Part Seven | Asset Protection Planning from A-Z: 26 Things to Think About Before Jumping In

Prepared by Jeffrey Zaluda and Shannon B. Miloch

Rush v. Sessions

The seminal Illinois case dealing with asset protection trusts is Rush University Medical Center v. Sessions (2012 IL 112906). In this case, Mr. Sessions created the Sessions Family Trust as a foreign asset protection trust in the Cook Islands. He was the grantor and a beneficiary and named himself the Trust Protector. He pledged a $1.5M gift to Rush Hospital in Chicago and based on this pledge, the hospital built a facility. He incorporated this testamentary pledge in his estate planning documents at that time but later revoked them. At death, there was not enough money in his estate to fulfill the gift to Rush. But there were more than enough assets (about $18M) in the Cook Islands Trust to facilitate the gift. Rush sued the Trust for breach of contract and more importantly for our purposes, that the transfer of the assets to the Trust was a fraudulent conveyance and the Trust should be voided. The Illinois trial court sided with the hospital and found that the Trust should be void because Sessions intentionally took actions to avoid fulfilment of the pledge, namely, moving assets to the Trust that he thought would be untouchable by the hospital. The Court of Appeals reversed the decision, and the case went to the Illinois Supreme Court, which sided with the trial court. The question became, then, what could the Illinois hospital recover from a trust based in the Cook Islands? The Cook Islands recognizes self-settled trusts and is not bound by an Illinois Court. But what if the same issue comes up between two states? For example, if an Illinois resident established a Nevada DAPT, would the exemption laws of Illinois (which does not recognize the spendthrift protection of a DAPT) or Nevada apply? Will the Full Faith and Credit Clause bind these decisions?

Separation of Powers

It is critically important for the success of any asset protection trust upon a potential challenge that the Grantor has been kept appropriately separate from the levers of control over the trust. Clients may find it difficult to choose the fiduciaries that will administer and manage the trust and trust assets. Clients should select individuals who they trust, but who will maintain the appropriate separation between the client and the trust. Any number of fiduciaries or quasi-fiduciaries can help in providing protection to a client. These may include trustees, managers, voting trustees, investment trustees, distribution trustees, directed trustees, trust protectors, trustee removers, trustee designators, and investment advisors. Most of these roles are easily and well understood. And in most cases, the idea is to separate as much control as possible from the at-risk client by utilizing these various roles. Including individuals such as trustee removers or designators is often essential to, at least, giving the client an antidote to the separation anxiety caused by placing his assets under another’s control.

The one fiduciary that may provide the most asset protection benefit is also the one with the most amorphous title: the trust protector. The beauty of the trust protector is that you can define the role in almost any way that works for the client (subject to public policy or legal restrictions). Commonly, a trust protector can veto distributions or investment strategies, as well as remove and replace a trustee. But, many trusts will also provide the trust protector the right to add, remove, and otherwise change beneficiaries and even, under certain circumstances, trust terms. Whether a trust protector (as well as investment trustees, distribution trustees, etc.) is deemed to act in a fiduciary capacity is not always well defined under state law, so an individual serving in that capacity should seek indemnification language in the trust instrument for acts not taken in bad faith (in Illinois, a trust protector is, by statute, serving in a fiduciary capacity). State law is sometimes unclear as to whether the Grantor can be the trust protector. For example, Alaska defines a trust protector as a third party (meaning the Grantor cannot act in this capacity) but other state codes are silent.

Trusts

Trusts are the Holy Grail of asset protection planning. Planning with trusts dates back to the time of the Crusades when feudal lords would place a trustee in charge of protecting their property while off fighting their infidels. Creative trust design coupled with state or foreign law protections make trusts ideal asset protection vehicles in almost any circumstances.

• It is rare to see a trust instrument that does not include a spendthrift clause. Spendthrift trusts are a cornerstone of estate planning and a key to asset protection. A spendthrift clause generally prohibits a trust beneficiary from alienating his interest in the trust for the benefit of his creditors. Almost all states give effect to spendthrift clauses with respect to most third-party creditors of a trust beneficiary. A spendthrift trust also protects the beneficial interest of a debtor in bankruptcy in the trust, provided that the applicable state law affords protection via a spendthrift clause. Some states have tried to limit the protection of spendthrift trusts, but the courts have interpreted these statutes very broadly to ensure that a beneficiary’s interest in a spendthrift trust is protected.

1. Spendthrift clauses are often broad, but it may be advisable to add specific provisions in an appropriate situation. For example, Illinois case law provides that spendthrift language in a "special needs" trust can protect the trust principal from a claim for reimbursement for government assistance (e.g., Medicaid) received by the trust beneficiary.
2. Accordingly, a sentence may be added to the spendthrift clause that specifically addresses government assistance reimbursement in a trust established for the benefit of an individual with special needs.

• The lifetime creditor protection benefits of a revocable trust established for one's own benefit are virtually nonexistent. There is still an advantage, however, to establishing and funding a revocable trust during one's lifetime. Many states, including Illinois, only allow a decedent's creditor to state a claim against probate assets. Accordingly, the assets that fund the trust prior to death may be outside of the creditors' reach, although this position has been little tested by the courts over the years.

1. There is clear authority in Illinois that the assets in a pre-death funded revocable trust will generally not be subject to the surviving spouse's right to take against the will.

• Subject to specific state law, a funded living irrevocable trust established for the benefit of the grantor may provide protection only to the extent of the interest not retained by the grantor. If the grantor has retained a right to the trust income, but not the trust principal, then the principal should remain protected from the grantor's creditors. The issue becomes clouded with respect to spray-type or discretionary trusts, in which case all the facts and circumstances must be explored, including whether the trustee has an interest adverse to the grantor, the extent of the trustee's discretion, and the standard for distribution (e.g., "support" vs. "best interests"). The safest route to protect assets is for the debtor grantor to retain no rights whatsoever in the principal nor any control over beneficial enjoyment.
• The trust terms themselves are also key to the amount of asset protection that can be enjoyed or utilized. For example, trusts can include:

1. Flight clauses (allowing change of jurisdiction)
2. Substitute trustee clauses
3. The ability to create sub-trusts for the benefit (or exclusion) of one or more trust beneficiaries
4. Powers of appointment Restrictions on “duress” distributions
5. Trust protectors who can change trust beneficiaries, terms, or trustees
6. Restrictions on the type of property that can be owned by the trust
7. Restrictions on the sharing of trust information
8. Use of discretionary and broad distributions standards
9. Use of spray trusts
10. Restrictions on covering the expenses of trust beneficiaries or grantors

Use It or Lose It

The estate tax exemption is due to sunset at the end of 2025 to an inflation-adjusted $5M (somewhere around $7.5M). It remains to be seen if Congress will act to prevent the sunset, allow the exemption to grow, or otherwise restructure the federal lifetime estate and gift tax exemption, but if the exemption is decreased on January 1, 2026, a client who has failed to act to reduce their taxable estate by utilizing their remaining exemption will have forever lost the opportunity to do so.

Even we experts cannot foretell whether the sunset will occur, and clients may be unwilling to make substantial gifts or other strategic moves to use their remaining exemption in exchange for the loss of control that comes with such planning before the sunset is a “sure thing.” We can begin having these conversations with our clients now, prepare trusts and appropriate assignments, and obtain valuations, then make the final decision about funding the trusts later in the year when there may be more clarity on the future of the federal exemption amount.

Valuation

One of the best ways to prove that no fraudulent transfer occurred is to be able to show equivalent value received as consideration for any asset transfers. Of course, valuation is often subjective, particularly when dealing with closely held assets or similar assets not readily traded on a public market. Estate planners also have a natural mentality do what is (legitimately) necessary to obtain a lower value for transfer tax purposes. That mentality may not always be consistent with the needs of an asset protection planner who is trying to defend a client’s transactions. Accordingly, obtaining independent third party validation on values used in the asset protection planning process is often critical.

Wandry v. Commissioner opened the doors to transferring gifts, subject to change in value, with the use of a formula transfer clause. A Wandry clause is a formula transfer clause that creates a fixed value for the assets transferred and adjusts the quantity of the assets to achieve the fixed value. The Wandry opinion likened this to “asking for $10 worth of gasoline” rather than a certain number of gallons of gas. This provides flexibility in gift planning whereby a client can gift up to their remaining estate tax exemption, subject to the results of a third-party valuation.

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