The Current State of Asset Protection
Numerous businesses and careers can subject proprietors and professionals to elevated risk of claims from clients and other potential litigants. As our society moves to a “sue now and gather the facts later” environment, structuring assets to shield them from potential claims; or at least creating a disincentive to sue, can be a valuable tool for preserving the fruits of one’s labor. In the right circumstances, a South Dakota Domestic Asset Protection Trust (DAPT) may be just the solution to provide that protection and disincentive.
What is a Domestic Asset Protection (DAPT) Trust?
A DAPT is a
self-established and self-funded trust that specifically incorporates
enforceable creditor protections codified by a jurisdiction such as South
Dakota. Only a handful of jurisdictions
have the statutory structure allowing these trusts. To qualify as a DAPT in South Dakota; the
trust must expressly incorporate South Dakota law; have a South Dakota Trustee
and be irrevocable. In addition, the
transfer of assets into the DAPT must not operate as a fraud on creditors. In
general terms this means that a grantor cannot impoverish themselves by
creating the trust. Thus, a DAPT is an effective tool for protecting a portion,
but not all of the grantor’s assets. So long as the trust meets these
qualifications, the trust will qualify as a DAPT even if the majority of the
assets are not in the state and even if some of the Trustees are residents of
What are the benefits?
A property established and administered DAPT can protect the property held in the trust from the claims of creditors. Subject to the fraud on creditors rule mentioned above, there are no specific limits to amount of property that can be held by the trust. The beneficiary of the trust does not have to reside in South Dakota and the property in the trust can reside outside the South Dakota jurisdiction. While the trust must be irrevocable, the grantor can still exercise limited control over the property in the trust by retaining the power to veto distributions. Income and principal of the trust may be distributed to the grantor at the trustee’s discretion. The grantor can also appoint who will receive the assets in the trust at their death.
Am I protected from all creditors?
Not all creditor claims are limited. Creditors claiming child support, alimony and property division pursuant to divorce are not limited. Also, claims for death, personal injury or property damage arising out of claims made before the trust was established are not protected. And of course, once income or principal is distributed back to the beneficiary, it is no longer protected. As mentioned above, fraudulent transfers intended to hinder, defraud or delay a known creditor are not limited. And in South Dakota, claims made within two years of the transfer are also not limited.
Is the trust “Guaranteed” to work?
There is very little case law on whether a DAPT can successfully shield assets from the claims of creditors. The majority of cases challenging DAPTs have given rise to a widely held belief that residents of a state with a DAPT statute can successfully transfer assets to a DAPT and, within the restrictions of the statute (expiration of the applicable time period following the transfer, "exception" classes of creditors, and the like); protect those assets from the transferor's creditors. In addition, just having the trust established prior to the claim provides an impediment to collection and places the grantor in a superior settlement position.
What else should I consider?
While a DAPT can provide protection from creditors and spurious claims, individuals in high risk professions should consider the trust as one of a number of strategies to mitigate risk. Additionally, individuals establishing these trusts should:
1. Plan early before claims arise. This prevents fraudulent transfer claims and starts the “look back” periods running. Retain meaningful assets outside the trust to avoid the impoverishment trap.
2. Retain experienced legal counsel in the jurisdiction providing the DAPT. They will have the highest degree of familiarity with unique attributes of that state’s laws.
3. Maintain other risk mitigation tools such as liability insurance and legal structures offering liability limitations (LLCs and corporations).
4. Select a Trustee in a jurisdiction that has the appropriate statutory structure but is also experienced and financially stable.
The effective utilization of DAPTs requires pre-planning, proper advice, execution and on-going management.
Scott E. Johnson, JD, CFP is
Vice President and Director, Wealth Planning and Strategy for Bankers Trust Company Of South Dakota.