As you begin to accumulate wealth and have some assets to protect, it is a good idea to implement asset protection strategies. Otherwise, you run a pretty high risk of being left with nothing at any moment. Whether it is your personal assets, or business property, potential creditors are able to take it all from you – the legal system today often appears to be structured in favor of plaintiffs, rather than defendants. Below, we outline a brief overview of existing schemes and methods, as well as the most important issues relating to asset protection.
What are Asset Protection Strategies?
Asset protection is a field of law that deals with shielding assets from the claims of creditors. It has nothing to do with tax planning or hiding property from the government.
The basic principle of asset protection is that any asset can be seized from you by a creditor except for assets you do not own. Therefore, asset protection strategies are all about removing you from the legal title to your assets, but allowing you to continue controlling them and enjoying its economic benefits.
There is no such thing as an iron-proof asset protection strategy. There is always at least a tiny chance for creditors to succeed, unfortunately. But you can make it extremely difficult for them to achieve this, which is the main goal of asset protection strategies – to make it as difficult and expensive as possible for a creditor to seize your personal property.
An asset protection strategy, if it is a good one, should discourage a legal opponent from considering pursuing you, and prevent the assets from being seized after a lawsuit is over.
4 Factors to Consider
The following factors are the minimum that should be considered when planning asset protection strategies:
- The identity of the debtor – whether business or personal assets; if he is single or married; if he plans ahead or already has troubles;
- The identity of the potential creditor and how aggressive he might be, etc.
- The nature of the assets (cash in the bank account, real estate, personal residency, etc.);
- The nature of the claim (tort claim, fraudulent transfer, claim dischargeable in bankruptcy etc.)
There are a number of strategies, some simple and others sophisticated. None is equally good for two different persons, whose circumstances can never be identical.
In case of high exposure to a claim, it might be required to create a business entity to shield the assets. If your exposure is low, it might be sufficient to use insurance or file a declaration of homestead and there would be no need to spend on offshore trusts or other expensive custom-designed, state-of-the-art strategies.
What Do Creditors Do?
To seize your property a creditor:
- must file a lawsuit against you
- substantiate it
- provide sufficient proof of claims
- obtain judgment against you
- convert the judgment into assets.
Prosecuting attorneys conduct an asset check before they sue someone. If there are no visible assets in your name, or these assets have no attachable value, you are not interesting to them as a potential defendant.
When someone wins a lawsuit against you, the court awards him a judgment amount. If you do not voluntarily pay this amount in full, there are still plenty of ways to convert the judgment into assets.
In case of real-estate, the plaintiff takes the judgment to the local record office for the real estate. Once it is registered, it is attachable to every real estate registered in your name in this country. So, they can sell it, or foreclose.
If you have a foreign bank account, you will be “requested” to return the funds by a so called “turnover order”, which is a direction from the judge to the debtor to turn over a specific asset to the plaintiff (creditor).
For other assets the judge issues a “writ of execution” for a specific asset (piece of art, furniture etc). Obviously, the creditor needs to be well-informed about the assets you own, or they could not proceed.
The prosecuting attorneys can file a “lien” on your property (any assets in your name that they can find). If the lien is filed, you factually lose the value of that property and you cannot have the lien removed. Herewith, the first targets for liens are real-estate and cash on your accounts.
Alternatively, the plaintiff can exercise a “prejudgment attachment” – place a lien on the debtor”s assets before the judgment. It is a good thing for creditors – by applying this instrument, they make sure there are still assets to pay by the time the lawsuit is concluded. This is much worse for you to deal with, so it makes sense to check if there are similar provisions in your home-country law.
In many cases free access to the information about your assets might become the determinative risk-factor. The question is how and where your legal opponent can get the information about your assets which might be an attractive target for a trial lawyer.
Depending on the type of assets, it can be available from the open public registries, from reports of a private investigator (who is not that expensive to hire) or even as a result of so called “debt exam”. The latter is when you are interrogated in the court about what properties you have and you must reply since it is conducted under the penalty of perjury.
Clearly, simple hiding of assets is not an effective method of protection. Privacy and secrecy is always an extra advantage, some creditors might simply walk away and do not file a suit. But you never know how aggressive your future creditors might be, so a better strategy would be the one that keeps you safe, including the eventuality of when you have to disclose your ownership rights.
What Does Not Help
- Gifting assets to family members is not an effective protection tool since the creditor can challenge a gift to a family member as a fraudulent transfer and ignore it.
- Community property laws (where applicable) undermine joint property of spouses that is each spouse is deemed to own all of the community property assets. Both spouses” assets are exposed even if only one of them is sued. Fortunately, normally states with community property allow you to opt out of the community property system.
- Quitclaiming assets to your spouse, some states require a written agreement for this purpose, for example, a transmutation agreement. Nevertheless, a quitclaim may be subject to a fraudulent transfer challenge similar to a transmutation agreement.
- A friendly lien against your property is also not a very effective tool, since any competent creditor is able to set it aside with no difficulties.
- A living trust, as a revocable trust it helps to pass assets to heirs without probate but offers no asset protection. It doesn”t help since you have the power to revoke it, so a creditor can make you revoke the trust and revert assets to your name.
- A personal guarantee is far from helping as well. Think twice before you decide to personally guarantee a loan, either for your own business, or for your friend. It means you are acting as a co-signer on the loan. So, if the borrower fails to make loan payments, the creditors will go after your personal assets.
Asset Protection Strategies: Popular Instruments
Reducing risk of being sued. It is rather difficult to control the things under “force-major,” such as, for example, a global economic downturn, but whenever you can, keep alert and do your best to reduce your exposure to the risk of being sued. Engage experts if your business is to provide professional advice, ensure you comply with occupational health and safety requirements if you are a retailer or manufacturer, for example.
Liability insurance is what professionals recommend as the next step. Even if you are found at fault, the insurance cover will satisfy the claim, at least partially, if not in full. Consider increased umbrella coverage on your homeowner policy, and increased liability coverage on your business insurance policy. Your expenses for the premiums are minimal, comparing to how much you can lose if you are ever sued.
A prenuptial agreement is one of the most effective asset protection tools available. The separate property of one spouse is not reachable by the creditors of the other spouse. Because a prenuptial agreement cannot possibly be a fraudulent transfer, it can never be challenged by a creditor. It protects both spouses from each other’s creditors.
A transmutation agreement is a simple written agreement that allows spouses to easily convert their community property into separate property. It ends community property and creates separate property. This is usually the very first step in the asset protection planning process for spouses. It is also a lot more difficult to challenge as a fraudulent transfer.
A declaration of homestead or similar procedure, where available, is a good instrument for the family residence protection. In some jurisdictions, you can file such declarations for a complete exemption; sometimes it provides exemption only under certain circumstances or a limited exemption (for example, up to $100,000). In any case, it is easy to file, requiring only a small fee, and, if it is available, never extra to use.
Equity stripping lien with consideration. You can go for a lien to capitalize your FLP or LLC using the home equity as collateral with a negatively amortizing note, in which some interest accrues and some is paid. It can be used with any real-estate property, whether in your name, or of a corporation, trust, partnership, or foundation. A judge can seize the property, but cannot remove a mortgage or deed of trust. In case of sale of the property, the mortgage bank and the LLC holding the lien must be paid first, before the Judge. Still the timing remains the issue. If you are sued within two years of placing this lien, the prosecuting attorney may charge fraudulent conveyance fees because of the timing.
Asset Protection Strategies: Using Business Entities
Using legal entities, such as corporations, limited partnerships, limited liability companies (LLCs), and off-shore companies to operate your business delivers two types of protection. It safeguards your personal assets from business liabilities, in the first place. Secondly, your business assets are shielded from your personal creditors.
An LLC is preferably used for protection of real-estate, boats, planes, running business, intellectual property. A family limited partnership is mainly used for shielding bank and brokerage accounts and the like.
Comparing a corporation with an LLC and limited partnership, the latter ones are safer than a corporation. Interest in an LLC or limited partnership is not subject to attachment and thus more protected – it cannot be seized by a creditor. On the other hand, this type of entity should not be used to protect a personal residence, just as with liquid assets, depending on circumstances.
Using of trusts to preserve assets from claims. People have used trusts for generations. There are many types of trusts for asset protection, such as spendthrift trusts, self-settled trusts, blend trusts, discretionary trusts, support trust, personal trusts etc. Each one has its benefits and drawbacks. But the key to using a trust as a protection tool is that the trust must be “irrevocable” and become the owner of the transmitted property.
Once given away, the assets are no longer personal and are not available to satisfy claims against initial owner. The settler must not keep any interest in the trust assets or visible control over the trust. It is possible to control an irrevocable trust through the appointment of a friendly trustee (a friend or a family member who would look after your interests and comply with your requests). Alternatively, consider using personal interest foundations (see below).
More advanced structures may combine LLC and limited partnership with such concepts as irrevocable trusts, sales and leasebacks, transmutations agreements, entity conversions and other. As well as utilize offshore asset protection structures, like foreign asset protection trust, private interest foundation, foreign corporation and LLC.
Offshore Legal Entities – One of the Most Effective Asset Protection Tools
Offshore companies, trusts and private foundations, established in international financial centers, are more expensive to setup compared to domestic instruments, but prove to be most effective in many situations.
Offshore structures are governed by the laws of a foreign country. They can be recommended to avoid domestic state-regulated operating formalities, in the first place. In fact, many international financial centers are rather straight-forward in their requirements for documentation and financial reporting, which makes is much easier to operate such structures.
Jurisdictions specializing in financial services do have asset protection provisions incorporated in their laws, such as bank secrecy, confidentiality, hard initiation of litigation etc.
Therefore, a successfully implemented offshore strategy ensures maximum financial privacy in the first place, and it is practically impossible to penetrate. Because it is a foreign state, it is much more difficult to enforce your home court judgment overseas. Even when established late, an offshore structure results in a 90-100% level of protection.
Timing, and Fraudulent Transfer
In some countries, in particular with the Anglo-American law system, there is a concept of fraudulent conveyance or fraudulent transfer. It is a civil cause of action, typically brought by creditors in situations when the debtor made a transfer of assets to a third party, when it is not a good-faith transfer and the debtor means to leave himself with no funds to pay the creditors.
A transfer of assets is more likely to qualify for a fraudulent conveyance if you do it after the event which potentially raised claims occurs, and you make a transfer for below the market price, or at the time when you are insolvent. Herewith, transfer is anything you do to make it more difficult for creditors to get your assets, including amendments to the statutory documents of your LLC or corporation.
This is not the same as a fraud and has no consequences such as penalties or jail time. But if proven, they will oblige you to recover assets.
Better Late than Never!
To be effective, asset protection should be put in place before you get into financial trouble and especially before you enter into any personal guarantees.
Nevertheless, even in a situation when it may be late to take measures of protection, it would be better to take them. There are always chances to win and keep what you have rather than just surrender it with no hope of retrieval.
Make sure you take the advice of professionals before you implement your asset protection strategies.