One way to attack an irrevocable trust is to prove that the trust is the alter ego of the grantor because the trust is operated in a manner so that it has no separate existence from the grantor. Some courts describe this as the grantor “exercising such control that the trust has become a mere instrumentality of the owner.” In re Vebeliunas, 332 F.3d 85 (2nd Cir. 2003).
In WILSHIRE CREDIT CORPORATION v. KARLIN, 988 F.Supp. 570 (1997), Allan and Mary Rozinsky established an irrevocable trust for their children and transferred their home to the trust. The Rozinskys paid rent equal to the amount of the mortgage, insurance, and monthly expenses. For a time, the trust also owned a beach home that the Rozinskys rented from the trust. The trustees were close friends and relatives who admitted that most of their decisions were made at the direction of the Rozinskys.
After a time, the Rozinskys became unable to make the rent payments and they issued promissory notes to the trust in the amount of the delinquent rent, although no payments were made on the promissory notes. The court held that under Maryland law, alter-ego will only apply where necessary to prevent fraud, and because no fraudulent transfer had occurred, the creditors could not reach the trust assets despite the control exerted by the settlors.
In UNITED STATES v. EVSEROFF, No. 00-CV-06029 (E.D.N.Y. April 30, 2012), Jacob Evseroff established an irrevocable trust and transferred his primary residence to it after having received notice of a tax deficiency of over $700,000. A series of family friends served as the trustees of the trust. Evseroff did not pay rent to the trust for the privilege of living in the residence, but he did pay the mortgage and expenses as he had when he owned the home. The trust never assumed the mortgage and it was never listed on the flood or fire insurance on the home.
The court held that a plaintiff may pierce the veil of a trust, under the laws of New York, if the plaintiff can show that “(1) the owner exercised such control that the corporation has become a mere instrumentality of the owner, who is the real actor; (2) the owner used this control to commit a fraud or ‘other wrong’; and (3) the fraud or wrong results in an unjust loss or injury to the plaintiff.” Because the transfers to the trust were found to be fraudulent, and because the facts indicated that Evseroff had dominated the trust, the court allowed the government to collect against the assets of the trust.
Lessons learned from these cases: (1) don’t wait until you have a liability problem to transfer assets to an asset protection trust, (2) appoint a trustee who will take control of the trust, and (3) don’t allow a person other than the trustee to control or dominate the trustee or engage in transactions with the trust on terms that are not commercially reasonable in an arms-length transaction.