Gray\u27s Ghost—A Conversation About the Onshore Trust

A trust is an arrangement whereby one person (the trustor) transfers property to another person (the trustee) and directs the trustee to hold the property for the benefit of another person (the beneficiary). Multiple persons may fill each role; for example, there can be several beneficiaries or co-trustees. One person may play several of these roles; for example, the trustor may also serve as trustee or may be a beneficiary of the trust. However, if the same person plays all three roles alone, then no trust is created. A self-settled trust is a trust that a person settles, or establishes, for his own benefit—a trust where the trustor is also a beneficiary. A spendthrift trust is a trust that includes a provision either prohibiting the beneficiary\u27s creditors from reaching the beneficiary\u27s interest in the trust (an involuntary transfer) or prohibiting the beneficiary from assigning his or her interest to a third party (a voluntary restraint). A self-settled spendthrift trust is, therefore, an arrangement where the trustor names herself as a beneficiary and includes a spendthrift provision that protects the trustor\u27s interest in the trust from the trustor\u27s creditors. This Article will explore avenues that a creditor might use to attack the onshore self-settled spendthrift trust. The Article assumes that state courts (other than the courts of Alaska, Delaware, Nevada, or Rhode Island) will be offended at the notion of a self-settled spendthrift trust, and, therefore, the creditor will want the enforceability issue to be resolved by a court in a jurisdiction other than the four identified states. Using a hypothetical, Part Ill(A) of this Article addresses whether a non-Alaska court (using a Washington state court as the example) could rule on the enforceability of tort and contract creditors\u27 judgments against the trust, despite the Alaska spendthrift provision. Before the court reaches the issue, however, the hypothetical creditors will face jurisdictional and choice of law hurdles, and full faith and credit problems as to whether Alaska will respect the Washington court\u27s judgment. There are also other methods of attacking the trust. As described in Part Ill(B), the creditors could claim that the transfer to the trust was itself a fraudulent transfer under Washington\u27s fraudulent transfer statute. Part IV sets forth the possibility that the creditors could attempt to bring the matter before a U.S. bankruptcy court, thus eliminating most of the jurisdictional difficulties. As Part V discusses, the contract creditor might also claim that the Alaska statute violates the Contracts Clause of the U.S. Constitution. The Article further addresses, in Part VI, whether the self-settled spendthrift trusts will serve their secondary goal-federal estate tax savings. As a general proposition, if the grantor of a trust has relinquished sufficient control over the trust assets, then, under federal estate and gift tax principles, the transfer is a completed gift, subject to gift taxes, and the trust assets will not be included in the grantor\u27s estate for estate tax purposes when the grantor dies. The estate tax advantage to such a trust would be that all post-transfer appreciation in value of the trust assets would not be subject to tax. Under the majority rule of self-settled spendthrift trusts, however, a grantor cannot get those tax benefits with a trust in which he retained an interest, because that retained interest would make the assets available to the grantor\u27s creditors, and creditor access is deemed to be equivalent to continued ownership by the grantor. Removing creditor access raises the possibility that the trust grantor could put money in a trust and continue to live on those trust assets, even while capping his estate\u27s tax liability at the value of the trust assets at the time he established the trust. Whether the estate tax liability is limited to the original transfer value depends, in part, on whether the trust actually prevents creditors from accessing it and, in part, on whether there are other grounds that the government may use to nevertheless include the trust assets in the grantor\u27s estate at their full date-of-death value. Finally, in Part VII, the Article will address whether the self-settled trust has any place in the U.S. legal system. The Article discusses this issue from the historical perspective of the original controversy over spendthrift trusts, and in light of the current justifications for these trusts. Supporters of the self-settled spendthrift trust cite the trend of enormous tort judgments as justification for allowing the introduction of a means to avoid all personal liability. Supporters also cite the other generous exemptions from creditor claims legally available, such as unlimited homestead exemptions in bankruptcy and the protection given to retirement plan and life insurance funds. Supporters inquire, why not allow a debtor to do directly what she can already do indirectly? These arguments ultimately fail, however. The other exemptions serve specific social policies and have limitations that discourage a debtor from placing all of her assets into the exempt form. The self-settled spendthrift trust, however, allows a debtor to place his entire savings into a trust and avoid all liability without affecting the debtor\u27s lifestyle. The proposition that these trusts are merely an antidote to a tort system run amuck also fails because the solution is overbroad and threatens the entire system of liability, rather than just the abuses within that system. The Article concludes that the original concerns about self-settled spendthrift trusts, and the damage they could do to our system of civil enforcement, far outweigh any potential benefits that they may offer