In re Huber – Will the Bankruptcy Courts Apply the Law of the DAPT Trust State or the Nonresident Settlor’s State of Residence?

In re Huber – Will the Bankruptcy Courts Apply the Law of the DAPT Trust State or the Nonresident Settlor’s State of Residence?

A 2013 bankruptcy case, In Re Huber invalidated a DAPT created under the law of a state different from the residence of the settlor. In Huber, the settlor was a Washington State resident who created an Alaska DAPT administered by an Alaska trustee into which he transferred Washington real property and business assets just prior to filing for bankruptcy. Facts cited by the Court included:

  1. Huber was a Washington real estate developer who, in the 2008 downturn, was threatened with financial disaster on multiple fronts;
  2. Huber’s son was a co-trustee;
  3. Huber transferred 78% of his assets to the trust;
  4. Huber began to receive substantial trust distributions immediately;
  5. The trustee did little active administration;
  6. The trust stated that it was created for creditor protection;
  7. The trust was executed in Washington; and
  8. All the settlor’s legal work was performed in Washington.

The Bankruptcy Court for the Western District of Washington correctly held that the bankruptcy had established that five badges of fraud existed in the case, which supported an inference of actual fraudulent intent to hinder, delay, or defraud Mr. Huber’s creditors, to wit: (1) the debtor was threatened with litigation when the transfers occurred; (2) the transfers were of substantially all of the debtor’s assets; (3) the debtor retained control of the transferred property; (4) the transfer from the debtor to the trust was to an insider; and (5) the debtor was attempting to remove the assets from the reach of the creditors.

Having properly struck down the transfers as fraudulent transfers, under both federal and state law, the court turned to the more far reaching choice of law issue, to wit: Should the validity of the trust be determined by the law of Alaska (for) or the law of Washington (against) and what factors should be considered? In reaching its decision, the Court first acknowledged that it would apply federal choice of law rules, which rely on the Restatement (Second) Conflicts of Laws § 270(a).

“An inter vivos trust of interests in movables is valid if valid (a) under the local law of the state designated by the settlor to govern the validity of the trust, provided that this state has a substantial relation to the trust and that the application of its law does not violate a strong public policy of the state with which, as to the matter at issue, the trust has its most significant relationship… (Emphasis added) “

Applying § 270(a), the Court made a factual finding that Washington state had the most substantial relationship to the trust by looking at four controlling (but not exclusive) factors for guidance. The stated controlling factors were:

  1. place of business or domicile of the trustee;
  2. location of trust assets;
  3. domicile of settlors; and
  4. domicile of beneficiaries

The Court also took note of the state of origin of the transferred assets, and the location of the creditors and the attorney who prepared the trust. Finally, the Court found that Washington State had a strong public policy against self-settled trusts. Following these facts, the Court chose the law of Washington, not Alaska, the state designated in the trust, and found the trust invalid because all the relationship factors favored the settlor’s home state of Washington. In baseball, this would be called batting 0 for 4. Notwithstanding the “bad facts,” the case’s relevant precedent is not the end ruling; rather the case is significant because the Court considered the unique facts of the case to be the determinant of which state had the most substantial relationship to the trust for choice of law purposes.

Huber has been seen by casual observers as a blow to self-settled trusts, but they have misunderstood. It is the opposite. By basing choice of law “validity” on the named “significant relationship” factors, the court de facto has provided a virtual safe harbor for structuring a DAPT sustainable in bankruptcy. By comparison, Liberty Street DAPTs do not involve a fraudulent transfer and strive to meet the Huber “substantial relationship” factors, except for the impossible: the residence of the settlor and her family beneficiaries. And this latter issue was specifically addressed in Hanson v. Denckla, where the Court labeled the urging of the plaintiff “that, because the settlor and most of the appointees and beneficiaries were domiciled in Florida, the [forum] court of that State should be able to exercise personal jurisdiction over the nonresident trustees…a non-sequitur.”

In its ruling, the Huber Court noted that Washington “has a strong public policy” against self-settled trusts. However, this factor is of no import about well-structured trusts, as demonstrated by reading the above excerpt from Restatement (Second) § 270(a), setting forth the Court’s justification in considering Washington public policy, but only because it had the most substantial relationship to the trust matter. Our Liberty Street DAPTs are easily distinguished: the trust state will have the most substantial relationship to the trust and will not have a “strong public policy” against DAPTs.

No Comments

Post A Comment

Liberty Street Advisory Group refers to the separate entities, Liberty Street Law, Liberty Street Capital and Trust & Estate Stewards. None of these entities or persons furnish actuarial, accounting or comprehensive tax advice. Liberty Street Law is a law firm, and does not provide investment management, or any financially-related services. Liberty Street Capital, is a limited liability company registered as an investment advisor in Georgia and other locations. Trust & Estate Stewards is a limited liability company. Past results are not a guarantee of future performance.