Protecting trust assets from creditors
Michigan recently became the 17th state to pass Domestic Asset Protection Trust (“DAPT”) legislation to aid in safeguarding trust assets. With the first U.S. state passing this law back in 1997, Michigan’s estate planning community had been long anticipating this type of legislation.
On December 5, 2016 Governor Snyder signed the Qualified Dispositions in Trusts Act (“the Act”) which becomes effective on March 8, 2017.
What is DAPT legislation?
DAPT legislation allows a person, the transferor, to create an irrevocable trust for his or her own benefit and to shield those assets from creditors. If this sounds like it might be too good to be true that’s because prior to this type of legislation it was. Previously, under common law, if a person created a trust for their own benefit, that person’s creditors could basically ignore the trust and still make a valid claim against those assets. Now, if the legal requirements are met, the transferor is able to retain certain rights and interests in the trust, while also protecting those assets from their creditors.
Overview of the new Michigan Act
The main features of the new Michigan Act are:
- The trustee of the DAPT must be a “Qualified Trustee”. That is, a corporate trustee or an individual, other than the transferor, residing in Michigan.
- The transferor can retain certain rights and interests in the trust.
- The transferor must execute an affidavit stating, among other things, that the transfer won’t render him or her insolvent, the transfer isn’t being completed with the intent to defraud a creditor, and he or she is not aware of any pending or threatened litigation, other than that which is disclosed in the affidavit.
- If properly created, the transferor’s creditors will have two years in which to challenge the creation of the DAPT as a fraudulent transfer.
Rights of the transferor
The transferor can retain certain rights, interests, and powers, including:
- The transferor can retain the right to veto distributions from the trust.
- The transferor can direct the investment decisions of the trust.
- The transferor can have a special power of appointment exercisable via their Will, effective at his or her death, to appoint the assets of the trust to anyone but his or her self, estate, creditors or the creditors of their estate.
- The transferor can receive income from the trust and/or receive principal distributions from the trust at the discretion of the trustee or advisor under a discretionary or support provision.
- The transferor can remove a trustee or advisor and appoint a new trustee or advisor.
- After the transferor's death, the qualified trustee has the power to pay the transferor's debts, the expenses of administering the transferor's estate, or any estate or inheritance tax imposed on or with respect to the transferor's estate, without regard to the source of the payment.
It should be noted that the transferor cannot retain the right to amend or revoke the trust or direct that the assets of the DAPT be returned to him or her.
Claims by creditors
The primary reason an individual would create a DAPT is to protect their assets from creditors. While creditors still have the ability to make a claim against property that was transferred to a DAPT under the Act, there are significant restrictions on those claims.
The Act limits claims by a creditor against property that was the subject of a “qualified disposition” and establishes requirements for the avoidance of a qualified disposition. It also states that a creditor would not have a claim or cause of action against the trustee and others related to a trust that was the subject of a qualified disposition.
So what is a Qualified Disposition? It is a disposition, or transfer, after which both of the following apply to the subject property: 1) The property is owned by one or more trustees, at least one of whom is a qualified trustee. 2) The property is governed by a trust instrument under which the transferor has only rights, powers, and interests that are permitted under the Act. One caveat to this is that a disposition is not considered qualified if, at the time of the disposition, the transferor was behind on a child support payments by more than 30 days.
If a qualified disposition is made to the DAPT, and a creditor subsequently files a claim after the qualified disposition is made, then the action by the creditor is limited to a claim involving actual intent to hinder, delay, or defraud the creditor. Furthermore, once the qualified disposition is made, the action by the creditor must commence within two years after the qualified disposition was completed.
Ensuring that a transfer is a qualified disposition when creating a DAPT is essential. If the transfer is not a qualified disposition then it could be void and creditor claims against the subject property would not have the protections under the Act.
As you can see, DAPT’s are a valuable planning tool for high net worth individuals to protect their wealth. And now, as of March 8th, Michigan residents will no longer have to look to another state’s legislation for this type of asset protection.