It is unfortunate, but true: We live in a highly litigious society and people today seem to sue one another over just about anything. Worse, you never really know what a jury might decide, regardless of how frivolous a lawsuit may appear. Even some of the people you love the most may need protection from themselves, such as those who suffer from drug or alcohol dependency, or who lack the maturity to handle a large inheritance on their own. All of this helps explain why Asset Protection Planning is such a rapidly growing area of the law and why it is so important for you to have a plan expertly tailored to your specific needs – particularly if you are a physician, attorney, CPA, business owner, real estate developer, or member of a profession that is subject to an unusually high number of lawsuits.
At Bohm Wildish & Matsen, our asset protection lawyers provide the guidance that individuals, families and owners of closely-held companies need in understanding the risks they face. We then design creative asset protection plans to guard against potential liabilities. With years of experience in all areas of asset protection law, and an extensive network of leading financial professionals world-wide, we are particularly skilled at establishing and managing offshore trusts and corporations. The techniques and strategies we can use to protect your hard-won assets and legacy include:
- Offshore and domestic business entity formation
- Domestic trusts designed to safeguard assets from predators
- Offshore trusts, placing your assets beyond the jurisdiction of U.S. Courts and out of harm’s way
- Equity stripping and asset isolation strategies to minimize the risks posed by potential predators and which ensure your privacy
Asset Protection Limitations – The Fraudulent Transfer Law
The most important limitation and obstacle to Asset Protection Planning is the Fraudulent Transfer Law. This law provides that a debtor cannot transfer assets if the principal reason for the transfer is to prevent present or future creditors from gaining access to these assets. The language of “delaying, hindering, or defrauding” creditors is the basis of setting aside transfers by creditors against debtors. Normally, in order for the transfer to be classified as fraudulent, the transfer involved, when taken into account with the potential amount of the creditor claim, has to make the transferor insolvent. The consequences of the Fraudulent Transfer Law make it imperative that the business owner or professional implement Asset Protection strategies before a creditor claim arises. Once the facts occur which give rise to the creditor claim, planning is much more difficult (although there are still some steps that can be taken in the appropriate circumstances).
Asset Protection Planning is a very important part of Estate Planning. It relates to the preservation and safeguarding of the assets that one has accumulated over the years and that have value. In other words, Estate Planning is not only concerned with the orderly and tax efficient manner of distributing assets at death, but also in preserving and safeguarding assets during lifetime.
One of the most important principles of Asset Protection Planning is to develop a multi-tier approach to preserving the assets. This multi-tier approach works together as a whole to bring an individual to a higher level of protection. Each individual situation may be different, but almost all tiers of the planning implementation are worthy of consideration and review.
Business persons have always been concerned about the exposure of their personal assets to claims against their business or real estate. It was for this reason that several centuries ago the corporate form of business entity with its shield of limited liability was invented and utilized by business persons in Europe. Over the last few decades expanding theories of liability and the proliferation of litigation have made it even more imperative that Asset Protection Planning be instituted.
Business owners, physicians, real estate investors and other professionals who render services must always be extremely concerned about potential liability against their personal assets, which liability is created from the operation of their business, from the rendering of their services or the ownership of real estate. In this regard, entities such as corporations, limited liability companies and limited partnerships exist to create a shield of liability from this potential personal liability. As our society has become more litigious, Asset Protection Planning has become more vitally important and has to be considered by everyone with any assets of any value whatsoever or of some substantial value.
“Inside” and “Outside Creditors” are terms of art that are utilized within the area of Asset Protection Planning. Inside Creditors are those creditors whose claim is directed against the business or real estate owned inside of separate business entity. For example, if one owns an apartment house and it is placed in a limited liability company or LLC and a slip and fall occurs at the apartment house, then this would be an inside debt. The creditor would go directly against the LLC that houses the apartment house. Hopefully, insurance will cover this, but, as most of you know, this is not always the case. Many times things can happen on real estate that are beyond the limits of the insurance or not covered by the policy itself. The corporation and LLC form of business entity are designed to protect personal assets from claims against the business or real estate. In other words, these claims are isolated within the entity itself and against the business operation or real estate itself and the other assets of the owner are, therefore, protected because of the confinement of the business and real estate claims.
If a manufacturing concern operates either in a corporation or an LLC and there is a breach of warranty claim, this would be an inside debt. The claimant would asset the claim against either the corporation or the LLC as the case may be and theoretically the claim would be limited to the particular business or real estate involved.
A. Victim Oriented Society
First of all we now live in a victim oriented Society. There is a strong societal tendency to assert claims based on misfortune and general ills against some specific person or entity. Many of these claims are just based on instances of accident or misfortune that occur on a daily and often times routine basis. In the past, our society recognized these unfortunate occurrences as part of life, but over the last few decades some people have developed a strong tendency to assign blame on someone or something instead of accepting the situation as part of life. In fact, this victim oriented principle is based to some extent on the division of the “haves” and the “have nots”. Victims of some of these misfortunes are prone to blame those who they perceive to have more assets or are in a better financial situation than they are.
B. Plaintiff Lawyers
Most of these lawyers take the claim on a contingency basis which makes it easier for the victims to pursue the claim because they are not out of pocket for legal fees or costs. The lawyers are willing to take the cases because of the potential pot of gold that is available at the conclusion of the case either by settlement or otherwise. The juries who may try these cases may be composed of individuals who believe in the victim oriented society philosophy or who are “have nots” and feel comfortable about taking from the “haves”. There also seems to be a surplus of lawyers and many of them are looking for any kind of a case to pursue because they don’t have an established law practice and other more deserving cases to litigate.
C. Deep Pocket Theory
The deep pocket theory is really based on the differentiation between the “haves” and the “have nots”. The rational apparently is that if an individual has some wealth then it really does not hurt them to extract a portion of their assets to compensate an alleged victim and to correct a so called impropriety or act of negligence.
D. Expanding Theories of Liability
Our courts are of a reflection of society and as the victim oriented philosophy and the aggressiveness of plaintiff lawyers have become more common, under pressure the courts have greatly expanded theories of liability. The courts often times are influenced by the philosophy that the risks of life of should be spread out among those who have the ability to pay compensation.
All of these factors combined together to create a tremendous need for Asset Protection among all individuals who have assets and property of some value and it is, obviously, better to plan ahead rather than to wait for the claim to be asserted (which greatly limits the availability of many Asset Protection Planning action steps).
I have compiled a list of individuals who are the most likely victims of lawsuits and claims and who need to protect their assets the most. This list is published in a book I have authored and published by the American Bar Associated entitled “ABA Consumer Guide to Asset Protection”.
The subject list as follows:
• Doctors, dentists, lawyers, CPAs, architects, engineers and other professionals subject to claims of malpractice and negligence
• Potential recipients of substantial inheritances from parents or other family members
• Business owners who might be subjected to personal liability as a result of the expanding theories of liability imposed by courts and statutes such as sexual and age discrimination, sexual harassment and other tort claims
• Sellers’ of business operations who are subjected to claims of fraud and nondisclosure when buyer’s remorse sets in
• Individuals with high-risk businesses, such as waste, refuse and other businesses that impact the environment
• Any business individuals dealing with investors who may become disgruntled if the investment turns sour
• Individuals who have to sign personal guarantees and bonds, i.e., contractors and other business owners
• Officers and directors of public companies who face personal liability as a result of such cases as Enron and other related claims
• Owners of boats, airplanes or extreme vehicles
• Real estate investors and owners
• Successful independent contractors who are at or near the top of a multilevel marketing or distribution program who have liability exposure from disgruntled, envious, and unsuccessful independent contractor underlings in their marketing and distributions systems
• Celebrities, high-net-worth and high-visibility individuals
• Wealthy spouse in a second marriage
• Children of wealthy individuals
• Almost anyone who has assets or property who is involved in a serious automobile or another type of accident resulting in personal injury
The typical creditor process begins when the facts creating the claim occur. If the claim is contractual in nature, the claim arises when the alleged contract is breached or there is a default. Other claims arise out of some sort of alleged action on the part of the defendant that is alleged to be wrongful in nature such as a driver of an automobile accident or the provider of alleged malpractice services by a professional.
Upon discovering the claim, the creditor at this time normally issues a demand for compensation. Often times in a more complicated case, the amount of damages cannot immediately be determined. The claimant then files a complaint and asks for damages either in a set amount or an amount to be determined in the future by the court. Once the claim is filed and the court process begins, the defendant most likely will have to retain an attorney. If the defendant properly does not respond to the court complaint, then a default might be entered and the defendant loses the right to contest the case. Assuming that the defendant files the proper response, the case then goes into the discovery process. During this process, both the plaintiff and the defendant need to demand answers to written interrogatories and subpoena records and take depositions.
When the discovery process is completed the case is set for a trial. During this period of time, there is an opportunity to have mediation or arbitration settle the case. If the case remains unsettled, then it would go before either a jury or a judge. The whole process is very expensive and time-consuming.
If the creditor obtains a judgment, then he or she may demand a judgment debtor examination to enforce the judgment. This examination will obligate the defendant/debtor to disclose all of their assets and sources of income. If there is a proper Asset Protection structure in place, then it will act as a firewall or a series of firewalls that will give the debtor/defendant much more leverage in dealing with the creditor. If there is proper planning soon enough, then these barriers might be able to prevent the plaintiff from reaching the assets at all.
It should be emphasized that because of the ability of the plaintiff/creditor to interview and demand information under penalty of perjury, the defendant debtor really cannot hide assets without committing a felony and going to jail. However, there are planning structures that, if properly set in place, can provide significant barriers to the plaintiff’s remedies and attempts to enforce collection. The critical element is to plan well and plan in advance and then properly implement the planning.
One of the first and most important decisions a business owner, real estate investor or practicing professional must address is selecting a proper form of business entity. This is a critical decision because of the on-going legal and tax ramifications. Liability protection is, obviously, the most important nontax consideration in the business entity selection process. Business owners and real estate investors need a shield or umbrella of liability protection that covers their business and real estate activities in order to protect their other personal assets from liability exposure. These kinds of claims are the inside debts that are talked about in questions No. 2, above. They are the claims that directly arise out of and are asserted against the business and real estate operations themselves. No prudent business or real estate owner in our litigious, deep pocket searching society can afford to do business without incorporation or establishing an LLC for liability protection purposes. In any event, a business owner or executive, a real estate owner or investor, and a professional rendering services need to make sure that the entity which is operating their business or owns their real estate assets is properly set up and provides the necessary shield of liability protection so that if there is a claim, it can be isolated against the business or real estate itself. In this way, the owner’s other personal assets will be free from attack.
Also, it is important that if we are talking about a corporation as the business entity that there is proper compliance relative to the entity. This means that there have to be minutes and proper resolutions and meetings of the shareholders and directors. This process has to be complied with in order to sustain the proposition that the corporation is a separate legal entity and affords the protection of the liability umbrella that is so necessary to withstand claims and defect the personal assets of the owner.
A Living Trust is a legal document drafted by a qualified attorney that contains the makers or the settlor or trustor instructions for the disposal of his or her assets at death. A Living Trust is just like setting up one’s own family company in that it continues past the maker’s death to carry out dispositive wishes. The concept is simple and avoids the expense and delay of court proceedings. The trustors retain control of the assets in the Trust during their lifetime and they can do everything they could do before when the assets were in their personal name such as buy and sell assets, change or even cancel the Trust and even file the same tax returns. Briefly, the benefits of the Living Trust are that it avoids probate at death and it provides maximum privacy and prevents court control of the asset in the case of incapacity.
However, the typical Living Trust provides no protection whatsoever against creditors of the maker of Trust or the Trust itself. It can provide protection against creditors of the heirs, but, normally, it will not provide protection against the Trustor’s own creditors. That is why that business owner, real estate owners and professionals explore other means to protect their asset during their lifetime. The Living Trust is an important document to have and basic Estate Planning is important to do. However, in reviewing the Estate Planning of any individual, the concept of Asset Protection Planning should be a critical part of that review and planning. Many times this means much more than just a traditional Living Trust and Will. It involves many other techniques that are set forth in the articles that follow.
When it comes to investment assets, the LLC is usually the entity of choice. The LLC is utilized in this content more than corporations because it provides more flexibility tax wise and has the same shield of liability that the corporation has. The LLC is a passive entity for tax purposes because it is either a disregarded entity (taxed like a proprietorship if it is not a single member LLC or pass through entity taxed like a partnership if it is a multi-member LLC). The LLC can elect to be taxed as a Sub S Corporation or even a C Corporation.
Many business owners and professionals purchase real estate as investments or vacation homes. This can expose the real estate owner to tremendous liability. Obviously, insurance can cover a lot of such liability. However, there are many claims that are either not within the purview of the insurance policy or they may exceed the policy limits. The LLC is very flexible both in a structure for management purposes and relative to its tax consequences. Because it is a pass-through entity, it is an excellent vehicle for holding title to real estate.
We have to recall again the fact that claims against the property itself are inside debts and these inside debts are kept within the confines of the property or the LLC when the LLC is properly set up and maintained. This means that the plaintiff cannot attack the other property of the defendant owners. The LLC isolates these claims by means of the shield of liability protection that surrounds the LLC.
It is true that many businesses have various assets and business operations that can be segregated and place into multiple liability protector entities. For example, in my book in Chapter Eight, I talk about a landscaping company can place all of its equipment and tools into a separate LLC. This LLC can then rent the equipment and tools to the corporation that provides the landscaping services. This is also a good structure for construction companies where they can place their expensive equipment into a separate entity so it would be more difficult for creditors of the business to attack them. Normally, real estate assets in the business should be kept outside of the entity that operates the business. Real estate should never be placed into a C Corporation because of the potential double tax consequences upon its sale. Doctors and other professionals who own the buildings in which they practice should have the buildings placed into LLCs and then lease to the entity that operates their practice or renders their professional services.
The Charging Order is a court mandate available to a judgment creditor that is directed to the LLC of which the debtor is a member. This Order grants the judgment creditor the right to whatever distributions would otherwise be due to the debtor member whose interest is being charged. This remedy is only available to a judgment creditor which means that first of all the creditor has to successfully sue the debtor and obtain a judgment for a specific sum of money. Specifically, the debtor’s LLC interest and not the debtor or the LLC itself would be charged to satisfy the judgment.
The Charging Order grew out of the English Partnership Act of 1890 which, in turn, was developed through the common law cases in jolly old England. The purpose of the Charging Order is to prevent the judgment creditor of an individual member from gaining access to the LLC assets while at the same time giving the creditor some recourse via distribution from the entity to the judgment debtor. The Charging Order then became the remedy of the judgment creditor denying the creditor direct access to the LLC assets. It limits the creditor exclusively to the collection of the income or distributions that the LLC assets might otherwise produce for the benefit of the judgment debtor.
In many states, the Charging Order is not the exclusive remedy of creditors against the LLC. Accordingly, aggressive creditors can petition the court for Charging Order provisions that ultimately give the creditor access to the assets of the LLC. For this reason, many attorneys recommend that a client utilizes an LLC which has been formed in a domicile that has made it clear that the Charging Order is the exclusive remedy. This is called forum shopping. What it means is that many times, for example, a real estate owner in California will elect to have either a Wyoming or a Nevada LLC utilized to hold title to their California property because it has a more favorable Charging Order law. Taking it a step further, it is many times advantageous to have the actual interest of the LLC owned by an Asset Protection Trust. This gives it an additional layer of protection because the client is not the technical owner of the LLC and the property within it. The Domestic Asset Protection Trust stands on its own to defend against the claims of the creditor.
A Domestic Asset Protection Trust is a trust that is governed by the law of the state that has special legislation that provides protection to the beneficiaries of the Trust that would otherwise not be there. We have already mentioned that a typical Living Trust in California provides no protection to the maker of the Trust. However, there are about 18 states now which provide Asset Protection Trust legislation wherein a business owner or investment owner can set up a trust that will be deemed to be protected from creditors because of its statutory provisions giving rise to such protection. Most states including California do not have such legislation nor is it likely that they will ever have the Asset Protection Trust law.
If properly set up and maintained, the Domestic Asset Protection Trust will be a significant barrier to creditors. This is especially true if the assets of the Trust that need to be protected are located in a state that is the domiciliary of the Domestic Asset Protection Trust. The main problem with the utilization of the Domestic Asset Protection Trust is that the courts of the non domiciliary state may not recognize the asset protection features of the Trust. For example, a California court may not recognize the asset protection features of the Nevada Trust under Nevada law. However, there is no question that a significant degree of leverage is created by means of the use of the DAPT in California or another state where there is no Domestic Asset Protection Planning legislation. This means that the Domestic Asset Protection Trust should be utilized and it definitely is a tool that has merit in respect to protecting against outside claims.
Accordingly, an individual who owns real estate in California may elect to form a Nevada LLC which, in turn, would be owned by a Nevada Asset Protection Trust. This modular setup of having the LLC interest owned by the Domestic Asset Protection Trust is a modular structure that has some substantial merit and can be utilized as protection against creditors. There are problems with the Domestic Asset Protection Trust because the court system in the United States may decide to adjudicate the issue contrary to what the law of the state domiciliary trust is and one has to be aware of that fact. However, in spite of that fact, many clients set up an LLC and have the LLC member interest owned by the Domestic Asset Protection Trust instead of owning it themselves. This does give substantial protection and leverage to the maker of the Trust.