Volume 17 Issue 1 --
Volume 17 Issue 1 -- January/February 2013
Traditionally, in Virginia and many other states, persons could not protect their assets from the claims of creditors by putting them into a trust from which they could benefit. For example, suppose Hapless Harry (Harry) is a careless contractor who builds buildings that tend to fall down. Harry could not protect himself from future claims by transferring his assets into a trust from which he could benefit.
Recently Virginia authorized Asset Protection Trusts (APTs) that, in some situations, allow individuals to shield assets from creditors by using a trust from which they can benefit. Does this sound too good to be true? Perhaps.
APTs as authorized in Virginia come with a number of potentially significant restrictions and limitations. These may render APTs less than desirable except in limited situations.
To qualify as an APT, the trust must be irrevocable and have a Virginia trustee that maintains at least some assets and records in Virginia. In addition, the transfer to the APT cannot be a fraudulent conveyance — that is, it cannot be intended to delay or hinder creditors and cannot leave the transferor unable to pay its bills.
The most difficult requirement is that the APT creator’s interest in the APT must be severely limited. In essence, the creator can receive only discretionary distributions of interest or principal, where the discretion must be exercised solely by an unrelated trustee.
The effect of these requirements can be substantial. First, under the Virginia law, creditors have 5 years from any transfer to an APT to challenge the transfer on grounds that it is a fraudulent conveyance. Suppose Harry knows that he made a mistake on a project and expects to be sued, so Harry transfers all of his assets to an APT that otherwise meets the APT requirements. The effect of the transfer is to leave Harry with virtually no assets. Harry’s creditors will have 5 years from the date he created the APT to challenge it.
Second, Harry can have no right to approve or veto any distributions from the APT. As noted above, the APT must be irrevocable, meaning that Harry cannot put assets into the APT when he is concerned about liabilities and then withdraw them later after he retires.
Potentially, one of the biggest hurdles facing APTs is the requirement that the trustee who makes the discretionary distributions to the APT creator must be “independent,” which means someone unrelated and not controlled by the APT creator. The law specifically excludes from being independent trustees, spouses, descendants, siblings, parents, employees, and entities in which the creator controls thirty percent of the vote. Who is left?
Most likely, the only persons that will be willing to serve as independent trustees will be commercial Trust Companies. Therein lies another whole set of problems.
Long gone are the days when local banks provide trust company services. Today, independent local banks that offer trust services are rare, and most trust services are offered by large national or regional banks which centralize their trust services in one location, often in a distant location. This means dealing with a large bureaucracy reachable only by telephone, mail, or email. In the case of some trust companies, this can be an enormous inconvenience.
In any event, the independent trustee who must approve any distributions to the APT creator will often end up being a stranger working for a large bank in a far off location. Is this someone Harry will want to trust to exercise discretion over his own assets?
Even if an APT meets all of the requirements of the Virginia law, how will other jurisdictions treat them? On that point there is little but uncertainty.
Suppose Harry sets up his APT in Virginia but gets sued and held liable in the State of Nirvana that does not recognize APTs. If the creditor in Nirvana sues the APT trustee in Nirvana because it is also doing business there, will the APT be effective to protect Harry’s assets from collection in Nirvana? The answer is unclear.
There are also potential issues in Bankruptcy. It is possible that Bankruptcy creditors may be able to reach any assets transferred to an APT for 10 years.
If you need help with trust or estate planning issues, contact Newland & Associates.
Published by the law firm of Newland & Associates, PLC
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Call us at (703) 330-0000 for a full range of business law and tax-related services.
While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.
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