Asset protection trusts have the effect of protecting assets from a variety of third party claims. Such trusts can take different forms. English law recognizes a "protective trust" under which the trust instrument provides that a beneficiary's interest under a trust will be terminated upon his or her bankruptcy or upon any attempted voluntary or involuntary transfer of his or her interest under the trust. Certain US states protect a spendthrift trust under which the trust instrument provides that the spendthrift beneficiary is prevented from transferring his or her trust interest to a third party, voluntarily or involuntarily. Each creates obstacles to creditors seeking to attach the beneficiary interest.
A settlor may also protect his or her assets through a discretionary trust. A discretionary trust will expressly provide that the trustee has the complete discretion to distribute any or all of the capital or income of the trust to or for the benefit of any or all of the beneficiaries as the trustee may from time to time decide. Thus, if a particular beneficiary was at any time subject to a creditor, inheritance or matrimonial claim, the trust assets would effectively be shielded from that claim by virtue of the discretionary nature of his or her interest under the trust and the fact the trustee does not exercise its jurisdiction in favour of the beneficiary.
Although the beneficiary's interest in the trust might be attacked by a creditor, the value of that interest is arguably nominal as a result of the discretionary nature of trust. If an objective is asset protection then this discretion is fundamental, since it is the trustee's right or entitlement not to make distributions to a particular beneficiary which renders the beneficiary's interest of uncertain and incalculable value thereby rendering it unattractive to third party claimants.
Given the potential for challenges to trusts in various legal theories, the greatest asset protection is often available through the use of an offshore asset protection trust. The enormous increase in litigation awards in Canada and the USA has caused many business owners and professionals to establish offshore asset protection trusts. While these vehicles are generally tax transparent, they do ensure assets stay safely away from nuisance creditors in jurisdictions plagued with runaway claims. Typically, these trusts make it difficult for the future creditors or successful plaintiffs to attach their claims or enforce their foreign judgments. To effectively utilize the asset protection trust the circumstances must be such that there are no known creditors and the individual settling the trust must be solvent at the time of the transfer of the assets to the trust. Such trusts are an effective vaccine but not a cure and should be structured before any cause of action arises. The use of an offshore trust in this fashion is effective to safeguard hard earned assets from frivolous and vexatious litigants and unpredictable judicial awards. Such asset protection trusts are becoming a necessary aspect of doing business today.
The asset protection trust by which assets are held outside the jurisdiction of residence enjoys a number of other advantages. The donor may continue to enjoy beneficial entitlement to and perhaps control of trust assets. Assets held in a discretionary trust enjoy enhanced asset protection from third party claims against the beneficiary, such as those arising from matrimonial, inheritance or creditor actions. The assets may be held in a jurisdiction other than where the individual reside, which provides the flexibility to choose the most attractive legal regime. Asset distribution through a trust avoids probate and the application related probate fees and allows for flexibility in establishing the scheme of ultimate asset distribution and avoidance of Wills Variation Act challenges. Continuity given concerns over resignation or incapacity of trustees can be anticipated by the appointment of a protector who has power to appoint and remove trustees. The settlor will often be the first protector. The protector has no power to distribute property. The settlor can resign and appoint a successor in the event of future adversities. Such successor is often a friend or relative of the settlor.
The trust document may provide that the law of the foreign jurisdiction be used to determine all questions concerning the capacity of the settlor and the validity and administration of the trust and the trustee will attorn to the courts of the jurisdiction for any matter affecting the interpretation, enforcement or administration of the trust. The trustee should also reside in the jurisdiction to minimize the risk of being ordered by a Canadian court to exercise his or her power in a particular way or to risk contempt of the court. A typical offshore trust will have foreign trustees, foreign choice of law governing the trust and a foreign situs of the trust assets. the trustees may have the power to transfer assets out of the trust to a new trust within or outside the chosen jurisdiction, to change the proper law of the trust and to prohibit distribution to a beneficiary at a time when he or she is insolvent or on the eve of insolvency.
Foreign asset protection legislation is often aimed at providing protection against creditor and other claims. Such debtor-friendly laws may seek to impose a short limitation period for bringing a claim to set aside a transfer into the trust, define "creditors" in a narrow manner excluding future unascertained creditors from the definition, require a criminal standard of proof beyond a reasonable doubt of an intention to defeat the interests of creditors rather than the usual civil standard of proof on balance of probabilities, refuse to recognize foreign judgments generally or orders related to bankruptcy, succession or matrimonial law, allow a settlor to validly create an interest in possession terminable on bankruptcy, and permit a transfer in breach of a forced heirship provision under the settlor's own law to be nevertheless valid.