One of the powerful tools available to Utah estate planners is the domestic asset protection trust (DAPT). This article briefly explores what a DAPT is, how it differs from other irrevocable trusts, how it came to be in Utah and how to avoid common DAPT pitfalls in practice.
What is a domestic asset protection trust?
A DAPT is an irrevocable trust created specifically for the benefit of the settlor (i.e., the individual who transfers assets to the trust) and any beneficiaries the settlor designates, the assets of which are sheltered from the settlor’s creditors. Utah’s DAPT enabling statute is Utah Code Ann. § 25- 6-14. If the requirements of the statute are followed, a DAPT protects assets from the settlor’s creditors in the following ways: (1) future creditors cannot attach property in the trust; (2) future creditors cannot force distributions from the trust; (3) future creditors cannot require trust distributions be made directly to creditors (rather than to a trust beneficiary); and (4) creditors existing at the time the trust is created have a limited period of time to assert claims against trust assets, which can be as little as 120 days if the settlor provides and publishes notice as set forth in the statute. Id. § 25-6-14 (3) and (9).
How does a DAPT differ from other types of trusts?
Although revocable trusts are an important part of basic estate planning, they do not provide asset protection, as does a DAPT. Id. § 75-7-501 and 505(1)(a).
Moreover, although other types of irrevocable trusts can provide asset protection, there are some critical distinctions that can make a DAPT more favorable when asset protection is a primary motivation. The Utah DAPT statute expressly enumerates the following advantages a settlor obtains when complying with the statute:
• A settlor (and not just non-settlor beneficiaries) may use and enjoy DAPT assets under the protection of spendthrift provisions, including living in a home funded to the DAPT, without the threat of creditor attachment or creditor-forced distributions. Id. § 25-6-14 (2), (5)(c) and 7(g).
• A settlor may serve as co-trustee of the DAPT over such things as investment decisions and asset management, provided the settlor does not participate in distribution decisions (except that the settlor may veto any distribution). Id. § 25-6-14 (7)(a), (c) and (d).
• A settlor may appoint and remove trust protectors (a special office within the DAPT), giving the settlor additional indirect control over trust assets. A trust protector may or may not have fiduciary duties and may have authority over a wide variety of trust matters, such as removing and replacing the trustee. Id. § 25-6-14 (7)(b).
• A settlor may have some debts at the time of asset transfer to a DAPT, provided the transfer does not render the settlor insolvent. Id. § 25-6-14 (5)(i).
• The DAPT can be revoked by the trust protector, acting alone, or by the settlor, with the consent of another beneficiary whose interest would be adversely affected by the revocation (i.e., a child with a remainder interest). Hence, “irrevocable” as to a DAPT merely means that the DAPT may not be revoked by the settlor acting alone. Id. § 25-6-14 (5)(d).
How did DAPTs come to exist in Utah?
Alaska was the first state to adopt legislation enabling asset protection trusts in 1997. Alaska Stat. § 34.40.110 (2010). Prior to that, spendthrift trusts benefiting the settlor were thought to be against public policy. Following Alaska’s lead, several states instituted similar legislation, Utah being one of them. Del. Code Ann. tit. 12, §§ 3570-3575 (1997); Haw. Rev. Stat. § 554G (2011); S.D. Cod. Laws §§ 55-16-1, et seq. (2005); Tenn. Code Ann. § 35-16-101 (2007); Utah Code Ann. § 25-6-14 (2003). However, Utah’s DAPT statutory provisions were originally not as favorable to planners. For example, the Utah statute required a corporate trustee, which some associate with high fees; and it contained numerous exceptions where categories of creditors could still reach trust assets. (Utah Code Ann. § 25-6-14 (2003)). Accordingly, Nevada emerged for a time as the state with the most protective asset protection trust. Nev. Rev. Stat. §§ 166.010-166.170 (1999). All of that changed in 2013, when Utah adopted the current DAPT statute. Utah Code Ann. § 25-6-14 (2013).
What are some common pitfalls of using a DAPT?
Fraudulent Transfers: When transferring assets to a DAPT, a settlor cannot intend to hinder, delay or defraud a known creditor; and the settlor cannot make transfers that would render the settlor insolvent. Id. § 25- 6-14 (5) (i) and (j). However, the right to sue the settlor for fraudulent transfer to a DAPT generally expires within two years of the transfer, or within 120 days of notice if the settlor provides notice of the transfer pursuant to the statute § 25-6-14 (9), as compared with a four-year statute of limitations on most other fraudulent transfer claims generally. Id. § 25-6-10.
Child Support Obligations: Utah’s DAPT statute contains provisions strongly recognizing the public policy that parents should not be able to avoid child support obligations. Id. 25-6-14 (5)(g) and (h).
Trust Protectors: While the statute expressly allows for trust protectors (and we use them in our practice in some circumstances), the courts have not yet dealt with many challenges to asset protection trusts based upon the theory that the settlor retains too much control by being able to remove and replace trust protect ors. We generally think it prudent to limit the circumstances under which a settlor may remove a trust protector (i.e., inability to serve or lack of legal capacity) until case law on the point begins to emerge.
Financial Statements: A settlor must not represent to a financial institution or other source of credit that it “owns” the assets in a DAPT; such representations can amount to bank fraud or otherwise put the trust assets at risk.
Mandatory Distributions: Distributions to beneficiaries should be in the discretion of the non-settlor trustee or subject to an ascertainable standard or other statutorily provided limits so that creditors of such beneficiaries cannot reach those assets. Id. 25-6-14 (5)(e) and 7(f).
A Utah DAPT, if implemented properly, can be a great way for high net worth clients, clients in high risk professions and even clients with modest estates who have excess discretionary assets to shield some of their assets from creditor claims.