Last week was the second anniversary of an Act in Michigan that authorized the creation, funding and administration of domestic asset protection trusts (DAPTs). This statutory recognition of DAPTs gives Michigan residents a significant new opportunity to protect assets from the claims of third-party creditors.
How a DAPT Can Protect You
Without a DAPT, if you control the use and enjoyment of an asset, that asset is generally subject to the valid claims of your creditors (whether arising under judgments from loans, malpractice, car accidents or otherwise). In other words, if you own it or control it (e.g., through rights under a trust), your creditors can get to it. However, with a properly-drafted and funded DAPT, you can now retain "certain" rights to the assets transferred into the trust, while restricting your creditors’ access to those assets.
Who Could Benefit from a DAPT
Individuals with high levels of professional risk, such as physicians, attorneys, investment advisors and officers/directors of large businesses, are good candidates for this type of asset protection. So are individuals contemplating marriage who are looking for an alternative to a more traditional pre-nuptial agreement.
Why a DAPT is Not Appropriate for Everyone
DAPTs are irrevocable (meaning you generally cannot terminate or change them), and they significantly restrict the rights that the Settlor (the person creating and funding the trust) can retain. Because of this, and the fact that most of us are not willing to give up significant control over a large portion of our assets, this is unlikely to be useful to everyone. That said, when DAPTs are used under proper circumstances and for their intended purpose, they can provide supplemental protection that will significantly enhance your overall estate plan.
Finding Balance with a DAPT
DAPTs are not intended to make you judgment proof. They are intended, however, to allow you to surrender significant rights over a reasonable portion of your assets, in order to protect those assets from your creditors, while reserving certain limited rights regarding the use and control of those assets.
The secret to appropriate use of a DAPT is to strike the right balance between the assets over which you retain complete control (and leave exposed to creditors’ claims) and those over which you retain limited control (and protect from creditors’ claims). That balance is obviously unique to your circumstances, and based in part on how much risk exposure you have from your choice of career and lifestyle, how much you value unfettered control of your assets, and how insurable your risks are.
What You Must Give Up for DAPT Protection
You can establish a DAPT that shields its assets from your creditors as long as the DAPT:
- Has a Qualified Trustee (a person/organization, other than you, who is a Michigan resident or is authorized to act as a trustee in Michigan);
- Does not make you, or a related or subordinate party, an advisor (someone who controls investment, distribution and trustee removal and replacement decisions); and
- Prevents you from benefitting under or controlling the trust and its assets, EXCEPT as listed below.
And this list is what makes a Michigan DAPT so powerful - where the exception may be greater than the rule. As the settlor, you may retain:
- A power to direct investments, veto distributions, remove or replace trustees and advisors and appoint assets upon your death;
- A right to receive income;
- A right to receive principal under specific discretionary or directive provisions or to pay income taxes;
- A right to receive minimum required distributions; and
- A few other very limited rights.
Benefits of Creating Your DAPT in Michigan
There are complicated enforceability and constitutional issues that arise when residents of a state without DAPT legislation create and administer a DAPT in a state that has DAPT legislation. With this new legislation, Michigan residents can now protect specific assets without those additional risks and complications. Additionally, some of the retained rights under Michigan’s DAPT legislation are more generous than those in other states with DAPT legislation.
What Trumps the Benefits of a DAPT
The Uniform Fraudulent Transfers Act (UFTA) trumps all protection provided under the various DAPT Acts, including Michigan’s. The purpose of the UFTA is to prevent people from transferring their assets when specific claims are anticipated or known. In other words, it is usually too late to create and fund a DAPT if your creditor's claim has already arisen. There are a few other items that also trump the creditor protection afforded by a DAPT (related to child-support, spouses, bankruptcy limitations and anticipated actions of lenders), but proper planning while you remain solvent will afford you the intended protections.
The Bottom Line
The Act, while clearly not intended to make you judgment proof, provides a very powerful tool to supplement your estate plan. Under the right circumstances, you may be well-served to protect an appropriate portion of your assets using a DAPT.
If you would like more information about creating a DAPT, please contact your Warner attorney or Jim Steffel at jsteffel@wnj.com or 231.727.2621.
