For Better Or For Worse-Prenuptial Agreement Or Domestic Asset Protection Trust?
By: Randall A. Denha, J.D., LL.M.
Instead of writing anything about COVID, I wanted to get back to business and write about planning and what has been on the mind of many people who are thinking about walking down the aisle.
It’s commonly said that half of all marriages end in divorce. While that may have been true at some point, that stat is out of date, at least for the United States. As demographics and economics change in our country, along with attitudes about marriage vs. cohabitation, the divorce number paints a much rosier picture than conventional wisdom. The Centers and Disease Control and Prevention notes that — as of 2016, the most recent information available — the real divorce rate in the United States is 3.2 per 1,000 people. A better number to zero in on, other than the 3.2 per 1,000 people, is this: The divorce rate dropped 18% between 2008 and 2016. That’s according to a recent study on divorce rates by Philip N. Cohen of the University of Maryland.
That said, and notwithstanding the good news on divorce rates, without appropriate planning, a spouse seeking divorce will likely be entitled to an equitable portion of marital property, which can include all assets, and in some cases, inheritances and other assets held prior to the marriage.
Therefore, it is important for couples contemplating marriage to find ways to clearly communicate their wishes with regard to their assets and income before the wedding day. Prenuptial agreements are often invalidated if executed too close in time to the wedding ceremony so communicating is the key.
So, what options exist for the protection of assets for those contemplating marriage? It typically is between a Prenuptial Agreement and Domestic Asset Protection Trust.
Prenuptial Agreement
A recent 2013 study found that only about 3% of all married or engaged couples have executed a prenuptial agreement. Absent appropriate care and attention to detail, prenuptial agreements are susceptible to challenges and may be invalidated by the court. Prior to 1991, prenuptial agreements were invalid in Michigan because such agreements were thought to encourage people to divorce. However, a court ruled that the state could enforce prenuptial agreements.
In essence, the Courts have always been able to pierce a prenuptial agreement to avoid an inequitable result. How can we possibly know, when entering into a prenuptial agreement, what will appear inequitable to a court (which we can’t choose) several years (and asset changes) down the road? There has never been a guaranteed answer to this question, but careful attorneys and parties will take steps to make prenuptial agreements appear more equitable.
Steps to limit an inequitable result include (1) signing the prenuptial agreement well before the wedding, (2) ensuring that both parties are independently represented by counsel, (3) full disclosure of the assets and liabilities of each prospective spouse on schedules attached to the executed prenuptial agreement. Additionally, Michigan courts will enforce prenuptial agreements if they meet the following conditions:
- There was no fraud, duress, mistake, misrepresentation or non-disclosure of material information when executing the agreement.
- The agreement was not unconscionable when the parties executed it.
- It would not be unfair to enforce the agreement because of a change in facts or circumstances.
One of the best ways to ensure that a prenuptial agreement is enforceable is to provide full financial disclosure to your partner. Additionally, each party should have adequate time to review the agreement with the assistance of an independent attorney.
As a practical matter, asking a future spouse to enter into a prenuptial agreement often causes discomfort to blossoming relationships. The person being asked to enter into a prenuptial agreement may well interpret such a request as implying that their future spouse does not trust them, or that their future spouse expects the marriage to fail. As a result, many couples are reluctant to even talk about such agreements. Moreover, many people are not comfortable sharing their financial information to satisfy the full and accurate financial disclosure requirement which further deters many couples who might otherwise consider a prenuptial agreement from entering into a signed agreement. The bottom line is that while many couples are delighted to share their lives together when entering into a marriage, they may feel uncomfortable sharing information about their net worth.
Domestic Asset Protection Trust
Because of the issues and complications surrounding prenuptial agreements, many couples are looking for alternatives to protect assets obtained prior to marriage and protect future inheritances. Asset protection trusts give couples a great alternative to the traditional prenuptial agreement. While asset protection trusts can be formed domestically or offshore, establishing and administering foreign asset protection trusts has become very expensive. And, in addition to the high cost, most people are uncomfortable with sending their assets offshore. A much better alternative may be a domestic asset protection trust (DAPT) sitused in one of the seventeen states that authorize the use of self-settled asset protection trusts in some form. DAPTs are powerful trusts that protect assets from potential unknown creditors, which by definition includes a future divorcing spouse. Moreover, a DAPT allows the creator to name himself or herself as a potential beneficiary in many cases—hence the name “self-settled” trust.
To recap: a DAPT is an irrevocable, self-settled trust, which permits the person establishing the trust (the “grantor” or “settlor,” referred to as the “transferor” in the law) to fund the trust with his or her own assets and remain a permissible beneficiary of the trust. A properly structured DAPT shields those trust assets from the claims of most future creditors of the grantor, making them particularly attractive planning techniques for business owners and professionals in high risk occupations, such as executives and medical professionals.
As with any estate planning technique, a DAPT must meet certain criteria to be valid. At minimum, the domestic asset protection trust:
- Must be irrevocable;
- Should appoint a trustee (or trustees) with the discretion to administer the trust;
- Must appoint a trustee, whether corporate or individual, that is a qualified trustee of the jurisdiction in which the trust is formed; and
- Must contain a spendthrift clause, which restricts the transferability of a beneficiary’s interests in the trust property.
Additionally, in exchange for restricting the use of the trust assets, those who establish DAPTs receive several benefits. First, because the assets gifted to the DAPT constitute trust property, the creator may protect those assets against claims made by future creditors of the creator, including a future spouse. Furthermore, unlike other types of irrevocable trusts where the grantor gives up all rights to the assets funded to the trust, a grantor or creator of a DAPT retains a beneficial interest in the trust while protecting the assets from future unknown creditors. Therefore, a potential spouse can establish a domestic asset protection trust that is fully discretionary, receive financial benefit from the trust during his or her lifetime, and protect the trust assets from a bad marriage that is solemnized after the creation of the trust.
In order to protect assets during a divorce, the assets must have already been placed in the trust. Therefore, in drafting a DAPT, all individual assets that your client wants to keep separate and prevent from becoming marital assets that their spouse is entitled to must draft these assets into the property provisions of the trust. Additionally, to protect assets from divorce, your client’s spouse should not be one of the discretionary beneficiaries that can benefit from the trust.
Provisions that make the trust completely discretionary maximize the protection a DAPT provides during divorce because if the trustee is the sole decider of whether or not to pay assets out of the trust account then there is less of an argument that the trust asset contributed to fund the marital lifestyle and add to the marital property.
One of the most effective provisions in protecting assets from a divorcing spouse is to have the property ownership interest transfer entirely to the trustee at the time the trust is established. In general, this will protect your client’s assets in states where the court is able to dip into the personal and separate assets of one spouse in order to make the marital division equitable. The court in general will not be able to access assets in the DAPT account that your client does not have any ownership or control over and these assets will not be considered part of your client’s personal and separate property.
Prenuptial Agreement or DAPT, or both?
Because of the possibility of a court rewriting the intent of the parties based on equitable principles, a better way to ensure protection of separate property prior to a marriage includes the use of irrevocable trusts, including a DAPT, which can be used by either party to provide enhanced asset protection for separate assets. I would argue that while a prenuptial agreement and DAPT are similar tools, a DAPT is superior and more powerful tool. Why? Prenuptial agreements are contracts and like any contract, can be misconstrued or equitably rewritten by a judge. Of course, you can have both as well, as a sort of belt and suspender approach, to provide a prenuptial contract for your understanding with your spouse and a DAPT to protect the assets that the spouse agrees not to pursue.
