Ohio is now one of a number of states with a so-called “asset protection” statute. Bankers with trust authority might view this development favorably because it may be another possible service line, and indeed Ohio trust companies and Ohio trust lawyers were the main proponents of the statute. Other bankers however, may encounter the statue as a roadblock in their collection efforts, to their dismay. The new statute was effective March 27, 2013.
Essentially, the statue creates another way to attempt to shield assets from creditor claims. Traditional spendthrift trusts provide such a shield, as does the incorporation of a business or the formation of a limited liability company. There are continuing questions about the effectiveness of asset protection trust statutes like the Ohio Legacy Trust Act. More on this later.
Here is a summary of how the statute works. A person referred to as the “transferor” transfers assets in what the statute calls “qualified dispositions” to an irrevocable trust and, indeed the point of the statute, is that the transferor can still benefit from those assets through actions of a “qualified trustee,” which must be an Ohio trust company. A benefit might be, for example, a transfer annually of a portion of the trust. In short, the statute spells out what rights the transferor may retain in the trust and what authority a trustee can have under the trust instrument to honor those rights.
The transferor must create a “qualified affidavit” in connection with the transfer of assets and must say in that affidavit that the transfer will not render the transferor insolvent, will not defraud his or her creditors, or is not being done prior to a filing for bankruptcy.
The statute establishes the ability of creditors of the transferor to access the assets in the trust under certain circumstances and it defines who qualifies as an exception creditor, such as a child support creditor.
An Ohio legacy trust must contain a "spendthrift provision" providing that the interest of a beneficiary is held subject to a spendthrift trust, or words of similar import, that are sufficient to restrain both voluntary and involuntary transfer of the beneficiary's interest. Any spendthrift provision in a legacy trust must be enforceable under section 541(c)(2) of the Bankruptcy Code regardless of whether or not the relevant legacy trust instrument makes any reference to that enforceability.
The Act prohibits a creditor from bringing any legal action: (1) against any person who made or received a qualified disposition, (2) against or involving any property that is the subject of a qualified disposition or is otherwise held by or for any trustee as part of a legacy trust, or (3) against any trustee of a legacy trust. For this purpose, a legal action would be an action to enforce a judgment entered by a court or other body having adjudicative authority, a court processing at law or in equity, or a court proceeding for an attachment or other final or provisional remedy
Within certain time limitations, however, a creditor may bring a court proceeding to avoid any qualified disposition on the ground that a transferor made the qualified disposition with the specific intent to defraud the specific creditor bringing the action. If the creditor is a creditor of the transferor before the relevant qualified disposition, this action must be brought within the later of the following periods: (a) 18 months after the qualified disposition, or (b) six months after the qualified disposition is, or reasonably could have been, discovered by the creditor if the creditor files a suit against the transferor (other than an action to avoid the qualified disposition), or makes a written demand for payment on the transferor that in either case asserts a claim based on an act or omission of the transferor that occurred before the qualified disposition, and that suit is filed, or the written demand is delivered to the transferor, within three years after the qualified disposition. If the creditor becomes a creditor after the qualified disposition, the action to avoid the qualified disposition must be brought within 18 months of the qualified disposition. The act also provides that in any action to avoid the qualified disposition, the burden is upon the creditor to prove the matter by clear and convincing evidence.
There are continuing criticisms of domestic asset protection trust statutes like the Ohio statute that have developed in the states that have had such statutes for a period of time like Alaska, Delaware and Hawaii. Generally speaking, under common law, the assets in self-settled trusts (a self-settled trust is one in which the settlor is a beneficiary of the trust) are available to creditors of the settlor to the same extent the assets would be in the hands of the settlor. Asset protection statutes, which thwart that result, have been attacked frequently.
One argument is that under the Full Faith and Credit Clause of the U.S. Constitution a state court must recognize and enforce the judgments granted by another state’s court. The argument is that an Ohio court would not be able to apply the protective provisions of the Ohio legacy trust act against a judgment rendered in another state that the transfer to the legacy trust was a fraud on creditors.
For example, if a resident of Texas settled an Ohio legacy trust, a Texas court could nevertheless ignore Ohio law and grant a judgment against the trustee or the trust assets under Texas law. Thus it has been suggested that the Ohio legacy trust act can only protect assets of (i) an Ohio resident against (ii) an Ohio-resident creditor where (iii) both the trustee and the trust assets are situated in Ohio.
Another criticism is based on federal bankruptcy law. Section 548(e) of the Bankruptcy Act includes a ten-year clawback for assets transferred by a bankrupt settlor into a spendthrift trust. Recent cases suggest that federal law may prevail in this context, thereby extending the exposure of a transfer to ten years instead of the relatively short time periods envisioned by the Ohio statute.
The requirement that the trustee be an Ohio trust company has also been criticized as another weakness of the act in that it may limit appeal of Ohio legacy trusts because many Ohio residents move to warmer climates later in life and may view an irrevocable Ohio trust with an Ohio trust company as an impediment to their ability to do so.
Asset protection arrangements are complex and knowledgeable counsel will be helpful in assessing them.