Self-Settled Trusts Choice-of-Law Difficulties under Restatement 270

By:  Christian Corkery

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Applying Washington law, the United States Bankruptcy Court for the Western District of Washington in In re Huber held that prepetition transfers of the debtor’s assets to a self-settled trust created under Alaska state law were void under Washington law.[1]  The matter before the court involved a debtor who created a self-settled trust in Alaska to protect his assets from creditors.  Because Washington state law does not recognize self-settled trusts, the debtor created the trust in Alaska under Alaska state law, which permits self-settled trusts.  The trust agreement included a choice-of-law provision which stated that Alaska state law would govern all legal disputes.[2]  After the trust was created, the debtor filed for bankruptcy.[3]  The chapter 7 trustee brought an adversary proceeding seeking to recover the assets that the debtor transferred to the self-settled trust and to deny the debtor a discharge.[4]  The court declined to apply Alaska law because Washington had a public policy interest against self-settled trusts, and Alaska did not have a substantial relation to the trust.[5]  The debtor was not domiciled in Alaska, his assets were not located in Alaska, and the trust’s beneficiaries were not domiciled in Alaska.[6]  The court found that Alaska’s only connections were that it was the location of where the trust was to be administered and the location of one of the trustees.[7]  As such, the court applied Washington state law which states that transfers made to self-settled trusts are void as against existing or future creditors, and therefore, the trustee was able to recover the assets.[8]

The court’s use of Restatement § 270 analysis to determine validity of self-settled trusts is similar to previous cases.  Section 270 provides that a state has a substantial relation to a trust if at the time the trust is created: (1) the trustee or settlor is domiciled in the state; (2) the assets are located in the state; and (3) the beneficiaries are domiciled in the state.[9]  In In re Portnoy, the Bankruptcy Court for the Southern District of New York applied New York state law over the trust’s choice-of-law provision in determining whether a self-settled trust created under the Isle of Jersey law was void.[10]  There, the New York resident attempted to shield assets in a self-settled trust created under Jersey law where the only connections to Jersey were that the trust was settled and administered in Jersey and the trustee was a Jersey resident.[11] However, New York does not recognize self-settled trusts.  Similar to Huber, under a § 270 analysis, the court found that New York held a stronger interest in applying local law because the trust, its beneficiaries, and the ramifications to creditors have a more significant impact locally.[12] Thus, the court held the trust was void. Alternatively, in In re Zukerkorn,[13] the Bankruptcy Appellate Panel for the Ninth Circuit dealt with another choice-of-law provision concerning a spendthrift trust created under Hawaiian state law.[14]  There, the debtor filed for bankruptcy in California while he was domiciled there.  The bankruptcy trustee moved for turnover of principal and income from the trust claiming the choice-of-law provision was invalid.[15]  The BAP held the trust had a substantial relationship to Hawaii because the trustee and settlor were domiciled in Hawaii at the time of the trust’s creation, the assets were located in Hawaii, and the debtor, a beneficiary of the trust, was domiciled in Hawaii and remained a citizen of Hawaii for over 70 years.[16]  Thus, Hawaii had a substantial relationship to the trust.[17]  The Hawaiian choice-of-law provision was honored because this was not a case of a California resident attempting to avail himself of the benefits of law in a foreign jurisdiction.[18]

Alternatively, Huber created his trust during a time of financial concern and the trust existed for only a few years before his creditors sought to reach the assets.  Huber was a Washington resident whose only relation to Alaska was his intention to avail himself of favorable laws.  Accordingly, Huber makes it clear that a debtor will likely only be able to successfully shield his assets in a self-settled trust if the jurisdiction where he is domiciled permits self-settled trusts.  Further, Portnoy lays out the courts’ concerns with local ramifications from applying foreign laws to self-settled trusts when void under local law.  Unless the individual is able to show a substantial relationship to the foreign state at the time of the trust’s creation, the home state court will be unwilling to protect a self-settled trust’s assets in a bankruptcy proceeding.  Zukerkorn demonstrates just how high the bar is set. There, the trust was created in Hawaii, while the beneficiaries, settlor, and trustee were all domiciled there as well. If an individual plans to create a self-settled trust in a foreign jurisdiction relying on a choice-of-law provision, the individual will only be protected against local laws when the ties to the foreign jurisdiction are very significant. Huber indicates courts will likely apply local law in jurisdictions that do not allow for self-settled trusts.  Individuals should not rely on choice-of-law provisions to avoid local prohibitions on self-settled trusts.

[18] See id.