Trust Experts Say Judge Made "Bad Law" in Landmark Asset Protection Case

Last week, trust gurus from every corner sounded loud sirens to register both discontent and caution over a recent federal bankruptcy decision that could shape the future use of domestic asset protection trusts.

Lawyers around the country have been heating up the Internet fretting over whether a seemingly routine bankruptcy hearing invalidates an entire class of trusts and could leave thousands of their wealthiest clients exposed to nuisance lawsuits.

After Alaska geologist Tom Mortensen filed for bankruptcy protection on about $250,000 in debt, the credit card companies came after his 1.25-acre vacation property in the vicinity of Anchorage.

In theory, that property was held in an Alaska trust, but the bankruptcy judge overruled state statute to let Mortensen’s creditors recover anyway.

That decision pushed a lot of lawyers over the edge muttering that domestic asset protection trusts like Mortensen’s were an endangered species and that sending their clients’ money offshore was once again the only real way to keep it safe.

Granted, the judge’s description of the trust as “a clever but fundamentally flawed scheme” to cheat potential creditors doesn’t exactly inspire confidence.

But trust companies that rely on asset protection as a selling point say the ruling is a fluke that won’t affect truly well-constructed vehicles of this type -- and the estate planners who know most about the field agree.

Overruling state statute

Alaska is one of 13 states that allow assets to be placed in self-settled spendthrift trusts, in which the former owner gives up legal ownership of the property while retaining full access to it.

Under Alaska rules, Mortensen’s trust was well “seasoned” once the state’s four-year statute of limitations was satisfied in early 2009.

“That’s still the case,” says Doug Blattmachr, founder of Alaska Trust -- which had nothing to do with the Mortensen trust. “As long as that statute runs out, you’re in pretty good shape.”

However, when Mortensen filed for bankruptcy shortly thereafter, he exposed his trust to the 2005 revisions to the bankruptcy code, which extended the statute of limitations to a full decade in cases where the transfer seems motivated by an attempt to evade looming debts.

Mortensen failed that test and automatically earned what Blattmachr calls a “badge of fraud” by arguing in court that the trust was designed to defeat his creditors -- the equivalent of an undocumented foreign national telling the border guards he’s hoping to work under the table.

As a result, the judge naturally thought his trust looked suspicious and applied the 10-year rule, so the credit card companies have a claim on the property.

But it’s not the end of the asset protection world, lawyers with their eye on the ball tell me.

“If there was ever an illustration of how extreme facts contradict the law, this might be it,” says Wisconsin estate planner Bob Keebler.

“The sky is not falling on domestic asset protection trusts,” he says. “This is really not a surprise to anyone.”

Cutting through the speculation

Maybe, but there’s still enough confusion about whether Alaska trusts need to be seasoned for a full decade that Keebler recently ran an elite estate planning seminar on the topic with Nevada asset protection guru Steve Oshins.

In their expert opinion, the 10-year rule only applies in circumstances when there’s real suspicion that the goal of the transfer was to weasel out of debt.

Mortensen’s financial condition was already deteriorating when he signed essentially all of his real assets over to the trust. His credit card bills were ballooning and his income was spotty at best.

“It was pretty clear he was using this to protect his assets from claims of creditors,” Keebler says.

“Someone with good solvency who moves a portion of his property into a domestic asset protection trust looks a lot less repugnant here than someone who is already in trouble and transfers most of his net worth.”

No reasonable suspicion that someone is looking to evade existing or likely future debt, no problem, says Alaska lawyer David Shaftel.

“You have to show an actual attempt to defraud,” he explains.

“Asset protection planning itself is not a badge of fraud. It’s still reasonable to want to protect your securities account or other assets from a car accident or the divorces of your children who might be your beneficiaries. Most attorneys will still say, ‘What’s wrong with that?’”

The dangers of do-it-yourself law

The coup de grace for Mortensen was filing for bankruptcy, Steve Oshins points out. Before that point, there was no reason for the 2005 federal statute of limitations to apply whatsoever, and the property would have been safe under the state’s rules.

Had there been no bankruptcy, the 10-year timeframe would never have come up.

Oshins wouldn’t have taken Mortensen -- who had net worth of maybe $3,000 and who designed his own trust from boilerplate forms he found online -- as a client in the first place.

“He was not an ideal candidate for a domestic asset protection trust,” he says. “This is a situation where he shouldn’t have been doing a self-settled asset protection trust in the first place.”

For the professionals and other high-net-worth people these trusts were built to protect, the rules remain the same.

And in any event, the clock is still ticking on all transfers.

“If it had been 10 years and a day, the judge couldn’t have done anything,” Doug Blattmachr says. “If you’re going to do one, do it now.”

Scott Martin, senior editor, The Trust Advisor Blog. Jerry Cooper contributed to the research.

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