When the rich go “jurisdiction shopping” for the state with the most favourable trust laws, they often end up in Delaware.

The Blue Hen State, so nicknamed for the fighting gamecocks its solders carried during the Revolutionary war, has long been known as a favourable corporate jurisdiction, with more than half of the Fortune 500 companies domiciled there. But over the years, Delaware has also polished its reputation as a trust-friendly jurisdiction with attractive tax advantages.

Several other states, including South Dakota and Alaska, allow individuals to set up trusts that offer asset protection and estate-planning advantages. So why choose Delaware?

“The real advantage of Delaware is it is a jurisdiction that has always been friendly to businesses, trusts and investment throughout its history and at the same time there are a lot of [trust companies] to choose from,” says Don Weigandt, a wealth adviser at JPMorgan Private Bank.

Daniel Lindley, president of The Northern Trust Company of Delaware, a limited purpose trust company in Wilmington, Delaware, says one important reason for establishing a trust in Delaware is the state’s Court of Chancery. It was established in 1750 and is well known for its corporate law decisions and expertise in trust matters.

“With an established body of fiduciary law and a bench comprised of highly experienced jurists, the Court of Chancery provides lawyers and their clients the assurance that if a trust dispute should ever arise, Delaware has the judicial infrastructure to resolve it efficiently and fairly,” he says. “It is not just the law, it is the court that stands behind the law. ”

The court also respects the confidentiality of matters that are being adjudicated. “In those occasional instances in which a trust is involved in a court proceeding, the Court of Chancery is generally amenable to sealing the record of one of the parties, to preserve the confidentiality of the details of the trust and the family’s financial affairs,” Mr Lindley says.

Moreover, neither Delaware trust agreements nor trust accountings have to be filed with a court in the ordinary course, thereby ensuring privacy.

Delaware also has an active trust bar that reviews legislation annually and “fine tunes” it, Mr Lindley adds.

There are other reasons why Delaware appeals to the affluent and their advisers.

The first is that the state – like several others – permits the formation of perpetual “dynasty” trusts that may be exempt from certain federal generation-skipping transfer taxes (also known as the GST tax). In 1995 Delaware became the first state to repeal its Rule Against Perpetuities, in effect allowing trusts of personal property to potentially last forever.

A “dynasty” trust is appealing to “anybody who has a substantial estate . . . and wants to control his/her assets from the grave for a very long time or is interested in building family wealth that will not be subject to a federal transfer tax,” Mr Lindley says. Some grantors set up these trusts “as a basis for motivating their progeny for generations to come, while others are more focused on the enormous transfer tax savings”.

A second factor is Delaware irrevocable trusts are exempt from income tax on accumulated earnings and capital gains if there are no remainder beneficiaries who are Delaware residents and if the trust is not treated as a grantor trust for federal income-tax purposes.

“Trust heirs deserve to receive the largest portion of their legacy rather than having it consumed by costly taxes and expenses,” says Dick Nenno, managing director and trust counsel for Wilmington Trust Wealth Advisory Services.

A third consideration is the asset protection trust statute, which provides protection from creditors’ claims. While a Delaware asset protection trust (APT) allows a person to legally shelter assets from creditor claims, these trusts can also serve other purposes. They are sometimes set up in lieu of a pre-nuptial contract or by parents who do not want to fund a child’s profligate spending.

“Parents are realising it’s a useful tool for reining in kids who have been reckless in their financial management,” Mr Lindley says.

Ten years ago the state adopted a self-settled spendthrift statute, which allowed a grantor to form an irrevocable trust in which he/she is a beneficiary – known as a “self-settled” trust – and to include a “spendthrift clause” in the trust agreement to shield those assets from creditors.

In so doing, Delaware allowed a grantor to set up a domestic APT, also known as an irrevocable, self-settled spendthrift trust. Until then, the only US trust that would protect assets was one that a grantor set up for the benefit of others, from which he/she could not receive any distribution of income or principal.

Alan Jensen, a partner at the law firm Holland & Knight, says: “The hallmark of an APT is that, unlike other forms of spendthrift trusts and other asset protection techniques, it permits the donor to retain a beneficial interest in the trust, while removing it from the reach of future creditors.”

But what if another state court issues a judgment against a debtor who has set up a domestic APT in Delaware? Does the “Full Faith and Credit Clause” of the US Constitution, which requires courts of each state to recognise judgments rendered by courts of another state, apply?

“It is a seminal issue as it is a constitutional issue that has not been decided,” Mr Jensen says. “There has not been a test case where a judgment from another jurisdiction is filed against a Delaware trustee because a settlor owes a debt.

“But I am optimistic that under the correct set of facts the asset protection laws of Delaware and other jurisdictions with similar APT statutes would be sustained.

“If there has been a fraudulent transfer to an APT it might be set aside in bankruptcy court or in accordance with an out-of-state judgment. In the real world, however, plaintiffs must weigh the heavy costs of litigation and the probability of proving a fraudulent transfer against the likelihood of successful recovery.”

Another reason why the state is promoted as a place to manage wealth is the Delaware “directed” trust, which allows someone other than the trustee to make investment decisions if the trust provides this flexibility. What sets Delaware apart from other states with similar laws, says Mr Nenno, is that the trustee is not liable if the adviser’s investments go bad.

A fifth point to consider is what Mr Lindley calls “freedom of disposition”.

“Delaware for decades has had [a] policy that enables somebody to do almost whatever [they wanted] to do with their trust assets as long as they clearly express their intent,” he says. To that effect, Delaware last year adopted a provision that allows “purpose” trusts for a designated purpose but without a clearly defined beneficiary.

Wilmington Trust’s Mr Nenno, who championed the “purpose” trust provision, says there are many uses for these trusts. One could be set up to maintain a collection of antique automobiles or to help prevent a family company from going public. In this instance, the idea is the family puts money into the trust and if the family needs to sell its stock, the trust could fund the purchase.

A final point to bear in mind, notes Mr Lindley, is that for a variety of reasons grantors sometimes want to keep the details, if not the existence, of a trust from their children. This, however, runs counter to a trustee’s common law duty to disclose to a beneficiary their interest in the trust.

So Delaware passed an amendment allowing a grantor to direct the trustee “for a period of time” not to fulfil his/her obligation to tell the children.

Many of Delaware’s provisions are not unique, but Mr Nenno says the state’s “ongoing efforts to maintain a salubrious trust climate make it the best place to have personal trusts”.

Perhaps that is why, in the words of Thomas Jefferson, the second-smallest state is “a jewel among the states”.

At least for those in the trust business.

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