Tuesday, May 16, 2017

Asset protection trusts in Michigan

Michigan has passed a new Qualified Dispositions in Trust Act, joining a small number of states that allow an individual to create a self-settled asset protection trust.

Previously, an asset protection trust could not be self-settled in Michigan. Another person, such as a parent or grandparent, could place property into an irrevocable trust, grant the trustee the power to make discretionary decisions only, and thereby prevent the beneficiary's creditors from having any access to the trust property. Suppose that Ben's grandmother creates such a trust with assets of $500,000. If Ben cannot require the trustee to make a distribution from the trust, neither can his creditors. But Ben could not accomplish the same thing with $500,000 of his own money. If he tried to do so, even though the trust would be valid under Michigan law, it would not be effective to keep the trust property away from Ben's creditors.

His option would be to create the trust under the laws of another state or another nation that permit the creation of self-settled asset protection trusts. That is why wealthy people would often set up "offshore" accounts and trusts in places like Bermuda or the Cayman Islands.

The new Act changes that. Now, an individual can create his own asset protection trust, and he can do it right here in Michigan. So long as the requirements of the Act are followed, it will be valid and it will be effective to prevent creditors from gaining access to the funds.

The requirements include:
  • When transferring property to the trust, the person transferring it must sign an affidavit that certifies:
  • (a) The transferor has full right, title, and authority to transfer the property to the trust.
  • (b) The transfer of the property to the trust will not render the transferor insolvent.
  • (c) The transferor does not intend to defraud a creditor by transferring the property to the trust.
  • (d) The transferor does not know of or have reason to know of any pending or threatened court actions against the transferor, except for those court actions identified by the transferor on an attachment to the affidavit.
  • (e) The transferor is not involved in any administrative proceedings, except for those administrative proceedings identified on an attachment to the affidavit.
  • (f) The transferor is not currently in arrears on a child support obligation by more than 30 days.
  • (g) The transferor does not contemplate filing for relief under the bankruptcy code, 11 USC 101 to 1532.
  • (h) The property being transferred to the trust was not derived from unlawful activities. 

    Creditors of the settlor may "avoid" (reverse) that transfer within two years after it is made, but only under certain conditions:
  • If the claim arises after the transfer is made, the creditor must show that the transferor had an actual intent to defraud the creditor, and the claim must be brought within the first two years after the transfer was made.
  • If the claim arose before the transfer is made, the creditor also has one year after he does or reasonably can discover the fact of the transfer to assert the claim.
  • Any such claim must be made under the Fraudulent Transfers Act, with the new amendments made to that Act.
  • All such claims must be brought before the probate court.
  • The creditor must establish the fraudulent intent by clear and convincing evidence.
There are some uncertainties. The first deals with the effect of a false statement in the affidavit. Would that false statement invalidate the trust or simply result in a decision that the property for which the false affidavit was given would not enjoy the protections under the Act?  

A more subtle issue also arises. Banks and credit unions are familiar with revocable trusts and are usually willing to lend money and take a mortgage on land owned under a trust, knowing that the land used to secure the loan can be foreclosed if the trustee does not keep up with the payments. But it is not clear how many financial institutions would be willing to extend a loan to a trustee who has the power but not the obligation to use trust property to make payments on the loan. Further, the right of the lender to enter a judgment against the borrower for any funds still owed after the land and home are sold after foreclosure - the "deficiency judgment" - would be futile when the court will not allow the bank as judgment creditor to have access to the trust property to satisfy that judgment.

In our area, investigation discloses that at least two banks will simply not make residential mortgage loans to the trustees of an irrevocable trust. Although perhaps overbroad, this policy has the merit of being both easy to understand and easy to apply. 

These and other complications will arise as practitioners adapt themselves to this new creature under Michigan law.

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