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WHERE THERE'S A WILL: It’s Trust Time in Tennessee!
It’s football time in Tennessee! Soon fans will hear those words as the Volunteers line up against Austin Peay to begin the Coach Butch Jones era. While expectations are modest for this season, many fans are optimistic that good times are ahead for Big Orange football.
Similarly, the Tennessee legislature and Gov. Haslam hope that Tennessee asset protection trusts, aided by recent trust law changes, will bring good times for Big Orange trust business. Two recent federal bankruptcy cases provide a game plan for victory.
‘Protect our kickers, our quarterback, our lead and our ball game’
The fourth of legendary UT coach Gen. Robert Neyland’s seven game maxims was “Protect our kickers, our quarterback, our lead and our ball game.” A similar maxim of estate planning is protect clients’ assets from creditors, divorces, and spendthrift beneficiaries. If Gen. Neyland were a Tennessee estate planning attorney, he might recommend a Tennessee Investment Services Trust (TIST) for such protection.
Under the common law, “self-settled spendthrift trusts” were void as to creditors, because it was against public policy to allow individuals to avoid their creditors by placing their assets in a trust from which they could benefit. The settlor-beneficiary’s creditors could reach the assets to the maximum extent that the assets could be used for the settlor-beneficiary’s benefit. As a result, many wealthy Americans instead transferred assets to offshore trusts in jurisdictions that uphold self-settled spendthrift trusts and provide substantial barriers to creditors reaching trust assets.
In an effort to keep some of that trust business at home, at least 14 states have partially supplanted the common law rule by statute, allowing individuals to create self-settled “domestic asset protection trusts” (DAPTs). DAPTs, generally requiring the use of a trustee in the state, purport to offer the same creditor protection available in offshore jurisdictions at a reduced cost, hassle, and cross-border risk. Tennessee joined the DAPT states in 2007 with passage of the Tennessee Investment Services Act.
Tennessee’s trust law was modified in 2013 with the specific goal of recruiting trust business from around the country, competing with states such as South Dakota that have been particularly successful in attracting trust business. The changes, effective July 1, 2013, make it significantly harder for a creditor to reach DAPT assets.
While DAPT laws are largely untested in the courts, two recent federal bankruptcy cases, In re Mortensen and In re Huber, weighed the efficacy of Alaska DAPTs and found them wanting. The cases provide maxims for TIST planners seeking asset protection victory for their clients.
Get big. In Mortensen, the debtor was an Alaska resident making use of the Alaska DAPT statutes. It appears that he met the basic requirements of the statutes and was technically solvent upon funding the trust. However, the court applied Bankruptcy Code Section 548(e)(1), which provides:
In addition to any transfer that the [bankruptcy] trustee may otherwise avoid, the trustee may avoid any transfer of an interest of the debtor in property that was made on or within 10 years before the date of the filing of the petition, if — such transfer was made to a self-settled trust or similar device; such transfer was by the debtor; the debtor is a beneficiary of such trust or similar device; and the debtor made such transfer with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made, indebted.
Because the value of Mr. Mortensen’s assets outside the trust barely exceeded his debts, the court found that he made the transfer to the trust with actual intent to defraud current and future creditors. TIST settlors must execute solvency affidavits, but that might not be enough for 548(e)(1). No team can compete in the SEC without size at most positions and only clients whose net worth is significant after funding the trust will have reasonable confidence that their transfers are safe from the 548(e) intent test.
Build a fence around Tennessee. The DAPT in Huber was created by a Washington resident but designated Alaska as the governing law. Alaska recognizes DAPTs but Washington does not, creating a conflict in the laws of the two states as to the validity of the DAPT. The court said federal bankruptcy courts in the Ninth Circuit apply federal, not forum state, choice of law rules, and follow the approach of the Restatement (Second) of Conflict of Laws (1971). Section 270 of the Restatement provides that an inter vivos trust of interests in movables will be valid if it is valid under the local law of the state designated by the settlor to govern the validity of the trust, provided that this state has a substantial relation to the trust and that the application of its law does not violate a strong public policy of the state with which, as to the matter at issue, the trust has its most significant relationship.
At trust creation, Mr. Huber, one of the trustees, and all the beneficiaries of the trust resided in Washington; all the property placed in the trust, except one small CD, came from Washington; and much of the property placed in the trust was Washington real property or business interests. The only relation to Alaska was that it was the location in which the trust was to be administered and the location of one of the trustees, Alaska USA Trust Company (AUSA). Since the court found that Washington had the most significant relationship with the trust and Washington has a strong public policy against self-settled trusts, the court disregarded Alaska law and applied Washington law to find that Mr. Huber’s transfers to the trust were void as to creditors.
Part of Coach Jones’ success will be to “build a fence” around Tennessee, convincing the top talent in Tennessee to play for the home-state team. Such a strategy is perfect for developing TIST business, as the conflicts of laws issues in Huber should be no threat to TISTs created by Tennessee residents using assets located in Tennessee (and any other assets not physically located in a jurisdiction without DAPTs), particularly if the trust has no trustees located outside Tennessee.
It is unclear how well TISTs will work for Tennessee residents funding the trusts with real property located in a non-DAPT state, or for residents of other states, particularly if funding the trust with assets not physically located in Tennessee. The Sixth Circuit position on choice of laws in bankruptcy (forum state or federal/Restatement) and the location of the bankruptcy proceeding will determine whether Tenn. Code Ann. Section 35-15-107, which seeks a broad application of Tennessee law to trusts that claim Tennessee governing law, controls.
Build it brick by brick. Hoping to be given at least four or five years to restore the Vols to their former glory, Coach Jones has said of his rebuilding job, “It’s like building a building. You build it brick by brick.” Translation: “This is going to take a while.”
The same is true for effective DAPT planning. In Huber, the debtor made a number of mistakes, but all were viewed in light of his waiting until he was in trouble with creditors to seek DAPT protection. The court found that Mr. Huber “was or had to be aware of the gathering storm clouds.” In a number of emails between Mr. Huber and his estate planning attorney, Mr. Huber expressed urgency in setting up the trust.
The court found the transfers to the trust to be fraudulent under Section 548(e)(1) of the Bankruptcy Code, as in Mortensen. The court also found the transfers fraudulent under Washington’s version of the Uniform Fraudulent Transfers Act (UFTA), pursuant to Section 544(b)(1) of the Bankruptcy Code, which gives the bankruptcy trustee authority to bring an action to avoid fraudulent transfers under state law. Under the Washington UFTA, a transfer is fraudulent if the transfer was made without consideration and the “debtor acts with actual intent to hinder, delay, or defraud a creditor.”
In determining whether Mr. Huber transferred his assets to the trust “with actual intent to hinder, delay or defraud” a creditor, the court described the many “badges of fraud” in the case, including (1) creditors already were threating litigation at the time of the transfers; (2) the transfers represented 78 percent of the value of Mr. Huber’s property; (3) he continued to benefit from the assets transferred; (4) he did not receive any consideration for the transfers; and (5) the trust specifically stated that it was created for the purpose of sheltering assets from his creditors.
Because of the multiple badges of fraud, the bankruptcy court concluded that Mr. Huber made the transfers “with actual intent to hinder, delay or defraud” his creditors and ruled that the transfers to the trust were voidable by the bankruptcy trustee.
Would the result have been different for a TIST? The 10-year look back of Section 548(e) applies to TISTs, and the Tennessee UFTA provision is similar to Washington’s. Both provisions call for early planning to put as much time as possible between transfers to a TIST and a future debt or bankruptcy. As stated above, TIST settlors must execute solvency affidavits, but those documents can be self-serving and will not establish intent. Lawyers counseling potential TIST settlors should perform their own due diligence as to whether the TIST client has “gathering storm clouds.”
The players don’t call the plays. Mr. Huber’s son, another individual (apparently a stepdaughter), and AUSA were trustees. The evidence showed that Mr. Huber made requests for disbursement from his son, the son then prepared a request for a payment, AUSA approved the disbursement without any inquiry, the son never met with representatives of AUSA, and “AUSA did nothing to become involved with the [preservation] and/or protection of the assets of the Trust and was acting merely in the nature of a straw man.”
A TIST requires at least one “qualified trustee” who “materially participates” in the administration of the trust, but the bar for material participation appears low and a court could find that a trustee meeting the basic statutory requirements is not really in charge.
Lastly, don’t show the other team the play book. When a business partner indebted to Mr. Huber threatened to transfer assets to a DAPT (before Mr. Huber had done so), Mr. Huber asserted in writing that such a trust would be fraudulent as to him. Jack Sells couldn’t have done a better job giving away the play book.
Big Orange football has a steep climb to get back to the top of the college football mountain, and Big Orange trust business has a long way to go to become the South Dakota of the South. However, Tennessee residents who hire Tennessee trustees for Tennessee assets have reasons for great optimism that TISTs are the best play to achieve asset protection victory. Go Vols, beat ’Bama! Go Big Orange TISTs, beat creditors and maybe South Dakota! It’s trust time in Tennessee!
- http://www.volnation.com/neylands_maxims.php. Although the seven game maxims are well-known, it appears Gen. Neyland had at least 38 team maxims. http://www.utsports.com/blog/2012/03/ neylands-38-team-maxims.html.
- See Kurt A. Friesen, “Domestic Asset Protection Trusts: 15 Years After Alaska and Delaware,” ABA Trust & Investments, March-April 2012 (citing Restatement (Third) of Trusts, §§ 58(2), 60 cmt. F (2003)).
- Tenn. Code Ann. §35-16-101 et seq. See Dan W. Holbrook, “The TIST Test: Tennessee Competes for Trust Dollars,” 43 Tenn. B.J. 21-22 (Aug. 2007); Darsi Newman Sirknen, “Tennessee’s Investment Services Act: A Monumental Change in Tennessee Trust Law,” 43 Tenn. B.J. 16-20 (Sept. 2007); Dan W. Holbrook, When to TIST? Here’s a List, 43 Tenn. B.J. 25-26 (Nov. 2007).
- 2013 Tenn. Publ. Acts 390. The far-reaching changes include:
Tenn. Code Ann. §35-15-105, Default and Mandatory Rules, and §35-15-404, Trust Purposes. Remove the requirement that trust purposes be “not contrary to public policy.”
Tenn. Code Ann. §35-15-502, Spendthrift provision. If a trust has a spendthrift provision, no creditor or assignee of a beneficiary may force any distribution, even if the beneficiary has the right to enforce a mandatory distribution. A fiduciary apparently can simply stop making mandatory distributions.
Tenn. Code Ann. §35-15-504, Discretionary interests — Effect thereof. Regardless of whether a trust contains a spendthrift provision, if an interest is a discretionary interest, no creditor may force or reach a distribution or require a fiduciary to exercise discretion to distribute.
Tenn. Code Ann. §35-16-104, Restrictions on actions, remedies, and claims. The legislature narrowed the time to file a claim to set aside transfers to TISTs as fraudulent and heightened the burden of proof. Prior to this change, creditors had to challenge qualified dispositions as fraudulent pursuant to the limitations period in the Uniform Fraudulent Transfer Act, Tenn. Code Ann. §66-3-310, which is essentially four years. With this revision, if a person is a creditor when the qualified disposition to the TIST is made, the creditor has the longer of (a) two years after the qualified disposition is made or (b) six months after the creditor discovers or should have discovered the qualified disposition. If the person becomes a creditor of the settlor after the qualified disposition is made, the action must be commenced within two years after the qualified disposition. A creditor cannot bring a claim with respect to property comprising a qualified disposition unless he or she can prove by clear and convincing evidence that the settlor transferred the property with the intent to defraud that specific creditor. See also Tenn. Code Ann. §35-15-505(g).
- Thanks to Hon. Richard S. Stair Jr., Bankr. E.D. Tenn., and Steven Lipsey, Esq., Knoxville, for helping this non-bankruptcy lawyer get the bankruptcy stuff right.
- Battley v. Mortensen (In re Mortensen), Ch. 7 Case No. A09-00565-DMD, Adv. No. A09-90036-DMD., 2011 Bankr. LEXIS 5004 (Bankr. D. Alaska May 26, 2011).
- Waldron v. Huber (In re Huber), Ch. 7 Case No. 11-41013, Adv. No. 12-04171, 2013 Bankr. LEXIS 2038 (May 17, 2013)
- Restatement (Second) of Conflict of Laws §270(a) (1971) (emphasis added).
- “Tennessee Vols building on brick theme,” Chattanooga Times Free Press, June 3, 2013, http://www.timesfreepress.com/news/2013/jun/02/vols-building-on-brick-th....
- Tenn. Code Ann. §66-3-305.
- Tenn. Code Ann. §35-16-102(12).
- See http://www.cstv.com/sports/m-footbl/stories/091702acd.html.
EDDY R. SMITH practices trust and estate law with Holbrook Peterson Smith PLLC in Knoxville. He is a fellow of the American College of Trust and Estate Counsel and past chair of the Tennessee Bar Association Estate Planning and Probate Section. He can be reached at email@example.com.