Domestic Asset Protection Trusts – A Shield Against Litigation

Domestic Asset Protection Trusts – A Shield Against Litigation

Silicon Valley is home to countless individuals who have created significant wealth through grit and ingenuity; but it is also located in California, a notoriously litigious state. Diversifying one’s concentrated wealth in a single company stock into a well-allocated portfolio can help alleviate market risk, but how does one shield hard-earned money against the various threats of legal action? With the rise in malpractice and errors and omissions claims, professionals from medicine to law as well as business owners, directors and officers all seek solutions to protect their assets from the reach of such lawsuits.

Having sufficient liability insurance coverage is important, but in situations where greater inherent exposure of liability exists, it could make sense to consider creating a domestic asset protection trust (DAPT), which is designed to provide an extra layer of protection between you and your future creditors. In the past, this level of protection could only be accomplished if the trust creator (settlor) relinquished complete control plus all economic benefit derived from any assets transferred into such a trust. However, seventeen states now recognize DAPTs and allow a settlor to retain certain benefits while creating an important additional blanket of possible legal protection for the financial assets placed in these trusts.

Because California is not one of these states, an option for residents to consider is to create a trust in neighboring Nevada with a trustee licensed there. The trust must be irrevocable, and the document must contain specific language referencing the domestic asset protection statute. Before transferring assets into the trust, work with your Wealth Manager to be sure that you have access to adequate resources outside the trust. The trustee has full discretion to make distributions to a class of beneficiaries such as a spouse and descendants, as well as the trust settlor. The settlor may request distributions, infrequently so as not to appear reliant on the assets. A two-year statute of limitations period in Nevada must lapse between the date of transfer and when such assets become protected from that settlor’s creditors. Nevada law also allows the settlor to retain all powers to make investment decisions, plus the ability to fire and hire trustees, giving further flexibility.

Again, these trusts are relatively new and have not been fully scrutinized by the legal system, so it is not yet clear how these vehicles will ultimately be regarded by the courts, particularly when utilized by a non-resident. Combining the DAPT with a limited liability company (LLC) formed in Nevada, in which the assets are considered to be owned by the entity rather than the individual, may add another wall around the assets. If a creditor were able to pierce the DAPT, they should only be entitled to a pro-rata share of any member distributions from the LLC, if applicable; but because the debtor has control over any distributions, he or she would decline to distribute.

Taking it a step further, in a “hybrid” domestic asset protection trust, the settlor is not initially listed as a beneficiary, but the trustee has the power to add that person at some future date. Should the settlor encounter liability issues, these assets would not be in consideration if the settlor has not yet been added as a permissible trust beneficiary.

The DAPT could be a useful planning tool, but it requires careful individual analysis with the help of an estate planning attorney well-versed in drafting this type of special document to ensure that the language meets all requirements, especially since the transfer of any assets into it is irrevocable.

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