Long ago, attorneys that drafted foreign asset protection trusts (FAPTs) recognized that a court could eventually force their client to disgorge assets. They used several strategies to prevent an actual payout. A “duress clause” – which I discussed in my last post – was one such tactic. Another was to place assets into a family member’s name — a tactic was used in Solow. But like the taxpayer in Lawrence, Solow lost, invalidating this structure.
The following transactions are at the heart of this case.
The Solow’s formed a Cook Island trust;Mrs. Solow was the sole beneficiary. Mr. and Mrs. Solow mortgaged the couple’s $5.2 million dollar residence and transferred the funds into the Cook Island Trust. Mrs. Solow was the sole owner of a second property valued at $1.2 million. She mortgaged this asset, and then placed those funds into the Cook Island Trust.
The SEC sued Solow, alleging he engaged in a fraudulent trading scheme. After losing, Solow faced $5.2 million in damages. Solow asserted the impossibility defense, arguing he owned no assets.
The court ruled against Solow, first noting, “where assets are held in an offshore trust, the ‘burden of proving impossibility as a defense to contempt will be especially high.’” By the time of the Solow decision, courts had come to view these trusts suspiciously, believing they allowed debtors to run up exorbitant debts only to claim poverty when the bill comes due. Not wanting to be seen as aiding unscrupulous behavior, courts had developed a jaundiced view of these structures. The court next concluded that Solow “failed to demonstrate that he had made in good faith all reasonable efforts to comply with the court’s disgorgement order.” Solow had paid the court a little under $3,000 over a six-month period — a paltry amount in relation to the total judgment. He hoped that by placing marital assets into his wife’s name – and then placing the bulk of those assets into a Cook Island trust — he could argue he couldn’t satisfy the judgement. While Solow was penniless on paper, he continued to benefit from the assets through his wife; together, the couple was still living the high life. The court easily saw through this charade.
But the following reasoning – like the Lawrence case – is Solow’s most important holding: “… an inability defense is unavailable where the inability was created by the defendant.” This is a legal principle with solid grounding in common law precedent. The court is saying, “we won’t let clever trust drafting techniques to allow a debtor to “have his cake and eat it, too.” This reasoning, combined with the already high bar courts place on offshore trusts, neuters a vast majority of plans using an FAPT.
Solow’s reasoning directly undercuts most planning using foreign asset protection trusts. Granters now face a two-pronged problem. They have to jump over an “especially high” bar when asserting the impossibility defense. But when they’re responsible for the barrier preventing their compliance, courts will rule against them. The combination of these two points is particularly damaging to FAPT grantors, coming close to invalidating these structures.
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