ASSET PROTECTION TRUSTS

Perhaps most obviously, many jurisdictions have laws which allow creditors to attack the validity of transactions undertaken with intent to defraud creditors or which unfairly prefer certain creditors over other creditors. So, for example, in the most obvious case, where a settlor who owns a business transfers some of the business' key assets into a trust immediately before bankruptcy, the creditors of the business may seek to claw back those assets to meet their claims against the settlor.

One of the problems a settlor often faces is the desire to retain control over the assets which have been placed into a discretionary trust. The extent of control is a matter which requires great care because if too much power is reserved to the settlor, the transfer of assets into the trust may be regarded as illusory, with the effect that at law the assets are regarded as never having been transferred at all.

The circumstances in which the transfer of assets to a trustee may be regarded as illusory will depend on the terms of the trust itself. Particularly where the settlor is both the protector and a beneficiary of the trust, as powers are increasingly reserved to the protector, there is a greater risk that the transfer of assets to the trustee will be regarded as illusory.

While the enquiry as to whether a disposition to a trust is illusory depends upon the terms of the trust, in some jurisdictions, the context of the formation of the trust goes to determining whether the trust exists and thus, whether transfers of assets to the trust are effective. Where the context suggests that there was no common intention to transfer ownership and control of the assets to the trustee despite the formation of the trust through an executed trust deed, the trust deed may be regarded as a sham and the trust may fail. So, for example, where the settlor at all times regards the assets within a trust as his own and intends despite the trust to retain ultimate control over them, there is a risk that a court may regard the trust as a pretense to mislead other people and thus, invalidate the trust on the basis that the trust deed is a sham.