One way to attack an irrevocable trust is to prove that the trust is the alter ego of the grantor because the trust is operated in a manner so that it has no separate existence from the grantor. Some courts describe this as the grantor “exercising such control that the trust has become a mere instrumentality of the owner.” In re Vebeliunas, 332 F.3d 85 (2nd Cir. 2003).

In WILSHIRE CREDIT CORPORATION v. KARLIN, 988 F.Supp. 570 (1997), Allan and Mary Rozinsky established an irrevocable trust for their children and transferred their home to the trust. The Rozinskys paid rent equal to the amount of the mortgage, insurance, and monthly expenses. For a time, the trust also owned a beach home that the Rozinskys rented from the trust. The trustees were close friends and relatives who admitted that most of their decisions were made at the direction of the Rozinskys.

After a time, the Rozinskys became unable to make the rent payments and they issued promissory notes to the trust in the amount of the delinquent rent, although no payments were made on the promissory notes. The court held that under Maryland law, alter-ego will only apply where necessary to prevent fraud, and because no fraudulent transfer had occurred, the creditors could not reach the trust assets despite the control exerted by the settlors.

In UNITED STATES v. EVSEROFF, No. 00-CV-06029 (E.D.N.Y. April 30, 2012), Jacob Evseroff established an irrevocable trust and transferred his primary residence to it after having received notice of a tax deficiency of over $700,000. A series of family friends served as the trustees of the trust. Evseroff did not pay rent to the trust for the privilege of living in the residence, but he did pay the mortgage and expenses as he had when he owned the home. The trust never assumed the mortgage and it was never listed on the flood or fire insurance on the home.

The court held that a plaintiff may pierce the veil of a trust, under the laws of New York, if the plaintiff can show that “(1) the owner exercised such control that the corporation has become a mere instrumentality of the owner, who is the real actor; (2) the owner used this control to commit a fraud or ‘other wrong’; and (3) the fraud or wrong results in an unjust loss or injury to the plaintiff.” Because the transfers to the trust were found to be fraudulent, and because the facts indicated that Evseroff had dominated the trust, the court allowed the government to collect against the assets of the trust.

Lessons learned from these cases: (1) don’t wait until you have a liability problem to transfer assets to an asset protection trust, (2) appoint a trustee who will take control of the trust, and (3) don’t allow a person other than the trustee to control or dominate the trustee or engage in transactions with the trust on terms that are not commercially reasonable in an arms-length transaction.

This is a summary of important findings from recent asset protection cases:

1. In re Baldwin, 593 F.3d 1155 (10th Cir Ct. App. 2010). Bankruptcy trustee can avoid restrictions imposed by state law charging order statutes if a partnership agreement is not an executory contract. Also see In re Ehmann 2005 WL 78921 (Bankr.D.Ariz. 01/13/2005) which had similar facts and a similar holding.

From these cases we learn the following: (1) Partnership agreements and LLC operating agreements should be carefully designed to ensure that they constitute executory contracts, (2) Personal use assets should not be held by business entities (except for valid lease arrangements), (3) Entities should be structured for valid business purposes, (4) If possible, entities should include legitimate partners other than the debtors (and unrelated to the debtors if possible).

2. Shaun Olmstead vs. Federal Trade Commission, No. SC08-1009, June 24, 2010.  The Supreme Court of Florida held that Florida law permits a court to order a judgment debtor to surrender all right, title, and interest in the debtor‘s single-member limited liability company to satisfy an outstanding judgment. A charging order is not the sole remedy authorized by law.

From this case we learn the following: (1) Some states provide much better asset protection than others for LLCs and limited partnerships. Many states, including Florida, mention a charging order as one remedy but remain silent as to whether it is the sole remedy of a creditor. This case shows that this language is insufficient to ensure “charging order protection.” (2) As we have learned from previous cases, including In re Albright, 291 B.R. 538, 540 (D. Colo. 2003), you cannot rely on a single member LLC to provide charging order protection. This does NOT mean that a single member LLC cannot provide asset protection to the members against the inside liabilities of the LLC.

3. Miller v. Kresser, 2010 Fla. App Lexis 6152 (Fla. 4th DCA 2010); Wachovia Bank, NA v. Levin, 419 B.R. 297 (E.D.N.C. 2009) and In re: Coumbe, 304 B.R. 378 (2004). From these cases we learn that the good old fashioned asset protection provided by a spendthrift trust continues to be upheld by the courts. This protection is even greater when the trust is designed as a discretionary trust (see Wilson v. U.S., 140 B.R. 400 (N.D. Tex. 1992). Once again, this protection is even greater when supported by a state statute that provides that a beneficial interest is not a property right and that the discretion of a trustee is “absolute.”

4. Sweeney, Cohn, Stahl & Vaccaro v. Kane, No. 2002-04052 (N.Y. App.Div. 03/08/2004).  A New York resident attempted to protect a residence by placing it in a Florida corporation whose shares were owned as tenants by the entirety under Florida law.  The Supreme Court of the State of New York- Appellate Division, found that Florida law applied because the state of incorporation has the greatest interest in determining whether the corporate veil may be pierced.  The court allowed the creditor to attach the residence under a theory of “reverse-veil piercing.”

This case affirms the fact that the internal affairs of a corporation, including a potential piercing of the corporate veil, are governed by the laws of the state where the corporation is filed, regardless of the fact that the plaintiffs, the defendants, and the cause of action in the case, were all located in another state.  The case also reminds us not to put personal use assets in a corporate entity without a lease or other business purpose to justify such an arrangement.

In the recent case, Miller v. Kresser, 2010 Fla. App Lexis 6152 (Fla. 4th DCA 2010), a Florida Appeals court overturned the ruling of a lower court which allowed a creditor to reach the assets of a trust.

The lower court allowed the creditor to reach the assets of the trust because the beneficiary exerted significant control over the trust, the trustee was related to the beneficiary, and the trustee basically failed to perform the administrative duties expected of a trustee. The appeals court overturned that ruling and upheld the asset protection provided by the trust despite the fact that the trustee was not fulfilling his duties.

Lessons learned from this case:

1. Courts continue to uphold the asset protection provided by a spendthrift trust, even in cases where the operation of the trust is imperfect.

2. You can improve your chances of protecting trust assets by appointing an independent professional as the trustee instead of appointing a family member.

3. If you must appoint a family member as a trustee, appoint an independent professional as a co-trustee in order to add legitimacy to the trust.

4. A trustee who does very little administration and allows the beneficiary too much control over the trust will jeopardize the asset protection provided by the trust. The trustee should keep books and records, participate in regular meetings, make investment decisions, sign tax returns, and take part in the administration of the trust.

5. Distribution of income and principal should not be mandatory at any time, but should be left to the unfettered discretion of the trustee.

6. The trust should be located in a jurisdiction that supports the asset protection provided by an irrevocable spendthrift trust.

Last Saturday I went snowcat skiing with my dad and my brother. We had a marvelous time. But the most impressive part of the day was watching the guides who led us to the steepest and deepest powder runs while avoiding the dangers all around us. The guides have years of experience on the same mountains and they know exactly where the best powder is found and how to avoid the avalanches and other dangers which were apparent all around us. All day the snowcat climbed up ridges no wider than the snowcat itself with thousand foot drops on both sides. We skied along narrow ridges where the guides insisted that we stay directly on their tracks to avoid collapsing the rims on either side. In one large bowl thousands of yards across, the guides showed us how there was avalanche danger on the right, icy crusty snow on the left, and one perfect powder run down the middle. They had us ski between the tracks of one guide on the right and the tracks of another on the left so we could take advantage of the lightest and deepest powder the mountain had to offer.

These guides did not rely on generalized weather reports or general backcountry experience. They were focused on the specific conditions of each particular hillside at each specific moment in time. They knew which slopes got the most sun, which got most wind, which got the most snow, and how this would affect the safety and enjoyment of the skiers at any particular time. Because of their specific knowledge, they were able to provide a safer and better experience than we could ever do for ourselves.

This same principal applies equally well in many fields. I keep a specialist file in my office with the name and contact information of people who are the very best in their field of specialization. So if you ever need an expert in municipal bonds, or the taxation of stock options, or mediation, or bankruptcy (hopefully not), let me refer you to a specialist. By focusing on one specific area, a specialist can stay up on the latest developments, dangers, strategies and ideas. Just like the ski guides, we can show you where the dangers are, and where the good stuff can be found.

Gooseberry Mesa is the greatest mountain bike trail on earth The trail involves sweet single track, endless slick rock playground, and breathtaking views. If you look east, you see the imposing cliffs of Zion National Park If you ride along the south or north edges of the mesa, the trail skirts sheer cliffs dropping hundreds if not thousands of feet to the valley floor At the end of the mesa is a narrow neck of rock, forty feet wide with a trail down the middle and cliffs on both sides Finally, the rock ends with sheer cliffs dropping off in front of you and on both sides A trip to Gooseberry Mesa is exhilarating, and refreshing to the soul.

The trail keeps you close enough to enjoy the view, but never puts you in danger of falling off the edge This is a good analogy for those of you who like to live on the edge I have many clients who get involved in aggressive tax planning, speculative investments, or high risk businesses Some push the limits too far and get burned; others live to play another day Sometimes it is luck that makes the difference; other times, a person is protected by taking precautionary measures that limit their exposure I recommend the following precautionary measures:

First, “Where no counsel is, the people fall: but in the multitude of counsellors there is safety” (Proverbs 11:14) A really good CPA not only helps you take advantage of every opportunity, but he also knows where to draw the line and when to push back when you get too greedy Before taking the plunge on a risky deal, I suggest you get several independent opinions from well qualified counselors.

Second, “He that maketh haste to be rich shall not be innocent” (Proverbs 28:20) If it sounds too good to be true, it probably is If it is that good, it is worth taking the time for some advance planning and due diligence.

Third, “He that walketh with wise men shall be wise: but a companion of fools shall be destroyed” (Proverbs 13:20) More important than any legal documents, tax opinions, or pro forma projections, is the character of the promoters.

Remember, a fine day at Gooseberry Mesa is made better by the fact that you are likely to survive, to do it again.