Story written by Randall A. Denha, J.D., LL.M. at Denhalaw
Alaska was the first state to pass legislation allowing for a so called domestic asset protection trust (“DAPT”), then came South Dakota, Delaware, Nevada and others. Now, Michigan has become the 17th state to permit these trusts and it’s time to plan! You may be wondering what the big deal is and why I haven’t yet explained what a DAPT is. Michigan’s new DAPT law is very exciting and truly opens new doors in protecting your hard earned dollars. Having worked in the asset protection area for 20 years, I fondly recall wondering when Michigan would welcome the DAPT and now I no longer need to wonder. Michigan is now open for DAPT business!
What is a DAPT? It’s a type of irrevocable trust that is created by you, the transferor, for your own benefit (i.e. self-settled) and beyond the reach of your creditors. Too good to be true? Before this new law, yes it was. Now, no longer.
Allowing one to place assets into a trust for his or her own benefit, and beyond the reach of creditors, cuts directly against commonly accepted principles of debtor-creditor law; including the concepts that assets held in “self-settled trusts” can be reached by creditors, and that fraudulent transfers (transfers intended to hinder, delay or defraud the creditors of the transferor) can be avoided by an injured creditor.
In general, a DAPT must be irrevocable; must appoint an individual or corporate trustee residing in the state under whose statute the trust is formed; and must contain a “spendthrift” clause, which provides that the beneficiary’s interests in trust assets cannot be transferred (voluntarily or involuntarily) before the trustee distributes those assets to the beneficiary.
Most DAPT statutes provide that assets in the DAPT are protected from creditor claims only after the expiration of a statute of limitations, which runs from the time the assets are placed in the DAPT.
Now more than ever with the federal government focusing on U.S. taxpayers moving money outside the country (legally and illegally), the trend will be towards using domestic asset protection trusts—not offshore trusts.
This unique arrangement has made the DAPT a favorite tool for the high-net worth, professionals, business owners, real estate developers, about to be married individuals and anyone else concerned about the potential for creditors.
So what does Michigan law provide in the Act and what planning opportunities exist? On December 5, 2016, Governor Snyder signed the Qualified Dispositions in Trusts Act (“the Act”) which becomes effective February 5, 2017.
This new law is what allows for the DAPT. These special irrevocable trusts, or DAPTs, require certain legal requirements to be met, and if done correctly, can shield assets from the claims of a person’s creditors. As stated above, the DAPTs should be strongly considered by those individuals who are concerned about possible creditor exposure, such as business owners, executives and physicians.
Previously, to use a DAPT a person had to transfer assets to an out-of-state trustee in a jurisdiction such as Delaware, Alaska or Nevada.
Now, assets will be able to be transferred to a person residing in Michigan, known as a “Qualified Trustee”. A Qualified Trustee must be someone, other than the transferor, who is a resident of Michigan, who maintains or arranges for custody of some or all of the trust property in Michigan, who administers all or part of the trust in Michigan and who maintains some or all of the trust records at such person’s usual place of business or residence in Michigan.
A few high level items that the Act provides are as follows:
- The individual creating the DAPT (i.e. transferor) would retain only the powers and rights provided by the trust instrument, and can identify certain rights, powers, or interests for which a trust instrument could provide.
- The transferor would retain the right to veto distributions from the trust.
- The Transferor can direct how the assets are to be distributed on the transferor’s death provided that the assets may not be transferred to the transferor, the transferor’s creditors, the transferor’s estate, or the creditors of the transferor’s estate.
- A creditor of the transferor would be limited to proceed against property that was considered a “qualified disposition” (see below definition) and establish requirements for the avoidance of a qualified disposition.
- Establish rules which would provide that a creditor would not have a claim or cause of action against the trustee and others related to a trust that was the subject of a qualified disposition.
- Allow a written agreement between a transferor and a creditor to provide for certain disclosure to, or consent of, the creditor.
- Specify certain responsibilities of a trust beneficiary and trustee.
- Specify that the probate court would have exclusive jurisdiction over certain actions related to qualified dispositions, and establish venue for such actions.
So what is a Qualified Disposition? A “Qualified Disposition” means a disposition, or transfer, after which both of the following apply to the subject property: (1) The property is owned by one or more trustees at least one of whom is a qualified trustee; and (2) The property is governed by a trust instrument under which the transferor has only rights, powers, and interests that are permitted under the Act.
This is important because if it is not considered a qualified disposition (i.e. transfer) then it could be void and/or fraudulent. Not a good result when what you thought was protected no longer is and a creditor now owns it. Therefore, you always want your transfer to a DAPT to be qualified and valid.
What if you make a qualified disposition to the DAPT and a creditor sues you trying to get the asset(s) transferred to the trust? The Act addresses this issue like many other states with DAPT laws and states that if the DAPT is properly established and funded, then the transferor’s creditors may not reach assets transferred to the trust upon expiration of a two-year period beginning with the date the assets are transferred to the trust except in certain instances of fraudulent concealment.
If someone files bankruptcy with a DAPT, then the rules change and the assets may not receive the same protection. Many other states have longer periods of time which are better for the creditor but Michigan’s shorter time period is more favorable to the transferor. Recall that Noah didn’t build the arc when it was raining. You must plan and make any transfers well in advance of a creditor claim to avoid a fraudulent transfer argument by a creditor.
For perspective and strategy, the following are a few examples of DAPTs that I’ve created for clients:
- Client established an automotive business years ago and had transferred some of the shares to his children. The value of the business at that time was nominal. Years later the business sold for over $200,000,000 and Client didn’t want the childrens assets (all physicians and quite responsible) to be subject to the claims of future ex-spouses, creditors or others. We decided to create a DAPT and move assets to the DAPT. The children can access the trust if they need the assets in the event of a rainy day.
- Client’s technology business takes off and before reaching its apex, we create a DAPT for the Client with other advanced strategies and when the business is sold a percentage of the assets drop into the DAPT, continue to be invested and generate an income for Client and remain protected in LLCs owned by the DAPT that can be easily accessed by Client. Client sells for a nine figure sum and now lives out of one of the LLCs owned by the DAPT while the other trusts accumulate moneys.
- Physician client with multiple surgery centers and an active surgical practice fears lawsuits. Various protective techniques are discussed and we ultimately decide that a DAPT makes sense. The DAPT is structured with layers of specially designed LLCs which allow for distributions to be given to the Physician, his family or others as the Trustee (and he (indirectly)) deem appropriate. In the event of a lawsuit, and assuming no fraudulent intent, the DAPT strategy should provide a wonderful fortress for protection.
- Client is considering marriage but wants to protect all of her hard work and considerable asset base. She is reluctant to discuss a prenuptial agreement with her fiance’ due to cultural concerns so we instead create a DAPT and move considerable assets to it well in advance of the planned marriage. In the event of a divorce, the assets owned by the DAPT will not be considered marital property and instead her separate property.
As to the 4th example above and what could be a boon to those contemplating marriage but are uncomfortable with a prenuptial agreement, Michigan law provides an answer.
Michigan law states that “if the trust beneficiary were the transferor of the qualified disposition, his or her interest in it or in property that was the subject of it would not be considered part of the trust beneficiary’s real or personal estate, and could not be awarded to the trust beneficiary’s spouse in a judgment for annulment, divorce, or separate maintenance if either of the following applied: (1) The trust beneficiary transferred the property more than 30 days before his or her marriage that was subject to the action; and (2) the parties to the marriage agreed that these provisions applied to the qualified disposition.
“Own nothing, but control everything,” said John D. Rockefeller who understood the importance of taking his assets out of his own name and placing them in a protected plan that let him maintain control over them — this to safeguard himself from legal entanglements with those who might seek a chunk of his fortune. But asset protection is not just for the super-wealthy anymore. With today’s “litigation explosion” virtually anybody with decent home equity, retirement funds, real estate holdings, and/or a business could be at risk of being sued.
The time to plan is now and Michigan may have now become one of the new darlings in the world of asset protection.
Posted by: The Trust Advisor