Warning

On the surface, it appears that an offshore trust represents an ideal way to shield assets from the reach of creditors. In fact, in many cases, offshore trusts have proved successful, often to the frustration of U.S. judges. This frustration culminated in a recent case, which has caused some practitioners to re-evaluate the risks inherent in offshore trusts. In this case a U.S. court used what is perhaps its only available weapon against an offshore trust--a criminal contempt citation against the trustor/beneficiary.

In 1999, the 9th Circuit Court of Appeals sustained a lower court ruling in a Cook Islands trust case that had held the couple who created the trust in criminal contempt of court and jailed them for six months, because they failed to obtain a withdrawal of funds from the trust pursuant to the court's order. The couple had relied on the impossibility defense (discussed above).

The court rejected the defense because it did not believe it was impossible for the trustors/beneficiaries to cause a withdrawal from the trust, despite the clear-cut provisions in the trust that made all withdrawals completely subject to the control of the trustee, and the anti-duress clause that automatically caused the removal of the couple from their positions as trust protectors and co-trustees of the trust.

The court based its conclusion on the following facts:

The couple had previously received distributions from the trust of about $1 million, which seemed to imply the couple had liberal access to the trust's assets. The court no doubt also was aware of the well-known fact that, in practice, trustees of offshore trusts virtually always distribute assets to the trustor/beneficiary upon request.

The couple served as the trust protectors for the trust. As such, they had not only the power to remove the trustee, but also the power to veto all of the trustee's actions. The court found these powers evidenced the significant control the couple exerted over the trust.

In accordance with the trust's anti-duress clause, the couple was immediately removed from this position, as soon as the trustee learned about the U.S. judgment. However, the court found this fact unconvincing, even though it meant that the couple was, in fact, powerless to force the trustee to make the distribution.

Similarly, the couple served as co-trustees of the trust. This too, the court found, was significant proof that the couple exercised control over the trust.

When the trustee learned of the U.S. judgment, the couple also was automatically removed from this position, in accordance with the trust's anti-duress clause. This, once again, did not move the court, thus indicating the couple's position relative to the trust, prior to the U.S. judgment, was the more important factor.

The court rejected the invocation of the anti-duress clause, which worked to prevent the trustee from making distributions to the couple and which also caused the removal of the couple as trust protectors and co-trustees of the trust. The court concluded that the couple themselves triggered the clause by contacting the trustee to inform him of the judgment. Of course, the couple did this ostensibly to request a distribution to satisfy the judgment. The court believed the notification was really done only to obtain protection under the anti-duress clause. The court concluded that this was self-serving, and thus something the court would censure.

In this case, the original court judgment against the couple was made pursuant to a Federal Trade Commission action. The couple had earned substantial sales commissions in a fraudulent investment scheme. While there was no finding that the couple directly engaged in the fraud, the court concluded that their actions bordered on fraud.

There is little doubt that the court was motivated by the fact that the couple apparently conceived of the trust as a means of shielding their profits from the fraudulent investment scheme. Had the couple's actions been honorable, it is possible that the couple would have not have faced the wrath of the court. (It should be noted that an action was subsequently filed in Nevis. The Nevis court ruled in favor of the trustee and the couple. This result was expected, given the provisions in the Nevis trust statute).

Work Smart

Planners are split on how to interpret the case. Some planners believe that, given this case, the risks of a finding of criminal contempt against the trustor/beneficiary of an offshore trust are too significant to warrant the continued use of this planning strategy.

However, many other planners believe that the case is simply an example of the old legal adage, "bad facts make bad law." Thus avoiding the "bad facts" could mean that the fate the couple suffered in the previously discussed case can be avoided.

In light of the U.S. Court's decision in the case discussed above, it would be wise to:

• Avoid being the trust protector or a co-trustee of the trust. Ideally, the trust protector (or a co-trustee if this is used) should be someone outside of the U.S. court's jurisdiction. A U.S. person may be acceptable, provided this person is not the trustor/beneficiary and is, in reality, independent of the trustor/beneficiary. By doing this, the trustor/beneficiary will be laying the groundwork for a finding that he or she did not have the ability to control the trust and thus his or her ability to force a distribution from the trust was impossible.
• Avoid personally notifying the foreign trustee of a U.S. court judgment. Let the judgment creditor or the court notify the trustee. In this way, the trustor/beneficiary cannot be accused of personally triggering the anti-duress clause.
• Avoid engaging in fraudulent or disputable conduct. Courts are likely to display extreme hostility toward a trustor/beneficiary who is either trying to shield assets that were acquired through illegal conduct, or where the trust's assets were legitimately acquired, but the creditor's claim is based on illegal conduct on the part of the trustor/beneficiary.