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An all-perils insurance policy

By Barry S. Engel

The idea of planning today in case financial calamity strikes tomorrow is nothing new. Consider, for example, homeowners insurance. The policy is acquired when there is no expectation of a fire in the home, premiums are paid hoping the policy will never be needed, and in the vast majority of cases the policy will not be needed. Such policies go hand in glove with home ownership, even though they are usually filled with exemptions and exclusions such that they do not cover “all perils.”

Consider also the integrated estate planning trust (IEPT): a trust (usually offshore) established to protect assets at a time when there is no expectation that assets will need protecting. The trust is administered each year hoping the policy will never be needed, and in the vast majority of cases it will not have been “needed,” except as next described.

The IEPT can be described as an “all-perils” insurance policy for, if properly conceived, designed and implemented, it will protect subject assets in the event a threat materializes, regardless of the peril involved.

The IEPT has other purposes that include those traditionally associated with estate planning trusts, e.g., estate or transfer tax mitigation, probate avoidance, privacy and ensuring a smooth transition of wealth.

Offshore Trusts in Context

Offshore trusts are not a new concept. What is relatively new is the use of offshore trusts for the protection of assets from future potential creditors as part of an overall integrated estate plan (IEP) wherein lifetime estate protection is combined with the overall estate plan. This is an extension of older protective planning found in other countries and include settling a foreign trust to safeguard against threats like monetary exchange controls, forced repatriation of assets, confiscatory tax rates, etc.

The question arises as to why a settlor would establish an offshore trust as opposed to a domestic trust as part of an overall IEP. In an effort to attract U.S. trust business, Alaska enacted statutory asset protection trust provisions in 1997. Delaware, Nevada and Rhode Island followed suit. Why wouldn’t a U.S. settlor with IEP goals simply settle an Alaska trust? This is an option, however, there are several reasons below why an offshore trust is more protective and flexible than a domestic trust:

Increased Ability of Settlor to Retain Benefit and Control. In many countries, local trust law restricts the benefit and control over a trust that the settlor can retain. In the U.S. there is a rule against a trust benefiting its settlor in whole or in part and that has as one of its goals the preservation of trust assets from creditors of the settlor (whether or not such creditors are currently known or identifiable—”self-settled spendthrift trust”).

Thus, while a trust created for the benefit of the settlor is valid, it is ineffective as to the settlor’s creditors. Alaska, Delaware, Nevada, Rhode Island (and to a lesser extent Colorado) are somewhat notable exceptions to this general rule against “self-settled spendthrift trusts.” The trust laws in a number of offshore financial centers (OFCs) are even more notable exceptions since their provisions are more flexible and permissive.

Offshore Trusts Not Automatic Targets. A domestic trust remains subject to the jurisdiction of local courts and can become a litigation target if it holds a significant corpus. The domestic trust could be subjected to a legal shake-down and exposed to the same hazards of litigation which the settlor may be exposed during the course of an opposing counsel’s attempts to force a settlement. A properly drafted, implemented and administered offshore trust is not nearly as likely to be the same automatic defendant as a domestic trust relating to the practical barriers next described.

Offshore Trusts Erect Practical Barriers. The mere presence of the foreign element under an offshore trust will impact a creditor’s decision regarding instituting suit or how far they are willing to go to pursue assets. The following offshore trust factors will have a strong deterrent or daunting effect on a creditor’s willingness to pursue IEPT assets:

• No Comity: A number of OFCs provide that judgments foreign to the particular OFC are not to be given force and effect.

• Required Burden of Proof. In many OFCs, the burden of proof in challenging asset transfers to a trust is always on the alleging party and does not shift to the transferor.

• Requisite Standard of Proof. A number of OFCs provide that the American criminal standard of “beyond reasonable doubt” must be met by the party making the allegations.

• Statute of Limitations. In many OFCs, the statute of limitations for challenging asset transfers to the trust runs from the date of transfer and not from the date the transfer is “discovered” by the claimant against the transferor.

• Costs and Fees. It is more expensive to pursue a claim out of state, let alone in one or more foreign countries.

• Psychological Barriers. Psychological barriers of dealing with foreign parties, customs and legal systems substantially enhance the protection a trust’s assets will enjoy should a threat materialize.

Foreign Trusts Ultimately More Protective. The trust law of certain foreign jurisdictions is simply more specific and protective than the trust law available under the fifty states. A properly designed foreign trust will ultimately succeed because it is legally sound, not because of smoke, mirrors or secrecy.

Sovereign Status; No Preemption Principle. Given the fundamental principle that federal law preempts state law, in the author’s view relying solely on state solutions such as the trust statutes of Alaska, Delaware, Nevada or Rhode Island may result in otherwise protectable assets being exposed. In the absence of a treaty or the like, while federal law does preempt state law, it does not preempt foreign law.

Will The All-Perils Policy “Work”?

There are many variables preventing one from making blanket statements like IEPTs “work” or “don’t work.” These include: (i) facts peculiar to a client’s situation, (ii) the client’s goals, (iii) the manner and extent the goals can be incorporated into the IEPT’s design, (iv) the skill with which the IEPT was crafted, (v) the nature of the asset(s) transferred to the IEPT, (vi) the skill with which the IEPT is attacked, (vii) the skill with which the IEPT is defended, (viii) the thoroughness and protectiveness of the IEPT’s applicable law, (ix) whether the opposing party is a governmental instrumentality, (x) whether criminal sanctions would result from the trustees or others involved exercising certain options they would otherwise be free to exercise if the litigants were all private parties, (xi) the law of the forum court, and (xii) any biases of the presiding judge.

The ultimate goal of the asset protection component of an IEP can be considered to have been realized if the client weathers a storm at least moderately better than he otherwise would have weathered the storm had he not engaged in the planning. However, with one notable exception involving a settlor who decided to ignore the existence of the structure he created, the author’s clients who have been threatened or confronted with litigation have enjoyed a result far surpassing this standard.

Barry S. Engel is a shareholder in the Greenwood Village law firm of Engel Reiman & Lockwood P.C. in Colorado.

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