Does a creditor have to prove fraud to reach assets a Tennessee debtor put into an investment services trust?

Subject

Opinion No. 11-79, Creditors' Claims under the Tennessee Investment Services Act of 2007, November 17, 2011

Plain-English summary

Tennessee opened the door to domestic asset protection trusts in 2007. The Tennessee Investment Services Act, codified at Tenn. Code Ann. §§ 35-16-101 to 112, lets a person create an irrevocable trust for the person's own benefit that shields trust assets from the transferor's future creditors. Before 2007, Tennessee was a "no self-settled spendthrift trust" state under cases like Citizens' Nat'l Bank v. Watkins (1912) and J.S. Menken Co. v. Brinkley (1895): a person could not set up a trust that protected the person from the person's own creditors. The 2007 Act reversed that traditional rule.

Senator Norris asked the AG to spell out what a creditor has to prove to reach assets in an investment services trust. The AG read the Act, alongside the Uniform Fraudulent Transfer Act it incorporates, and gave a clean two-track answer.

For the trust to qualify, four conditions must be met. The trust instrument must (1) appoint a "qualified trustee" under § 35-16-102(12); (2) expressly incorporate Tennessee law on validity, construction, and administration; (3) be irrevocable; and (4) include a spendthrift clause barring transfer, assignment, pledge, or mortgage of the transferor's or beneficiary's interest before distribution. § 35-16-102(7).

For creditor attacks on a "qualified disposition" of property into the trust, § 35-16-104(a) makes the UFTA the exclusive procedural channel and adds a wrinkle for after-arising claims: "in the case of a creditor whose claim arose after a qualified disposition, unless the qualified disposition was also made with actual intent to defraud such creditor."

The AG read those provisions together with the UFTA's two main fraud-of-creditors sections:

• Tenn. Code Ann. § 66-3-305(a) covers both existing and future creditors. Subsection (a)(1) requires "actual intent to hinder, delay, or defraud." Subsection (a)(2) requires only constructive fraud (transfer without reasonably equivalent value while engaged in undercapitalized business or unable to pay debts as they come due).
• Tenn. Code Ann. § 66-3-306 covers existing creditors only and is a pure constructive-fraud provision (transfer without reasonably equivalent value while insolvent).

Put it together. If the creditor's claim arose before the qualified disposition, the creditor can use either constructive fraud under §§ 66-3-305(a)(2) or 66-3-306, or actual fraud under § 66-3-305(a)(1). If the creditor's claim arose after the qualified disposition, the § 35-16-104(a) overlay kicks in and requires actual intent to defraud that particular creditor. Constructive fraud is not enough for after-arising creditors.

The Act also imposes a statute of repose at § 35-16-104(b): pre-existing creditors must sue within the UFTA's normal limitations period (§ 66-3-310). Concurrent or post-disposition creditors must sue within four years of the qualified disposition, even if the normal limitations period would otherwise run longer.

Currency note

This opinion was issued in 2011. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

The Tennessee Investment Services Act has been amended since 2011, and case law continues to develop around domestic asset protection trusts. Anyone planning or attacking a TIST should consult current statute text and case law.

Background and statutory framework

The Tennessee Investment Services Act. Tenn. Code Ann. §§ 35-16-101 to 112, enacted by 2007 Tenn. Pub. Acts Ch. 144. The Act overrode Tennessee's traditional rule against self-settled spendthrift trusts. Pre-2007 cases (Citizens' Nat'l Bank v. Watkins, 126 Tenn. 453, 150 S.W. 96 (1912); J.S. Menken Co. v. Brinkley, 94 Tenn. 721, 31 S.W. 92 (1895); State v. Nashville Trust Co., 28 Tenn. App. 388, 190 S.W.2d 785 (1945)) all held a self-settled spendthrift trust unenforceable against the transferor's creditors.

Investment services trust definition. § 35-16-102(7): four-part test. (A) qualified trustee; (B) Tennessee governing law; (C) irrevocable; (D) spendthrift clause as quoted above. § 35-16-102(7)(C) sets out the required spendthrift language.

Qualified disposition. § 35-16-102(11): a disposition by or from a transferor with or without consideration, to an investment services trust after the transferor executes a qualified affidavit.

Creditor attack procedure. § 35-16-104(a): no attachment, provisional remedy, or avoidance action against property that was the subject of a qualified disposition, except through the UFTA. For after-arising creditors, the qualified disposition must also have been made "with actual intent to defraud such creditor."

UFTA standards. Tenn. Code Ann. § 66-3-305(a): "A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor's claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation: (1) With actual intent to hinder, delay, or defraud any creditor of the debtor; or (2) Without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor: (A) Was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or (B) Intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor's ability to pay as they became due."

Tenn. Code Ann. § 66-3-306: "(a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made or the obligation was incurred if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation."

Constructive vs. actual fraud. Bankruptcy court decisions describe § 66-3-305(a)(2) and § 66-3-306 as constructive-fraud sections; only § 66-3-305(a)(1) requires actual intent. In re Webb Mtn., LLC, 420 B.R. 418, 431 (Bankr. E.D. Tenn. 2009); In re Silvey, 378 B.R. 186, 189 (Bankr. E.D. Tenn. 2007).

Statute of repose. § 35-16-104(b): pre-existing-claim creditors must sue within the limitations of § 66-3-310 in effect on the date of the disposition; concurrent or post-disposition creditors must sue within four years of the qualified disposition.

Common questions

Why does Tennessee even allow self-settled asset protection trusts?

The 2007 legislation followed a wave of similar enactments in Delaware, Alaska, Nevada, and other states that compete for trust business. Tennessee was preserving its trust industry by matching the legal product offered elsewhere. The federal Bankruptcy Code's 10-year clawback for self-settled trusts (11 U.S.C. § 548(e)) limits the bankruptcy-side protection but does not directly govern state-court creditor actions.

What is the "qualified affidavit" requirement?

Section 35-16-102(11) ties a qualified disposition to a "qualified affidavit" executed by the transferor. The affidavit requirements (full disclosure of solvency, no pending litigation, intent to defraud) are set out elsewhere in the Act and are a key compliance point. A defective affidavit can knock out qualified-disposition status.

Why is the after-arising-creditor standard so much harder?

The whole point of an asset protection trust is to shield the transferor from claims that arise later. Allowing constructive-fraud attacks by after-arising creditors would gut the protection, because nearly every funding event could be challenged as constructive fraud if the trust later turned out to have made the transferor judgment-proof. The Act draws the protection line at the disposition date.

What happens if a creditor proves actual intent to defraud?

The qualified disposition can be avoided to the extent necessary to satisfy the creditor's claim. The Act and the UFTA together let the creditor recover the property or its value from the trust.

Does this affect federal bankruptcy treatment?

Yes, indirectly. The federal Bankruptcy Code at 11 U.S.C. § 548(e) provides a ten-year clawback specifically for transfers to a self-settled trust if the transferor had actual intent to hinder, delay, or defraud a present or future creditor. The federal standard is stricter on the time horizon than the Tennessee four-year repose. Bankruptcy trustees often use § 548(e) regardless of state-law repose.

Citations

• Tenn. Code Ann. §§ 35-16-101 to 112
• Tenn. Code Ann. § 35-16-102(7)
• Tenn. Code Ann. § 35-16-102(7)(C)
• Tenn. Code Ann. § 35-16-102(11)
• Tenn. Code Ann. § 35-16-102(12)
• Tenn. Code Ann. § 35-16-102(14)
• Tenn. Code Ann. § 35-16-104
• Tenn. Code Ann. § 35-16-104(a)
• Tenn. Code Ann. § 35-16-104(b)
• Tenn. Code Ann. § 66-3-305(a)
• Tenn. Code Ann. § 66-3-306
• Tenn. Code Ann. § 66-3-310
• 2007 Tenn. Pub. Acts Ch. 144
• Citizens' Nat'l Bank v. Watkins, 126 Tenn. 453, 150 S.W. 96 (Tenn. 1912)
• J.S. Menken Co. v. Brinkley, 94 Tenn. 721, 31 S.W. 92 (Tenn. 1895)
• State v. Nashville Trust Co., 28 Tenn. App. 388, 190 S.W.2d 785 (1945)
• In re Webb Mtn., LLC, 420 B.R. 418 (Bankr. E.D. Tenn. 2009)
• In re Silvey, 378 B.R. 186 (Bankr. E.D. Tenn. 2007)

Source

• Landing page: https://www.tn.gov/attorneygeneral/opinions.html
• Original PDF: https://www.tn.gov/content/dam/tn/attorneygeneral/documents/ops/2011/op11-079.pdf

Original opinion text

November 17, 2011
Opinion No. 11-79
Creditors' Claims under the Tennessee Investment Services Act of 2007

QUESTION

Whether the Tennessee Investment Services Act of 2007 requires a creditor to prove fraud in order to prevail on an action for attachment or other provisional remedy against property that is a qualified disposition to an investment services trust, or to avoid a qualified disposition to such a trust?

OPINION

Yes. If the creditor's claim arises before a qualified disposition, the creditor may prevail by proving actual or constructive fraud. However, if the creditor's claim arises after a qualified disposition, the creditor must prove actual intent to defraud.

ANALYSIS

The Tennessee Investment Services Act of 2007 ("the Act"), codified at Tenn. Code Ann. §§ 35-16-101 to 112, permits a person to establish an irrevocable "investment services trust" that shields trust assets from the transferor's future creditors. See Tenn. Code Ann. § 35-16-102(7) & (14); Tenn. Code Ann. § 35-16-104. Prior to the passage of this Act, Tennessee law did not permit a person to create a spendthrift trust for his or her own protection. See Citizens' Nat'l Bank v. Watkins, 126 Tenn. 453, 150 S.W. 96, 97 (Tenn. 1912); J.S. Menken Co. v. Brinkley, 94 Tenn. 721, 31 S.W. 92, 94 (Tenn. 1895); State v. Nashville Trust Co., 28 Tenn. App. 388, 190 S.W.2d 785, 790 (1945). See also 2007 Tenn. Pub. Acts Ch. 144, § 13.

Under Tenn. Code Ann. § 35-16-102(7) of the Act, a trust instrument must meet four requirements before it will qualify as an "investment services trust." First, the instrument must appoint a "qualified trustee," as defined by Tenn. Code Ann. § 35-16-102(12). Second, the trust must expressly incorporate Tennessee law regarding the validity, construction, and administration of the trust. Third, the trust must be irrevocable. Finally, the trust instrument must provide that "the interest of the transferor or other beneficiary in the trust property or the income from the trust property may not be transferred, assigned, pledged or mortgaged, whether voluntarily or involuntarily, before the qualified trustee or qualified trustees actually distribute the property or income from the property to the beneficiary." Tenn. Code Ann. § 35-16-102(7)(C).

Tenn. Code Ann. § 35-16-104 of the Act addresses creditors' claims against property subject to a "qualified disposition,"[1] stating in pertinent part:

(a) Notwithstanding any law to the contrary, no action of any kind, including, but not limited to, an action to enforce a judgment entered by a court or other body having adjudicative authority, shall be brought at law or in equity for an attachment or other provisional remedy against property that is the subject of a qualified disposition to an investment services trust or for the avoidance of a qualified disposition to an investment services trust, unless the action is brought pursuant to the provisions of the Uniform Fraudulent Transfer Act, compiled in title 66, chapter 3, part 3, and, in the case of a creditor whose claim arose after a qualified disposition, unless the qualified disposition was also made with actual intent to defraud such creditor.

(b) A creditor's claim under subsection (a) shall be extinguished unless:

(1) The creditor's claim arose before the qualified disposition to an investment services trust was made, and the action is brought within the limitations of § 66-3-310 in effect on the date of the qualified disposition; or

(2) Notwithstanding § 66-3-310, the creditor's claim arose concurrent with or subsequent to the qualified disposition and the action is brought within four (4) years after the qualified disposition is made.

Tenn. Code Ann. § 35-16-104(a)&(b).

Accordingly, pursuant to Tenn. Code Ann. § 35-16-104(a), a creditor must bring his or her action for attachment or other provisional remedy against property in the qualified disposition pursuant to the Uniform Fraudulent Transfer Act ("UFTA"). The UFTA contains two sections addressing creditors' claims seeking to avoid and recover fraudulent transfers. The first section addresses the avoidance and recovery of fraudulent transfers by existing and future creditors, and provides:

(a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor's claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation:

(1) With actual intent to hinder, delay, or defraud any creditor of the debtor; or

(2) Without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor:

(A) Was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or

(B) Intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor's ability to pay as they became due.

Tenn. Code Ann. § 66-3-305(a).

In short, subsection (a)(1) requires the creditor to prove actual fraud by the debtor in order to avoid and recover the transfer of property by the debtor as a fraudulent transfer. Subsection (a)(2) requires only a showing of constructive fraud, meaning the property at issue may be avoided and recovered as a fraudulent transfer by a creditor without proving an actual intent to defraud. In re Webb Mtn., LLC, 420 B.R. 418, 431 (Bankr. E.D. Tenn. 2009); In re Silvey, 378 B.R. 186, 189 (Bankr. E.D. Tenn. 2007).

The second section of the UFTA addressing creditors' claims is Tenn. Code Ann. § 66-3-306. It addresses avoidance and recovery of fraudulent transfers by existing creditors, stating:

(a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made or the obligation was incurred if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation.

(b) A transfer made by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made if the transfer was made to an insider for an antecedent debt, the debtor was insolvent at that time, and the insider had reasonable cause to believe that the debtor was insolvent.

Tenn. Code Ann. § 66-3-306.

Like Tenn. Code Ann. § 66-3-305(a)(2), Tenn. Code Ann. § 66-3-306 requires a showing of constructive fraud. In re Webb Mtn., LLC, 420 B.R. at 18; In re Silvey, 378 B.R. at 190-91. Accordingly, if a creditor's claim arises before a qualified disposition, pursuant to Tenn. Code Ann. § 35-16-104(b) the creditor will prevail on an action for attachment or other provisional remedy against property that is a qualified disposition to an investment services trust, or for the avoidance of a qualified disposition to such a trust, if the creditor establishes either actual or constructive fraud by the transferor of the property.

The aforementioned UFTA provisions govern any actions by an existing creditor to attach or pursue any other provisional remedy against property in a qualified disposition. However, with respect to a creditor's claim arising after a qualified disposition, Tenn. Code Ann. § 35-16-104(a) grafts an additional limitation on the UFTA's provisions by requiring such a creditor to show that the qualified disposition was made with the actual intent to defraud the creditor. Thus, if a creditor's claim arises after a qualified disposition, the creditor must prove actual fraud in order to prevail on an action for attachment or other provisional remedy against property that is a qualified disposition to an investment services trust or for the avoidance of a qualified disposition to such a trust.

[1] A "qualified disposition" is "a disposition by or from a transferor with or without consideration, to an investment services trust after the transferor executes a qualified affidavit." Tenn. Code Ann. § 35-16-102(11).

ROBERT E. COOPER, JR.
Attorney General and Reporter

WILLIAM E. YOUNG
Solicitor General

LAURA T. KIDWELL
Senior Counsel

Requested by:
The Honorable Mark Norris
State Senator
9A Legislative Plaza
Nashville, TN 37243