Users of an APT:

  1. Physicians
  2. CEOs
  3. Professional Athletes
  • Rob’s practical observation: An APT is probably not a reliable tool for real estate developers, who are always leveraged. More to the point, real estate values are always hard to determine, as are the entities that developers often use to hold title to their real estate projects. Consequently, it will be difficult  to document and confirm in an affidavit the developer’s financial ‘solvency.’

Rob’s Overview of Michigan’s APT’s Purpose and Use

  1. Not all money/assets of the settlor should go into the APT; perhaps one-third of settlor’s liquid wealth should go into the APT; enough should be retained ‘outside’ the APT for daily living expenses
  2. The settlor’s solvency  is viewed from ‘the lens of the creditor, not the settlor’ at the time of the transfer of assets to the APT
  3. The purpose of an APT is “to not go to court to ‘win;’’ rather, it is to “leverage a better settlement of the settlor’s creditor’s claim” meaning the creditor must work very hard, filing the set-aside claim in Michigan courts, with expensive attorneys, to access assets held in the name of the APT
  4. Consider two layers of creditor protection with the use of the APT: (i) wrap investments in an LLC; (ii) transfer the LLC units to the APT; the result is that the APT is the sole member of the LLC, so that if the APT is successfully challenged all the creditor will receive are LLC units, subject to the continued control of the APT trustee which remains as the LLC manager
  5. Compared to a normal irrevocable  discretionary trust, several key benefits  come with APT: (i) two year statute of limitations (SofL,) to challenge the transfer to the APT, not the normal 6 year SofL;  (ii) rather than creditor meet its burden of proof using a preponderance of evidence standard in  circuit court litigation,  it is a clear and convincing evidence standard burden of proof in probate court litigation where the judge is presumed to understand beneficial interests in trusts much better than a circuit court judge; (iii) with a contingent (i.e. hard to quantify debt or claim) the value of the debt is discounted to its current FMV before distribution is made to the successful creditor; (iv) only the amount sufficient to pay the successful creditor claim  can be ordered paid by a probate court from the APT (not all creditors benefit by one creditor’s success (each must file their own lawsuit), and thus not all assets removed from the APT if only one creditor is successful pursuing a claim); and (v) court costs and the creditor’s attorney’s fees get paid out of the court ordered amount that is to be paid from the APT to the successful creditor.
  6. Exception creditors are limited only to child support [ Note: Rob suggested that it might be good idea to prepay child support prior to the transfer of assets into the APT]; normal exception creditors, e.g. government agencies, pre-existing tort claims, and alimony are not treated as exception creditors in contrast to many other state’s APT statutes [Rob did say, however, that probably the IRS could go after the APT for back taxes since ‘the IRS always wins’
  7. There might be greater interest in the use of an APT as a prenuptial agreement surrogate in light of the current attack on prenuptial agreements in Michigan courts
  8. A ‘bad’ subsequent transfer to the APT, i.e. when the transferor is insolvent,  does not ‘taint’ earlier ‘good’ transfers to the APT by the settlor for purposes of creditor challenges, i.e. the last transfer might be disgorged from the APT but not earlier transfers to the APT when the settlor was solvent
  9. Ordering rules apply to distributions from the APT: the most recent transfer into the APT will be the first transfer of assets out of the APT if ordered by a court to a successful creditor- in short, the APT act is structured to keep ‘old’ money in the APT as long as possible in order to satisfy the 2 year SofL
  10. Advisors to clients who adopt an APT are protected under the statute, i.e. no ‘aiding and abetting’ claims can be brought against attorneys or trustees who participate in setting up or administrating an APT

State Comparisons

  1. Nevada has most aggressive APT statute, i.e. no exception creditors whatsoever; South Dakota is close behind Nevada
  2. Illinois has no APT legislation- consequently, Michigan might be a good market for some Chicago area clients  who feel the need to establish an APT
  3. Michigan’s APT statute was modeled on Tennessee and Ohio’s statutes, with a few more provisions intended to make it that much more difficult for a creditor to attack the APT
  4. Michigan’s statute might  be slightly better than Delaware’s APT statute, although Delaware’s statute has been in place for a much longer period of time

Federal Bankruptcy and IRS Claims

  1. Federal bankruptcy law uses a 10 year ‘look back’ period  for a bankruptcy trustee to challenge an APT, despite the Michigan APT 2 year ‘look back’ period
  2. It is more likely that a Michigan APT will not survive an attack in federal bankruptcy court; (i) the creditor files in federal court, not a Michigan probate court; (ii) federal case law precedent favors the bankruptcy trustee, in contrast to the limited few state APT reported cases, where the settlor has more often succeeded. Consequently, the settlor’s APT is more likely to succeed, i.e. protect against creditor claims,  if it is challenged in a state court. [Note- it takes three creditors to force a debtor into bankruptcy; there may not be enough creditors to force the challenge to the APT into a bankruptcy court setting]
  3. The IRS tends to ignore limitations of state property law when it comes to levying and attaching a taxpayer’s assets, e.g. Craft decision ( Supreme Court but coming out of the Western District of Michigan, 2002) where the local federal court ignored Michigan’s entireties limitations to attach one spouse’s interest in an entireties owned asset to satisfy one spouse’s unpaid income tax liability- per Rob:‘The IRS always wins.’

Current Issues and Current Criticisms to the Act

  1. Michigan’s Voidable Transfer Act needs to be amended to confirm that any litigation that challenges the APT must take place in Michigan, regardless of the domicile of the APT settlor [currently the Voidable Trust Act permits litigation to be filed in the transferor’s state domicile, which may not be Michigan, e.g. back to the example of Chicago residents setting up a Michigan APT to make their creditors come to Michigan to litigate the validity of the APT.]  Remember: the goal is to force creditors that intend to challenge the APT to have to come to Michigan to file their lawsuit, before Michigan courts that are familiar with the purpose and scope of the Michigan APT statute, at far greater expense than litigating claims closer to home for the creditor
  2. Michigan banks may soon begin to require as part of all loan application borrower representations and warranties that the borrower will promise to not create an APT without the bank/lender’s prior consent [it seems that the bankers were asleep when the Qualified Dispositions in Trust Act was adopted and they are only now waking up to the dangers (for them) caused by a borrower’s APT]
  3. Michigan requires the use of an affidavit of solvency by the transferor of assets into the APT, e.g. solvent, assets not the product of unlawful activity, etc. Some states do not require as a precondition to the effectiveness of their APT an affidavit, so that the need for an affidavit each time an asset is transferred to an APT is viewed as an expensive and unnecessary encumbrance to the regular use of an APT, or so the argument goes. Moreover, an defective or incomplete affidavit could possibly jeopardize the entire APT. But such an affidavit may actually be helpful if the APT is challenged 10 years later in a federal bankruptcy proceeding [potentially long after the records documenting solvency are no longer readily available]

Practical Observations with Regard to Michigan’s APT

  1. There should be no implied agreement between the settlor and the trustee that the settlor will receive a distribution whenever requested of the trustee
  2. The trustee should administer the APT consistent with its terms, not at the whim of the settlor
  3. Just because the APT statute permits several retained rights by the settlor does not mean that all  of those permissible rights should be retained by the settlor in the APT; the fewer the retained rights, the better chance the APT will withstand a later challenge by an unhappy creditor
  4. The APT should never be viewed as a bank or lending arm of the settlor’s family [back to the implied agreement concerns expressed above]
  5. While any Michigan resident can serve as the trustee of the APT, it is best to use a professional trustee. A professional trustee is far more likely to adhere to the limitations imposed by the APT statute and abide by the language contained in the trust instrument than an individual trustee. [The implied purpose behind the adoption of Michigan’s APT legislation was to bring more business to Michigan banks and trust companies, away from Ohio. So while a Michigan resident can serve as the trustee of an APT, Rob strongly cautioned against naming one, especially a family member of the settlor.]
  6. Adopting an APT is not an excuse to not have casualty, auto, or homeowner’s insurance in place
  7. Not all clients are candidates for an APT, e.g. when most wealth is held by spouses by the entireties (where only one spouse faces high risks of liability)  or most of the client’s wealth consists of qualified retirement benefits which are cloaked with protection from creditor claims by other state and federal statutes, e.g. ERISA.
  8. Only consider the use of an APT when there exists a realistic exposure to creditor claims- real claims, not imagined claims that an attorney might conjure
  9. Because the APT can be attacked several years down the road, e.g. the 10 year ‘look back’ rule in bankruptcy, it is imperative to obtain and retain at least 5 years of the settlor’s 1040 income tax returns, actual investment account statements, qualified appraisals of closely held businesses and real estate, and a comprehensive personal financial statement,  all of which may be necessary to prove that the representations of solvency in the settlor’s affidavit are accurate at the time of the transfer of assets into the APT
  10. Most spendthrift clauses in most trust instruments will have to be revised for the trust to be compliant with the Michigan APT statute
  11. Many common irrevocable trusts that clients create, e.g. GRAT, ILIT, CRUT, QPRT for their own benefit, or for trusts that will become irrevocable upon the client’s death, e.g. a QTIP Trust or a Credit Shelter Trust for spouse and children, can effectively be created as APTs; thus many current trusts can be adapted, or decanted, to modify language to become APT compliant.
  12. Make sure there is a strong narrative that goes along with the creation of an APT, e.g. describe concerns over a beneficiary’s spendthrift tendencies, or a companion material purpose clause in the APT, that provides an explanation why an APT was created and thus explains the settlor’s motivation was to not delay, hinder or defraud creditors but was some other legitimate purpose.