14-05-2025
Self-Settled Asset Protection Trust Upheld By Delaware Court
Consider a self-settled asset protection trust to protect your wealth from claims.
Case May Provide A Roadmap to Better Planning
A Delaware court (by the Magistrate in Chancery) recently upheld the validity of a domestic asset protection trust (DAPT). In the Matter of the CES 2007 Trust, C.A. No. 2023-0925-SEM. The claimant sought to pierce the trust to reach assets held in limited liability companies (LLCs) and the Court refused. The Court found that the trust met the requirements of Delaware law to qualify as an asset protection trust and should be respected. This is a big deal! This case provides you with a roadmap of many dos and 'don'ts' in pursuing this type of planning.
What is a Self-Settled Domestic Asset Protection Trust (DAPT)?
An asset protection trust is an irrevocable trust you create that you can be a beneficiary of. That is the estate planning and asset protection nirvana – you may protect assets from your creditors while you may still benefit from those assets. The ruling in this case gives anyone (perhaps you?) considering this type of planning more confidence that it may work. And this type of planning, especially after this case, may be beneficial for lots of people. For people who are not uber wealthy, being able to give assets to a trust that you can also be a beneficiary of, is a key that may make you comfortable pursuing asset protection (or estate tax) planning. The biggest impediment for most people is that they may need to access or benefit from the money they want to protect.
Risks Remain to this Planning
The reason for the use of the word 'may' is that this case, while favorable to asset protection and the use of asset protection trusts, doesn't resolve every issue with this type of planning. The one big issue that many commentators have questioned about using the self-settled trust technique that was the subject of this case is if you live in a state that does not permit such trusts, e.g., New York or California, but you create this type of trust in a state that does, e.g., Delaware in this case (but there are about 20 states that permit this type of planning), will your home state have to respect the trust created in Delaware? That critical issue was not addressed in this case. But it should be noted that in the many years since Alaska created the first domestic asset protection law in 1997 no case has taken this adverse position.
Finally, this case, like all cases, is fact sensitive. In a different situation with different circumstances any court might reach a different conclusion. But in the Court's discussion of these matters, it provides valuable insights on things that you might do, and stuff you should probably avoid, if you are doing this type of planning. That is really valuable to learn and those points will be discussed below. Being methodical and deliberate in your planning, and in particular, doing the planning years before a claim arises, may put you in a favorable position like the person in this case (we'll call him the 'settlor') to protect your wealth.
Why Asset Protection and Estate Planning Often Go Hand-in-Hand
If you give away or sell assets, e.g., to an irrevocable trust (see below), and those assets are not reachable by your creditors (that is asset protection planning), those assets will generally also be outside of your taxable estate for estate tax purposes. This is why if you pursue estate tax planning you are also obtaining asset protection planning benefits too. The flip side is also true, and is why so many more people that should take steps to protect their assets also get estate tax benefits. If you move assets outside your estate, e.g., by a gift to an irrevocable trust, those assets should also be difficult to reach by future claimants or creditors. This is a misunderstanding many people have: 'My estate is not big enough to worry about estate taxes.' That may be, but that doesn't mean you shouldn't be taking similar steps to protect your assets. So, even if your estate is well under the exemption amount it doesn't mean that setting up planning similar to what wealthier taxpayers might do will be beneficial for you, for another reason, protecting what you own.
Defendant's Asset Protection Plan Explained
The following is an oversimplified overview of the asset protection plan the person in the case put in place that the court upheld. Big picture the donor (the person transferring assets to a trust) created an irrevocable trust. Irrevocable simplistically means that the trust cannot be changed. A cornerstone of most estate and asset protection planning is one or more irrevocable trusts. Although an irrevocable trust might be modified by various techniques after it is created (decanting, non-judicial modification, etc.), not everything can be changed, there are limits.
The settlor in this case took a further step in his planning beyond just an irrevocable trust. This was smart, and something you should consider (and we'll give you some tips on how to do it better below). Instead of gifting assets directly to the trust he gave interests in limited liability companies (LLCs). That is a smart move. If a creditor pierces through the trust they then may face a challenge having to reach assets inside an entity owned by the trust, like an LLC. Now in this case he probably had to have the assets owned by an LLC since they were real estate assets outside of Delaware which was where the trust was based. You should not have a trust in a trust-friendly state like Delaware own real estate or tangible personal property (e.g., artwork) located in a different state. Instead, if an entity, like an LLC owns those assets, the trust can own the entity. If this is not done the trust could be subject to the jurisdiction of that other state where the property is located and that could undermine the trust. But using entities like LLCs is not an assured protection. The plaintiff in this case argued that the settlor had maintained too much control over the entities in the trust and that on that basis those entities should be pierced (reached through to get at the LLC real estate). The court declined to do that, but important lessons are to be learned.
What's The Big Deal of Being A Beneficiary of Your Own Trust?
As mentioned briefly above, being a beneficiary of your own trust is a big deal! If you are really wealthy (wealth relative to your income/cash flow and net worth) you might be able to set up a trust that you won't need to benefit from. But for most people it may be uncomfortable if not scary to give away money that you may not be able to get to. For example, many married couples create a special type of irrevocable trust called a spousal lifetime access trust (SLAT). That type of trust, if done properly, can provide valuable asset protection. But if you are the settlor creating such a trust you can only benefit indirectly from that trust through your spouse. It is not really clear how permissible indirect benefits are defined so there is risk associated with that. But more worrisome, what if your spouse divorces you or dies prematurely? That would cut off your indirect access to the trust. That could be financially devastating. So, when you weigh the potential asset protection benefits of using a trust plan, versus the worries of running out of money, you may reasonably determine that the creditor and other liability risks are less worrisome then losing control over your money. But that is precisely why a self-settled trust or DAPT is so powerful. You arguably can give your money away to a trust, protect it from claimants (and perhaps future estate taxes) yet you can remain a beneficiary! That's the asset protection version of having your cake and eating it too! And, this is why this recent case is so important, it found that this type of trust worked. For those who are not zillionaires, this type of planning (still not without risk) could be the mechanism that gets you comfortable taking steps to protect your assets.
The Trust/LLC Plan in This Case Is Common
The overall structure or plan that the settlor used in this case is very common in estate and asset protection planning. Setting up irrevocable trusts to hold entity interests that hold valuable assets is pretty classic estate and asset protection planning. There really is no data on how many of Each variation of trust is created, and there are a myriad of variations, but it's likely that most trusts are not self-settled trust (he was a beneficiary of his own trust in this case). Planning is more often done without the person doing the planning (the 'settlor' who created the trust) being a beneficiary. That is in part due to the fact that, while about 20 states permit this planning, about 30 states do not. Also, many lawyers are not familiar with this type of planning and of those that are familiar some are hesitant to do this planning because of the perceived risks that a self-settled trust, especially if you live in a state that does not have that type of law, could be overturned. The fact that the Court upheld the plan with the settlor as a beneficiary is a valuable development for anyone doing similar planning and may encourage more people and more lawyers to consider this approach.
With the above background we can now review the case.
Facts
The settlor created the Trust on April 30, 2007, for the benefit of its beneficiaries, namely the settlor's wife (if any), parents, and issue. The trust predates the claimant's loan and the follow-on Michigan litigation.
In 2014, the claimant loaned one of the settlor's companies' money to finance a luxury real estate development project in Michigan. The deal wasn't successful and the claimant sued. In 2019, the Michigan Court entered a judgement of almost $14 million in favor of the claimant.
A Michigan court held in favor of the claimant and gave him an award the settlor of the trust plan was personally required to pay. Because the settlor had no assets to pay the claim, the claimant tried to pierce the trust plan involved in this case to get at the valuable real estate assets it held.
Pause and consider how much time all this litigation took, and the costs in terms of not only legal fees, but also, lost time, and undoubtedly incredible stress.
Wonky Transfers and Transactions by the Settlor
For reasons that are unclear the settlor engaged in a number of unusual transactions with the properties or LLCs that were ultimately held in the trust. Many of these were bad facts that would have been better to have been avoided. Below are a few excerpts of some of the transactions that the settlor had with the properties and/or entities in the trust [footnotes from the case omitted]:
'The Birmingham Property is currently owned by the 305 LLC. But it was originally the Respondent's, personally. On June 30, 1999, the Respondent purchased the Birmingham Property for $450,000. To finance construction, the Respondent then procured a loan of approximately $1.3 million, secured by a mortgage on the Birmingham Property. After construction, the Respondent used, or claimed, the Birmingham Property as his primary residence from 2001 to 2018. Ownership of the Birmingham Property changed hands several times through transactions initiated at the whims of the Respondent. In 2004, the Respondent quitclaimed the Birmingham Property to a bonding agency for collateral related to a lawsuit. Then in 2006, the Respondent transferred ownership from himself (presumably having regained ownership after the 2004 quitclaim) to the 305 LLC for $1.00. That transfer did not last long, though, and on the same day, the Respondent transferred the Birmingham Property back to himself for the same de minimus price. He again transferred the Birmingham Property to the 305 LLC on March 19, 200735 and several years later, on March 4, 2014, shored up that conveyance. Finally, in early 2020, the Birmingham Property went through successive transfers out of the 305 LLC to the Respondent, personally, who pledged the property toward a personal indebtedness, before quitclaiming it back to the 305 LLC a few days later. It remains owned by the 305 LLC.'
The repeated transactions with respect to a property that had been a residence should not have been undertaken, and regardless of the success in this case such repeated transfers that some, such as the claimant, interpreted to reflect control over the property should be avoided. Similar odd transactions occurred with other assets and entities.
Claims Made Against the Trust and LLC
The case was brought by a creditor of the trust's grantor or settlor.
Requirements for a Delaware Asset Protection Trust.
The Qualified Dispositions in Trust Act (the 'Act') permits someone to create an Asset Protection Trust, and irrevocably transfer assets to the trust, to protect those assets from claims against the grantor/former owner. The requirements are contained in 12 Del. C. §§ 3570–76. The requirements include:
A qualified disposition to a qualified trustee may only be reached by a claimant in limited circumstances. Pre-transfer creditors (claims that existed before the transfers were made to the trust), can be overturned if they were fraudulent transfers. For post-transfer creditors, they must prove that the qualified disposition was made with an actual intent to defraud such creditor.
Court's Rulings
The trust was found to have met the statutory requirements for the protections of a Delaware asset protection trust. The trustees were found to be a qualified trustees as required under the Delaware statute for an asset protection trust. The claimant argued that the settlor was a de facto trustee because of transactions with the LLCs held by the trust, and for serving as investment trustee, but the Court found that he had not acted as a trustee. Finally, the claimant failed to prove that the spendthrift provision in the trust, which is critical to the protection the trust provided, should be invalidated.
Lessons to Learn from the Case
There are many lessons to learn from this case. Most of the points below are based on specific facts or court comments in the case, a few suggest planning points that were not addressed in this case but which may be helpful.
Conclusion
If you have not undertaken asset protection steps, or might benefit from further protective measures, review the possible use of a self-settled asset protection trust holding entities that hold underlying assets with your estate planning attorney.
