Virginia State Bar

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Trusts and Estates

A Section of the Virginia State Bar.

Spring 2012 Newsletter

Newsletter - Trusts and Estates

Volume 22, No. 6

An Overview of Battley v. Mortensen: The End of Domestic Asset Protection Trusts?

By Jennifer L. Moccia, J.D., LL.M. [Estate Planning] RACK & OLANSEN, P.C. VIRGINIA BEACH, VIRGINIA

In early 2011, a landmark federal bankruptcy case shed doubt on the asset protection powers of the previously lauded domestic asset protection trust (DAPT), alarming many attorneys and distressing certain of those trust-wielding clients. In a decision filed by the United States Bankruptcy Court for the District of Alaska on May 26, 2011, Judge MacDonald set aside Thomas Mortensen’s transfer of real property to an Alaska asset protection trust as a fraudulent conveyance.1 This case deviated from previous DAPT holdings because, not only was Mortensen deemed solvent at the time of the transfer, but Alaska’s four-year statute of limitations for reaching the assets transferred to the DAPT had already run. This controversial ruling has sparked heated debates among estate planners on whether its outcome could ultimately invalidate thousands of trusts formerly thought to provide exceedingly reliable asset protection.

Facts of the Case. In 1994, Mortensen and his former wife paid $50,000 for “1.25 acres of remote, unimproved real property located near Seldovia, Alaska.”2 Four years later, the parties divorced and, upon conclusion of the costly litigation, Mortensen received all of the interest in the Seldovia property. Between 2000 and 2004, he improved the property by building a shed and several other small structures, and installing a well and septic system.

In February of 2005, Mortensen became aware of the asset protection trust strategy for sheltering property, researched a template for such a trust and personally drafted the “Mortensen Seldovia Trust (An Alaska Asset Preservation Trust).”3 Mortensen had admittedly “not recovered from the financial carnage” of his divorce, and created the trust to hold and protect his recreational real property in Seldovia, worth approximately $60,000 at the time of the transfer.4 In the trust document, Mortensen expressly stated that the purpose of the trust was to “maximize the protection of the trust estate or estates from creditors’ claims of the Grantor or any beneficiary and to minimize all wealth transfer taxes.”5 The beneficiaries of the trust were Mortensen and his descendants, and he named his brother and a personal friend to serve as trustees. Upon establishing the trust, his mother gave him $100,000 “to transfer the [Seldovia] property to trust because she wanted to preserve it for her grandchildren.”6 Mortensen accepted the funds from his mother and transferred $80,000 into the trust.

Mortensen registered his trust by quitclaim deed recorded in the Seldovia Recording District in February of 2005,7 and submitted an accompanying affidavit stating that: (1) he was the owner of the property being placed into trust, (2) he was financially solvent, (3) he had no intent to defraud creditors by creating the trust, (4) no court actions or administrative proceedings were pending or threatened against him, (5) he was not required to pay child support and was not in default on any child support obligation, (6) he was not contemplating filing for bankruptcy relief, and (7) the trust property was not derived from unlawful activities.8

After the establishment of his trust, Mortensen did not receive a steady source of income, due in part to increasingly unfavorable market conditions for his profession as a selfemployed construction project manager. He spent the funds he received from his mother to make “speculative investments in the stock market,” which were subsequently lost, and “to pay living expenses.”9 In April of 2009, Mortensen became ill and accrued massive credit card debt, filing for Chapter 7 bankruptcy in August of the same year. He disclosed $26,421 in assets on the itemized personal property list provided to the Court, but did not include his interest in the DAPT (although he revealed the existence of the trust).

Conflict of Law. The plaintiff alleged that Mortensen did not establish a valid DAPT under the governing statutes of Alaska because he was not solvent at the time that the trust was established. Since Alaska’s asset protection trust statute and authoritative case law do not define “insolvent,” the Court applied the definition found in the Bankruptcy Code, which provides as follows:

(A) [W]ith reference to any entity other than a partnership and a municipality, financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at a fair evaluation exclusive of

(i) property transferred, concealed, or removed with intent to hinder, delay, or defraud such entity’s creditors; and

(ii) property that may be exempted from property of the estate under section 522 of this title;10

In applying this definition of insolvency, the Court concluded that insolvency would be established if Mortensen’s liabilities exceed his assets, excluding the value of any fraudulent conveyances and exemptions, which exemptions would be determined under state law. The Court also determined that the $100,000 transfer from Mortensen’s mother would be included as an asset on his balance sheet in order to determine solvency as of the establishment of the trust in February of 2005. As of that date, Mortensen had $153,020 in assets, some of which were exempt, and between $49,711 and $85,000 in liabilities. Therefore, Mortensen was found to be solvent at the time he created the trust, and the trust was determined to be created in accordance with Alaska law.

Despite Alaska’s four-year statute of limitations for reaching assets transferred to a valid DAPT, which was met by Mortensen, the Court applied federal law to the matter. The applicable federal rule includes a ten-year statute of limitations from the date a bankruptcy petition is filed for setting aside a fraudulent transfer, if the transfer was made with “actual intent to hinder, delay, or defraud” a creditor. The Court found that the assets of the trust would be reachable by the debtor’s creditors in bankruptcy if the elements of Section 548 of the Bankruptcy Code were met, which Section provides as follows:

(e)(1) In addition to any transfer that the trustee may otherwise avoid, the trustee may avoid any transfer of an interest of the debtor in property that was made on or within 10 years before the date of the filing of the petition, if

(A) such transfer was made to a self- settled trust or similar device;

(B) such transfer was by the debtor;

(C) the debtor is a beneficiary of such trust or similar device; and

(D) the debtor made such transfer with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made, indebted.11

This provision of the Bankruptcy Code was described by the Court to have been “directed at the five states that permitted such trusts, including Alaska.”12 Since Mortensen’s trust was held to satisfy subsections (A)-(C) of this Section, the remaining issue to be decided was whether Mortensen made the transfer of property to his trust with the actual intent required to set aside the transfer.

Decision of Alaska Bankruptcy Court. Mortensen contended that the trust was created to preserve the Seldovia property for his children, and not with the intent to defraud his creditors. Since, by its own terms, the purpose of the establishment of the DAPT was “to maximize the protection of the trust estate or estates from creditors’ claims,” the Court held that the transfer was made by Mortensen with the clear intent to hinder, delay or defraud his creditors. Although Alaska law also states that “a settlor’s express intention to protect trust assets from a beneficiary’s potential future creditors is not evidence of an intent to defraud,” 13 the ten-year statute of limitations under federal law was enacted in order to close this self-settled trust loophole, and the Court followed this legislative intent. The Court opined that it “would be a very odd result for a court interpreting a federal statute aimed at closing a loophole to apply the state law that permits it.”14

In determining Mortensen’s actual intent, the Court not only looked to the purpose provision within the trust, but also considered other factors. His continual steady decreases in income, mounting credit card debt and statements of financial strife after his divorce were viewed as evidence that he created the trust in order to protect the Seldovia property from impending claims of his creditors. Further, his election to use the trust “as a vehicle for making stock market investments” with the $100,000 received from his mother reflected poorly upon his claim that he created the trust solely to preserve the asset for his children.15 The Court also commented that he could have applied such funds toward his substantial known credit card debt, rather than transferring them into the DAPT. These factors contributed to the Court’s ultimate determination that Mortensen created the trust in anticipation that creditors may attempt to claim the property in satisfaction of his escalating debt. Thus, the transfer to the DAPT was set aside and the recreational property in Seldovia, Alaska was sold to satisfy his creditors. As stated by the Court, “Mortensen will now pay the price for his actions.”16

Analysis of Impact on DAPTs. Is this ruling the beginning of the end of DAPT planning, or was this merely an advisory, fact-specific ruling that provides additional clarity to the current DAPT rules?

Lawyers are split as they speculate whether this outcome was a fluke or the new reality. Although the Court did not uphold Alaska’s fouryear statute of limitations to prevent Mortensen’s transfer from being set aside, the four-year rule is still effective and powerful against claims for assets held by a DAPT. However, when Mortensen erred by filing for bankruptcy without consulting an attorney, he unknowingly exposed himself to the Bankruptcy Code and its ten-year “clawback” rule. Had he not filed, Mortensen would have remained protected by Alaska’s four-year rule.

Despite the concern that this case signals the end of the DAPT, many argue that Mortensen was simply a case of bad facts with an unsurprising result, given that (1) the debtor elected to file for bankruptcy prior to the expiration of the ten-year federal statute of limitations, and (2) he openly admitted in the language of the trust that the trust was created to protect his assets from creditors – the very intent that is required by federal law to set aside the transfer!

Ultimately, Mortensen was not a proper candidate for a DAPT since he had waning anticipated income, almost no net worth beyond the Alaska recreational property and escalating debt. While some contend that the sky is falling and landmines are erupting in the realm of DAPTs, this case provides clarity and guidelines for properly establishing an asset protection trust. Rather than contributing to uncertainty, the Court ultimately validated those DAPTs that were not established to defraud creditors, as well as those trusts established more than ten years prior to filing for bankruptcy, regardless of their purpose. In light of this holding, DAPTs remain an effective asset protection strategy when properly marketed, drafted and implemented.

1 Battley v. Mortensen, (In re Mortensen) Ch. 7 Case No.
A09-00565-DMD, Mem Adv. No. A09-90036-DMD, (Bkrpt D.
Alaska May 26, 2011).
2 Id at 2.
3 Id at 5.
4 Battley v. Mortensen, (Bkrpt. D.Alaska 2011), Pl.’s Ex 9 at
15.
5 Battley v. Mortensen, (Bkrpt. D.Alaska 2011), Def.’s Ex A
at Mortensen 0006.
6 Battley v. Mortensen at 7.
7 Battley v. Mortensen, (Bkrpt. D.Alaska 2011), Def.’s Ex D.
8 Battley v. Mortensen at 6.
9 Id at 9.
10 11 U.S.C. § 101(32)(A).
11 11 U.S.C. § 548(e).
12 Battley v. Mortensen at 14; 5 Collier on Bankruptcy ¶
548.10[1], [3] [a] n.6 (N. Alan Resnick & Henry J. Sommer
eds., 16th ed.).
13 AS 34.40.110(b)(1).
14 Battley v. Mortensen at 16.
15 Id at 19.
16 Id.