IMGCAP(1)][IMGCAP(2)]Effective asset protection requires the strategic use of several legal components.
These include the transfer of assets to protective structures (such as limited liability companies and trusts), proper allocation of legally protected assets, insurance and proper titling of assets to maximize legal exemptions from claims. Proper structuring insulates assets against claims from future, unknown creditors.
Timing is critical; this cannot be overstated. An effective plan must be implemented before clouds form. Existing and expected liabilities are not avoidable. Reactionary transfers—made to avoid liability—might be reversed and could entwine others in litigation, including recipients and professional advisors.
Take, for example, one client who owned and operated several successful franchises in Florida. Despite his financial success, animosity existed for several years between the franchisor and franchisee, culminating in non-renewal of the franchise agreements. A disagreement over termination and final accounting ultimately led to a lawsuit in the franchisor's home state where the court entered a judgment against the client for over $1.6 million. Personal planning initiated prior to the lawsuit proved effective and the judgment was settled for less than 10 cents on the dollar.
How is this possible? For one, the client owned very few assets in his own name. He was married and most personal assets were properly titled to maximize the benefits of marital ownership.
His several real estate holdings were generally owned in protective structures such as multi-member LLCs with various partners, sometimes in a parent-subsidiary relationship. Cash and other liquid assets were held in entities designed to make maximum use of business entity laws in the state of formation. Business operations were structured to make best use of income exemptions.
The end result is that the client owned very few personal assets that were available to satisfy the judgment. Nothing was hidden from the creditor. In fact, settlement talks picked up steam after we disclosed the client’s organizational chart to the creditor’s attorney. With no exposed assets, the creditor’s recovery was limited to whatever the client was willing to offer to resolve the matter. Effective asset protection planning promotes favorable settlements.
Consider the result if the client had waited until the beginning of the lawsuit or after entry of the judgment to engage in asset protection planning. Most states’ laws permit creditors to reach otherwise protected assets which are the subject of a “fraudulent transfer.” These laws permit suit against both the debtor and the recipient of the transfer and empower creditors to reach assets intended to be transferred outside their grasp.
Some states may even allow claims against third-party professionals involved in the transfer. There have been cases in Florida, for example, where banks, financial advisors and lawyers have been sued in connection with a fraudulent transfer. Regardless of the end result, being named in a lawsuit is never a good thing.
In our case study, had the client waited until being sued to initiate planning, any protective transfers or re-titling of assets might have exposed the client and others involved to a separate fraudulent transfer lawsuit to unwind the transfer. Business partners, the client's spouse, attorneys and any other professional advisors involved in the transfer might also have been dragged into the lawsuit.
Creditors can prove a fraudulent transfer by showing actual or constructive intent to hinder collection. Actual intent is a subjective analysis that generally depends on the debtor’s state of mind. Such proof is implied through the debtor’s actions and often relies upon innuendo and assumption. In contrast, constructive intent generally requires showing that a debtor made a gratuitous transfer (i.e.: made without receiving “reasonably equivalent value”), which left the debtor insolvent, undercapitalized or otherwise unable to pay debts in a timely manner.
These factors can often be demonstrated through valuation analysis, financial statements and payment histories. As an objective analysis, constructive intent to avoid a creditor is generally easier to prove and is therefore usually the preferred fraudulent transfer attack by creditors.
The determination of solvency and reasonably equivalent value lie beyond the traditional expertise of legal counsel and often require advice from other professionals. Those financial professionals who may be called upon, such as accountants, valuation experts and financial advisors, must understand the basic concepts of asset protection and fraudulent transfers.
If a client seeks asset protection advice or involves a financial advisor in a potentially fraudulent transfer, the advisor must understand the limits and potential pitfalls. Where fraudulent transfer laws are implicated, it is best to involve the advice of counsel experienced in the area.
Asset protection involves several legal and financial components which, if not properly negotiated, can have potentially devastating legal ramifications. When a client seeks asset protection, always consider the implications of fraudulent transfers.
Gary Forster and Eric Boughman are partners at the law firm of
