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Asset Protection
Scott G. Beattie, J.D., LLM

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It won't be news to any of you that we are living in the most litigious times in American history. Too many lawyers per capita and too few disincentives have led to a proliferation of litigation -- frivolous and otherwise. From three million dollar coffee spills to multi-billion dollar car wrecks, punitive jury awards frequently go beyond the pale of what is reasonable. In environmental litigation, you don't even have to contribute to the hazard to be held liable. Causation has been removed from the legal equation in many circumstances.

For every lawyer who will not take on a frivolous case, three will appear who are only too happy to file suit. Frivolous litigation is a modern day Hydra -- three heads spring up for every one that is chopped off. The so called "American Rule" that each party bears the cost of his or her own legal expenses is a major part of the problem. The "English Rule" requires that the loser pay the winning parties legal expenses. Overseas the English Rule stems the tide of frivolous litigation, causing attorneys and litigants to think twice before entering the fray. But the American Rule continues to hold sway in the States.

It is no wonder that a virtual cottage industry has sprung up in the area of "asset protection" and "wealth preservation" planning. Such planning is designed to protect wealthy and not so wealthy individuals from losing hard earned assets to creditors and litigants. However, because of the widely varying levels of competency and ethics among the lawyers engaging in such planning, there have been a number of abuses. For every legitimate asset protection plan, there are asset protection scams that won't pass muster. Even seemingly legitimate asset protection plans have failed to achieve their objectives in many instances.

So is asset protection planning a fleeting fantasy concocted by unethical attorneys or a solid reality upon which individuals of wealth can build a foundation of legal protection? In several recent San Francisco Chronicle Articles, Richard Sommers -- the self proclaimed "Tax Prophet" -- has stated his belief that asset protection plans are "expensive and wasteful exercises in wishful thinking" that will not hold water under judicial scrutiny.

The nay sayers such as Sommers tend to focus on the more expensive and exotic plans such as those using offshore trusts to hide assets of U.S. taxpayers. Typically such trusts are set up in tax havens such as the Cayman Islands, Vanuatu, the Cook Islands and the Isle of Man. The gurus of the asset protection world have focused on the use of such trusts as the lynchpin of their asset protection plans. The basic premise is that by placing assets in foreign jurisdictions they will be beyond the power and authority of U.S. courts. The off-shore asset protection industry suffered some setbacks in recent litigation. In a recent case of note, the Ninth Circuit District Court placed Linda and Michael Anderson in jail for six months for contempt of court until they obeyed an order to repatriate assets they had moved offshore. The Anderson's were represented by a major international law firm, but the Court of Appeals for the Ninth Circuit (which includes California) made it clear they didn't buy in to the legitimacy of the off-shore asset protection trust, particularly since the Anderson's had obtained the funds in a scheme to defraud U.S. Citizens.

Nevertheless, there are a number of legitimate and more pragmatic planning techniques that have asset protection or wealth preservation features and which don't require such exotic and risky planning. Here are some rules of thumb for solid asset protection planning:

 
1. Always maintain adequate levels of liability insurance (I know this is a plug for the insurance industry, but its good basic protection);
    
2. Acquire assets which are exempt from creditor's claims. Where possible, contribute to Qualified Pension and Profit Sharing Plans rather than IRAs (O.J. Simpson got it right with this one -- reports indicate he has approximately $3,000,000 sheltered in his qualified pension plan). Don't roll over your qualified plan into an unprotected IRA or SEP-IRA. Only qualified pension and profit sharing plans are protected from creditors under the bankruptcy laws. In some states (but not California), life insurance cash values are also exempt;
    
3. Make testamentary bequests in trust rather than as outright distributions. Particularly for professionals (e.g., Accountants, Dentists, Doctors, Lawyers) and others with high liability risks (e.g., contractors) inheritances should be received in trust for your benefit rather than outright if you want your inheritance to be a nest egg that won't be exposed to creditors. Spendthrift clauses in such trusts protect assets from a child or grandchild's creditors also. The trustee can then provide beneficiaries with direct lifetime benefits (e.g., purchase vacation homes in the trust) and income without making outright distributions that would expose the trust principal to creditors.
    
4. Always plan early, before litigation arises. Fraudulent transfers designed to leave you insolvent shortly before creditors can get their hands on your assets will be readily set aside by the courts;
    
5. Operate your business in an entity for which you are not liable and follow the technical requirements for maintaining that entity (e.g., registering business assets in the entity, holding annual meetings, etc.). Use separate entities for separate functions. Segregate assets and business or investment activities with potential liability exposure into separate entities such as Corporations and/or Limited Liability Companies. This is the don't keep all your eggs in one basket principal carried into the world of legal entities. If one entity is exposed to a liability (e.g., for a tort or environmental hazard), the assets properly segregated into the other entities can be protected from the claim.
    
6. Homestead your residence. Some states allow residents to completely protect the equity in a personal residence (e.g., Florida) while other states allow residents to protect a major portion of the value of a family residence (e.g., Texas). California is among the worst states in this regard as the California legislature in its wisdom has limited the homestead exemption to a maximum of $75,000 for married couples.
    
7. Add hurdles for creditors which will encourage a more favorable settlement. For example you may hold investment assets in entities such as limited partnerships or limited liability companies and split the ownership among family members. Such entities contain features which are not desirable to creditors. Creditor remedies in most states limit your individual creditors from accessing the assets in the entity. Instead creditors are only entitled to charging orders against distributions. If distributions aren't made, the creditors may be subject to adverse income tax results without receiving the financial benefit.
    
8. Beware of exotic and complex schemes that promise guaranteed asset protection. There is no magic pill here and the perfect asset protection plan does not exist. Fraudulent transfers can be set aside whereas techniques that have other legitimate estate and business planning purposes may be respected.

As with most tax and legal subjects, there are many complexities to asset protection planning which are beyond the scope of this article. You should not attempt to implement an asset protection strategy without consulting your tax and legal advisers.

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