Foreign APTs On Trial:
The End of an Era or Just Another Predictable Case?
by Matt Blackman for Offshore Financial USA Sept/Oct.
1999 Edition
(Note: This article was the basis of the OFUSA article.)
As time passes following the decision in Federal Trade Commission v. Affordable Media LLC (the "Anderson case"), two schools of thought are emerging on the implications of this ruling. Some, such as Jay Adkisson whose views are eloquently expressed in the article preceding this one, argue that the decision spells the end of foreign asset protection trusts (FAPTs), while others argue that the case is distinguishable on its facts.
This article will examine the arguments on both sides by surveying the opinions of leading professionals in the industry.
The end is near
Adkisson is not alone in his harsh analysis of the Anderson case.
Arnold Cornez: Cornez is a lawyer and frequent speaker at asset protection, wealth preservation, and offshore investment seminars. He is also the author of The Offshore Money Book. Cornez agrees with Adkisson's assessment of the impact of the Anderson case. "I have been taking the strategic position that the demise of the asset protection trust occurred two years ago and have ceased encouraging their formation," he said. "Say what you want about the facts of Anderson, this decision gives judges in the Ninth Circuit at least, virtual carte blanche to simply throw the grantor of a foreign trust in jail until assets are returned, whether the grantors technically have the power to return the assets or not.
"I further predict that this concept will sweep across the US to the other Districts rendering the FAPT an ineffectual asset protection tool. What is further disturbing is that among the required elements of civil contempt is the 'possibility of compliance with the Order' by the person being cited. Here, in the Anderson case, there was clear irrevocability of the transfer of funds - legal impossibility existed. Yet, this new concept was found proper and upheld on appeal. The equities overcame the shocking facts. We now have one less requirement for contempt where the defendant seeks offshore jurisdictions to frustrate, hinder and delay the creditor."
Cornez concluded by saying, "personally, I believe that the US Supreme Court would reverse the decision, since the basic premise of irrevocability of an asset protection trust - where the asset is no longer the property of the settlor - no longer governs!"
Counterpoint on the demise of the FAPT
FAPTs have been abused to harbor funds derived from illegal or unethical activities and structured so that the settlors do not in reality relinquish control. This is the point that the opposing camp argues. They suggest that the facts in the Anderson are not typical and that the trust document was not properly structured or implemented.
Barry Engel: Engel is a lawyer and specialist on the use of asset protection trusts in financial planning. He recently completed a paper entitled, Asset Protection Planning and Contempt of Court for the American Bar Association which addresses the implications of the Anderson case. Engel opens his paper by saying:
"Both State and Federal Courts have broad discretion to impose sanctions on an individual found to be in contempt of court. Sanctions can include fines, forfeiture of rights, and imprisonment. When analyzing the issue of whether the settlor of an asset protection trust (or any other trust for that matter) may be held in contempt of court, the court must consider whether the settlor's actions come within the definition of contempt, and whether any valid defenses exist.
Under an asset protection trust that is properly drafted, properly implemented and properly administered, the 'impossibility of performance' defense to a charge of contempt will be a complete defense to any such charge, so long as the impossibility is not 'self-created', in bad faith, or in close time-proximity to the issuance of the court order or subpoena."
Engel pointed out that the Ninth Circuit was clearly aware that the Andersons retained control of the trust assets, even though they attempted to hide that fact. In the words of the court:
"The provisions of the trust also make clear that the Andersons' position as protectors gives them control over the trust ... the trust agreement makes clear that the Andersons, as protectors, have the power to determine whether or not an event of duress has occurred.
Moreover, the very definition of an event of duress that the Andersons assert has occurred makes clear that whether or not an event of duress has occurred depends upon the opinion of the protector.
Therefore, notwithstanding the provisions of the trust agreement that the Andersons point to, it is clear that the Andersons could have ordered the trust assets repatriated simply by certifying to the foreign trustee that in their opinion, as protectors, no event of duress had occurred."
Engel reiterated that "in the case of a well-drafted and administered asset protection trust, under which control is relinquished to a professional trustee, neither the settlor of the trust nor any of its beneficiaries will have the ability to comply with a court's order to repatriate assets. Performance will be 'factually impossible.' As such, the impossibility of performance defense will be available to any charge of contempt for failing to comply with the court's order."
Logical deductions
Vernon Jacobs: Jacobs is a CPA and author of the The Jacobs Report on Asset Protection Trusts. Although he has worked with Cornez in producing a number of offshore publications, he is clearly on the other side of the fence on this issue. "If a US court is able to pierce the veil of a corporation where a dominant investor treats the corporation as if it didn't exist," he says, "does that mean that no one should ever use a corporation to protect the assets of investors?
"Obviously, the corporation continues to serve as a useful barrier to the claims of business creditors who would otherwise seek recovery from passive investors of the company. But in extreme cases, where the investors are the managers of the business and they ignore the legal distinctions between the corporation as an entity and their own funds, the courts will properly ignore the existence of the corporation."
Jacobs argues that the reasoning should apply to FAPTs. In cases where the settlor attempts to retain control and gain access to assets, the structure runs the risk of enduring the same fate as the Anderson's trust. He also argues that the non-application of the impossibility defence is easy to reconcile, since the Andersons themselves created the condition that made it impossible to recover the assets after they were ordered to do so by the court. The impossibility was therefore self-induced.
On the facts, Jacobs argues that the case is not typical for two main reasons. First, the Andersons admitted to knowing that people were being defrauded under the telemarketing scheme in which they were involved; and second, the creditor was a government agency attempting to recover assets by people who had been defrauded. "Where some government agency is your adversary," he says, "I agree that the FAPT is less effective than where your adversary is a private party or company."
The fatal flaw
Daniel Ertel: Ertel is also a CPA and is now in private practice. He has several years of experience working for the Internal Revenue Service. Ertel is sckeptical about the implications of the Anderson case. "Some commentators have decided that the Anderson case has been the final death knell for foreign asset protection trusts," he says, "it seems to me that this is like throwing the baby out with the bath water. In a recent article in the Journal of Asset Protection, Ertel observed that:
"While the Andersons refused to comply with a court order to repatriate their APT assets, relying on the defense of impossibility of performance, the Court found the impossibility to be self-created because the Andersons served as trustees throughout the litigation.
Only after the Court's order of repatriation did they notify the foreign trustee of the litigation, triggering the trust's anti-duress provisions. I don't know who created the Andersons FAPT but the flawed trust provisions dealing with trustee powers appear to be what caused the correct ruling by the Court."
Ertel is of the opinion that a properly structured FAPT still effectively performs the function of protecting assets from future creditors, while avoiding incarceration for contempt. "Of course there's always the option of doing nothing and subjecting yourself to the risks of litigation," he added.
An ounce of prevention
Robert Lambert: Lambert is a lawyer and president of Asset Protection Corporation. He argues also that that the Anderson trust was fatally flawed in both structure and implementation. Lambert has a number of clients who have faced court challenges and because the foreign asset protection trusts were correctly structured and used honestly, were able to successfully protect their assets.
Lambert offers some guidelines based on his personal experience and the ruling in the Anderson case:
i) Settlement of assets into the trust should not render the client insolvent. Leave something for creditors to fight over. Such an arrangement is less likely to be challenged.
ii) In the event that money transferred into the trust is fraudulently obtained, the statute of limitations begins to run anew with each transfer. A trust used for legal purposes and established well in advance of trouble, will unlikely have transfers challenged as fraudulent conveyances.
iii) In a properly structured trust, control is relinquished to a professional trustee and protector. Where such roles are assumed by the settlor or beneficiary, it begs for trouble in the event of a court challenge.
iv) Don't rely on secrecy to hide assets. It doesn't work!
v) Use common sense and keep adequate reserves.
In the final analysis
While, only time will tell if the foreign asset protection trust is ineffectual after the Anderson case, a number of attorneys believe such a pronouncement premature.
Gideon Rothschild: Rothschild is the Chairman of the Asset Protection Planning Committee of the American
Bar Association. His remarks expressed on the ABA listserv site and are congruent with those made by Barry Engel.
"Let's not forget a few critical facts which make this [Anderson] case quite distinguishable from the offshore trusts that many planners create for their clients. First, this appears to have been engaged in with an eye towards committing an egregious fraud. Even if a trust is created in advance of a problem I don't believe it gives a license to anyone to steal or commit tortious acts. In fact I believe even the offshore courts would eventually deal with such transfers in a morally correct fashion. The use of an APT in likely furtherance of intentional fraud of thousands of innocent investors is far different from, say, the surgeon who is prudently concerned about potentially catastrophic malpractice liability or a contract creditor who never extended credit based on trust assets. The analogy should be to the corporate form; it is universally recognized as a legitimate device for limiting liability but in the appropriately egregious case a court will piece the corporate veil."
"A second aspect to this case is that the trust was clearly structured poorly. Prudent asset protection planning would not have the client as trustee and would limit the client's powers as protector or alternatively eliminate the client as protector in favor of an independent, off-shore protector. By having named the Andersons as trustees and protectors added to the fact that they drew out $1 million without anyone else's consent, as well as the timing of their discharge as trustees it's not surprising that the court ruled that they had control over the trust. Furthermore, the trust provided affirmative protector powers allowing, for example, the Andersons to determine whether a certain action is an "Event of Duress". Accordingly, the court held that they had the ability to direct the repatriation of the assets."
"Obviously, as can be expected, those who have criticized APTs in the past will latch onto this decision as the death knell to APTs. Although, some of the court's statements are, admittedly, quite critical of offshore trusts, they are merely dicta and, in my opinion, must be viewed in the context of this egregious case. What they ruled on was simply the issue of whether the trust, as written, supported the Anderson's defense of possibility of performance. The court stated " we are unsure that we would find the Andersons inability to comply ... a defense to a civil contempt charge. We leave for another day the resolution of this more difficult question because we find the Andersons have not satisfied their burden of proving that compliance with the district court's order was impossible." (p.33)
"I believe that, just as in the bankruptcy court decisions that have been rendered in this area, bad facts make bad law. This is a case where the participants appear to have knowingly defrauded investors. This is not hopefully the types of clients most attorneys in this establish APTs for (assuming we do the proper due diligence). As several judges have stated to me - there is nothing inherently wrong with asset protection planning (whether it be via an APT or transfers to spouses or other means) just as there is nothing wrong with pre-bankruptcy planning. But, when it is used as an instrument to commit fraudulent acts, these transfers should not be protected. This case and the negative reactions thereto demonstrate further the importance that we must attach to conducting our practice in an ethical manner. If attorneys and offshore trustees continue to assist clients in these types of situations it will be only a matter of time before the backlash causes the end of the asset protection industry as we know it today. I implore those involved in this field to improve their client screening process so as to reduce the possibility that more of these cases reach this outcome."
Conclusion
All advisors agree on one thing: trusts are just one on may structures used to facilitate the protection of assets. There have been and will continue to be more negative articles in the popular media about the pitfalls of taking assets offshore to protect them. This is to be expected: bad news sells, good news doesn't. Ultimately it will be the client who must decide whether to use the FAPT or not. As CPA Daniel Ertel says, "an asset protection trust is certainly better than nothing in the event someone tries to take your hard-earned property from you in court."
Matt Blackman is an offshore consultant and author who has written articles for a number of international
finance publications. He is host of an offshore information web site and may be reached at (604) 987-1609
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