Date of Publication:
Estates, Gifts and Trusts Journal; BNA Tax Management
Howard Rosen, Esq. and Patricia Donlevy-Rosen, Esq.
On March 22, 2003, Utah joined the growing list of states (1) which have enacted asset protection trust legislation. (2) This article provides a review and critique of those provisions of the Utah legislation which pertain to asset protection. Trusts which are subject to the new legislation will be referred to herein as “Utah trusts”.
The core of the new legislation, section 25-6-14(1)(a) permits the creation of self-settled spendthrift trusts (3) on or after May 5th, 2003 (4):
For trusts created on or after May 5, 2003, a settlor who in writing irrevocably transfers property in trust to a trust company as defined in Subsection 7-5-1(1)(d) may provide that the income or principal interest of the settlor as beneficiary of the trust may not be either voluntarily or involuntarily transferred before payment or delivery to thesettlor or beneficiary by the trustee. (emphasis supplied).
Although the statute protects the interest of “the settlor as beneficiary” (5), the term “settlor or beneficiary” is used throughout the balance of the statute, which is a non sequitur, as a non-settlor beneficiary’s interest in a spendthrift trust is protected under common law principles in any event. To clarify, the statute should use the term “transferor” (6).
In order to qualify under section 25-6-14, the settlor must irrevocably transfer property to a trust company (7) authorized to engage in trust business in Utah. A sole individual Utah trustee cannot be used. The statute does permit a nonresident individual to serve as co-trustee the Utah trust company (8), but does not address the issue of whether a Utah resident individual may serve as a co-trustee with a Utah trust company.
One issue which always arises in connection with self-settled spendthrift trusts is whether the corpus of such a trust would be included as “property of the estate” where the settlor-beneficiary seeks the protection of the bankruptcy laws. Section 541(c)(1) (9) of the Bankruptcy Code provides that all of the debtor’s interests in property become property of the bankruptcy estate except that:
A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title, (10)
resulting in the exclusion of such property from the bankruptcy estate.
Under the common law, a settlor-beneficiary’s interest in a spendthrift trust is not “[a] restriction on the transfer of a beneficial interest of the debtor [settlor] in a trust that is enforceable under applicable nonbankruptcy law” (11). In order to avoid any uncertainty regarding whether the settlor’s beneficial interest in a Utah trust would become property of the bankruptcy estate, section 25-6-14(1)(a) provides that “the provision shall be considered to be a restriction on the transfer of the settlor’s beneficial interest in the trust that is enforceable under applicable nonbankruptcy law within the meaning of Section 541(c)(2) of the Bankruptcy Code or successor provision.”
A Utah trust may be created to hold any type of personal property or interest in personal property; however, the spendthrift and bankruptcy protection does not apply to any interest in real property (12).
Except through the seven avenues of attack discussed below, neither a creditor existing on the date the settlor transfers assets (13) to the Utah trust nor a person who becomes a creditor thereafter (or any other person seeking to satisfy a claim of the settlor’s interest in the trust) can satisfy a claim, either at law or in equity, from the settlor’s spendthrift interest in the Utah trust.
The spendthrift restriction will not, however, prevent a claim from being satisfied from the beneficiary’s restricted interest (14) if:
1. The transfer is a fraudulent transfer (15) under the Utah fraudulent transfer statute (16)
2. The settlor can revoke or terminate (17) all or part of the trust without the consent of a person who has a substantial beneficial interest in the trust which interest would be adversely affected by such revocation or termination. Note: among the powers which may be retained by the settlor which will not constitute a power to revoke or terminate is a power to appoint nonsubordinate advisers or trust protectors (the terms “adviser” and “protector” are not defined in the new statute). Although the Utah spendthrift provision is declared by the statute to be a valid restraint on alienation enforceable under nonbankruptcy law, the power to appoint a trust protector who can remove and replace trustees could amount to property of the bankruptcy estate (requiring turnover to the bankruptcy trustee) under section 541 as was the situation in Lawrence (18), which resulted in Mr. Lawrence’s incarceration for contempt for failure to comply with a turnover order;
3. The trust instrument requires that all or part of the trust income or principal, or both, must be distributed to the settlor or beneficiary (19). Query: what if the trust instrument, as is often the case in a properly structured asset protection trust, authorizes the trustee to withhold such required distribution in the event of a creditor attack against a trust beneficiary, or permits the trustee to convert such mandatory beneficial interest into a discretionary beneficial interest? The statute gives us no guidance here.
4. At the time of the transfer or any time thereafter, the settlor or beneficiary is in default by 30 or more days in making a payment due under a child support judgment or order (20);
5. The transfer renders the settlor or beneficiary insolvent after the transfer (21);
6. At the time of the transfer, or at any time thereafter, the person (22) receives public assistance and recovery is allowed under Title 26, Chapter 19, Medical Benefits Recovery Act (23); or
7. At any time before or after the transfer in trust is made, the settlor is or becomes subject to a claim of tax of Utah, its agencies, or its political subdivisions (24).
Subsections (3), (4), and (6) (25) qualify the above subsection (2)(c) (26) avenues of attack by providing that:
1. The satisfaction of a claim under subsection (2)(c) is limited to that part of the Utah trust to which the claim applies (27), so that the entire Utah trust will not necessarily be invalidated by a successful claim;
2. The burden of proof by clear and convincing evidence shall be upon the creditor (28);
3. A cause of action brought by an existing creditor must be brought within the later of three years of the date of the transfer to the Utah trust, or one year after the transfer is or reasonably could have been discovered by the creditor (29). Note: the “reasonably could have been discovered” provision (30) could result in an open-ended extension of the statute of limitations not subject to an ascertainable standard. Example: a creditor could conceivably argue, in the case of a transfer which was incomplete for federal transfer tax purposes, “How could I have discovered the transfer? It was incomplete for federal transfer tax purposes, so no gift tax returns were filed, and, as the trust is a grantor trust for federal income tax purposes, the settlor is still reporting the income.” What should a settlor do to shorten the statute of limitations to the 3 year minimum? Beyond properly transferring ownership and possession of the trust corpus to the trustee and making certain that statements for brokerage and bank accounts are addressed to the trustee, the settlor should revise his or her financial statements to delete the transferred assets (31). Trust registration provisions, such as those provided in the Uniform Probate Code (32), should be added to the Act to provide a method of obtaining statute of limitations closure.
4. A cause of action brought by a person who becomes a creditor after the transfer to a Utah trust is extinguished unless brought within two years of the date of the transfer (33).
Section 25-6-14(5) provides that if a trust contains the spendthrift language of section 25-6-14(1) (34), then the satisfaction of the claim may only be sought against trust assets or against a transferor under the uniform fraudulent transfer act, and, importantly, no one can assert a cause of action against a trustee or anyone involved in the counseling, drafting, preparation, execution, or funding of the trust for conspiracy to commit a fraudulent conveyance; aiding and abetting a fraudulent conveyance; or participating in the trust transaction. As written, this exculpatory language would seem to apply, for example, to an offshore asset protection trust drafted by Utah counsel which contained the requisite language.
Section 25-6-14(7) provides that “the transfer shall be considered to have been made on the date property was originally transferred in trust” (emphasis added). This could be a two-edged sword: what if a settlor on May 6, 2003 creates and funds a revocable trust (35) as part of a conventional estate plan. On May 7, 2006, the trust is amended and restated (as irrevocable, etc.) to qualify under section 25-6-14. On May 8, 2006, the settlor is sued. What result? Is a cause of action barred by the statute of limitations? It would appear that the section 25-6-14 protection would obtain under section 25-6-14(7), as the property was originally transferred “in trust” more than three years before the action was commenced (36). The other edge of the sword: a settlor creates and funds a revocable trust (37) described above on May 4, 2003. The trust is amended and restated as an irrevocable spendthrift trust on May 6, 2003. Is the trust forever ineligible for the protection under §25-6-14 because it was “created” before May 5, 2003? The result here is less clear than the result discussed above, as the statute does not address the issue of what constitutes creating a trust on or after May 5th, 2003.
For nonvested property interests or powers of appointment created on or after May 5, 2003, §75-2-1207 provides a 1000 year rule against perpetuities. Query: Why not abolish rule altogether? (38)
If the trust provides that it is to be governed by Utah law, then Utah law will govern if “any administration” of the trust is done in Utah. (39) For this purpose, administration includes, without limitation, the requirement that: there be some asset presence in Utah (40) or that trust records be physically maintained in Utah and the trust’s tax return is prepared or is arranged to be prepared (presumably) in Utah. (41)
If the intent of the Utah Legislature was to create an asset protection trust regimen, as it appears it was, then the legislation has created a house of straw rather than a house of bricks. Although the law provides (42) that “a trust is not void, voidable, liable to be set aside, defective in any fashion, or questionable as to the settlor’s capacity, on the grounds that the trust or transfer avoids or defeats a right, claim, or interest conferred by law on a person by reason of a personal or business relationship with the settlor or by way of a marital or similar right (43)“, the provision does not go nearly far enough. Not addressed in the legislation is the “maximum potential property interest rule” (44), which provides that the creditor of a settlor can reach the maximum potential property interest of the settlor (as a trust beneficiary) in the trust. Thus, assume X establishes a trust for himself and his two nieces. Under the terms of the trust the trustee has the unfettered discretion to distribute all or any portion of the income and/or principal to any one of the three beneficiaries. Under this rule, X’s creditor could reach the entire trust because that would represent the maximum property interest potential receivable by the settlor (X) in the trust. Section 25-6-14(2)(c) provides seven bases by which a creditor can attack the spendthrift restriction, but is the settlor’s discretionary interest protected? In the author’s view, which is shared by the Restatement of Trusts (45), the spendthrift protection and the protection afforded to discretionary interests are two separate matters, and must be separately addressed. Also not addressed were common-law bases for attacking a trust, such as the sham trust argument. Thus, for example, the settlor’s retained power to veto a distribution from the trust, although excepted under §25-6-14(2)(d)(i) as not constituting a power to revoke or terminate the Utah trust, might permit an attack on the validity of the trust under the common-law sham trust principle set forth in the Rahman case (46). An example of a statute which fully addresses this issue is §13C of the International Trusts Act 1984 (Cook Islands), which provides:
13C. Retention of control and benefits by settlor – An international trust and a registered instrument shall not be declared invalid or a disposition declared void or be affected in any way by reason of the fact that the settlor, and if more than one, any of them, either –
(a) retains, possesses or acquires a power to revoke the trust or instrument;
(b) retains, possesses or acquires a power of disposition over property of the trust or the subject of the instrument;
(c) retains, possesses or acquires a power to amend the trust or instrument;
(d) retains, possesses or acquires any benefit interest or property from the trust or any disposition or pursuant to the instrument;
(e) retains, possesses or acquires the power to remove or appoint a trustee or protector;
(f) retains, possesses or acquires the power to direct a trustee or protector on any matter;
(g) is a beneficiary, trustee or protector of the trust or instrument either solely or together with others.
Finally, whenever domestic asset protection trusts are discussed, United States Constitutional issues arise. Specifically, the full faith and credit clause, (47) the supremacy clause, (48) and the contract clause (49)
Under the full faith and credit clause, each state is required to recognize the judgments of the courts of the other states. Under the supremacy clause, the federal government and its laws are supreme to the extent they conflict with state laws. Under the contract clause, no state may pass a law which infringes on the ability of persons to contract with each other.
In arguing that the full faith and credit clause does not affect the ability of Utah trusts to protect assets, it has been argued (50) that the trustee is not the same person as the settlor, and that therefore a judgment obtained against the settlor would not be enforceable against the trustee in Utah (who is a different person than the settlor). While this is entirely true, its avoids the issue of how trust assets are actually reached by claimants. If a judgment were obtained against a settlor in Florida who had created a Utah trust and the claimant was unable to collect that judgment, he or she would bring a post-judgment fraudulent transfer action and join the trustee in Utah as a transferee (as any transferee would be joined over whom jurisdiction could be obtained). Once that joinder is accomplished, the Florida court would have jurisdiction over that trustee, and an order issued by the Florida court determining that the transfer into the trust was a fraudulent transfer, will, as a result of the full faith and credit clause, be enforceable in Utah. On the other side of the full faith and credit coin, even though the Constitution provides (51): “Full Faith and Credit shall be given in each State to the public Acts, Records, and judicial Proceedings of every other State” (emphasis supplied), the Supreme Court recently held (52) “…the Full Faith and Credit Clause does not compel ” ‘a state to substitute the statutes of other states for its own statutes dealing with a subject matter concerning which it is competent to legislate.’ “. This holding calls into question the viability of any state’s asset protection trust law when challenged outside of its home state.
In summary, the protective efficacy of the Utah statute, as is the case with any United States based protective planning, ultimately depends upon a United States court upholding the planning in the settlor’s favor and the inapplicability of the full faith and credit clause of the United States Constitution.
1. Alaska: The Alaska Trust Act, effective April, 1997, Alaska Laws, SLA 1997, Ch. 6; Delaware: the Qualified Dispositions in Trust Act, Del. Code Ann. tit. 12, § 3572-73 (1997); Nevada: Nev. Rev. Stat. § 166.040 (2001); Rhode Island: R.I. Gen. Laws § 18-9.2-1, et. seq. (2001); Missouri: Mo. Rev. Stat. § 456.080(3) (West 2001); Colorado: Colo. Rev. Stat. § 38-10-111 (2001).
2. 2003 Utah Laws Ch. 301 (H.B. 299). As there are many areas of the new legislation requiring clarification, it is expected that the law will be amended, similar to a tax law “technical corrections” act.
3. No specific language is required to create a spendthrift trust. The statute provides, “that the income or principal interest of the settlor as beneficiary of the trust may not be either voluntarily or involuntarily transferred before payment or delivery to the settlor or beneficiary by the trustee.” Such language is sufficient to create a spendthrift trust. For a detailed discussion, see, Rosen and Rothschild, 810-2nd T.M., Asset Protection Planning, p. A-49.
7. § 25-6-14(1)(a). The term “trust company” is defined in §7-5-1(d) to mean an institution authorized to engage in the trust business under chapter 7. Only the following may be a trust company: a Utah depository institution or its wholly-owned subsidiary; an out-of-state depository institution authorized to engage in business as a depository institution in Utah or its wholly-owned subsidiary; a corporation, including a credit union service organization, owned entirely by one or more federally insured depository institutions; a direct or indirect subsidiary of a depository institution holding company that also has a direct or indirect subsidiary authorized to engage in business as a depository institution in Utah; and any other corporation continuously and lawfully engaged in the trust business in Utah since before July 1, 1981.
11. See, e.g., Restatement (Second) of Trusts § 156 (1959): “(1) Where a person creates for his own benefit a trust with a provision restraining the voluntary or involuntary transfer of his interest, his transferee or creditors can reach his interest.”
14. The statute uses the term “beneficiary’s restricted interest”, which presumably refers to the beneficiary’s interest in the trust subject to the spendthrift restriction; however, the term should be defined.
17. §25-6-14(2)(c)(ii). §25-6-14(2)(d) lists the following as not constituting a power to revoke or terminate: a power to veto a distribution from the trust; a testamentary special power of appointment or similar power; the right to receive a distribution of income, principal, or both in the discretion of another, including a trustee other than the settlor (the apparent implication being that the settlor could be a trustee), or an interest in a charitable remainder unitrust or charitable remainder annuity trust, or a right to receive principal subject to an ascertainable standard set forth in the trust; or the power to appoint nonsubordinate advisers or trust protectors who can remove and appoint trustees, who can direct, consent to or disapprove distributions, or is the power to serve as an investment director or appoint an investment director under Utah §75-7-302 (13) and (14).
20. §25-6-14(2)(c)(iv). Presumably the exposure of the trust assets here is limited by § 25-6-14(3) to that portion of the trust which would be required to bring the payments current accordance with the child support judgment or order. Query: would the claiming spouse have to litigate each payment as it became delinquent? And, after the termination of the statute of limitations, would the trust assets is still be subject to payments for child support?
28. §25-6-14(6). A higher standard of proof than the “preponderance of the evidence” standard required in some states to establish a fraudulent transfer or conveyance. See, e.g., In re Lance S. Brown, 265 B.R. 167 (2001).
29. §25-6-14(4)(a). Utah’s uniform fraudulent transfer act, § 25-6-10(1), provides in all other cases that a claim is extinguished unless it is brought “within four [not 3] years after the transfer was made or the obligation was incurred or, if later, within one year after the transfer or obligation was or could reasonably have been discovered by the claimant;”.
31. See, Donlevy-Rosen, RIA Tax Advisors Planning Series, Title 32, Asset Protection Planning, § 4.04, addressing this issue and discussing “equitable tolling” and a six year statute of limitations for the federal government which runs from the time when transfer facts are known or should have been known under 28 U.S.C. § 2415.
44. For a discussion, see, Rosen and Rothschild, 810-2nd T.M., Asset Protection Planning, p. A-62. See also, Restatement (2d) of Trusts, §156 (2); Ariz. Rev. Stat. Ann. §14-7705(B) (Supp. 1993); Cal. Prob. Code §15304; Va. Code Ann. §55-19.
45. Restatement (Second) Of Trusts, § 155, comment b on subsection 1 provides: “Discretionary trust distinguished from spendthrift trust. A trust containing such a provision as is stated in this Section  is a “discretionary trust” and is to be distinguished from a spendthrift trust…”(emphasis added).
46. Rahman v. Chase Bank (CI) Company Limited, 1991 J.L.R. 103, Royal Court of Jersey. See also; The Meaning of the Rahman Decision, Michael St, J. Birt, The Offshore Tax Planning Review, V3 1991/93, Issue 1, p. 81.
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