On March 8, 2017, Michigan’s Qualified Disposition in Trust Act became effective and Michigan became the 17th state to allow individuals to create Domestic Asset Protection Trusts (“DAPTs”). This, of course, is good news for individuals and families in Michigan and elsewhere who wish to protect their assets from the claims of third party creditors.
DAPTs have been used in other states since 1997 to protect assets from the claims of creditors. DAPTs are of particular interest to individuals with heightened levels of professional risk, such as officers and directors of large businesses, physicians, attorneys and investment advisors, and to individuals who are concerned about the risks of tort liability or claims by the government. Furthermore, even though much of the wealth owned by high net worth families may be held in trusts created by other family members and may already provide a measure of protection from creditors, DAPTs are a useful planning tool to protect the wealth of the wealth creator and to protect assets inherited outside of trusts. Moreover, for individuals residing in states where the enforcement of prenuptial agreements is questionable or less certain, DAPTs can be an alternative to a prenuptial agreement.
With the adoption of enabling legislation, residents of Michigan and other states may now avail themselves of DAPTs formed under the Michigan statute. What’s more, Michigan’s DAPT legislation offers distinct advantages (in terms of flexibility and protection) that are not necessarily available in all other DAPT jurisdictions. In fact, a recent national ranking of state DAPT statutes ranked Michigan’s DAPT statute as the fifth best DAPT statute in the United States.
What is a DAPT?
Simply defined, a DAPT is a self-settled and funded irrevocable trust created by an individual, or “settlor,” the assets of which are protected from the settlor’s creditors. Michigan’s DAPT statute permits the trust settlor to retain certain powers and interests in the DAPT, including the right to receive distributions, while maintaining significant protection for the assets of the DAPT. Before passage of this legislation, the assets of so-called self-settled trusts for the benefit of the settlor in Michigan and a majority of the rest of the country could generally be reached by the settlor’s creditors.
What are the Requirements of a Michigan DAPT?
In Michigan, the following basic requirements must be satisfied to establish a bona fide DAPT:
- The trust agreement must be governed by Michigan law
- The trustee, who cannot be the settlor, must be a Michigan resident or an organization authorized to act as a trustee in Michigan
- The settlor or any person related or subordinate to the settlor must not retain powers and interests over the trust unless permitted by the statute
- The settlor must not be more than 30 days behind on child support obligations.
Strict compliance with these requirements is critical, as the failure to meet them can be fatal to the effectiveness of the DAPT and the protection of DAPT assets from the settlor’s creditors. Aside from these requirements, creators of Michigan DAPTs have considerable flexibility to design trusts that meet their and their family’s needs.
Michigan’s DAPT legislation includes a “Qualified Affidavit” provision, which is a common feature in the statutes of other states. The Qualified Affidavit provision “requires” the settlor of the DAPT to sign an affidavit stating, among other things, that the settlor does not intend to defraud a creditor by creating the DAPT and that the creation of the DAPT will not leave the settlor insolvent.
Unlike the other requirements outlined above, the settlor’s failure to comply with the affidavit requirement is not fatal to the effectiveness of the DAPT. However, in the event of an attack on the DAPT by a creditor, the absence of a Qualified Affidavit may be used as evidence to call into question the circumstances surrounding and motivations for creating the DAPT. In any case, satisfying the Qualified Affidavit requirement is advisable given that the required affirmations are aimed, in part, at testing the overall sustainability of the DAPT.
What Powers and Interests May the Settlor of a Michigan DAPT Retain?
The powers and interests that may be retained by the settlor of a DAPT warrant particular consideration, because when one compares the various state DAPT statutes, the allowable powers and interests can vary widely. One of the distinguishing features of the Michigan DAPT statute is that the powers and interests that a settlor of a Michigan DAPT may retain are substantial and include, among other things:
- The power to replace trustees
- The power to direct investments
- The right to receive income
- The right to receive principal under discretionary or support standards
- The power to veto/refuse distributions
- The right to direct the disposition of remaining assets upon death
These powers and interests are expansive when compared to DAPT legislation in other states. For example, the settlor of a New Hampshire DAPT may not retain the power to direct investments, and the settlor of a Virginia DAPT may not retain the right to veto or refuse distributions.
What Protections Michigan DAPTs Provide
The degree of creditor protection afforded to a DAPT is also a variable that may vary depending on the jurisdiction. In Michigan, a creditor’s claims against a DAPT must be specifically grounded in at least one of two specific sections of the Michigan Fraudulent Transfer Act (“MFTA”). Either the creditor must prove by clear and convincing evidence that the DAPT was created to defraud a creditor or that the creation of the DAPT left the settlor insolvent. All other claims and legal theories are specifically precluded.
Moreover, the creditor has a limited timeframe within which to initiate its MFTA related attack. Generally, a creditor whose claim arises after the creation of the Michigan DAPT has two years from the date the DAPT is created to initiate a claim to reach the DAPT’s assets in satisfaction of the creditor’s claim (meaning that a creditor’s claim is barred if the claim arises two more years after the DAPT is created). If the claim arises before the creation of the DAPT, the creditor must initiate the claim before the later of:
- Two years from the date the DAPT is created
- One year after the existence of the DAPT could have reasonably been discovered if the creditor’s claim was fraudulently concealed.
Compare these rules to DAPTs created under the laws of Delaware and New Hampshire with respect to which four year limitations periods generally apply, and in Virginia, where a five year limitations period generally applies.
Takeaways
To be sure, DAPTs are not appropriate for everyone and should be used only after extensive and careful analysis and consideration of an individual’s assets, existing creditors, risk of or exposure to future creditors, and the individual’s ability to tolerate the restrictions on use and enjoyment of assets that may come with a DAPT. Specifically, individuals who are interested in creating and funding a DAPT, must understand that it requires the relinquishment of some degree of control over the transferred assets.
Accordingly, in cases where the creation of a DAPT is desired, consideration should be given to the laws of the state under which the DAPT will be created to ensure the greatest amount of protection and flexibility. Fortunately, in enacting its new DAPT legislation, the Michigan legislature was sensitive to both of these issues, making Michigan an attractive state within which to establish a DAPT.
Warner Norcross + Judd LLP has Michigan’s largest and most prominent Trusts and Estates Practice. For further information regarding the Michigan Qualified Dispositions in Trust Act or “DAPT” statute, contact Mark Harder at mharder@wnj.com or 616.396.3225.