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Asset Protection and Retention Control: Is Peaceful Co-Existence Possible?

Published by: University of Miami Business Law Journal
Author: Howard Rosen, Esq.
Date of Publication: 1992

Traditional thinking has held that protecting your assets from future creditors while continuing to control and enjoy the income from those assets are mutually exclusive goals. In his article, attorney Howard Rosen explains how the combined use of established business and estate planning techniques can permit both to be realized. 

Today we live in a society where litigation has become a popular tool for the accumulation of wealth — not only for money hungry plaintiffs, but for their ambitious lawyers as well. The explosion of all types of liability claims and new theories of liability, coupled with ever-increasing insurance premiums and defense costs have stunned the business and professional community in Florida.

As an example, consider the case of Tallahassee Furniture Company(1), where the Court awarded $2.5 Million to a woman who was stabbed by the company’s delivery man. The company had failed to interview the man, or to have him fill out an employment application (after all, he wasn’t being hired as the company president).

The case did not make new law, but it did illustrate, once again, the ever increasing risk of just conducting business, and the propensity for enormous jury awards being upheld by our appellate courts. Jury awards being granted under oldand new theories of liability, to the point where many businesses simply cannot afford to continue on. This type of loss has a “ripple” effect, resulting in increased insurance costs (if the company was fortunate enough to have coverage with a solvent insurer), which are eventually passed along to the public in the form of higher prices for goods and services. Moreover, if punitive damages are awarded, even a solvent insurance company won’t help -punitive damages generally aren’t covered by insurance.

What’s left for the businessperson or professional who would like to continue in business or practice his or her profession – and be able to sleep at night without the fear of a financial catastrophe? What can the wealthy individual, seeking a bullet-proof pre-nuptial arrangement do? What’s left for the retiring professional faced with staggering tail premiums, providing, in many cases, totally inadequate coverage?

Seeking to protect oneself from potential creditors is nothing new. Traditional methods have typically involved outright transfers to a spouse or other family members, creation of irrevocable trusts, and secret “asset return” arrangements. The effectiveness of these methods in protecting assets is doubtful, and the use of each creates its own set of problems, which include: fraudulent conveyance issues, exposure of the property to the transferee’s creditors, gift tax issues, and most importantly, loss of income and control.

A properly structured domestic trust may solve some of these problems, but where the client-transferor retains “strings” over the transferred property, the asset protection is nullified(2). Those who wish to use a domestic trust to protect their assets must sever all ties to the trust, and be prepared to accept the resulting loss of income and control, and to address the resulting gift tax issues. None of the traditional methods mentioned seem to provide a solution to the asset protection dilemma. What is the answer?

The answer is: to adopt advance planning strategies which place assets beyond the reach of potential future creditors. By utilizing sophisticated estate and business planning techniques — none of which are new — a businessperson, professional, entrepreneur, or other target individual can effectively protect his or her assets from future creditors and at the same time retain control over the assets and their income.

This type of planning involves the combined use of a limited partnership and an international asset protection trust. Importantly, it is not based upon secrecy or violating the fraudulent conveyance rules, nor does it result in gift tax problems.

The plan works by transferring the ownership of a client’s assets to a family limited partnership, the owners of which typically consist of the client as the general partner, and an international trust created by the client as the limited partner. This combination creates an impassable legal obstacle course in the path of a client’s potential future creditors. As the general partner, retaining as little as a 1% ownership interest in the partnership, the client has 100% control over the partnership and its assets. He makes all the decisions, he writes the checks, he is in control.

The limited partnership is the first hurdle in the legal obstacle course. Under the law, a partner’s creditor cannot reach the partnership assets — the creditor can only place a lien on the client’s partnership interest(3). This lien does not give the creditor any voice in the management of the partnership(4); it only entitles the creditor to the cash distributions which would otherwise go to the debtor partner(5). Since the client is in control of the partnership as the general partner(6), he will make no distributions (as such) to himself until the creditor goes away. Even though the creditor will receive no actual distributions, the Internal Revenue Service says he must pay tax on the share of partnership income attributable to the liened partnership interest, regardless of whether it’s distributed to him(7). Creditors (and people in general, for that matter) do not like to pay tax on income they don’t receive. This first hurdle in the obstacle course provides the client with substantial leverage to bring the creditor to the settlement table — on the client’s terms. While beyond the scope of this article, several methods exist for the client to access the partnership funds for his or her benefit while the creditor is still lurking — without exposing those funds to the creditor.

If the creditor is particularly unrelenting, the limited partner, which is the international trust established by the client in a “trust favorable” jurisdiction(8), can liquidate the partnership and receive a distribution of its capital account (typically 99% of the partnership). At this point, these assets are beyond the reach of a U.S. court’s judgment — the foreign jurisdiction where the trust is established will not recognize a judgment obtained in the United States(9). In order for the creditor to try to reach the client’s assets at this point, he must start his lawsuit all over again in the foreign country — under its laws, and with one of its lawyers! Only lawyers in the U.S. can take cases on a contingency fee basis, so if the creditor is adamant enough to try to pursue the assets in the foreign country he must pay the foreign lawyer from his own pocket — as he proceeds with the lawsuit! The creditor must then convince the foreign court that it has the jurisdiction to hear his case — an alleged wrong which occurred in the United States.

If the creditor can overcome that hurdle, which is not likely, he must then convince the foreign court that the client’s trust (which is a separate “person” in the eyes of the law) is responsible for the client’s alleged wrong. In the very unlikely event that a creditor has the tenacity and financial means to pursue the client’s assets this far, the trust can move to another trust favorable country, forcing the creditor to start his lawsuit all over again, and so on. In the meantime, the client and his family can continue to benefit from the trust assets and income — without exposing those assets or income to the lurking creditor. Unlike the laws governing domestic trusts, referred to above, the laws of certain foreign jurisdictions permit the client to retain significant controls over the trust without exposure of the trust assets to his creditors(10). When the creditor is made aware of the procedural, financial, and geographical hurdles he will confront in attacking this plan, he usually becomes quite willing to discuss a realistic settlement, rather than pursue the litigation.

One of the objects of this type of planning is to lower the client’s financial profile. The result is to deflect the creditor to another deep pocket or to the settlement table — quickly, before the legal defense fees mount up. The importance of advance planning must be underscored for asset protection clients; first, to avoid fraudulent transfer issues(11), and second, to provide the planner with sufficient time to identify and implement the appropriate planning strategies. Asset protection planning is entirely permissible as long as it is done before a creditor is on the horizon.(12)

The legal basis for this type of asset protection is not new — the laws have been in place for decades, but law schools don’t teach this type of planning. Lawyers are taught how to sue and how to defend, but not how to prevent lawsuits. In fact, for many law firms, offering asset protection services could represent an actual conflict of interest, in that it would tend to reduce business for their litigation departments.

The Florida Constitution(13) and statutes(14) provide creditor protection via the homestead exemption and the exemption for the proceeds of annuity contracts(15), among others. Although it is doubtful that the homestead exemption will change, the favored annuity exemption has come under attack in a recent legislative session, and, in the author’s opinion, the attack will be renewed in the near future. These exemptions should not be viewed as the “answer” to asset protection, rather they should be viewed as one part of the solution. The client should recognize that although his home will appreciate, it is not an income producing asset, and that although the proceeds of his annuity contracts are exempt under current law, the annuity itself is only one type of investment, generally providing a somewhat limited return, with its continued status as an exempt asset open to question. The sophisticated planning described above is based upon partnership legal principles which are firmly entrenched in 49 states (as compared with Florida’s special annuity exemption), and the laws of foreign jurisdictions whose revenue depends upon keeping these laws securely in place.(16)

Finally, the entire structure — the partnership and the international trust — is tax neutral(17). The client continues to report and pay income tax on the earnings of the trust(18), and on his general partnership interest in the partnership(19). The structure is gift and estate tax neutral as well. Even though the trust is irrevocable, the client-grantor retains certain powers over the trust which, for federal estate and gift tax purposes only, render the transfer to the trust an incomplete gift(20). The trust includes the estate tax credit shelter and QTIP provisions necessary to achieve the maximum estate tax savings on death, and the partnership may be utilized as the basis for a structured gifting program; thus, both are easily integrated into an existing estate plan, or they may form the foundation for a new estate plan.

Asset protection planning will become more and more important as the explosion of tort litigation and the expansion of theories of liability continues in the United States. How much does this type of planning cost? Typical legal fees range from $18,500 on up, but considering the immediate savings available to some clients in the form of reduced insurance premiums, and the potential for subsequent savings in the form of legal defense fees not paid, the plan will invariably save money, rather than cost money! In today’s economic and litigation environment, can a “target individual” really afford not to give asset protection planning serious consideration?

1. Harrison v. Tallahassee Furniture Co., Inc., 529 So.2d 790 (Fla. 1st DCA 1988).

2. If a Settlor creates a domestic trust for his or her own support, or a trust where the trustee has the discretion to make or withhold distributions to the settlor, or where the settlor retains a general power of appointment, the trust assets are exposed to the settlor’s creditors. See, Restatement (Second) of Trusts 156(2) (1959); Restatement (Second) of Property (Donative Transfers) 13.3 and comment a (1986); Ware v. Gulda, 331 Mass. 68, 117 N.E.2d 137 (1954). See also, Creditor’s Rights Against Trust Assets, 22 Real Property, Probate and Trust Journal 734 (Winter 1987).

3. FLA. STAT. 620.153 (1991).

4. See, FLA. STAT. 620.152(1)(b) (1991).

5. FLA. STAT. 620.152(1)(c) (1991).

6. See, FLA. STAT. 620.125 (1991).

7. Revenue Ruling 77-137, 1977-1 C.B. 178.

8. Such as the Cook Islands, Isle of Man, Bahamas, Gibraltar, and the Cayman Islands. The laws of these jurisdictions were not enacted to help people defraud their creditors, or gain an unfair advantage over them; their laws, which we view as protective, are a reflection of their perception of a rational, balanced, legal system.

9. See, for example, 13D of the Cook Islands International Trusts Amendment Act of 1989. See also, Cook Islands International Trusts Amendment Act of 1991, which improved certain protective aspects of the prior legislation, and clarified certain issues relating to community property and trust situs transfer.

10. Id. at 13C, for examples.

11. See, generally, Chapter 726, Florida Statutes (1991).

12. E.g., Hurlbert v. Shackelton, 560 So.2d 1276 (Fla. 1st DCA 1990); Eurovest, LTD. v. Segall, 528 So.2d 482 (Fla. 3d DCA 1988).

13. Fla. Const. art. X, 4(a).

14. See, generally, Chapter 222, Florida Statutes (1991).

15. FLA. STAT. 222.14 (1991).

16. In the unlikely event the government or the laws of the situs country are changed with the effect being a less stable government, or a less favorable trust legal environment, the trust instrument provides that the trust can move to another more favorable jurisdiction.

17. The trust, although irrevocable, contains certain provisions which result in the trust income being taxable to the grantor under Subpart E of Chapter 1 of the Internal Revenue Code ( 671 – 679). The Internal Revenue Service has tacitly recognized this “tax neutrality” in Revenue Ruling 87-61, 1987-2 C.B. 219, where it held that the 1491 tax, usually applicable to transfers of appreciated property by U.S. persons to foreign trusts, does not apply to a trust which is taxable to the grantor under the provisions of Subpart E.

18. I.R.C. 671.

19. I.R.C. 701, 702.

20. See, for example, Treas. Reg. 25.2511-2(c).

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Donlevy-Rosen & Rosen, P.A. is a law firm with a focus on asset protection planning and offshore trusts. Attorneys Howard Rosen and Patricia Donlevy-Rosen co-founded the firm in 1991, and have since become recognized authorities in the field of asset protection planning. Let us explain the significant difference our experience can make when protecting your assets. Call 305-447-0061 or simply visit our contact page