Back in 2014, members of our firm reported on a significant legal victory for a trust settlor who had shifted his substantial net worth into a foreign asset protection trust in order to stave off guarantor liability on a commercial loan with Branch Banking & Trust Company (BB&T). As one of the most recent cases to touch on the “impossibility defense,” the case reinforced what many asset protection planning attorneys had been asserting for years: That by relinquishing control of your assets to a foreign trustee, there is little that a U.S. court can do to compel repatriation. See Branch Banking & Trust Company v. Hamilton Greens, LLC, 2014 WL 1493086, Case No. 11–80S07–CIV (S.D. Fla. March 24, 2014), aff’g 2014 WL 1603759 (S.D. Fla. February 26, 2014) (referred to herein as “BB&T I“).
Contempt in Asset Protection Planning
One of the many concerns raised by lawyers and their clients engaged in asset protection planning is the risk that a judge might incarcerate a trust settlor for contempt. The “impossibility defense” acknowledges the conundrum faced by a settlor of a foreign asset protection trust: Sometimes, in order to convince a judge, you might have to risk contempt of court in order to “prove” that you have relinquished all control over your assets. Moreover, if the impossibility is self-created, some courts deny impossibility as a defense. Yet, this risk is almost always overstated: In virtually every case in which a settlor of a foreign asset protection trust has been cited with contempt, the settlor defied the orders of the court through affirmative conduct. As the BB&T I court acknowledged at the time:
Civil contempt is a drastic remedy. Civil contempt orders are coercive in nature. It is often said that the decisive characteristic of civil contempt is that it leaves the contemnor to “carry the key of his prison in his own pocket.” Maggio v. Zeitz, 333 U.S. 56, 68, 68 S.Ct. 401, 92 L.Ed. 476 (1948). “To jail one for a contempt for omitting an act he is powerless to perform would reverse the principle and make the proceeding purely punitive, to describe it charitably.” Id. at 72. Contempt orders will not be issued if the court finds no willful disobedience but only an inability to comply. S.E.C. v. Ormont Drug & Chemical Co., Inc., 739 F.2d 654, 657 (D.C.Cir.1984).
The BB&T I ruling carved out an exception where the settlor was engaged in fraudulent conduct and was subsequently charged with a disgorgement order. However, the cases cited by the court in support of this exception do not in fact test whether the settlor can be charged with contempt after failing to obtain the cooperation of an offshore trustee with the court’s disgorgement order. Of more reliable guidance is U.S. v. Grant, 2008 WL 2894826 (S.D.Fla.), 101 A.F.T.R.2d 2008-2676 (S.D.Fla., May 27, 2008), in which a trust protector residing in the U.S. – who was unable to gain the cooperation of the foreign trustee to pay a federal tax liability – could not be held in contempt due to lack of control over the trust assets.
The better interpretation of prevailing case law is that, if the court believes the settlor controls the assets of the foreign asset protection trust, the contempt powers of the court may be used to achieve compliance. Yet, even in the most egregious cases, incarceration for contempt cannot last forever. At some point, the U.S. court will direct the creditor to take up the matter in the foreign venue and not waste valuable court resources on a private matter.
The Alternative to Contempt: The Stalemate
We have cautioned lawyers that even the best-laid foreign asset protection plans can only achieve one possible result in the face of a sophisticated creditor attack: A stalemate in which neither the creditor nor the trust beneficiaries gain access to the assets of the trust. This proved to be the case in U.S. v. Grant several years later, when the IRS obtain a permanent injunction requiring Ms. Grant and her children to turn over any assets received by them from the foreign trustee. A similar result entailed more recently in the case we refer to as “BB&T II“: Branch Banking & Trust Company v. Hamilton Greens, LLC, Case No.. 11-80507-CIV-Marra/Matthewman (S.D. Fla. Jun 14, 2016).
In BB&T II, the bank managed to achieve one more bite at the debtor. While the bank had been denied a contempt order in BB&T I, this time the bank raised a host of arguments. First, BB&T argued that the original transfer in trust by the settlor was a fraudulent transfer under Florida’s version of the Uniform Fraudulent Transfer Act. Second, BB&T charged that distributions from the trust had been made to the settlor’s children at the direction of the settlor, and that those distributions should be regarded as fraudulent transfers.
The Fraudulent Transfer in Trust Claim
Surprisingly, the district court concluded that the original funding of the trust was not a fraudulent transfer, even though the debtor transferred substantially his entire liquid net worth on the eve of liability. A number of facts were cited by the magistrate in support of this conclusion:
- The settlor’s beneficial interest in the trust was an asset that could be included in his net worth for purposes of determining whether he was rendered “insolvent” following the transfer;
- BB&T had access to other collateral to satisfy the debt; and
- The settlor established a good faith, reasonable belief that other guarantors on the BB&T debt would contribute toward the liability.
The first fact – that the settlor could include his beneficial interest in the trust in his net worth – is similar to the finding by the Second Circuit a few weeks ago in In re Adelphia Communications Corp., 2016 WL3315847, *2 (2d Cir. June 15, 2016). In that case, the Second Circuit concluded that a cable company did not engage in a fraudulent transfer when it repurchased a significant number of shares from a number of management-affiliated shareholders shortly before assuming a massive debt, even though the company had already defaulted on some of its bonds. The Second Circuit noted that similarly-situated cable companies faced similar struggles but were all able to access capital markets on similar facts.
The lesson of these cases is that the law on fraudulent transfers concerning net worth and solvency are fact-intensive concepts. With the right foundation, a debtor can establish to the satisfaction of a judge that his or her net worth remains unimpaired by substantial asset transfers.
The Claim Against Distributions to Beneficiaries
The weak link in the planning conducted by the settlor in the BB&T II case turns on the method by which the trustee made distributions to the beneficiaries. According to the magistrate in this case, the settlor instructed the trustee to make distributions to his daughter, who was also a named trust beneficiary. Why the trustee did not engage in independent decision-making for distributions is not explained (partly because the trustee was not named in the litigation), although one assumes that this was because no distributions would have been made but for the settlor’s request.
The facts established that the distributions were made at the behest of the settlor. Accordingly, the magistrate concluded that the distributions to the daughter were, in substance, transfers to the settlor (using his daughter as his proxy). Thus, when the daughter transferred those funds onward, such transfers were fraudulent transfers. The court noted that the vast majority of the transferred proceeds was subsequently spent by the settlor, but the district court ultimately charged the daughter with liability to the extent by which she had been unjustly enriched, including funds remaining in her bank account from the distributions as well as amounts she spent on her own lawyers to defend herself in the proceedings.
Analysis
The result in BB&T II is similar to that in the U.S. v. Grant case: Assets transferred into the foreign asset protection trust remain outside the reach of creditors, and the debtor cannot be cited with contempt where control has truly been relinquished to the foreign trustee. Yet, as seen in both cases, the determined creditor will ultimately obtain an order requiring any inbound transfers to be held for the benefit of the creditor. This has the effect of producing a stalemate, wherein neither the creditor nor the beneficiaries can reach the assets of the trust for the duration of any court order that would otherwise require the beneficiaries to relinquish distributions received from the trust.
In our experience, court orders sometimes reach distributions made by the foreign trustee to named beneficiaries. However, given the fungible nature of money, a foreign trustee remains free to pay bills and apply trust funds in a way that benefits the named beneficiaries while not giving them money directly. BB&T II is likely to add fuel to the fire by inspiring more foreign trustees and their clients toward making distributions indirectly, minimizing transferee liability.
At least one notorious online commentator in Forbes has proclaimed that BB&T II represents the “point of pain” that creditors can inflict on debtors who engage in foreign asset protection trust planning. However, the case actually suggests the opposite: The daughter was held liable for a paltry sum of money in comparison to the significant amounts distributed to her from the foreign trustee. Rather, BB&T II suggests that collection activity directed against a foreign asset protection trust is a time-consuming, expensive process that ultimately yields little benefit to the creditor.
The Forbes commentator was particularly harsh in his assessment of the legal skills of BB&T’s trial counsel and knowledge and reputation of the federal district court magistrate. It should come as no surprise that the Forbes commentator markets his legal services to creditors seeking to collect against a foreign asset protection trust; what may be a surprise to a few people is that, in our discussions with major foreign trust companies, we cannot identify a single case in which this self-publicized commentator has ever succeeded in obtaining a substantial repatriation from a foreign asset protection trust.
In our experience, regardless of the additional strategies that BB&T’s trial counsel could have employed, it is doubtful that they would have achieved any greater outcome for their client in a U.S. court. BB&T’s best resolution would be to obtain a permanent injunction requiring the settlor and beneficiaries to remit direct distributions to the court, as that is the best possible remedy available to the creditor under such circumstances. Immediately thereafter, BB&T should negotiate a settlement with the debtor, as that is the greatest leverage BB&T will ever gain on the settlor at its present pace.
There is at least one significant weapon that BB&T has at its disposal and seems to be completely unaware of. We are not at liberty to discuss this technique publicly, and you will not read about this weapon in Forbes anytime soon. Those of us with experience in the foreign trust industry know exactly how to take apart a foreign asset protection trust, as well as what measures are most effective at repelling creditor attack. Based on the information reported by the magistrate in BB&T II, the trust is vulnerable, but we doubt that BB&T will be the creditor to figure this one out.
Conclusion
In our view, with proper planning, the settlor still retains the upper hand with a foreign asset protection trust. BB&T II confirms the possibility that proper planning may yield a stalemate in which neither the creditor nor the debtor can directly reach the assets of the foreign asset protection trust. Still, the foreign trustee retains a substantial ability to effect distributions indirectly to trust beneficiaries in ways that cannot be easily countered through a U.S. court.