In a prior lifetime I earned my living by suing (and defending) people. It gave me a healthy understanding of the difference between what works on paper and what works in a real, live courtroom. From this perspective, I believe many “asset protection plans” have a “chink” in their armor, just waiting for a deadly bolt from a plaintiff’s crossbow. I will point out this chink and I’ll share my ideas about how it might be fixed. But first let’s take a broader look at the area of asset protection planning.
The goal of asset protection planning is to protect one’s hard-earned assets from predatory (or even meritorious) law suits. The area is incredibly complicated and involves a complex interplay of state and federal law. It has many tax and financial ramifications beyond mere law suit protection. It should only be undertaken with advice from competent, experienced, and specialized legal counsel, working with a team which includes a financial planner.
Step one in asset protection planning is to eliminate as many potential sources of liability as possible. If you own a business or practice a profession, a loss control or liability prevention audit is well worth the money. If you own rental property or are engaged in any other business activity, conducting that business inside a properly structured liability limiting entity, such as a corporation, LLC, limited partnership, etc. is vital. Motor vehicles, especially in Florida, can be problematic. In general, avoid holding title to automobiles driven by others.
The second step in asset protection is adequate liability insurance. High limits of liability coverage protect you from the effects of an ultimate judgment. Of equal importance, they keep the insurance company engaged in the defense of the law suit. Often the cost of defending a law suit can exceed the amount in controversy!
There are some who argue that high limits of liability insurance encourage law suits. Depending upon whose anecdote you are hearing, they may or may not. But more importantly, they protect you! A potential plaintiff may be willing to accept the “easy” insurance money in exchange for not attacking your personal assets. That’s a trade-off most people are willing to make. If you can avoid years of trauma and the risk of losing your assets, by an insurance company writing a check, wouldn’t you prefer it?
No matter what steps you take or entities you create, you’re still exposed to potential liability, and you can’t insure against all of it. This is where traditional asset protection planning begins, and where I believe, the chink in the armor exists.
The third step of asset protection planning consists of making as much of your net worth as possible, either protected from the reach of creditors, or undesirable to them. This may involve transfers of ownership to a less liability-prone spouse, to tenancy by the entireties (a special form of joint ownership by husband and wife, in some states), to assets that are protected from creditors by state statutes, such as life insurance cash values, annuity cash values, etc., or by transferring assets to entities that are harder for creditors to reach under state law, such as certain partnerships, LLCs, domestic asset protection trusts, and foreign asset protection trusts.
It is this third step of asset protection, the inner armor, in which the “chink” begins to form and the weak spot develops by rushing into the process. This rush to asset protection planning usually results from a “scare”, i.e. a close call, hearing a horror story about someone else, or perhaps the occurrence of a serious liability producing event. Asset protection does not happen in a day. Do not make the mistake of waiting until an incident occurs, a law suit threatens, liability is incurred, or even until a friend is sued. Asset protection is a living, breathing, ongoing process if it is to be effective.
Most states have laws intended to protect creditors from certain asset protection strategies. These laws define “fraudulent asset transfers” and “fraudulent asset conversions”. The new Bankruptcy Act of 2005 (know as “BAPCPA”) has added significant teeth, complexity, and uncertainty to this area of the law. In very general terms, these laws give a court the power to set aside a transaction if the creditor can prove that it was done with the “intent to hinder, delay, or defraud” creditors. A fraudulent transfer may be a transfer to a spouse, to joint ownership, or to some other person or entity without “full and adequate consideration”. This includes transfers to domestic or foreign asset protection trusts. A fraudulent asset conversion may consist of the purchase of an asset for full consideration, but which is exempt from claims of creditors under state or federal law.
While these laws are incredibly complex, the common thread running through them all is the intent to “hinder, delay, or defraud creditors”. So imagine Dr. Smith having a bad result in the operating room, or business woman Jones with a business transaction about to head south. They contact an attorney whose specialty is asset protection planning. A flurry of activity begins. When the flurry is over and the dust settles, many of their assets are in the names of their spouses, paid in as cash values of life insurance policies and annuities, and owned by an LLC which is in turn owned by a trust domiciled in the Cayman Islands
Now, picture that defendant sometime later after final judgment has been rendered against him or her. He or she is on the witness stand, under oath in a debtor’s examination. The plaintiff’s attorney asks “What prompted all this?” “What was the purpose of this flurry of transactions and transfers?” Remember, you’re under oath, and all of the written records are there. The dates of all of the transfers are within a few months of the “event”. What is the “truth, the whole truth, and nothing but the truth”?
I’ve oversimplified the example but I’m sure you get the point. This flurry of transactions over a short period of time in response to a legal threat (or in close proximity with the threat) sure looks like “intent to hinder, defraud, or delay creditors.” And if it looks like a duck, quacks like a duck and walks like a duck, a court will likely decree that it is in fact, a duck, despite earnest protestations to the contrary by the judgment debtor.
The goods news is that you need not be in this position. Just as you wouldn’t wait until there’s a lump growing out of the side of your head to go to the doctor for a check-up, don’t wait to protect yourself from future risks. In my practice as a wealth advisor I developed an approach I call Protection Sensitive Planning™. As part of this process of sound investment planning, tax planning, financial planning, retirement planning, and estate planning, we are sensitive to protection issues. When I use the term “protection issues”, I don’t just mean law suits. Protection Sensitive Planning™ includes protecting the entire family to the largest extent possible, from the financial consequences of law suits, death, disability, income and capital gains taxes, estate and gift taxes, financial market fluctuations, and the present and future need for medical and long term care.
As it turns out, many of the strategies one would logically implement to enhance one’s financial position, reduce taxes, protect one’s family, and reduce risk from financial markets fluctuations, also happen to include large elements of creditor protection. If these strategies have been implemented over time for financial purposes, tax purposes, risk reductions purposes, etc., it’s pretty hard to prove that they were undertaken with the intent to hinder, delay, or defraud creditors, because they were not! Even aggressive strategies, such as off-shore asset protection trusts are less vulnerable if they are established well in advance of any potential claim.
The moral of this story is that if you are doing comprehensive planning in a pro-active way, rather than reacting to a real or perceived legal threat at the 11th hour, you have eliminated or greatly reduced this chink in your armor.
Please understand that there is no perfect asset protection plan. However, by doing a great pro-active, ongoing job of protecting your finances, protecting your family, reducing your taxes, and preparing for your financial independence and legacy, a whole lot of asset protection comes along for the ride.
So what are you waiting for? I personally believe that procrastination has cost more money than all the IRS agents and plaintiff’s lawyers put together. Sit down with your team of financial advisors immediately. It should include competent, experienced, specialized legal counsel, your CPA, and your financial planner or wealth advisor. Catastrophes of all sorts don’t just happen to the other person. Protection Sensitive Planning™ can build a moat around your fortress. Do it right now!