New Asset Protection Opportunities in Ohio
Kegler Brown Creditors' Rights + Bankruptcy Alert July 15, 2013
Summary of New Creditor Protection Opportunities
Ohio has leaped into the lead by enacting some of the most modern provisions in the country designed to protect assets from creditors. On December 20, 2012, House Bill 479, which is also known as the Ohio Asset Management Modernization Act of 2012 (“AMMA”) was signed into law effective March 27, 2013.
Simply put, AMMA when combined with prior changes to Ohio law, substantially expands Ohio’s statutory authority for creditor protection. Accordingly, if you are concerned about protecting assets in a complicated environment, whether from loan reversals, bad investments, lawsuits, or other threats and would like to protect a nest egg from creditor reach, AMMA may be just what you wanted.
While AMMA is a complicated and extensive piece of legislation, the major provisions about creditor protection can be summarized as follows:
- AMMA has increased Ohio’s homestead exemption to $125,000 per debtor. The pre AMMA homestead exemption was only $21,625 per debtor. This new exemption is subject to triennial inflation adjustments.
- Ohio law now expressly protects 529 Plans from creditor claims.
- Ohio law now exempts inherited or stretch IRAs from creditor claims. These new exemptions along with pre existing exemptions for other pension and retirement plans apply to alternate payees (such as a divorced spouse), as well. It should be noted that AMMA also provides that these retirement plans are protected even if the program or plan is flawed in its intended compliance under the Internal Revenue Code, so long as the error was made in good faith.
- AMMA overturns case law in Ohio that found that disclaimers can be deemed as fraudulent relative to the disclaimant’s creditors. AMMA specifically states that a disclaimer is not considered a transfer or conveyance by the disclaimant and, therefore, no creditor of the disclaimant may seek the disclaimed assets.
- Creditors are expressly deprived of any recourse against a trustee who pays a beneficiary’s expenses rather than distributing commensurate amounts directly to the beneficiary.
- AMMA provides that a breach of a post closing solvency covenant will not convert a non recourse loan to a recourse loan.
- Finally, out of AMMA comes the Ohio Legacy Trust Act effective March 27, 2013. With this legislation, Ohio joins 14 other states that permit Domestic Asset Protection Trusts (“DAPTs”). Generally, these are irrevocable trusts into which someone can transfer assets that will be protected from claims of future creditors of the transferor. This is the case even though the person that transferred the assets into the trust (hereafter referred to as the “settlor,” “grantor” or “transferor”) continues to benefit from the trust and retains some control over the trust. The Ohio Legacy Trust Act provisions are discussed further in the next section of this newsletter.
Ohio Legacy Trust Act
Effective March 27, 2013, if an individual transfers assets to a trust that qualifies as a “Legacy Trust,” the assets transferred into the same will be protected from the future creditors of the transferor notwithstanding that the transferor essentially retains control of the assets and, more importantly, still benefits from the trust. With this legislation, Ohio effectively overrules the long standing American rule that self settled trusts (unless specifically exempted by statute, such as an IRA) cannot protect the assets from the claims of the settlor’s (transferor’s) assets.
To qualify as a “Legacy Trust” the trust must be in writing; it must appoint at least one qualified trustee (which essentially means an Ohio resident other than the Grantor, or a trust company chartered in Ohio); it must expressly incorporate Ohio law; it must be an irrevocable trust; and it must contain a spendthrift provision that is applicable to any trust beneficiary. A spendthrift provision is a provision that prohibits the voluntary or involuntary transfer of the transferor’s interests in the trust.
A trust will be treated as irrevocable and will not be treated as violating the spendthrift provisions notwithstanding that certain rights are retained by the transferor/settlor. The permissible retained rights in the Legacy Trust include the following:
- The right to receive annual income from the trust.
- The right to withdraw up to 5% of the trust assets in a given calendar year.
- The right to receive distributions of principal from the trust at the discretion of the trustee.
- The right to veto distributions from the trust.
- The right to use real property (such as a residence) or tangible personal property owned by the trust.
- The right to effectively control the disposition of the trust assets upon death.
- The right to remove and replace an advisor or trustee.
- The right to use trust assets to pay income taxes.
- The right to serve as advisor to the trustee in connection with investment decisions.
The Ohio Legacy Trust Act generally prohibits a creditor from bringing an action of any kind against a Legacy Trust, the person who created the trust, the trustee of the trust, or against any person involved in the counseling, drafting, administration or funding of the Legacy Trust. The only way to bring a successful action against the trust is to void a specific transfer to the trust on the basis that the transfer was made with “a specific intent to defraud the specific creditor bringing the action.” The burden of proof to establish this fraud rests with the creditor and the creditor must demonstrate the matter by clear and convincing evidence. Moreover, any such claim must be brought within a designated and restricted timeframe which is generally 18 months from the date of the transfer. Further, the prevailing party will be awarded reasonable attorney fees.
Legacy Trusts are designed to protect against future problems that might not ever occur, but if they did occur, could be catastrophic. Therefore, these trusts should in most every case only be used to protect a portion of someone’s estate and should only be established when the person has a clean slate as to creditor claims. The idea is to protect a “nest egg” from the claims of creditors.
As discussed above, the Ohio statute provides that a whole litany of retained rights can be given to the transferor/grantor of the trust and still qualify the trust as a Legacy Trust. However, it may not be prudent to retain all those rights if, in fact, the grantor wants to derive maximum creditor protection. For example, if the grantor is given the right to all the income from the trust, then a creditor could levy against the income. If the grantor insists on having this right granted to him or her, then the trust should contain a provision that terminates the grantor’s rights to this income when and if a creditor claim may arise. This right of termination would likely be given to a trust advisor. The same holds true for giving the grantor the right to withdraw 5% of the trust corpus. If the grantor has this right, then the creditor would have this right.
Suffice it to say that with this new legislation, Ohio has caught up to or surpassed the 14 other states that have similar legislation. Therefore, it is no longer necessary for Ohio citizens to seek these protections in other jurisdictions that required that the trustee reside or be chartered in these other jurisdictions. These out-of-state endeavors have been time consuming and costly, not to mention subject to challenge from creditors outside the chosen jurisdiction. Ohio is deemed by most experts as being one of the top 5 pieces of legislation establishing DAPTs to date for many reasons including but not limited to its provisions that are designed to enforce its protections against creditor claims that arise outside of Ohio.
Certainly, it is always prudent to take steps to protect your assets from the claims of creditors. The purchase of liability insurance, when applicable, is still a prudent investment as a starting point for creditor protection. Further, as indicated above, Ohio has added exemptions to its laws including, but not limited to, 529 plans and inherited IRAs. The exemptions that existed prior to this legislation remain intact with the homestead exemption increasing in value. For example, life insurance is still a protected asset. The use of limited liability companies is still good practice and with recent legislation, we now know that a “charging order” is the sole and exclusive remedy given to a creditor with respect to a member’s interest in a limited liability company.
Accordingly, before embarking on the establishment of a Legacy Trust, it is recommended that the traditional tools first be utilized. Then to the extent deemed necessary, a Legacy Trust(s) can be put in place to further protect assets including, but not limited to, LLC interests that might be transferred into the same. If done properly, these Legacy Trusts will work to protect the transferred assets from the claims of the transferor’s creditors without fear that any laws have been violated.
Over the years, many individuals have sought our advice to protect their assets from potential malpractice and other claims. In the past, we have advised them of the opportunity to seek protection with the establishment of a DAPT or DAPTs in other jurisdictions. We can now utilize the laws of Ohio to better accomplish this objective.