It is no secret there is a litigation explosion in the United States. As a result, more and more healthcare providers and executives are seeking ways to protect their hard-earned assets from lawsuits, frivolous claims, creditors and predators.
Asset protection is a complex field covering many technical areas, including the laws of bankruptcy, tax, criminal, international and trusts. As such, this article is meant merely to cover some of the most basic concepts in a general way and should not be considered or relied upon as legal advice.
Fraudulent Transfers
You may think you can transfer your assets at any time to your spouse, child or a trust for the benefit of such individuals to protect assets from creditors' claims. However, you must observe the maxim, "transfers when waters are calm are okay, while transfers when waters are choppy are too late." So, if a lawsuit already has been filed against you, it is too late. The transfer, in such a case, would be deemed fraudulent and the court will have the power to set it aside in favor of the creditor.
Fraudulent transfer laws originated in England with the 1571 Statute of Elizabeth. It states, "If a transfer is made with actual intent to hinder, delay, or defraud any creditor of the debtor, it is fraudulent as to a creditor whose claim arose before or after the transfer date." This is addressed in the Uniform Fraudulent Conveyances Act (now the Uniform Voidable Transactions Act) which most states have adopted. In addition, if the transfer is one which renders you unable to meet your expected debts or obligations, it is deemed fraudulent regardless of your intent.
However, not all creditors can take advantage of this fraudulent transfer rule. A creditor's claim must be in existence at the time of transfer. Thus, transfers can serve as insurance against a possible future creditor, e.g., a physician transferring assets to his or her spouse to protect against lawsuits for malpractice not yet committed.
Specific Asset Protection Techniques
Under some circumstances, assets can be protected without having to give up all ownership interests. For example, assets may be placed in a joint tenancy, tenancy-by-the-entirety or be owned through a limited partnership or placed in a retirement plan.
Joint Tenancy
These techniques have shortcomings, however. Holding real estate or other assets as joint tenants with right of survivorship still would allow a creditor to force partition and sale of the debtor's interest. The only benefit would be if the debtor dies before the creditor perfects his claim. Then it is too late for the creditor to enforce his claim against the debtor's interest.
Tenants-by-the-Entireties
Holding assets as tenants-by-the-entireties is only available for spouses. (See Finley v. Thomas, summarizing the differences between a joint tenancy with right of survivorship and a tenancy by the entireties.) In Tennessee, the creditor of one spouse can't touch real estate held as tenants-by-the-entireties unless the marriage dissolves or the debtor's spouse predeceases the debtor. However, joint debts of the spouses are not protected. Moreover, with respect to assets held as tenants-by-the-entireties other than real estate, the courts are divided as to whether a creditor of one spouse could seize all or a portion of the asset in satisfaction of the creditor's claim. Thus, tenancy-by-the entireties may not be a good long-term solution.
Limited Partnerships
Limited partnerships, if properly drafted, can offer some protection for assets owned by the partnership. For example, if the debt is unrelated to the partnership's activities, the creditor will only be entitled to the income allocated to the debtor's partnership interest, if the general partner decides to distribute the income. Further, the creditor will not gain any interest in the asset itself or any other rights in the partnership.
However, if the lawsuit is related to the activities of the limited partnership, then creditors can reach all partnership assets and all assets of the general partners. In such instances, limited partners risk the loss of their investments in the partnership.
Retirement Plans
Retirement plans may also offer significant asset protection. The U.S. Supreme Court has ruled ERISA-qualified plans are protected against creditors. Regular IRAs have no federal protection, but are protected in some states by statute. However, there is still some question whether Roth IRAs are similarly protected.
The Problem with U.S.-Based Trusts
Revocable or living trusts offer no asset protection to the creator of a trust since the creator still has control over the assets and can be required to use them to pay legitimate debts.
In most states, irrevocable trusts are not much better if the creator retains an interest as a beneficiary since that interest can still be reached. In addition, in almost every state, the trust is subject to a legal doctrine known as the Rule Against Perpetuities. This may limit the creator's ability to protect the assets for unlimited future generations or to take advantage of generation-skipping transfer tax exceptions. Additionally, the trust's investments are limited by Securities and Exchange Commission (SEC) regulations, so certain foreign investments are not accessible to the domestic trust.
Domestic trust assets are easy for lawyers to discover and attack as fraudulent. The burden of proof is typically fairly easy to meet, and the transfer need only have been fraudulent as to any creditor, even one not part of the lawsuit. Once the transfer is proven fraudulent, the entire amount of property in the trust is set aside and available for all current creditors. There is not great expense or risk to attacking domestic trusts. Usually, it is done on a contingency fee by the creditor's attorney. Finally, there are long statutes of limitations to attack a fraudulent domestic transfer; six years or more is typical.
Foreign Trusts Advantages
Because of the numerous shortcomings of domestic trusts just discussed, more and more wealthy individuals (and their advisors) are looking offshore to a foreign trust. There are now a small number of foreign countries that offer superior asset protection for the following reasons:
- Their very foreignness -Location, currency, language, customs, court systems, etc., all must be learned and dealt with by the creditor.
- The offshore trusts distance from U.S.
- Must hire a local attorney -Most countries do not allow contingency fees. Further, most attorneys will be conflicted out and, therefore, unavailable to the creditor because of current work with one or more of the country's large trust companies.
- Bond -In most cases, forfeitable bond must be posted to institute a lawsuit if the plaintiff loses.
- Legal fees -The defendant's legal fees may have to be paid by a losing plaintiff.
- No Rule Against Perpetuities -A true dynasty trust may be set up for unlimited future generations which also allows taking full advantage of the $1 million generation-skipping transfer tax exemption.
- Grantor -The grantor may be a discretionary beneficiary and the trust will still be protected against creditor attack.
- Global investment opportunities are not limited to SEC-approved securities -Note, however, the assets need not be relocated to the foreign country. The grantor's local trusted advisor may safely continue to manage the assets unless and until a threat of a lawsuit is perceived.
- Difficult to discover -It should be pointed out, however, that secrecy is not the important key to the soundness of this plan.
- Difficult to attack -There is a higher burden of proof required to prove the transaction was fraudulent, e.g., beyond a reasonable doubt (the standard of evidence required in the Cook Islands) versus a preponderance of the evidence (the standard required in most states.) The transfer must have been fraudulent as to the particular creditor who is the plaintiff. Finally, if a transfer is found to be fraudulent as to a particular creditor, only such assets will be set aside as are necessary to satisfy that creditor's claim, forcing each creditor to litigate separately.
- Judgments obtained in the U.S. are not recognized by the foreign entity, i.e., no comity -A new lawsuit must be begun on foreign soil, retrying the claim. Witnesses, exhibits and all other evidence must be transported to the foreign country at great expense to the creditor.
- Short statutes of limitations -These may range from zero to two years from the date the property is titled in the name of the trust if the grantor was solvent at such time and if an obligation or liability existed on the date of transfer and the transferor had actual notice of it. After the period has run, no creditors may attack the trust on fraudulent transfer grounds.
- A transfer to an offshore trust that took place before a cause of action accrued is not deemed to be fraudulent and therefore cannot be attacked.
The bottom line is that when faced with all of the above hurdles, the debtor usually will be able to negotiate an early, cheap settlement with the creditor or prevent the filing of the lawsuit in the first place. Finally, the test is not, "Have you absolutely protected your assets from creditors?" but rather "Are you in a better position after creating your asset protection plan than you were before you started?"