Stephen Speiser
September 2024
Foreign Asset Protection Trusts (FAPTs) are a powerful tool for safeguarding assets from potential creditors and legal disputes. However, when it comes to divorce, the effectiveness of these trusts can be put to the test. Divorce proceedings often involve complex asset division and can lead to intense scrutiny of any trusts established by either spouse. In this article, we will explore how divorce can impact FAPTs, the enforceability of prenuptial agreements, and how to structure trusts to protect assets during marital disputes.
Understanding Foreign Asset Protection Trusts
FAPTs are trusts established in foreign jurisdictions that are known for their strong asset protection laws. These trusts are designed to shield assets from creditors, including former spouses in the event of a divorce. The key advantages of FAPTs include:
- Confidentiality: Many foreign jurisdictions offer higher levels of privacy, making it difficult for outside parties to access information about the trust.
- Legal Protections: Certain jurisdictions have laws that are highly favorable to asset protection, such as short statutes of limitations on fraudulent transfer claims and high standards of proof required to challenge a trust.
- Trustee Independence: FAPTs typically involve independent trustees located in the foreign jurisdiction, adding an additional layer of protection against claims.
Divorce and Asset Protection: The Legal Landscape
When divorce enters the picture, the protection offered by a FAPT may be challenged. In many divorce cases, one spouse may attempt to access or claim a portion of the assets held in a FAPT. U.S. courts, particularly family courts, have broad authority to divide marital assets, and they may scrutinize the legitimacy and purpose of the trust.
Key considerations include:
- Timing of the Trust: If the FAPT was established before the marriage or before any marital discord arose, it is more likely to withstand scrutiny. However, if the trust was created shortly before or during the divorce proceedings, it may be viewed as an attempt to defraud the spouse and could be disregarded by the court.
- Control and Beneficial Interest: Courts will examine the degree of control the settlor (the person who created the trust) retains over the trust assets. If the settlor maintains significant control, such as the ability to direct distributions or change beneficiaries, the court may determine that the trust is a sham and treat the assets as marital property.
- Jurisdictional Issues: While FAPTs are governed by the laws of the foreign jurisdiction where they are established, U.S. courts may not recognize these laws if they conflict with domestic public policy and/or frustrate the distribution of assets desired by the court. This might result in the court awarding other assets remaining in the U.S. or which can be traced to U.S. accounts to the spouse to achieve the distribution of assets desired by the court and, failing that, could result in contempt proceedings. Nevertheless, with respect to funds held in trust outside the U.S., the court would have no jurisdiction over those funds and the spouse would have to file suit against the trust in a foreign jurisdiction to try to recover those funds (an expensive and difficult undertaking).
Prenuptial Agreements and FAPTs
Prenuptial agreements can play a crucial role in protecting assets held in a FAPT during divorce. A well-drafted prenuptial agreement can clearly define which assets are considered separate property and thus not subject to division in the event of a divorce. When a FAPT is part of a prenuptial agreement, it adds an extra layer of protection.
Structuring FAPTs to Protect Against Divorce Claims
To enhance the protection of assets in a FAPT during divorce, careful planning and structuring are essential. Here are some strategies to consider:
- Early Establishment: Create the FAPT well before marriage or any signs of marital trouble. This reduces the likelihood that the trust will be viewed as an attempt to shield assets from a spouse.
- Independent Trustees: Ensure that the trust is managed by truly independent trustees in the foreign jurisdiction. The settlor should avoid retaining too much control, as this can weaken the trust’s protection.
- Irrevocable Discretionary Trust Structure: Use of an irrevocable trust, where the trustee will reject distributions to creditors where the settlor is under legal duress (e.g., where the settlor is subject to a court order directing the payment of funds to a creditor), provides stronger protection.
- Proper Documentation: Maintain clear and detailed documentation of the trust’s purpose and the source of the assets. This can help demonstrate that the trust was not established to defraud a spouse in the event of divorce.
- Consideration of U.S. Legal Requirements: Although FAPTs are governed by foreign laws, U.S. courts may still exert influence over the assets. It is important to consider how the trust might be viewed under U.S. law and take steps to mitigate risks.
Conclusion
Foreign Asset Protection Trusts can be an effective way to safeguard assets from a variety of threats, including those that may arise during a divorce. However, the protection offered by a FAPT is not absolute. Proper planning, including the timing of the trust’s creation, the choice of jurisdiction, and the structure of the trust, is crucial in ensuring that the assets are protected. Additionally, integrating the FAPT into a comprehensive prenuptial agreement can provide added security.
In the end, anyone considering a FAPT as part of their asset protection strategy should seek advice from legal professionals experienced in both U.S. and international law. This will help ensure that the trust is established in a way that maximizes protection while minimizing the risk of being overturned in divorce proceedings.
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