Stephen Speiser, Esq.
September 2024
In the realm of wealth management and asset protection, trusts play a pivotal role in safeguarding assets against potential creditors, legal judgments, and other financial risks. Two prominent types of trusts utilized for these purposes are Foreign Asset Protection Trusts (FAPTs) and Domestic Asset Protection Trusts (DAPTs). Each type offers unique features, legal protections, and considerations. What follows is a comparison between FAPTs and DAPTs, examining their jurisdictional protections, enforceability in U.S. courts and their risks and benefits, as well as how U.S. courts have historically treated each structure.
Jurisdictional Protections
Foreign Asset Protection Trusts (FAPTs): FAPTs are established under the laws of foreign jurisdictions that are known for their strong privacy laws and resistance to foreign legal claims, such as the Cook Islands, Nevis, and Belize. These jurisdictions do not recognize judgments from U.S. courts, which means that creditors must start new legal proceedings in the trust’s locale. This is a costly and time-consuming process and highly effective at deterring potential claims. In addition, these jurisdictions have adopted legal frameworks that are specifically designed to protect trust assets from creditors and offer protections not available under U.S. law such as short statutes of limitations for challenging trusts, high burdens of proof for creditors, and fraudulent transfer rules that are stringent and difficult for creditors to satisfy. On balance, the offshore nature of FAPTs provide a level of protection that is simply not available in the U.S.
Domestic Asset Protection Trusts (DAPTs): DAPTs can only be established in states that have specific legislation permitting these kinds of trusts, such as Nevada, Delaware, Alaska and South Dakota. At present, there are 20 states that permit the use of DAPTs. While DAPTs offer the convenience of being located in the U.S. and are more accessible, they do not provide as robust a barrier against creditors as FAPTs. While DAPTs do provide some protections, their value as an asset protection structure is weaker than FAPTs due to the ability of U.S. courts to pierce the trust and seize the assets it holds.
Enforceability in U.S. Courts
FAPTs: The primary advantage of FAPTs lies in their offshore jurisdiction, which make it extremely challenging for U.S. creditors to pursue claims. U.S. courts lack jurisdiction over foreign trustees and cannot compel the enforcement U.S. judgments or court orders. As a result, attempting to collect on a judgment abroad can be a complex and costly undertaking for creditors, often deterring legal action altogether.
One potential vulnerability to the asset protection shield offered by FAPTs is the fact that the settlor (the person creating the FAPT) is subject to U.S. jurisdiction and can be ordered by a court to repatriate assets held in the trust. Failure to comply with such an order can lead to contempt of court charges, making the protective strength of FAPTs somewhat dependent on the settlor’s willingness to face personal legal risk.
This risk can be mitigated, however, through careful legal planning. Contempt proceedings are appropriate only where the settlor of the FAPT retains sufficient control over the structure so as to be able to cause the repatriation of assets. If the FAPT is structured correctly as a discretionary trust, however, the foreign trustees – not the settlor – are the only ones who have the power to make such a distribution; and if the settlor lacks the power to compel the trustees to comply with a U.S. court order, contempt proceeding are not appropriate.
DAPTs: While DAPTs are legally enforceable, they too are subject to the jurisdiction of U.S. courts where they can be attacked by creditors. U.S. courts have the inherent power to bypass DAPT protections and will often do so in cases involving bankruptcy, divorce, or claims brought under federal law. In addition, states that have not enacted DAPT legislation are not obligated to recognize the validity of DAPTs, and there are cases where courts have chosen to ignore the trust’s protective provisions, particularly if they perceive an attempt to defraud creditors. For a full discussion of the critical flaws and legal deficiencies of DAPTs, see “The Folly of Domestic Asset Protection Trusts.”
Conclusion
Both FAPTs and DAPTs offer valuable tools for asset protection, but their effectiveness varies based on jurisdiction, legal complexity, and the nature of the threat. Understanding their differences is crucial for individuals seeking to shield their assets, as the choice between a FAPT and a DAPT should align with their specific risk profile, asset protection needs, and willingness to navigate the complexities of each structure.
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