Start early, keep it simple, and don’t try to hide stuff from your creditors. Those who worry the most about asset protection are those who are the most likely to get sued; think doctors and, more recently, real estate investors here. But average folks often get caught up in difficult situations, and thus if you have something to protect then the topic of asset protection should at least cross your mind.
Asset protection planning is the debtor’s side of creditor-debtor law. While creditors are concerned about the strategies and techniques of collection, debtors are interested in the strategies and techniques for protecting their most valuable assets from potential creditors. In this calculation, it is not just about protecting assets, but also about making sure that one does not end up in jail for contempt or bankruptcy fraud for engaging in the process.
Keeping in mind the law school adage that “General rules are generally inapplicable”, the following 11 rules should be kept in mind when you try to keep other’s hands off your stuff.
- Start Planning Before A Claim Arises
Many things you can do will effectively provide asset protection before a claim or liability arises, but few things will afterwards. That’s because what you do after a claim rises could be undone by “fraudulent transfer” law. Moreover, the point at which a claim arises is earlier than a layman might think—it is, for example, usually much earlier than when a demand letter or a process server shows up at the door.
- Late Planning Usually Backfires
Asset protection planning after a claim arises is apt to make matters worse; think of it as getting a flu shot while you have the flu, and the shot itself making you even more woozy. It is a common misconception that the only thing a judge can do is to unwind a fraudulent transfer, leaving a debtor who unsuccessfully tried late planning no worse off than if he had done nothing. To the contrary, both the debtor and whoever assisted in the fraudulent transfer can become liable for the creditor’s attorney fees, and the debtor can lose the hope of getting a discharge in bankruptcy.
- Asset Protection Planning Is Not A Substitute For Insurance
Asset protection planning should not be a substitute for liability and professional insurance, but rather should supplement insurance. It is a myth that asset protection plans invariably scare away plaintiffs, and an asset protection plan doesn’t pay legal fees to defend against a lawsuit. Insurance also supplements asset protection planning, since it can help a debtor survive a claim a fraudulent transfer claim. If you get sued, let the insurance company pay to defend it and pay to settle it — that’s what you’re paying the premiums for.
- Business Assets Are For Business Entities
Business entities such as corporations, partnerships and LLCs are meant to be vehicles for commercial operations, not to act as personal piggybanks. When personal assets are placed into a business entity, the potential for the entity to be pierced by a creditor on some theory or another, such as alter ego, increases exponentially. A rental house is a legitimate business asset since it is used in the business of residential rental real estate, but a primary residence or vacation home is strictly a personal asset.
- Utilize Certain Accounts and Financial Vehicles Where Appropriate
Many retirement plans, some educational savings accounts, annuities, and cash value of life insurance policies are protected from creditors to different degrees through various federal and state laws. These accounts and financial vehicles have all sorts of benefits and drawbacks with respect to taxes, fees, liquidity, and financial guarantees. You should not simply look at these in terms of the asset protection afforded by them, but must weigh the other pros and cons to see if they fit within your overall financial plan.
- Too Much Control Is A Bad Thing
Asset protection planning attempts to reach a balance between giving the client sufficient control so that the assets do not disappear, but at the same time not so much control that a creditor can successfully argue that the debtor and the asset protection structure are effectively one-and-the-same and thus should be disregarded on alter ego or some similar theory.
- Asset Protection Planning And Tax & Estate Planning Don’t Always Jive
Often asset protection planning and estate planning work together, but sometimes they are at odds and what might be a good idea for estate planning may not be such a hot idea for asset protection. For example, the making of gifts (to children and other prospective heirs) is common in estate planning but anathema in asset protection planning since gifts are often easy to set aside as fraudulent transfers. Meanwhile, homestead exemptions are a very powerful asset protection planning tool, but this usually traps the value of the home in the debtor’s estate.
- Your Money May Be Offshore But You Are Here
Recent cases have recognized the power of courts to require debtors to bring their money back to the U.S. through what are known as “repatriation orders”. If the debtor does not comply with a repatriation order, a court may issue a bench warrant for contempt of court and hold you in contempt (and in jail) until the money does come back, or for many years. The record? It is 14 years in jail served by former corporate lawyer H. Beatty Chadwick who refused to repatriate money from overseas to pay alimony to his ex-wife.
- Don’t Count On Bankruptcy As The Last Refuge Of A Desperate Debtor
Once upon a time, bankruptcy was akin to a nice warm shower that allowed a debtor to wash all debts away while still retaining a goodly amount of assets. Not anymore. In 2005, the bankruptcy laws changed to become a cold acid bath that leaves debtors with bare bones and little flesh. State homestead exemptions have been substantially limited, and other new provisions in the bankruptcy code and new bankruptcy case law can make parts of asset protection plans very difficult to protect in bankruptcy. Plus, bankruptcy judges have some of the strongest powers to make debtors cough up assets.
- If You Can’t Explain It, It Will Never Work
Many asset protection plans become so complicated that not even the client can explain how assets are held or how those assets were transferred. But such questions can be expected in depositions or a debtor’s examination, and a failure to fully and clearly explain what happened and why will make the court very suspicious and potentially give the court grounds to begin disregarding entities or setting aside transfers. Most judges start asking themselves, “What is really going on here?” If the structure and transfers are too complicated and not well explained, there is a much higher chance that the judge will find fraud on creditors. Indeed, the best asset protection plans are often simple plans, such as creating and funding an irrevocable trust for the benefit of their children.
- Most Likely Everything Sees The Light Of Day Eventually
Asset protection planning should be based on the presumption that the entirety of the planning and its purpose will eventually become known to creditors, because one way or another it usually does. Asset protection plans that require secrecy will face a plethora of problems, from how not to disclose the structure or activity on tax returns, to how to keep a mad ex-spouse or disgruntled employee from talking to creditors. And don’t even think about going into bankruptcy without making a full disclosure about assets and transfers. The failure to make a full disclosure will usually lead to a denial of discharge, and the failure to make a truthful disclosure can amount to charges of perjury and bankruptcy fraud.