Pensum Offshore Ltd.

The Purpose
The main purpose of an asset protection trust is to place assets beyond the reach of future creditors. The settlor is divested of ownership of the trust principal and subsequent income to the extent necessary to defeat any future creditors of the settlor. At the same time, the trust preserves the settlor's ability to benefit from the fruits of those assets and possibly to reacquire the trust principal at some future date. This structure became possible as a result of changes contained in the 1976 Tax Reform Act, especially Internal Revenue Code §679 which caused the tax law to diverge from other areas of law, especially creditors' rights and bankruptcy law.

Principal Uses of Asset Protection Trusts

To protect personal assets against future creditors.
To protect corporate assets, including movable assets such as ships and yachts, against future creditors.
To establish pre-nuptial and post-nuptial agreements.
To protect assets against problems of inheritance or forced heirship.
To protect assets against exchange and investment controls in the event of deteriorating economic conditions.

Some Trust Formation Considerations

The trust must be created and administered under the laws of a non-U.S. jurisdiction.
The settlor may write a letter or memorandum of wishes as part of the formation of the trust. This may be attached to the trust deed and will set out guidelines for the trustees in the discharge of their duties.
The settlor can sit on a committee of trust protectors that advises, but may not instruct, the trustee(s). The committee can discharge and appoint trustees, but all trustees must be independent. The beneficiaries should have some role or representation on a committee that includes the settlor to avoid any allegations that the settlor (especially if he is committee chairman) is the de facto trustee.
The chosen country should have legislation allowing the transfer of the trust to another jurisdiction in the event of any action which may threaten the trust or its assets. Inclusion of a "flight" provision of this kind in the trust deed is advisable in most cases.
The chosen country should be one that does not impose any taxes on trusts, corporations or estates.
The chosen country should not be one that would accept and enforce the judgement of a U.S. court. Hence the matter would have to be relitigated in the trust domicile, where awards for damages might be far less than the U.S. and where various forms of punitive damages would not be countenanced.
The trust must be discretionary and irrevocable for a period of time. The length of this term will be determined by the objectives of the trust but is typically of the order of 10 to 15 years.
If the settlor survives the period of the trust's irrevocability, the trust will terminate and all accumulated income and principal (that has not already been distributed during the trust’s term) may be returned to the settlor or other beneficiaries. However, the trustees should have the right to elect to extend the trust so that if there are problems with creditors at the nominal expiry of the trust, the trustees can exercise their discretion either to extend the trust or distribute the trust assets to the trust beneficiaries. When drafting the trust deed, care must be taken not to violate the rule against perpetuities. Trusts in the Cayman Islands may be for up to 150 years.
The trust may own the shares of a company which holds and manages the trust's investment portfolio or holds other assets such as real estate or a yacht.
The identity of beneficial ownership of such a company may be made totally confidential in jurisdictions such as the Cayman Islands. In this way the extent of ownership of trust assets may be kept confidential.
A major shareholder of a U.S. corporation could use an asset protection trust to protect himself from liability whilst still benefiting from involvement with the company. The trust would own the shares of the corporation and the settlor could control the business operations of that corporation by being elected an officer by the trustee or other shareholders. The corporation could avoid accumulating earnings that might otherwise be regarded as undistributed dividends, by paying salary and fringe benefits to the settlor. Under these conditions the only asset that creditors could attempt to attach would be the settlor's salary and even this may be protected from undue garnishment by state and federal law.
The creation of a private trust should be co-ordinated with the settlor's estate plan since the trust, in effect, is a form of will substitute for the relevant assets.
Where possible, trust assets should not be located in the United States. In certain circumstances it may also be advisable to avoid retaining assets in civil law countries where inheritance distributions are prescribed and not discretionary.

U.S. Taxes
When a U.S. person transfers assets to a foreign trust, even though the transfer may be irrevocable, the trust will, in effect, be ignored for tax purposes. The trust is created as a "grantor trust" and the U.S. settlor must report and pay tax on any earnings associated with the trust's assets as though they were still the settlor's own personal property.

A typical trust might own shares of closely held companies and shares of holding companies that own other assets such as real estate, yachts, aircraft or motor vehicles. The settlor must be careful not to put income producing assets into grantor trusts where he will be directly taxable on the income but ineligible for trust distributions, unless of course he can afford the enforced savings inherent in such a structure. Income producing assets are often better placed into a corporation whose shares are owned by the trust. Trust jurisdiction law will then have to be considered. Where a trust jurisdiction imposes capital transfer or other taxes, appropriate planning will have to be undertaken.

The Statute of Elizabeth
The Statute of Elizabeth 1571 was introduced so as to formalise what had previously been the common law of England. It provides that all conveyances and dispositions of property made with the intention of delaying, hindering or defrauding, creditors or others, should be clearly and utterly void, frustrate and of none effect, not merely voidable. Claims brought under this statute are not subject to any limitation period. Some form of fraudulent conveyance statute based upon the Statute of Elizabeth exists in most if not all of the States of the U.S. and in most colonies, former colonies and dependencies based on the English legal system. It is therefore important when choosing a trust domicile, to examine closely the effectiveness of any Statute of Elizabeth override provisions that may have been enacted in that jurisdiction.

Selecting a Trust Jurisdiction
To be effective, the trust must be created and administered under the laws of a non-US jurisdiction. A common law jurisdiction affords greater protection than one which deals with trusts by statute or civil law. Examples of the latter are the Channel Islands, Liechtenstein and the Netherlands Antilles.

The common law country should have specific legislation that overrides the Statute of Elizabeth, as detailed in our information sheet. The Cayman Islands have very effective legislation in this area.

The Cook Islands probably have the most aggressive legislation in the asset protection field. There is a suspicion that their legislation might be just a little too creative, resulting in significant risk that the jurisdiction will fall into disrepute through the quality of client it attracts. This will be especially so, if it relies on its legislation and goes to the extremes that the legislation appears to allow.

The Turks and Caicos Islands have very short provisions which protect transfers to trusts by individuals who are solvent at the time and do not become insolvent as a result of the transfer. The brevity leaves a number of unanswered issues, particularly pertaining to the trustees.

Bermuda's Trust Provisions Act of 1989 includes a Statute of Elizabeth override clause that is effective, provided it does not contravene corresponding Bermudan laws or public policy rules. Bermuda does have such laws as may be seen in section 37 of its 1983 Conveyancing Act where it expressly provides for the avoidance of conveyances of property made with an intent to defraud creditors. Hence there may be avenues through which a Bermudan trust could be open to attack.

The Isle of Man's Evidence Act of 1736 is substantially the same as the Statute of Elizabeth. Until such time as that act is overridden, the Isle of Man cannot be regarded as a suitable domicile for an Asset Protection Trust.

The Bahamas copied the Cayman Islands legislation in toto, except for two provisions. The period in which the relevant disposition can be attacked, even if made with wilful intent to defraud creditors, is six years in the Cayman Islands. In the Bahamas it is two years. The second provision relates to the position of trustees in the case of a disposition that is set aside as fraudulent.

The time period in which a fraudulent disposition can be attacked was long debated in the Cayman Islands before being set at six years. It was felt important, particularly in the light of the significant amount of banking and finance business conducted through the Cayman Islands, not to send the wrong signal to the international financial community. It was felt that international bankers or other creditors should have a reasonable period in which to proceed against an improper transaction. In turn, a trust should have a more favourable banking relationship in a jurisdiction where this time period is reasonable. It was thus decided to bring the time period in line with other statutory limitation periods such as those set for tortious claims and breaches of contract. The six year period is still conditional upon creditor establishing that the settlor had notice of his claim prior to the disposition of assets into the trust. The Cayman Islands do not want to be a facilitator of fraudulent conveyances with the attendant reputation that such action would invoke. However, they do want to enable the honest person to protect his or her assets.

This article is only intended to provide broad guidelines on the subject of asset protection. Specific legal and tax advice should be sought from appropriate specialists in these fields.

For more information on any specific aspect of asset protection, please Contact Us.