June 6, 2017

For those who have been saying that domestic asset protection trusts (“DAPTs”) don’t work, the new Nevada Supreme Court case of Klabacka v Nelson has at least concluded that with regard to Nevada residents, Nevada asset protection trusts do work, even in highly sensitive situations that involve divorcing spouses.

Eric and Lynita Nelson (each, a “settlor”) created their own “separate property” trust (each with their own legal counsel’s input) and funded the respective trust with his or her separate property. This fact is important in that if the trusts had received community property, the outcome may have been different.

The trusts were converted to “asset protection trusts” in 2001. Eric later initiated divorce proceedings in 2009, which brings us now to this 2017 court opinion. Eric testified that the trusts were created for the purpose of protecting the assets from creditors (but no known creditors, at the time). This is interesting as well in that some attorneys in the field have raised the concern that simply making such an admission makes the trust funding a “per se” fraudulent transfer. This is of course not the case and this Klabacka case makes that more evident.

Back to the facts, a trustee in the Klabacka case was serving as the individual who held the discretion to make distributions to the beneficiaries, but subject to the settlor’s veto. The respective settlors, however, in the capacity of also being an “investment trustee,” retained the power to hold and manage the investments of the respective trust.

The lower district court mentioned that the trusts could be invalidated because of the failure to follow some trust formalities. The Supreme Court disagreed, saying that this may be a basis for trustee liability, but not a basis to invalidate a trust.

The Supreme Court also ruled that when the trust agreement makes it clear that no creditors will have access to the trust assets, the court cannot consider extrinsic evidence to the contrary. In fact, considering such extrinsic evidence would be an abuse of the court’s exercise of its discretion.

The Supreme Court also reiterated the nature of the spendthrift provisions contained in the trust agreements are an effective prohibition on a court mandating that a trustee exercise the trustee’s discretionary powers in favor of a creditor, absent a showing of any fraudulent transfer.

The Supreme Court further confirms that (1) there are no applicable “exception creditors” here (i.e., super creditors who are not impeded by trust spendthrift clauses) and (2) there is no public policy exception to penetrating the spendthrift protections in cases involving alimony or child support claims (in contrast for example, per the court, to Florida case law, the Restatement (Third) of Trusts, and some other state laws). This is noteworthy in light of some other positions that view alimony and child support as “duties” versus creditor claims, meaning that the spendthrift barrier would not have applied to such “duty”-type claims.

Another comment of interest in the court opinion was that equitable remedies like constructive trust claims (in which the trust is deemed to be held for the creditor’s benefit) are not a way to pierce through the protective spendthrift nature of a trust unless and until some future specific legislation is passed to allow for that.

Bottom line, the protections afforded assets in properly designed asset protection trusts in the right circumstances are effective. Keep in mind however that having such a trust will not make the spouse’s obligations to pay alimony and child support any less enforceable against the spouse in connection with his own personal sources of income and personally owned assets.

 

Cite: Klabacka v. Nelson, 2017 WL 2303609 (Nev., May 25, 2017)

By Edward D. Brown, Esq., LLM, CPA

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