Offshore Trusts: Not So Watertight

Recent U.S. court rulings make it harder to stash funds abroad

Like many other well-heeled Americans, options trader Stephan Jay Lawrence succumbed to the lure of offshore trusts as a supposedly safe way to protect his assets. He lost big-time during the 1987 crash, with margin calls putting him in hock to his brokers at Bear Stearns & Co. Not long before he was socked with a $20.4 million arbitration award in 1991, Lawrence put the bulk of his assets--upwards of $7 million, according to court records--into a trust in the Republic of Mauritius. And when Bear Stearns moved to collect, Lawrence filed for bankruptcy.

But last September, a bankruptcy court judge in Miami refused to let Lawrence discharge his debts and thwart Bear's collection efforts. And the Mauritius trust was the primary reason. "A bankruptcy discharge for a debtor who engages in this type of conduct should be as rare as the dodo bird that once graced the shores of Mauritius," ruled Judge Thomas S. Utschig.

The Lawrence case is one of several setbacks that are raising questions about the future of such trusts. They are no longer an effective tax stratagem. In cases ranging from divorces to plain old debt evasion, more judges are refusing to accept these trusts as a legitimate way of stiffing creditors. And in the most chilling blow yet, in mid-June Judge Charles E. Wiggins of the U.S. Ninth Circuit Court of Appeals in San Francisco upheld a lower court's decision to jail a California couple for contempt after they argued it was impossible to repatriate money from their Cook Islands trust. "These are big nails in the coffin," that could soon "eliminate offshore trusts as an asset-protection tool," says Jay D. Adkisson, who publishes The Adkisson Analysis, an asset-protection newsletter.

Lately, the rich have flocked to set up offshore. Although there are no hard figures, Adkisson says he would not "be surprised if over 100,000 Americans have set up offshore trusts in the last five years." Estimates of money stashed offshore exceed $1 trillion. The appeal is obvious. As a result of the lawsuit explosion, "most don't think their money is protected in America," explains Arnold S. Goldstein, a lawyer who specializes in asset protection.

Among popular havens are the Cook Islands, Gibraltar, Nevis in the Caribbean, and a dozen other small islands that have drafted trust laws to lure Americans. "These erect a series of brick walls" designed to keep U.S. creditors at bay, says Denver attorney Barry S. Engel, who co-authored the Cook Islands' trust law. Most of these jurisdictions refuse to recognize U.S. court judgments, forcing creditors to start all over again in the remote home of the trust, where the odds of success are slim. Clients usually cede control to a foreign trustee to insulate themselves further from legal attack.

LOST LUSTER. Until recently, these trusts worked well. "We cut off most creditors at the pass" by getting them to settle, says Gideon Rothschild, a New York lawyer who heads the American Bar Assn.'s asset-protection committee. And many such settlements have been meager. Engel brags that of the 50 to 60 trust challenges in which he has been involved, "the average settlement has been less than 10 cents on the dollar."

But now the trusts are losing their appeal. Although some promoters are still hawking trusts as a way to evade U.S. taxes, the Internal Revenue Service effectively closed that loophole three years ago. Rigorous reporting rules now require any U.S. citizen who creates a trust or who transfers money overseas to notify the government within 90 days, or face heavy fines. As a result, an offshore trust "won't save you anything in taxes," says Rothschild.

And trusts are becoming less effective at shielding your assets from an angry spouse in divorce court. Take the case of Dr. Roger Reichers, a Mt. Kisco (N.Y.) urologist who moved $4 million to a Cook Islands trust that didn't specifically designate his wife, Mary, as a beneficiary. When Mary later filed for divorce, Roger argued that he had been trying to protect the family from malpractice claims, not keep money away from his wife. But a New York judge ruled in July, 1998, that the trust had been funded with "marital assets," and that Mary was entitled to half the $4 million. Roger is appealing the ruling.

Last August, another New York judge went even further in a case involving a $1.5 million Cayman Islands trust set up by New York businessman Vazha Papson. Ruling the trust "was a bald place marital property out of his wife's reach," the judge ordered Vazha to terminate the trust and bring back the money to be divided up. Given such rulings, "I don't favor using trusts in a divorce context," says Austin (Tex.) lawyer Duncan E. Osborne, a leading offshore expert.

Offshore trusts are also coming under attack in bankruptcy courts. One of the earliest cases involved Larry Portnoy, a New York executive who had put assets into a trust in Jersey--in the Channel Islands--and then asked to be discharged from his debts to Marine Midland Bank. But in 1996, the U.S. Bankruptcy Court judge in New York refused to discharge Portnoy's debts, arguing such a result would "offend strong [state] and federal bankruptcy policies."

In the Lawrence case, Judge Utschig was far more scathing in his refusal to accept the Mauritius trust. In late June, Lawrence abandoned his appeal of Utschig's ruling. That has freed his creditors "to leave no stone unturned" to crack the trust, says Paul S. Singerman, the Miami lawyer for the bankruptcy trustee.

But no development is more frightening to the offshore trust industry than the new Ninth Circuit ruling. The case involved Denyse and Michael Anderson, who in 1997 sought investors to back the sale of water-filled dumbbells and "talking pet tags"--which the Federal Trade Commission charged was actually "a Ponzi scheme." Much of their $6 million in commissions from the aquatic-barbell scheme had been moved to a Cook Islands trust they had set up in 1995. The Andersons protested their innocence, but the FTC prevailed in court.

UNMOVED. When U.S. District Judge Lloyd D. George ordered the Andersons to repatriate their assets, they argued it was "impossible" to comply because of the rules governing the trust. George was unmoved. He ordered the Andersons jailed for six months for contempt of court. From now on, creditors can cite this decision to ask courts "to throw people in jail for contempt if they refuse to bring trust assets back to the U.S.," predicts Adkisson.

Not surprisingly, advocates of offshore trusts don't think their days are numbered. Most unfavorable rulings "involved egregious fact patterns and fraudulent transfers," argues Engel. Comparing the safety of offshore trusts to flying, Engel argues that "just because a plane crashes doesn't mean we can't fly." Still, Rothschild admits these rulings will have "a chilling effect" and force trust planners to be more careful.

For all the bad news, Engel and other hard-core advocates aren't deterred. These rulings "won't limit the use of trusts by me," vows Engel, who says properly designed trusts are still working well. Arnold Cornez, a consultant and author of The Offshore Money Book, says offshore annuities and life insurance policies could prove more effective since, when you buy them, you are giving your money to a third party. "There is very little downside to the process," adds Rothschild. In the "worst-case scenario," if you are threatened with jail, "you can always become an expatriate," he adds. Or you can do the unthinkable--and pay up.

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