Trusts can protect your assets, to a certain extent. Foreign and domestic asset protection trusts can protect them even more, if you structure them correctly. The jail time starts when you wait until you already have creditors banging on the door before you relinquish control or a beneficial interest in one of these trusts. Unfortunately for one person in California this April, courts call that a “fraudulent transfer,” especially if you do not seem to be getting anything of value in return (other than, of course, being able to exclude assets from a bankruptcy).

In In re Olson, a woman who owed a lot of money to a creditor first tried to hide the existence of a Cook Islands asset protection trust, and later relinquished her beneficial interest in the trust to her two children. A short time later, she filed for bankruptcy. The court saw that Olson did not get anything of value in return for her relinquishment (“consideration”), decided that she only transferred the interest to keep it out of her bankruptcy estate, and ordered her to repatriate the funds. She went through the process of doing so, but sent a separate email to her Cook Islands trustee that was supposed to trigger a provision in the trust that removed her from all control if the trustee thought that she was engaging in the process under duress. For this, the Bankruptcy Court ordered her jailed for civil contempt, and she remained there for more than a year refusing to repatriate the funds.

After a while, the bankruptcy trustee decided that everyone would be better off if he was willing to make a deal to get at least some of the funds. He bargained with Olson’s father (as acting guardian of her children, still the beneficiaries) to repatriate the funds and split it between the creditors (80%) and a new domestic trust for the children (20%). After her father did so, the trustee went to the Bankruptcy Court asking for approval for the deal – and got it.

The Court acknowledged that they should not reward Olson for for her contempt, but expressed the opinions that (1) something is better than nothing, and (2) that taking the entire amount after Olson’s father had repatriated it in good faith would lose the Court its moral high ground. The Court also wanted to avoid going through the formal process of “officially” finding that the transfer was fraudulent in the first place, because there was some concern about the liability of the minor children involved, as recipients of a fraudulent transfer. The creditors, of course, appealed this decision to the federal district court, claiming that the Bankruptcy Court should have followed the normal bankruptcy priorities, and that it abused its discretion by accepting the deal.

The federal district court agreed, finding that the Bankruptcy Court should have gone through the process of officially branding the transfer as fraudulent because the minor children would not have been liable – the trust would have (and was essentially going to be, regardless!). They also argued that not keeping faith with the trustee’s deal in this case was not going to lead to a rash of debtors refusing to repatriate funds from foreign trusts because the Courts have other ways to “discourage” such malfeasance. It is worthy to note however that the district court did conclude that Cook Islands self-settled trust assets are not assets of a bankruptcy estate. This is an important point in that properly timed offshore trust planning continues to be a very effective asset protection planning strategy.

Takeaway: The bottom line here? Just don’t engage in fraudulent transfers. Engaging in fraudulent transfers makes the pain worse, and draws it out for longer. Desperately trying to outsmart courts and creditors at the last minute is both uncomfortable and futile. If you want to protect your assets and your family, you need to set up your asset protection structure before there are even any clouds visible on the horizon. Cook Islands trust are very effective if done with the proper motive (e.g., in advance of any creditor threat). It seems that if the risk of finding the existence of a fraudulent transfer had not been so prevalent in the above scenario in the Olson matter, the debtor and her family may have been more willing to stand pat with the protective nature of the foreign trust. Without a fraudulent transfer scenario, the district court would not have viewed the trust assets as being a part of a bankruptcy estate that would have been available to creditors. Instead, the debtor and her family would have been less likely to agree to the repatriation of assets to the United States, which is what then allowed the courts to more easily break down any remaining barriers to the assets from that point forward.