Asset-protection trusts

An asset-protection trust is a term which covers a wide spectrum of legal structures. Any form of trust which provides for funds to be held on a discretionary basis falls within the category. Such trusts are set up in an attempt to avoid or mitigate the effects of taxation, divorce and bankruptcy on the beneficiary. Such trusts are therefore frequently proscribed or limited in their effects by governments and the courts.

Trusts were developed at common law in England originally to minimize the impact of inheritance taxes arising from transfers at death. The essence of the trust was to separate "legal" title, which was given to someone to hold as "trustee", from "equitable title", which was to be retained by the trust beneficiaries.

In the United States and England, a practice developed whereby trust settlors began to use "spendthrift" clauses to prevent trust beneficiaries from alienating their beneficial interests to creditors. Over time, courts were asked to determine the efficacy of spendthrift clauses as against the trust beneficiaries seeking to engage in such assignments, and the creditors of those beneficiaries seeking to reach trust assets. A case law doctrine developed whereby courts may generally recognize the efficacy of spendthrift clauses as against trust beneficiaries and their creditors, but not against creditors of a settlor.

The asset-protection trust is a trust that splits the beneficial enjoyment of trust assets from their legal ownership. The beneficiaries of a trust are the beneficial owners of equitable interests in the trust assets, but they do not hold legal title to the assets. Thus this kind of trust fulfills the goal of asset protection planning, i.e. to insulate assets from claims of creditors without concealment or tax evasion. A creditor’s ability to satisfy a judgment against a beneficiary’s interest in a trust is limited to the beneficiary’s interest in such trust. Consequently, the common goal of asset protection trusts is to limit the interests of beneficiaries in such a way so as to preclude creditors from collecting against trust assets.

Such trusts must be irrevocable (a revocable trust will not provide asset protection because and to the extent of the settlor's power to revoke). Most of them contain a spendthrift clause preventing a trust beneficiary from alienating his or her expected interest in favor of a creditor. The spendthrift clause has three general exceptions to the protection afforded: the self-settled trusts (if the settlor of a trust is also a beneficiary of a trust), the case when a debtor is the sole beneficiary and the sole trustee of a trust, and the support payments (a court may order the trustee to satisfy a beneficiary's support obligation to a former spouse or minor child). The first general exception, which accounts for the majority of asset protection trusts, no longer applies in several jurisdictions. The laws of certain jurisdictions including Alaska, Bermuda, and the Cayman Islands allow self-settled trusts to afford their settlors the protection of the spendthrift clause.

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