Domestic Asset Protection Trusts in the “Perfect” Situation

I’ve previously written about the existence of some uncertainty regarding Domestic Asset Protection Trusts here and here. [Do not confuse Domestic Asset Protection Trusts with asset protection trusts formed under local common law, which have far less uncertainty surrounding them. The links above go over the distinction.] The extremely distilled version of those posts is that for residents of states which don’t recognize DAPTs, the validity of an out of state DAPT may be up in the air. There are basically three reasons for this:

  1. Trustees solicit business all over the country, and consequently it would be easy for a court in any state, including a state that doesn’t recognize DAPTs, to get in personam jurisdiction over the DAPT trustee.
  2. The DAPT likely holds assets in brokerages with offices all over the country, making it easy for a court in a non-DAPT state to get in rem jurisdiction over the trustee.
  3. There is a ten year clawback for DAPTs in bankruptcy.

For an explanation of those three points, and what the terms contained within them (such as in personam and in rem) mean, see the two prior posts linked above. 

Despite the potential drawbacks, some clients may still wish to choose to proceed with a DAPT. For those clients, I would suggest the following steps to reduce the risk of the trust being pierced. I will assume here that we are taking about a New Jersey resident forming a Delaware DAPT.

Choose a Trustee Carefully. Rather than choose a large well-known trustee that does business in many states, try to choose a trustee with as few contacts outside of Delaware as possible. To further avoid any accusation that the trustee “does business” outside of Delaware, you should also sign all trust documents in the Delaware office of the trustee. All of these factors reduce the chances that a New Jersey court can exercise in personam jurisdiction over the trustee. To see an example where taking these precautions worked, see First American Bank of Va. v. Reilly, 563 N.E.2d 142 (In. Ct. App. 1990). In Reilly, an Indiana court held that it had no jurisdiction over a Virginia bank acting as trustee, despite the grantor of the trust being an Indiana resident. We have no New Jersey case quite as clear on the issue as Reilly, but Rector v. Rector, 62 N.J. 577 (1973), does stand for the proposition that a trust cannot be brought into a New Jersey suit unless the trustee has “minimum contacts” with New Jersey.

Keep all DAPT Assets inside Delaware. This isn’t that hard, and is a no-brainer. This limits the ability of a New Jersey court to exert in rem jurisdiction over the trustee. Use a Delaware-based credit union and brokerage without non-Delaware branches.

Take Advantage of the Delaware Escape Valve. If the DAPT is formed in Delaware, and a New Jersey court finds jurisdiction despite your best efforts, you do have a potential safety valve. Under 12 Del. C. 3572(g), if an out of state court gains jurisdiction over a Delaware DAPT trustee and declines to apply Delaware law, the trustee immediately loses all powers and a replacement trustee can be appointed by the Delaware Court of Chancery. Hopefully the Chancery Court would appoint someone with even less contacts, such as perhaps a Delaware attorney with no New Jersey contacts at all.

Stay Out of Bankruptcy for Ten Years. This might be tough, but you want to stay out of bankruptcy for ten years to avoid the potential problems present in Mortensen. If it does ever appear that bankruptcy is going to happen, consider becoming a Delaware resident to increase the likelihood of Delaware law applying in the bankruptcy court’s determination of the validity of the DAPT.

Those are my main suggestions. If you have any comments or questions about DAPTs, feel free to contact me.

TAX ADVICE DISCLAIMER: Any tax advice contained in this communication (including attachments) was not intended or written to be used, and it cannot be used, by you for the purpose of (1) avoiding any penalty that may be imposed by the Internal Revenue Service or (2) promoting, marketing, or recommending to another party any transaction or matter addressed herein.
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