John D. Pocket was a successful real estate developer in New Jersey. He had accumulated a sizable portfolio of real estate and securities investments. John always sought the advice of his attorney and CPA with respect to his business and personal affairs. However, although planning was evident, there was always the exposure of a lawsuit.
A few years ago Congress passed legis-lation known as the Comprehensive Environmental Response Compensation and Liability Act (CERCLA), which pro-vides for substantial penalties and liability for cleanup of contaminated soil. John recently became aware of a multimillion dollar claim arising under this law.
As if that were not enough, the real estate market took a nosedive when the economy began to sour and John is left with substantial negative cash flow and is being squeezed by his lenders. As a result things began to collapse and John found himself retaining bankruptcy counsel.
John and his family have lost all their assets and rewards of many years of hard work. Had he availed himself of appropriate asset protection planning as part of his estate planning the outcome could have been very different.
In addition to real estate developers, other candidates for such planning are physicians, attorneys, accountants, architects, board members, and those with "deep pockets" who need to pro-tect themselves from claims of future creditors or predators.
The Basics
Some of the basic techniques used to protect assets include transferring assets to a spouse and establishing trusts for children or other family members. Such transfers, however, involve the surren-der of all rights to control the asset and subject the owner to potential problems such as divorce or other intra-family dis-putes. Using a constructive trust theory, some courts have held that the transfer of assets to a spouse is ineffective since the spouse is merely holding the prop-erty for the debtor spouse as a trustee. Gifts in trust, where the grantor retains certain rights over the property, are gen-erally not protected from attachment from the grantor's own creditors. Grantors seeking to protect assets by transferring to domestic trusts must therefore sever all ties to the trust prop-erty. Other traditional planning tech-niques include the use of homestead exemptions (especially in Florida and Texas which have very liberal exemp-tion statutes), the life insurance exemp-tion, and property held in a joint tenan-cy. However, these techniques are limit-ed in their application
Form a Limited Partnership
One of the more common and effective asset protection techniques is the use of a limited partnership. The owner of the property contributes it to a limited partner-ship in which he or she is the general partner and family members are the limit-ed partners. As the general partner the transferor retains control over the assets. Under the Uniform Limited Partnership Act, a creditor of a limited partner is only entitled to attach the limited partner's interest in the partnership. If the limited partnership is structured and conducted properly, the creditor of the general part-ner/transferor will not be able to attach any of the assets owned by the partner-ship nor force a sale of such assets. The general partner can receive a salary from the partner- ship and controls the timing of any distributions.
In addition to the asset protection, such a partnership affords an extra ben-efit in the estate planning area. If a par-ent is the general partner and transfers fractional interests to his or her children, the estate taxes on the parent's death would be based only on the fractional interest the parent retains, even though the parent has retained total manage-ment control.
However, concealing or transferring assets in anticipation of a lawsuit, may be construed as a fraudulent con-veyance under most state statutes. Accordingly, any transfers made must not make the transferor insolvent as a result of the transfer. Such determina-tion must be made with consideration of any pending or threatened litigation.
Offshore Trusts
Some attorneys take the partnership concept one step further by establishing offshore trusts. The use of such trusts is based on the procedural and substan-tive laws which certain foreign jurisdic-tions have enacted to protect assets. The principal that a grantor cannot establish a spendthrift trust to avoid his own creditors is not found in the laws of many foreign jurisdictions. In the U.S., a judgement rendered in any state is enforceable in any other state. This would result in subjecting a domestic trust to a judgment. On the other hand, certain foreign jurisdictions do not rec-ognize U.S. judgments. Some of the jurisdictions which have enacted these statutes are the Isle of Man, Cook Islands, Cayman Islands, and, most recently, the Bahamas.
In addition to giving protection to creditors, foreign trusts provide other benefits such as probate avoidance and confidentiality. Foreign trusts are not intended to be used as a tax avoidance device and therefore must comply with U.S. tax laws. They are intended as vehicles for asset protection and preser-vation. Foreign trusts allow the grantor to retain control of the property without violating any spendthrift rules.
[Editor's note: Asset protection is not a matter of evading the payment of obli-gations that are properly and fairly due; it is a matter of shielding assets from the potentially unreasonable exposures of the existing civil justice system.]
Editors:
David H. Gerson, JD, CPA
Ernst & Young
Joseph V. Falanga, CPA
Goldstein Golub Kessler & Company
Contributing Editors:
Martin J. Salzman, CPA
Reminick Aarons & Company
Richard H Sonet, JD, CPA
Zeitlin, Benado, Sonet & Witt
Dan A. Diers, CPA
Rashba & Pokart
Jeffrey A. Grossman, CPA
Goldstein Golub Kessler & Company
Larry Elkin, CPA
Arthur Andersen & Co.
Edward A. Slott, CPA
E. Slott &. Co.