Bankruptcy Court Delivers Unfavorable Ruling Relating to Alaska Domestic Asset Protection Trusts

May 31, 2013

In a case of first impression relating to Bankruptcy Code Section 548(e)(1), the court in In re Huber, 201 B.R. 685, 701 (Bankr. Rptr. W.D.WA. May 17, 2013) held that an Alaska self-settled trust offered no protection with respect to claims of the grantor’s creditors in bankruptcy.


The grantor of an Alaska Domestic Asset Protection Trust (“DAPT”) was a lifelong resident of the state of Washington who had conducted business in Washington for decades. In 2008, when the grantor transferred his assets into the DAPT, there was threatened litigation against him. Foreclosure of real property with loans guaranteed by the grantor was becoming increasingly likely.


The court found that the trust document designated Alaska as the state of governing law and administration. It found that Alaska USA Trust Company was a co-trustee, but it did not appear the trust company was actively involved in the administration of the majority of the trust assets and that it was acting more in the nature of a straw man. The court found the grantor, co-trustee (also the grantor), and all the trust beneficiaries (one of whom was the grantor) resided in Washington. It also stated most of the trust assets were located in Washington. The court then concluded a self-settled trust is void under Washington law, at least as it pertains to sheltering assets from existing or future creditors of the grantor.


The court’s application of Washington law may be in error. Section 273 of The Restatement (Second) of Conflict of Laws provides “[w]hether the interest of a beneficiary of [an inter-vivos] trust of movables is assignable by him and can be reached by his creditors is determined by the local law of the state, if any, in which the settlor has manifested an intention that the trust is to be administered, and otherwise by the local law of the state to which the administration of the trust is most substantially related.” This rule is without exception or limitation or reference to any public policy. It is arguable that when a DAPT recites that Alaska law governs the interpretation and administration of the trust, that recital should be controlling and the spendthrift provision under Alaska law should prevail. However, it appears the Bankruptcy Court used the bad facts and circumstances of this case to reach the conclusion that the contacts with Alaska were minimal and the majority of the administration was actually taking place in Washington and that, under Washington law, the trust was invalid.


The Bankruptcy Court also cited to In re Portnoy, 201 B.R. 685, 701 (Bankr. S.D.N.Y. 1996), and In re Brooks, 217 B.R. 98 (Bankr. D. Conn. 1998). In those cases the courts exposed the trust assets to the grantor’s creditors by finding the trusts to be invalid. Those courts made their analysis under Section 270 of The Restatement (Second) of Conflict of Laws, which provides that a trust owning movable assets is valid if valid under the local law of the state designated by the grantor to govern the validity of the trust, provided 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 under the principles stated in Section 6 of the Restatement. The court then concludes, without much analysis that the public policy of Washington against self-settled trusts outweighs all other interests, thus making the trust assets available to creditors.


The Bankruptcy Court next addressed whether the Bankruptcy Trustee could avoid the transfers the grantor made to the DAPT pursuant to Section 548(e)(1) of the Bankruptcy Code. If Code Section 548(e)(1) were applicable, the trust assets would be available to the grantor’s creditors in bankruptcy. Section 548(e)(1) permits the bankruptcy trustee to disregard any transfer of property to a DAPT that was made on or within ten years before the date of the filing for bankruptcy protection if, among other conditions, the grantor / debtor made the transfer to the trust with the intent to hinder, delay, or defraud a creditor to which the grantor was or became, on or after the date that such transfer was made, indebted.


The court stated that in determining whether the grantor made the transfer with intent to hinder, delay, or defraud a creditor, it should consider the “badges of fraud.” Badges of fraud are “circumstances so commonly associated with fraudulent transfers that their presence gives rise to an inference of intent.” Examples of badges of fraud are: 1) actual or threatened litigation against the grantor, 2) a purported transfer of all or substantially all of the grantor’s assets to the DAPT, 3) insolvency or other unmanageable indebtedness on the part of the grantor, 4) a special relationship between the grantor and the beneficiary of the trust, and, 5) after the transfer is complete, retention by the grantor of a beneficial interest in the property transferred.


The court found that when the grantor transferred his assets to the Alaska DAPT, there was threatened litigation against him. The court further found the grantor transferred ownership of all or substantially all of his property to the trust. It also held the grantor had significant indebtedness at the time he transferred his assets to the trust. The grantor admitted he had a special relationship with the trust, as he was the grantor, a co-trustee, and a beneficiary. Finally, the Bankruptcy Court held that the grantor received benefits from the trust, including its income and occupancy of a home owned by the trust. The court found these badges of fraud were sufficient to conclude the grantor had an actual intent to hinder, delay or defraud his creditors and, therefore, Section 548(e) applied. After finding the transfers to the Alaska trust were made with the intent to hinder, delay or defraud creditors, the Bankruptcy Court held the transfers were voidable for purposes of Bankruptcy Code Section 544.


It seems that regardless of whether the conflict of laws and public policy analysis relating to the application of Washington law was in error or not, the application of Bankruptcy Code Section 548(e)(1) would have caused the trust assets to have been pulled into the bankruptcy estate in any event. While this case is an example of bad facts making bad law, it provides instruction on what to avoid if a grantor is attempting to use a DAPT to provide asset protection against creditors.


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