This is an excerpt from Chapter 1 of the Asset Protection Planning Guide -- A State-of-the-Art Approach to Integrated Estate Planning (published by CCH) by lead author Barry S. Engel of the Colorado firm of Engel & Reiman pc.
101--Overview
Years ago, when asset protection planning was a new concept that was not well understood, many attorneys viewed it with suspicion. Some even questioned whether it was ethical. Today, however, the tables have turned. Asset protection planning has become a well-recognized area of practice. Many articles, magazines, and treatises have been written on the subject. The Real Property, Probate and Trust Section of the American Bar Association has formed an Asset Protection Subcommittee. Within the last 10 years, close to 20 countries and four states have passed some form of asset protection trust legislation. Today, many estate planning attorneys and other wealth planners who have at least a working knowledge of the concepts involved in asset protection planning are of the view that it is a necessary component of planning. Many planners feel that the failure to advise a client about asset protection planning options may be grounds for a claim of malpractice.
Although asset protection planning has made strides, it was often done in isolation without regard to the client's overall estate plan. Similarly, many estate planners did not provide for the lifetime side of estate planning. In other words, without regard to lifetime asset preservation, many estate planners focused on tax mitigation at the time of death, avoidance of probate, the smooth transition of property, and making sure the deceased's dispositive wishes were followed. As planning principles and concepts have evolved, the wealth planning community is uniting these two disciplines more and more into one integrated estate planning process--integrated estate planning (IEP). This discussion assumes that the planner has a basic understanding of the estate planning component of IEP. Therefore, the focus is on the asset protection component of IEP.
101.01--Does Asset Protection Planning Work?
Several recent cases regarding poorly designed and implemented asset protection plans have led some practitioners to question whether asset protection planning really works. In most situations, a properly structured asset protection plan that integrates asset protection planning with an IEP results in a better outcome than without. This result depends, however, upon several variables. These variables range from the client's net worth, the client's goals, the nature of the assets transferred, the skill with which the asset protection plan was drafted and defended, and the asset protection vehicles selected to implement the asset protection plan (see 115).
Definition of Asset Protection Planning
Technically, asset protection planning is the process of organizing one's assets and affairs in advance to guard against risks to which the assets would otherwise be subject. The phrase "in advance" warrants strong emphasis. One who is planning to protect assets must be cautious and avoid the negative implications that may follow if there are creditors who are entitled to remedies under applicable fraudulent transfer and similar laws. Asset protection planning may be applied to protect every type of asset, including an operating business or a professional practice (see 125).
101.02--Definition of Asset Protection Planning
Safeguarding assets from the many risks involved is not a new idea or planning goal. Asset protection is more in the forefront of planning because of expanding theories of liability. New liability theories are sometimes coupled with results-oriented judges and juries who decide things based more upon a perceived desired outcome than upon the law. An ever-present concern includes some of the high dollar amounts of jury awards that we hear about today. Asset protection must be addressed in the new legal arena because of concerns with the adequacy of traditional forms of protection. Although there are arguments for and against the contingency fee system, it is undeniable that our current legal system, coupled with contingency fees, has helped contribute to the litigation explosion. For this reason, asset protection planning is increasingly important (see 135).
Goals of Asset Protection Planning
The goals of the asset protection component of IEP are varied but all must be addressed to create a high-quality plan. The plans must be user-friendly or they are doomed from the beginning due to the client's discomfort with an unfriendly plan. Since being a party to a lawsuit is often a loss in the client's mind, plans must be drafted to deter litigation. The plan must provide an incentive for an early and cheap settlement if it fails to deter the litigation in the first place. The net effect of the deterrence or an early settlement is to level the litigation playing field between the plaintiff and the defendant. This leveling enhances the client's bargaining position. Any plan must be flexible enough to provide options as the game is played because litigation may not come from the originally considered source. The overall goal of any plan is for the client to ultimately win the game. Once goals are discussed with the client, the planner should incorporate them into both the asset protection and estate planning components of the IEP (see 145).
Engel Ladder of Asset Protection Planning Tools
There is no one asset protection planning tool or technique that universally protects all of a client's assets, so a plan needs to involve a mix of the various tools and techniques available to the planner. The Engel Ladder of Asset Protection Vehicles identifies the various tools available to the asset protection planner and arranges them in ascending order of efficacy. At the bottom of the ladder is gifting, midway up the ladder is the family limited partnership, and close to the top of the ladder is the foreign integrated estate planning trust (IEPT) (see 155).
The Engel Maxims of Asset Protection Planning
Although there is no one right way to design an asset protection plan, there are many wrong ways to design one. The planner must be familiar with all of the asset protection planning vehicles. In order to effectively use the different types of asset protection, the planner must be familiar with the strengths and weaknesses of each asset protection planning vehicle (see 165).
What Asset Protection Planning Is Not
As important as it is to know what an asset protection planning component is, it is equally important to know what it is not. Asset protection planning will not aid a client in evading the payment of taxes. Asset protection planning does not use the concept of hiding assets but works in general to protect those assets. A hidden asset may be found, but a protected asset is a more secure one. Professional and ethical advisors do not use asset protection as a means of defrauding creditors (see 175).
115--Does Asset Protection Planning Work?
Barry S. Engel, in a 1993 article, predicted that over the course of time, claimants would attack a certain number of offshore asset protection plans and that a certain percentage of these attacks would produce less than favorable results for the planning structures involved. These results would come about because of the way in which the asset protection plan was designed and implemented. [Barry S. Engel, "Asset Protection and Fear of Flying," 36 Offshore Investment 28 (May 1993).] This prediction has proven to be accurate. Because of these attacks, some wealth planners and their clients have become concerned about the effectiveness of asset protection planning. Should they be concerned? At the risk of sounding too vague, the answer is that "it depends" on a number of issues, including (1) the standard applied in determining whether a plan worked, (2) the many variables that existed under a given asset protection plan, and (3) the asset protection vehicle or vehicles used within the asset protection plan.
First, the standard applied in determining whether the asset protection component of the integrated estate plan (IEP) "worked" must be defined by reference to where a client would have been, financially, had he or she not engaged in an IEP. The ultimate goal of integrated estate planning is realized if the client weathers a legal storm at least moderately better than he or she otherwise would have in the absence of any planning.
COMMENT: The authors' experiences as well as those of many other attorneys with whom the authors have co-counselled have shown that IEP cases have far surpassed this standard. Further, even in those published cases where an asset protection plan did not completely stop a creditor, in almost all cases the defendant fared the legal storm substantially better than he or she would have had the defendant not implemented the asset protection component of the IEP.
Second, the many variables that exist under any given IEP prevent, in all fairness, the use of blanket statements such as a "particular asset plan works or it does not work." The following variables are generally of key importance in determining how extensive an asset protection plan needs to be in order to protect against a future creditor:
The client's net worth. There is a cost/benefit relationship with regard to the asset protection planning component of the IEP.
PLANNING NOTE: Generally, clients with a net worth of less than $1 million should use the simpler, less protective asset protection vehicles. On the other hand, due to the incrementally smaller cost, most clients with a net worth greater than $1 million should use the more sophisticated forms of asset protection planning, such as a foreign integrated estate planning trust (IEPT). For more on planning with foreign jurisdictions and the foreign IEPT, see Chapter 12.
The client's goals. Some clients wish to protect most of their assets with an asset protection structure (i.e., the "in toto" approach). Others wish to protect only a nest egg.
The nature of assets transferred under the plan. Liquid assets are generally easier to protect when compared to assets such as real estate and business interests. On the other hand, certain asset protection vehicles, such as the family limited partnership combined with the foreign IEPT, are much more effective in protecting real estate and business interests than other asset protection vehicles. For more on planning with family limited partnerships, see Chapter 8.
The skill with which the plan was crafted.
COMMENT: Unfortunately, similar to estate planning, there are now do-it-yourself "kits" being commonly sold for asset protection planning. There are many attorneys without any experience in the area who claim to be asset protection, as well as estate planning, experts. Naturally, many of these asset protection plans will create some poor press regarding asset protection planning and integrated estate planning in the future.
The skill with which the plan is attacked.
COMMENT: There is a considerable difference in the strength of an attack between the legal resources of a major law firm with international capabilities and an attorney who is a sole proprietor.
The skill with which the plan is defended. Defense of a sophisticated asset protection structure typically involves a team. These team members constitute the chain of defense. The team will only be as strong as its weakest link. Such a team consists of: The attorney who designed the plan, The co-counsel, the certified public accountant, or the financial planner who has a personal relationship with the client, The foreign trustee(s), and The foreign money manager(s).
The thoroughness and protectiveness of the applicable law. Almost all sophisticated asset protection plans involve the use of the applicable law of a state or foreign country that has favorable asset protection features. With regard to domestic IEPTs, there can be a sizable difference in the degree of asset protection that is derived from the use of one jurisdiction versus another jurisdiction (see 1135).
Who is the creditor? Whether the opposing party is a tort claimant, a contractual claimant, a single person, a large national bank, a bankruptcy trustee, a governmental agency, or possibly even a spouse has a significant impact on how a plan is drafted and what asset protection vehicles are utilized. Often if a governmental agency is the creditor, there may be criminal sanctions against exercising certain options that a client would otherwise be free to exercise if the litigants were private parties. For more on what happens when the type of creditor is not considered, see Chapter 16. The biases or the bent of the presiding judge. Over the last 30 years, some U.S. judges have created new and creative theories of liability or of the law in general. Third, the asset protection component of an IEP involves implementing one or more asset protection vehicles, such as state or federal exemptions, a family limited partnership, a limited liability company, a domestic trust, or a foreign asset protection trust. Some of these tools, such as exemptions, protect only certain types of assets, such as retirement plans. Other tools, such as a domestic trust, generally are more effective for asset protection purposes (e.g., when a parent transfers assets in an irrevocable trust to a child). Many plans combine one or more asset protection vehicles (such as the family limited partnership with a foreign IEPT). Therefore, in addition to the definition of success and the variables under the asset protection plan, the asset protection planner's knowledge of whether and when to implement the various asset protection vehicles will strongly affect the degree to which a given asset protection plan will "work."
COMMENT: To date, the authors' firm has drafted over 1,000 foreign IEPTs and helped title more than $5 billion in value into foreign IEPTs. Of these 1,000 foreign IEPTs, approximately five percent (or around 50) of the foreign IEPTs have come under attack by an adverse party. The authors do not consider this a high percentage considering the wealth profile of their typical asset protection client. Further, in all but one case, the client weathered the storm in substantially better shape than he or she would have in the absence of any planning, far surpassing the "moderately better" standard for determining a successful asset protection plan.
The following Examples highlight asset protection scenarios planned by the authors' firm, and the results that followed.
Example 1: Robert and Judy Albert sold the family business for $12 million. Promptly following the sale, they settled their net after-tax proceeds in a foreign IEPT. A few years later, the business that was sold filed for bankruptcy. The bankruptcy trustee filed an action against the Alberts as sellers based upon a reverse fraudulent transfer theory under which the bankruptcy trustee sought to recover the gross sales proceeds received by the Alberts ($12 million). In other words, the bankruptcy trustee was seeking to recover more from the Alberts than they had received after taxes. Generally, a bankruptcy trustee is a particularly problematic creditor due to all of the powers granted to the bankruptcy trustee under the Bankruptcy Code. In this case, however, the bankruptcy trustee learned of the asset protection planning structure that was undertaken several years earlier, and the bankruptcy trustee settled his claim for $175,000 (i.e., about 1.5 cents on the dollar).
Example 2: Bart Bernard was a real estate investor. Knowing the many perils of the real estate market and given his various liquidated and contingent liabilities, he protected as much of his estate as was appropriate at the time by transferring as much of his assets to a foreign IEPT as he could and still avoid any possible claim under a fraudulent conveyance theory. Several years later, Bernard suffered a judgment as a co-guarantor. Unfortunately for Bernard, the other guarantors had already been forced into bankruptcy due to other real estate deals that they were involved in. Therefore, Bernard became the sole focus of a collection effort by a very large bank and its Wall Street law firm. This combination would represent a formidable opponent for most asset protection plans. Fortunately, Bernard had utilized a foreign IEPT. Therefore, even though the foreign IEPT held one-half of the assets in Bernard's home state, a fact of which his creditor was fully aware, the judgment against Bernard was settled for less than five cents on the dollar.
Example 3: Dr. Joe Calvin was an uninsured practicing physician. Within months of Calvin's foreign IEPT being funded, Calvin was unexpectedly named as one of several defendants in a malpractice nuisance suit. The plaintiff's legal counsel was advised that Calvin's assets had been protected with a foreign IEPT, and a token settlement offer was extended. After confirming that Calvin's assets were indeed protected and that Calvin was uninsured, the plaintiff accepted Calvin's settlement offer. Unfortunately for the remaining defendants, the plaintiff continued to pursue the claim against them.
Example 4: Robert Donahue, the owner of vast real estate holdings, was concerned about the potential of a toxic waste problem with one of his holdings. At the time of funding his foreign IEPT, Donahue had no reason to believe that this general concern was a reality and otherwise did not know whether any of his property was in fact contaminated. Several years went by, and, as is the case with many asset protection planning clients, the motivating factor (i.e., toxic waste) for his concern did not materialize. Instead, a different asset protection concern developed as Donahue's wife filed for divorce. As a result of Donahue's asset protection planning, a property settlement was reached as part of the divorce negotiations. In the words of Donahue's divorce counsel, the settlement was substantially more favorable than would have resulted had Donahue not implemented his planning.
Example 5: Stuart Eckersly was an entrepreneur who had a proclivity for making deals happen and making money. Unfortunately, Eckersly incurred a substantial liability attributable to a general partnership in which he was one of the general partners. Not only did Eckersly lose most of his hard-earned wealth, but he lost his drive and ambition to continue making deals happen, since he felt that his future successes would serve only to satisfy his sole past failure. Although little integrated estate planning may be done to protect existing assets from a present claim, the same is not true for future business opportunities. Future business opportunities may be diverted to a foreign IEPT prior to their ripening into "property interests." Eckersly settled a foreign IEPT and the trustees of the foreign IEPT pursued any future business opportunities that Eckersly came across. The new wealth accumulated in the foreign IEPT was protected.When Eckersly later filed for bankruptcy, he was granted a discharge from his sole past failure, and the assets that developed from the business opportunities that were transferred to the foreign IEPT were not included in his bankruptcy estate.
Example 6: Dr. Juan Martine was besieged with a series of groundless and frivolous malpractice lawsuits immediately following a negative exposé on local television. Prior to the television exposé, Martine had an almost clean slate with regard to any malpractice actions. One of the plaintiff's lawyers thought, at a minimum, that they would be able to settle with Martine merely by subjecting him to the hazards of litigation and the high costs of defending himself. Unfortunately, in the early stages of the lawsuit, the attorneys were somewhat correct. Martine's malpractice premiums soared; he was constantly spending time gathering documents, meeting with defense attorneys, and being deposed or going to court; and he ultimately left his practice. After a few years of fighting the legal battles, Martine established a foreign IEPT. Martine's assets were protected to the extent permitted under applicable fraudulent conveyance law under the circumstances. Martine then fired his battery of defense counsel and proceeded to negotiate an end to each of his remaining malpractice suits. By showing his adversaries that his assets were now protected (to the extent allowed by local fraudulent conveyance law), Martine was able to settle each suit for $2,500 or less.
Example 7: Kevin Mesmer, Chuck Gallant, Gary Holland, and Mike Inez settled and funded foreign asset protection trusts with personal assets at a time when their business was current on all its obligations and cash rich. At this time, there was no reason to believe that they would be called upon with respect to the personal guarantee on which each of them was personally liable. Therefore, there was not a fraudulent conveyance issue at the time that the trusts were funded. A few years later, the economy sputtered and their business started a slow downward spiral. At this time, the bank called the personal guarantees of Mesmer, Gallant, Holland, and Inez on the business loans. Since most of their personal assets had been transferred to foreign IEPTs, the bank attempted to pursue collection of the debt against the foreign asset protection trusts abroad. This pursuit proved unsuccessful, and the bank ultimately agreed to a global settlement on a substantially discounted basis. In fact, the discount that the bank accepted was so steep that no settlement payment was required of or was made by any of the foreign asset protection trusts involved.
Example 8: Jerry and Susan Marconi were referred by their litigation counsel at a time when they were being sued on a promissory note secured by real estate. Since there was a pending claim, due to fraudulent conveyance issues, the Marconis would be required to leave, outside of any newly created integrated estate planning structure, a sufficient amount of assets to satisfy the existing claim. Here, the Marconis wanted the creditor, a large bank, to proceed against the real estate and sell it rather than to proceed against the Marconis' substantial liquid assets. The liquid assets had a very low tax basis that would generate a substantial capital gain if they were used to satisfy the amount due on the promissory note. On the other hand, the real estate had a high tax basis that would actually generate a loss on sale. Unfortunately, the bank did not want to be bothered with the details of a foreclosure sale and was unwilling to allow the clients sufficient time to sell the property and remit the proceeds to the bank. The bank wished to proceed directly against the Marconis' liquid assets. In order to force the bank to proceed against the real property that secured the indebtedness, most of the liquid assets were transferred to a foreign asset protection trust. The result was that the bank could not reach these assets and was forced to look to the collateral that secured the loan for payment.
For a more in-depth discussion of fraudulent conveyance issues, see Chapter 2.
As noted above, the goal of asset protection planning is for a client to weather a legal storm moderately better than the client would have had the client not engaged in asset protection planning. It is the hope of every asset protection planner that he or she will be able to negotiate settlements for substantially less than the amount owed.
COMMENT: Settling a valid claim at 18 cents on the dollar is quite a success for both the client and the negotiating attorney. For example, assume that a $5 million claim was settled for $900,000. The client just saved $4,100,000. A planner certainly would have no problem admitting that he or she just saved a client more than $4 million through asset protection planning.
COMMENT: Over the last decade, we have found asset protection planning to be one of the most fruitful and profitable areas of our practice. Not only has asset protection planning benefited our firm, but, as evidenced by our many success stories, asset protection planning has helped the firm's clients in ways that otherwise would not have been available to them. In almost all cases, these clients have weathered the legal tide, not just moderately but substantially better than they would have without asset protection planning. So, does asset protection planning work? Absolutely!
125--Definition of Asset Protection Planning
Asset protection planning is but one component of integrated estate planning. The other two components are estate planning and financial planning. Asset protection planning may be viewed as the lifetime side of estate planning, and may be defined as the process of organizing one's assets and affairs in advance in order to guard against risks to which the assets would otherwise be subject.
In order to guard against such risks, in most situations, assets will be transferred from an unprotected form of ownership (e.g., direct individual ownership) to a different type of ownership or asset using an asset protection vehicle (see 155). Sometimes this transfer may involve moving assets from a nonexempt asset to an exempt asset. An in-depth discussion of using exemptions as a planning tool is discussed in Chapter 5. Other times, such a transfer may be to a family limited partnership. Using family limited partnerships in asset protection planning is discussed in Chapter 8. In many cases, the family limited partnership will be combined with a foreign integrated estate planning trust (IEPT) to maximize both the asset protection and the estate planning goals of the client. Integrated estate planning trusts are discussed at 1285.
PLANNING NOTE: The planner should ensure that the client understands the asset protection planning process. The client should understand exactly what is and is not a part of the client's asset protection plan. A good place to document this information is in the fee agreement. The fee agreement should give a detailed description of what is and is not included in the fee charged by the planner. After the clients have had time to review the agreement and discuss its provisions with the planner, the agreement should be signed by the planner and by all clients. For a sample fee agreement, see Practice Tool 10,460.
The concept of asset protection planning in advance cannot be stressed enough. Since asset protection planning generally involves the transfer of assets from a less protected to a more protected asset protection vehicle, everyone involved in the plan (including the planner) must endeavor to avoid establishing a protection plan after the client's assets have been "attacked." Protecting assets after there are creditors entitled to the remedies under the applicable fraudulent transfer act or similar laws could open the client and planner to criminal and/or civil action. All involved in the asset protection plan, including the planner, must be cautious and avoid the negative implications that may follow from failing to plan to protect assets in advance of when there are creditors who are entitled to remedies under applicable fraudulent transfer and similar laws. For more on fraud and fraudulent transfer issues, see Chapter 2. Asset protection planning concepts may be applied to protect every type of asset, whether cash, stocks, bonds, business interests, insurance proceeds, jewelry, art, antiques, real property, and so on. Although asset protection planning is typically applied in the context of protecting individually accumulated wealth, a number of applications exist for the operating business or professional practice.
135--Why Asset Protection Planning?
The idea of safeguarding assets from the many risks to which assets are subject is certainly not a new concept. For Americans and, increasingly, for persons in other countries, this is the case particularly when trying to protect against the potential of a future legal liability. Indeed, today a client whose attorney fails to advise him or her to incorporate a business or form a limited liability company to protect the client against the personal risks of owning and operating a business would no doubt wish that his or her own asset protection planning was in place. The importance of this question and the reasons for asking can more easily be illustrated through the following Example.
Example: Anne Fasbee was a senior tax partner in the Los Angeles office of a nationwide accounting firm. She was a professional who was thorough and ethical in her work. She was also extremely hard working and successful. By the time she was in her early forties, she was earning a high salary and had managed to accumulate a sizable net worth.
Fasbee was as diligent with her personal affairs as she was with her clients' affairs. Her estate and her spouse's estate were as well planned as they could be (or so they thought). They had pour-over wills, revocable living trusts, durable springing powers of attorney, living wills, a recently funded irrevocable insurance trust, a trust for each of their three children, burial instructions, and a charitable remainder unitrust. The Fasbee financial plan was also finely tuned with net after-tax returns for the previous several years reaching well beyond the upper reaches of expected norms. Unfortunately, as well planned as the Fasbees' estates were, one very important form of planning soon became quite conspicuous by its absence--asset protection planning.
The first of a series of lawsuits was served upon Fasbee's accounting firm in the latter part of the 1980s, shortly after the Fasbee family returned from three weeks in Spain and Italy. This suit was a class-action suit alleging, among other things, that fraudulent and misleading financial statements were prepared by the firm's Houston office in connection with a public offering of subordinated debentures. The next two suits involved allegedly faulty tax opinion letters rendered by the firm through its offices in Denver and Chicago. Several other suits followed as well. After failing to have two adverse judgments reversed on appeal and following the tremendous drains on the firm's cash and other resources due to the strains and expenses of "fighting the battles," the partners voted to seek federal bankruptcy protection for the firm. Consequently, many of the firm's partners had no choice but to do the same. This included Fasbee and, because she and her family resided in a community property state, her spouse as well. Therefore, the community assets were available to satisfy the separate debts of either spouse.
At last report, Fasbee was a single parent and solo practitioner sharing office space with a number of other professionals. Because of this most unfortunate personal experience, Fasbee learned that all of her sophisticated estate and financial planning was of little value to an estate that was itself of little value.
PLANNING NOTE: Had the Fasbees taken an integrated estate planning approach to their overall planning, the ultimate outcome of their misfortunes would likely have been much more favorable. It certainly would not have been any worse.
A number of factors evolved in the 1980s and into the 1990s, however, that make persons with wealth not only more aware of the need to engage in some form of protective planning but which in fact leave those who fail to plan more exposed than ever before.
135.01--Expanding Theories of Liability
By definition, a system whose legal decisions are based on legal precedent will be subject to expansion of its theories of liability. Each decision in the chain will set the stage for the next step of expansion. This, coupled with the apparent and increasing willingness of judges and juries to expand a theory of liability, leaves a tremendous amount of uncertainty and exposure for the person who has relied on traditional forms of planning.
Ten years ago, the idea that a smoker who developed lung disease would sue a tobacco company seemed ludicrous, but today we have become familiar with this commonplace theory of legal liability. Is it possible that in 10 years we will become familiar with a situation in which people with a more carnivorous persuasion develop heart disease and sue the grocery store where they had purchased their red meat over the years?
135.02--Concerns over High Jury Awards
The popular press headlines are frequently filled with cases that resulted in high jury awards to the plaintiffs. These types of articles are often what motivate the client to proceed with asset protection planning. This is easily understood when a planner considers articles similar to the one covering the $38 million jury award to the 26-year-old couple who did not like the way that a Mississippi bank treated them when the bank repossessed their car. [Martha Brannigan, "Why a Mississippi Jury Found a Small Dispute Worth $38 Million," Wall St. Journal, Apr. 12, 1995, at A1.] Lest we forget, there is the famous McDonald's hot-coffee-in-the-lap case. [Milo Geyelin, "Just Imagine: What Might Have Happened to Noted Plaintiffs Under Legal Overhaul," Wall St. Journal, Mar. 28, 1995, at B1.]
135.03--Concerns with Traditional Forms of Protection
The corporate veil seems to be pierced far more than ever before. Concerns with insurance coverage exist as well, whether it is with the solvency of the carrier, its continued willingness to write coverage, the existence of policy exclusions (e.g., punitive damages or damages that result from acts of gross negligence), or the like. For more on how insurance works in asset protection planning, see Chapter 7.
135.04--Jury of One's Peers
People of wealth who have ever needed to consider the right to a trial by jury have frequently felt that, if sued, they would never have a jury of their peers. Few litigators can claim to have ever tried a case before a jury comprised of individuals whose average net worth even approached that of the wealthy defendant.
135.05--Deep-Pocket Syndrome
Frequently, trial lawyers will base part of their case analysis on whether the potential opposing parties could pay a judgment against them. A party with sizeable assets and a veritable unlimited ability to pay is considered a deep-pocket defendant. An example of this is an advertising campaign by an asset search firm showing two lawyers huddled over a table with one of the lawyers commenting to the other that "the defendant has assets, so let's proceed." The converse to this would be that "the defendant does not have much, so let's not bother."
Many good arguments may be advanced on behalf of the contingency fee system. However, at least as many good arguments may be advanced against the contingency fee system. These arguments include the manner in which the system fuels litigation and otherwise often results in groundless or frivolous suits being brought by a plaintiff's counsel whose hope is to reach a favorable settlement with the client rather than to proceed to a trial on the merits.
135.06--Once You've Been Sued, You've Lost
Defendants experience a broad range of powerful emotions. These emotions run the gamut of fear, anger, and self-doubt. Once sued, defendants often feel that no matter what may happen, they have already lost.
The psychology affecting the players in the drama of a lawsuit actually can have a greater effect on the ultimate outcome of the lawsuit than the actual facts. Defendants are at a considerable psychological disadvantage. Experienced plaintiff's attorneys know this and know how to exploit this to the benefit of the plaintiff. In contrast, the defendant may feel as if he or she is carrying the full weight of the U.S. legal system on his or her back.
Often, being sued is a major life event that the defendant wants to bring to an end at the earliest possible moment. Many are willing to pay "too much" to do so. Imagine a scenario wherein a defendant is found not liable five years after the initial complaint was filed and after spending hundreds of thousands of dollars in legal fees. In the interim, the defendant has had many sleepless nights and has suffered tremendously both in terms of anxiety and inconvenience. The defendant's business and marriage likely will have suffered from absences and distractions. But ... the defendant won!! Perhaps it would have been preferable either to have discouraged the suit in the first place or to have been in a position to encourage an early and less expensive settlement.
It is unfortunate that efforts at tort reform have done little to curb the ever-increasing spiral of lawsuits. [David McIntosh, "Without Malpractice Reform, Forget Health-Care Reform," Wall St. Journal, Sept. 22, 1993, at A19.] The nature of the U.S. system where, generally, each party bears its own costs and expenses has the effect of shifting much of the financial burden of litigation to the defendant. Surprisingly to some, the U.S. rule is the exception. Much of the rest of the world follows the "loser-pays" rule.
145--Goals of Asset Protection Planning
Having defined the asset protection planning component of integrated estate planning (see 125) and having analyzed the reasons that this form of planning has become increasingly popular (see 135), what are the planner's goals in developing a plan? The planner must consider making a user-friendly plan or the client will never use it. The plan should naturally deter any litigation, but once that is initiated, the plan should try to steer the outcome to a favorable settlement. This is accomplished by leveling the playing field in the litigation arena by improved bargaining positions that are flexible enough to change while the litigation runs its course, with the intent being to win the game for the client.
145.01--Create a User-Friendly Plan
Planners sometimes too easily forget that most clients are laypersons who must live within the confines of the plan designed for them and deal with it on a sometimes daily basis. Asset protection plans that consist of myriad of entities designed to obfuscate and confuse third parties may also serve to confuse and frustrate the client. A properly designed structure that works because it is sound in legal theory and operation, rather than because it is complex, is not only better for the client but ultimately more protective as well.
145.02--Deter Litigation
Avoiding the deep-pocket syndrome (see 135) by reducing the size of the target may itself accomplish much in the asset protection context. Wealth is, of course, a target or a magnet for lawsuits in the United States. Put another way, those with wealth are often involved in many activities that increase exposure to litigation. Similarly, insurance itself, although designed to solve the problem, may simply become a substituted target, and may in fact encourage or attract litigation.
145.03--Provide Incentive for an Early and Cheap Settlement
Economics drive the legal system. Personal experience proves that much can be achieved by knocking the "profit" out of the pursuit and by being able to demonstrate to a judgment creditor that being paid is not the given that it was expected to be. Any seasoned litigator would confirm that it is one thing to win a judgment but another thing to collect a judgment.
145.04--Level the Litigation Playing Field
A defendant who has no asset protection planning in place will have fewer strategies and defensive maneuvers available at critical points during the course of litigation. A properly designed asset protection plan will, by its nature, create numerous issues with which some future adversary will have to contend. In fact, it may even be possible to tilt the playing field back in favor of the client and thereby obliterate the "once you have been sued you have lost" psychology.
145.05--Enhance One's Bargaining Position
Throughout the course of litigation, one who has a well-designed plan in place will have the benefit of a vastly improved negotiating position as a result of the mere fact that the planning was properly conceived and implemented. Well-positioned clients may even have the privilege of playing hardball with the other side.
145.06--Provide Options as the Game Is Played
A well-tailored plan will not tie the client's hands or lock the client into a course of action that must be followed regardless of what happens. Rather, it will provide a series of options that would not otherwise exist.
145.07--Win the Game
Proper planning will create a series of hurdles that the opponent must clear. With the realization that, deep-pocket driven, an emotional plaintiff may have the stamina and strength to clear the hurdles, the planning must ultimately work because it is legally sound. Therefore, a proper plan will construct a brick wall on the other side of the last hurdle. A plan that merely attempts to stay one step ahead of the pursuit is no plan at all. "Flight" clauses (see 1365) and "hop-scotching" jurisdictions may be incorporated as a part of the overall plan, but should not be relied upon to win at the end of the day.
It also is important to note that the plan should be designed to ultimately protect against any potential adversary. Life is more random and less lineal than we would like to think. For example, a client may have some sort of free-floating anxiety over the possibility of a professional malpractice claim being filed at some point in the future. However, a problem of a completely different nature (e.g., a dispute resulting from a future business transaction or a negligence action) could certainly develop. By definition, the proper plan must protect against future perils regardless of source or nature.
155--Engel Ladder of Asset Protection Planning Tools
There is no one asset protection planning tool or technique that universally protects all of a client's assets or that is an ideal match for all clients. Asset protection plans will almost always (if not always) involve a mix of the various tools and techniques available to the planner.
In determining what tools to use in the mix, the asset protection planner must analyze and take into consideration a number of factors. These will include, but are not limited to, the goals of the client, the concerns and sensitivities of the client, the nature of the assets to be protected, the location of the assets involved, and the net worth of the client.
The Engel Ladder of Asset Protection Vehicles identifies the various tools available to the asset protection planner and arranges them in good-better-best fashion, in ascending order of efficacy. A list of each rung of the Engel Ladder of Asset Protection Vehicles beginning with the least effective form of asset protection and ascending to the most effective form is detailed below:
Gifting (see Chapter 3).
Joint ownership (see Chapter 4).
Exemption planning (see Chapter 5).
Swiss annuity or Swiss insurance product (see Chapter 6).
Insurance (see Chapter 7).
Family limited partnership (see Chapter 8).
Domestic trust (see Chapter 9).
Hybrid company (see Chapter 12).
Stiftung or civil foundation (see Chapter 12).
Foreign integrated estate planning trust (see Chapter 13).
Expatriation (see Chapter 14).
See the Practice Tool at 10,020 for a diagram of the Engel Ladder of Asset Protection Vehicles.
The conspicuous absence of retirement plans from the Engel Ladder of Asset Protection Vehicles is not because retirement plans fail to protect assets but because they are frequently unutilized for different purposes. Many times, the owner of a closely held business will create a retirement plan for tax benefits. Other times, a retirement plan is created to attract and hold key personnel. It is true that the Employee Retirement Income Security Act of 1974 (ERISA) [P.L. 93-406] provides provisions that protect retirement benefits from creditors. It is also true that the protection from creditors afforded by ERISA is quite extensive. State exemption law may also provide protection. However, the use of a retirement plan is seldom motivated by the need or desire for asset protection planning. Rather, either the client's employer automatically provides for retirement plan benefits for the employee or the client owns his or her own business and establishes a retirement plan for nonasset protection plan reasons. In addition, the amount that one can contribute to such a plan is severely limited.
COMMENT: ERISA-protected retirement plans are seldom used as an asset protection planning tool, and for this reason retirement plans are not listed on the Engel Ladder of Asset Protection Vehicles.
For more on the protection afforded by retirement plans is provided, see Chapter 15.
165--The Engel Maxims of Asset Protection Planning
To effectively understand the Engel Ladder of Asset Protection Planning (see 155), the planner must clearly identify the goals of asset protection planning. There are several helpful, basic maxims to observe when performing asset protection planning services for a client. The practitioner must help the client anticipate the need for asset protection by doing preventive versus reactionary planning.
PLANNING NOTE: Whatever plan is adopted, it must be easily maintained by the client or it will be abandoned. If the plan is never used for asset protection, it must still serve the client's overall goals during his or her life and after death. Remember the law of diminishing returns and that it may not be necessary to protect every last penny. The planner must work within his or her own competency and do what he or she thinks is the best plan. The planner must ensure that if he or she recognizes that a planning opportunity is beyond his or her competence, the planner should get outside help as opposed to doing a bad job for the client.
A determined creditor may be able to access the assets despite the client's having a plan in place, but the overall goal of having the client in an equal or better position may still be accomplished when mental well-being is also considered. Being sued is not a good thing, and an effective asset protection plan may give the client a sense of control. That peace of mind, more than the money used to settle the suit, may help the client to more ably approach the suit and achieve better results.
165.01--Better to Look Ahead and Plan than to Look Behind and Regret
Many options that a client will want available must be planned for and created in advance of a legal challenge. After the storm clouds have gathered, and even as they are brewing on the horizon, the range of planning possibilities will certainly have narrowed. Some planning options may even be eliminated altogether.
165.02--Asset Protection Planning Should Be a Way of Life, Not a Reaction to a Problem
People in business learn one way or another to avoid unnecessary risks. If there is a relatively straightforward and cost-efficient method by which one can implement a plan in advance, then such a plan should at least receive thorough consideration. Ensuring that the client consistently follows through with the adopted plan by way of the client's subsequent actions is equally important to the overall plan.
165.03--Asset Protection Planning Is a Vaccine, Not a Cure
Asset protection planning is most effective when done before the client has a problem. It is a vaccine for the prevention of creditors and is not a cure for "ailments" already contracted.
165.04--Don't Sweat the Last Three Percent
This maxim of life management has broad application in the asset protection arena. The cost-benefit analysis of protecting the last three percent may just not pan out, whether from a financial point of view or from the client's own emotional point of view.
165.05--Hope the Asset Protection Plan Will Prove to Be a Waste of Time and Money
The ideal plan is one in which many years after the planning is undertaken, the client will be lying on his or her deathbed lamenting the fact that the asset protection plan was never challenged. This is a victory for the plan; it may even have been the existence of the plan itself that prevented the challenge from arising. Even if it that is not the reason for the lack of challenge, the client still wins in this situation if the planning has taken into account all possibilities, even at death.
165.06--There Is No Such Thing as the Perfect Offshore Financial Center
There are more than 60 offshore financial centers (OFCs). Each of them has different attributes and characteristics, and none can be said to be the "perfect" jurisdiction. In the course of designing the asset protection plan with foreign or offshore elements, the planner is well advised to take advantage of the best of what each OFC has to offer. For example, it would not be unusual to design and implement a structure that utilizes a Nevis Trust with an Isle of Man limited liability company that holds a managed account in Switzerland.
165.07--There Is No One "Right" Way to Design an Asset Protection Plan
Blatant (and even not so blatant) errors in the design of the estate plan are relatively easy to identify. The same applies in the asset protection arena. If five qualified and experienced planners were locked in separate rooms with an estate planning case, each would likely emerge (at some point) with a different yet competent plan. Until a plan is challenged, who is to say which is the better plan? Of course, a competent plan must be measured in terms of the goals of the particular client and the nature of the client's holdings.
165.08--If You Can Reach Your Assets, So Can Your Creditors
Generally speaking, under American law, "strings" exist between a client and property to which a creditor can grasp hold. The creditor then "reels in" the property in satisfaction of a judgment.
165.09--Once You've Been Sued You've Lost
The negative psychology of being sued can be overwhelming unless an effective asset protection plan is in place. The thought, however remote, that one may lose a significant portion or all of one's assets is a significant advantage for the plaintiff. Good plaintiff's attorneys know this and depend upon it. It renders the defendant susceptible to settlement pressures in even spurious and unfounded lawsuits. Just the cost and the perceived continued harassment that is the hallmark of prolonged lawsuits can lead an otherwise forceful and rational defendant to commit weak-kneed mistakes without asset protection planning. One is far less prone to such lapses in judgment when the fear of loss has been eliminated or at least mitigated through asset protection planning.
165.10--The Golden Rule
A well-known variation of the "golden rule" used to be "he who has the gold, rules." Today, without sophisticated asset protection planning, the "golden rule" is "he who has the gold, pays." The sad news is that many courts have adopted a risk-spreading approach to lawsuits. For instance, one argument suggests that businesses should pay for any and all ills derived from accidents without regard to a finding of fault, since a business may more readily purchase insurance and spread the loss among a broad segment of society. It appears that this attitude also is incrementally being applied to persons of wealth. Unless asset protection planning has been put in place, wealth can actually be a magnet for lawsuits that otherwise would not even have crystallized in the mind of the most imaginative plaintiff's attorney.
175--What Asset Protection Planning Is Not
As important as it is to know what asset protection planning is, it is equally important to know what it is not. Asset protection planning is not an excuse or vehicle for evading taxes, is not based on hiding assets, and is not an excuse to defraud creditors.
175.01--Not an Excuse or Vehicle for Evading Taxes
Some clients and advisors are attracted to asset protection planning by the tax advantages that they hope to find. This is particularly true when the planning involves the use of foreign entities. Since relatively few tax maneuvers involving foreign entities exist for the global investor today, a well-designed asset protection plan will have no particular income, gift, or estate tax advantage (or disadvantage). However, the familiar estate tax advantages that can be accomplished through tax-oriented approaches ordinarily found in domestic inter vivos or testamentary trusts will generally be included.
Most importantly, under most circumstances, a well-designed asset protection plan will have no particular income, gift, excise, or estate tax disadvantages, either domestically or abroad; it will be tax neutral. Both the planner and the client should be aware of this on an ongoing basis. However, both tend to be no more involved than those clients and their planners who tend to be associated with more familiar approaches. Tax neutrality will, therefore, prevail for the proper plan.
175.02--Not Based on Hiding Assets
Hiding assets can be dangerous; therefore, an asset protection plan that is based on such an approach is dangerous. The dangers arise from the likelihood that the client will have to make a choice between protecting assets and committing perjury if the client becomes involved in litigation. Whether or not the client ever becomes embroiled in litigation, the client may face some difficult decisions each year when the client's tax return is filed because full disclosure on a tax return is certainly inconsistent with planning based on secreting assets. Further, depending on the creditor, hiding assets may carry with it certain criminal implications. Finally, the intricately elaborate and tangled web that often results from such planning is inconsistent with the goal of creating a user-friendly plan.
PLANNING NOTE: Although many clients appreciate the confidentiality that can be obtained through an asset protection plan, a properly devised plan will not rely on hiding assets or even obscuring the asset trail to be successful.
175.03--Not an Excuse to Defraud Creditors
In the world of asset protection planning, the "clean" case is easy to identify. This is the case that involves an individual with neither an outstanding judgment nor a pending, threatened, or expected claim, but who, nevertheless, wishes to protect against the possibility of the "what if" occurring one day. The "dirty" case is also easy to identify. This is the case that involves an individual who is on the brink of bankruptcy (although prebankruptcy planning--a different type of planning altogether--may offer some hope for this person). In between are the many shades of "gray" in the world of asset protection.
Fraudulent conveyance law varies by state, as discussed in Chapter 2. A statutory body of fraudulent conveyance laws applicable to certain situations exists at the federal level as well. Our common law system favors the free alienability of property. As a result, one who is free from current creditor or expected creditor issues is absolutely free to dispose of his or her property as he or she sees fit. This person may want to make gifts to charities or to his or her children. Gifts to a spouse, whether outright or in trust, are also well within the realm of the ordinary, as are gifts in trust for the benefit of members of the client's immediate family. Fraudulent conveyance laws tend to focus not on who the transferee is but rather on the intent of the transferor at the time of the transfer. Since they are concerned with such intent, fraudulent conveyance laws generally protect present and subsequent creditors from transfers made by a person who is or foreseeably will become the debtor. The class known as "subsequent creditors" does not, however, include every person who becomes a creditor at some point in the future. For the good of the client and the planner, an asset protection plan must be implemented within the bounds of propriety as defined by reference to applicable fraudulent conveyance laws and ethical standards.
End Chapter 1 of Asset Protection Planning Guide--A State-of-the-Art Approach to Integrated Estate Planning by Barry S. Engel, David L. Lockwood and Marc Merric.