Subscribe via RSS Feed Connect on LinkedIn View videos on YouTube

Poorhouse Prevention

January 17, 1997 0 Comments

Published by:

Author:

Date of Publication:

Women’s Business Journal

Patricia Donlevy-Rosen, Esq.

January 1997

Litigation in our society is a popular tool for the accumulation of wealth – by plaintiffs and their attorneys, who often take cases on a contingency basis. Attorneys handle lawsuits if there is any basis for a claim, and, most importantly, if there is a source of funds from which they will be paid. Asset protection planning makes the source of such funds minimal at best. If you think you do not need to secure your wealth, ask yourself: Am I absolutely certain that I will never be sued? And, if by some chance I am sued, that I will be fairly treated by our justice system? Most will answer “No!”, and wonder what they can do. Asset protection planning is the answer.

Asset protection planning is the adoption of advance planning techniques which place one’s assets (inherited, earned, or won) beyond the reach of future potential creditors. In its legal and ethical form it does not involve hiding assets, secret return arrangements, or fraudulent transfers. It is based upon sophisticated, yet very legal, business and estate planning techniques.

An individual with a nest egg, or the likelihood of accumulating one (high earning or inheritance potential), needs to do advanced asset protection planning with a qualified, licensed professional.

The most popular protection plan used by the clients of the law firm of Donlevy-Rosen & Rosen, P.A., Coral Gables, Florida, is the use of the U.S. family limited partnership and offshore asset protection trust combination. It sets up an impassable legal obstacle course in the path of an individual’s future potential creditors.

How does this work? A client forms a limited partnership and contributes those assets which are to be protected to the partnership. The client acts as the general partner, and the limited partner is the offshore asset protection trust, also created by the client. As the general partner, the client retains control over management, investment, and distribution of the protected assets.

The limited partnership is the first impediment in a future creditor’s obstacle course. Why? Because under the law of most states, a partner’s creditor cannot reach the partnership assets or foreclose on a debtor-partner’s interest to satisfy its claim (as it could if the client’s interest were stock in a corporation or other unprotected asset) – the creditor can only place a lien on the debtor-partner’s partnership interest. This lien does not give the creditor any say in the management of the partnership; it only entitles the creditor to the cash distributions which would otherwise go to the debtor-partner. Since the client (the debtor-partner) is in control of the partnership as the general partner, she will make no distributions (as such) to herself until the creditor goes away. There are methods, beyond the scope of this article, whereby the client may access the partnership funds for her benefit while the creditor is still lurking – without exposing those funds to the creditor. Moreover, the IRS says that regardless of whether the creditor gets any distributions from the partnership, the creditor must pay the tax on distributions that would otherwise go to the client-debtor! A creditor continuing to pay tax on the client-debtor’s share of partnership income, while waiting for a distribution which may never come, is more likely to settle the matter favorably for the client.

Why also use the foreign trust? First, certain assets should not be held by a limited partnership, but may be owned by a trust. In addition, although the use of a limited partnership should provide significant protection, how a local court will act can be unpredictable. Sometimes a “result-oriented” judge will ignore the statute limiting the creditor’s rights against a partner in a limited partnership, and somehow pierce the partnership protection; this has happened. Therefore, individuals secure significant additional protection by the use of an offshore trust as the limited partner in the family limited partnership.

If a creditor is unrelenting, or there is a concern that a result-oriented judge may pierce the partnership, then the asset protection trust, which is settled in a “trust favorable” jurisdiction, can liquidate the partnership and take back its capital account (usually 98-99% of the partnership). The trustees will move the assets offshore – beyond the jurisdiction of a U.S. court. If the creditor has the financial means to pursue the matter, he will have to begin his lawsuit all over again in the foreign country – under its laws and using its attorneys (who are not permitted to take cases on contingency)!! The creditor must convince the foreign court that it has jurisdiction to hear the case – an alleged wrong which occurred in the U.S. If the creditor can overcome that hurdle, which is unlikely, he must convince the foreign court that the client’s trust is responsible for the client’s alleged wrong. In the meantime, the trust can move to another trust favorable jurisdiction, forcing the creditor to again start over. When a creditor is made aware of the procedural, financial, and geographical hurdles he either quickly settles, or gives up.

Let’s look at an example: Nancy and Myriam invest $200,000 each in a corporation they form: ABC, Inc., through which they operate a small drycleaning business. In setting up and operating this small business, some of ABC’s vendors require Nancy and Myriam to give personal guarantees. Outside of their capital investment in ABC, each has approximately $500,000. Nancy keeps her monies in a local bank account. Myriam, at a time when the business is doing well, contributes her $500,000 to a family limited partnership in exchange for a partnership interest, and has her offshore trust be the 99% limited partner. Some time later, ABC begins to lose money, and its creditors look to Nancy and Myriam’s personal guarantees.

Under this scenario Nancy is a vulnerable target for the creditors of ABC. Why? Because her assets are liquid, and being in her name can be reached by them. She is not only a “deep pocket”, but an open one. Myriam, on the other hand, has protection; she holds only a partnership interest which is subject only to the charging order remedy; and, if her partnership is liquidated and the assets put offshore, her $500,000 (plus earnings) are out of the reach of ABC’s creditors.

Asset protection planning should be done before a problem arises, so as to avoid fraudulent transfer issues, and to provide the attorneys with sufficient time to identify and implement the appropriate planning strategies. It is entirely legal as long as it is done before the dispute arises, and is generally done as part of an estate or business plan. The basis for and concepts are not new – the laws have been in place for years. However, such planning is not done as a matter of course because most lawyers are trained to sue and to defend, not to prevent lawsuits.

The trust’s assets may be located anywhere, including a U.S. local bank (until a problem arises). The trust itself will likely be domiciled in the Cook Islands or other trust favorable jurisdiction, chosen after a consideration of numerous factors. In the case of a problem arising in the U.S., the trustee can relocate the assets outside of the jurisdiction of a U.S. Court.

Not everyone has the means to use this advanced sophisticated planning. However, there are other avenues. The Florida Constitution and statutes provide creditor protection via the homestead exemption, and the exemption for certain wages, insurance and annuity proceeds, etc. However, each of these protections may unwittingly be forfeited.

Finally, a word of caution about married couples holding property jointly. Tenancy by the Entirety (“TBE”) is a form of concurrent ownership available only to a husband and wife in Florida; it provides limited asset protection. There are three major defects in this protection. First, while the protection does exist, it is limited to the liabilities owed by one spouse; no protection is afforded against joint liabilities owed by the couple. Second, TBE protection disappears in the event of death of the non-debtor spouse or divorce, unless the property is awarded to the non-debtor spouse. Third, one unified credit may be wasted (the $600,000 per individual exemption), resulting in an overall increase in a couple’s estate tax.

 

To conclude, prior to making any changes in the manner of holding one’s assets, individuals are advised to seek qualified legal counsel for a full understanding of the ramifications of those changes.

 

This article is displayed with the permission of the publisher.  Unauthorized reproductions are not permitted.