Power Of Appointment As An "Asset” In Bankruptcy?
By: Morris Law Group - September 22, 2014
Any attorney who creates an asset protection plans for clients needs to be familiar with bankruptcy laws. Bankruptcy trustees have the broadest sweeping power to access assets to satisfy creditors, and bankruptcy courts are often liberal in helping trustees exercise those powers. In other words, if assets would be safe from a bankruptcy trustee, they would be safe from just about anyone else.
When crafting an asset protection plan, most attorneys think in terms of powers or rights versus property ownership. The golden rule is to own few or no assets but to control as many assets as possible and have them available for your benefit, enjoyment, and use. One way to achieve that goal is through the use of a special power of appointment. A special power of appointment (an “SPA”) is a right granted to an individual that allows them to give or “appoint” assets to another person. If a trust is drafted properly, the power holder should be prohibited from exercising the power in favor of him or herself, or in favor of his or her creditors or estate.
Under section 541 of the Bankruptcy Code, an SPA is not an asset that has to be disclosed in a bankruptcy proceeding, so it is a fantastic way to retain control without having ownership. In addition, it allows for privacy, because you can truthfully state that you have no ownership interest in a specified asset.
Here’s the rub: These powers have to be carefully crafted to ensure that they don’t create too much power or allow the power holder to appoint assets directly to him or herself. In the recent bankruptcy decision of In re Behan, 506 B.R. 8 (Bk. D. Mass, Feb. 25, 2014), the court held that a power of appointment was an asset that the bankruptcy trustee could invade and exercise in favor of creditors. The court reached this result despite valid spendthrift provisions in the trust stating that creditors could not reach assets so long as they remained it the trust.
The bankruptcy judge reasoned that “The power of appointment, although not exercised, defeats the spendthrift provision set forth in the Trust. As a property interest, the Chapter 7 Trustee is authorized to exercise the power of appointment for the benefit of the Debtor’s bankruptcy estate…”
In other words, the court held that contradictory provisions in the trust would be resolved in favor of the bankruptcy trustee. The implications of this decision, if carried to the extreme logical conclusion, is that the asset protection benefits of a power of appointment are being eroded and could completely disappear at some point. That’s why careful planning is essential.
In the case of clients who want a higher degree of asset protection, the best course of action is to make sure that the holder of SPA has very limited power to appoint (and never the ability to appoint to him or herself). Moreover, the SPA should automatically vest in another individual (or better yet a panel of individuals) in the event of a bankruptcy proceeding or any attempt to circumvent spendthrift provisions in a trust. In addition, the trust should specifically indicate to whom such powers may be delegated. Therefore, a bankruptcy trustee or creditor could never claim to be the rightful recipient of the power.
When properly structured, the original holder of an SPA may delegate the power to a panel of trusted advisors. Thus, assets inside a trust can be appointed back to the original trust creator, without any risk of invasion by the bankruptcy trustee or another creditor. This type of planning not only provides excellent asset protection from lawsuit risk, but also potentially shields assets from a future bankruptcy. It further allows for the possibility that the trust creator can end up “re-owning the assets” with no adverse tax consequences.
If you’re interested to learn more about how an SPA can be combined with a Offshore Trust (or a trust that is domestic but can be “sprung” to an offshore jurisdiction if the need arises), please contact us, and we’ll be happy to discuss the options available to you. The only real impediment to creating a very strong asset protection plan is waiting too long, because once a claim exists against it, it becomes much more difficult to protect your wealth.
** Disclaimer Required by IRS Circular 230** Unless otherwise expressly approved in advance by the undersigned, any discussion of federal tax matters herein is not intended and cannot be used 1) to avoid penalties under the Federal tax laws, or 2) to promote, market or recommend to another party any transaction or tax-related matter addressed.