Ethical Considerations in Asset Protection Planning
Published by: Estates, Gifts, and Trusts Journal; BNA Tax Management
Author: Howard Rosen, Esq.
Date of Publication: May, 1993
Much has been written lately about asset protection planning (“APP”): offshore trusts, offshore trust jurisdictions, limited partnerships, and fraudulent transfers. The purpose of this article is to discuss the ethical considerations an attorney must address when rendering services in this expanding sub-specialty. APP is referred to as a sub-specialty because, in the author’s opinion, it falls within the discipline of estate planning. Both traditional estate planning and APP require the lawyer to take an analytical approach wherein the lawyer will: obtain information regarding the client’s financial condition, determine the client’s lifetime and testamentary dispositive goals, and design/implement a plan that achieves those goals. In addition, both utilize similar tools and techniques: wills, trusts, partnerships, outright gifts, gifts in trust, and so on.
The traditional goal of the estate planner in carrying out his client’s wishes has been to preserve and protect his client’s assets for the benefit of the client’s family following the client’s death – reducing transfer taxes, avoiding probate costs and delays; APP expands this respectable endeavor to include preserving and protecting the client’s assets for the client’s own benefit during his lifetime.
THE THRESHOLD QUESTION
The threshold ethical question the planner must consider is whether APP itself is ethical. A California attorney recently requested an opinion of that State’s Bar regarding whether assisting a client in APP was ethical. In essence, the California Bar responded by stating that as long as the transfers involved were not fraudulent, there was no ethical issue involved. In 1984, the South Carolina Bar Ethics Advisory Committee held that an attorney would not be in violation of that State’s ethical rules if he assisted a client in transferring property to the client’s spouse where thesole purpose of the transfer was to avoid the possibility that a future creditor could recover a judgment against the subject property.(1) The Advisory Committee held that as long as there was not an immediate reasonable possibility of a judgment being entered against the client, assisting the client in the proposed transfer to avoid the loss of the property as a result of a possible future action of a creditor was not improper.
APP has been defined in a variety of ways, and the term may have different connotations for different people. Therefore, in order to properly answer the threshold question of whether APP is itself ethical, we need a frame-of-reference definition of APP.For purposes of this article, a workable definition would be: The adoption of advance planning strategies which place assets beyond the reach of future potential creditors.(2)
Although ethical considerations are governed by the code of professional responsibility of the planner, it is the author’s view that, within the above definition, APP is entirely ethical and proper.(3)
Some writers, including the author, have even suggested that an estate planner’s failure to address asset protection issues where otherwise appropriate could be actionable by his client. For example, consider the following: A wealthy client consults his attorney regarding a comprehensive estate plan. During the course of his analysis, the attorney is made aware that the client has significant liquid assets, which he recommends be transferred to the revocable trust he is drafting for the client. Three years after the estate plan is implemented, the client is sued for a matter which arose two years after he met with the estate planner.
The client suffers a financially catastrophic judgment, and is required to liquidate his revocable trust in order to satisfy the judgment. Query: Couldn’t (or shouldn’t) the client bring an action against the attorney and argue that if the attorney had recommended APP to him at the time of his estate planning consultation, he would have undertaken such planning, and he would now be in a significantly better financial position had the attorney properly advised him? The author is not aware of any such case on the books at this time, but considering the litigation explosion in recent years, can such a case be far off?
Estate planners utilize a variety of techniques to avoid the payment of estate taxes, including, for example, structuring a nonresident alien individual’s ownership of U.S. real property through foreign entities to entirely avoid the U.S. estate tax. Query: Isn’t this a form of APP? How many planners have thought that avoiding the estate tax in these situations was unethical? Applying similar reasoning, assisting a client in protecting his assets from the claims of future potential creditors should be considered to be an ethical endeavor.
PAST THE THRESHOLD
If one concludes that APP is a proper undertaking in general, additional ethical issues will ordinarily arise during the course of representing the APP client. The first of these additional issues to be faced by the estate planner will be whether he may ethically assist this particular client in APP. The chief factor the planner will consider in resolving this issue will be the various state and federal fraudulent transfer laws.
A discussion of the various fraudulent transfer laws is beyond the scope of this article. However, the APP lawyer must be thoroughly familiar with the state and federal fraudulent transfer statutes applicable to his client’s matter. The ABA model Rules of Professional Conduct, Rule 1.2(d)(4) provides that a lawyer “shall not counsel a client to engage, or assist a client, in conduct that the lawyer knows or reasonably should know is criminal or fraudulent…” Therefore, assisting a client in structuring a fraudulent transfer would be prohibited if the action would constitute fraud or criminal conduct.
The lawyer discipline cases in this area have typically involved egregious actions on the part of the attorney, although there is no reason to believe that a proceeding would not be brought against a lawyer who, through ignorance of the fraudulent transfer rules, assisted his client in defrauding a creditor.(5) In Townsend v. State Bar of California(6), an attorney was suspended from the practice of law because he assisted his client in a transfer of property two days before a judgment against his client was entered, in circumstances where the recordation of the deed was designed to hide the lawyer’s participation in the matter. In The Florida Bar v Cohen,(7) an attorney was suspended from the practice of law for participating in a scheme with his client whereby he and the client recorded and foreclosed upon a mortgage (based upon a nonexistent debt) from the client’s corporation so that the corporation would not have to pay high liability insurance premiums, and to avoid paying damages to possible claimants against the corporation.
The foregoing being said, another basic tenet of professional conduct for attorneys is that “A lawyer shall provide competent representation to a client.”(8) The lawyer engaging in APP must harmonize these rules, and carefully assess each client’s financial condition and goals before assisting the client with respect to such planning. The APP lawyer will see cases ranging from one end of the factual spectrum to the other: In one case, the client will seek to engage in APP because of a vague or undefined concern over his future well-being, with no specific creditor or transactional concerns,(9) while in another case, the client’s creditor will be (figuratively speaking) lurking outside of the lawyer’s office, or nipping at the client’s heels.(10) Cautious and fully informed planning is the watchword.
SUMMARY AND CONCLUSION
Traditional and rudimentary methods of protecting assets have included outright gifts, creating tenancies by the entireties, gifts to irrevocable trusts established for the benefit of spouses, relatives, and friends, and secret “asset return” arrangements. Even beyond the ethical issues involved, the problems encountered in “eleventh hour” utilization of the foregoing include: fraudulent transfer issues, exposure of the property to the transferee’s creditors where an outright transfer is made, gift tax issues, loss of income and control, and re-exposure of the assets to the client’s creditors where the “protection” depends upon the survival of a spouse in a tenancy by the entireties.
Effective APP will not be based upon secret arrangements, nor will it be based upon fraudulent transfers – the planner’s assumption should be that everything is discoverable.
People confronted with a discussion of APP seem to either have a very positive reaction or a very negative reaction to the subject — very few reactions in between. In the author’s experience, those who have a negative reaction either believe that APP involves hiding assets or laundering money, or have sued someone (unsuccessfully) who has properly protected himself.
In APP, as in tax planning, timing is an all important factor in determining whether a particular plan is ethical or unethical, proper or improper. The APP undertaken at the last minute will likely run afoul of a fraudulent transfer rule, just as certain tax planning strategies so undertaken would be considered improper unless part of the transaction were “old and cold”
1. South Carolina Ethics Advisory Committee, Opinion 84-02, May 25, 1984. It is open to question whether the same result would obtain if such “sole purpose” planning were fraudulent per se under the State’s fraudulent transfer act.
2. “Future potential creditor” is a term of art referring to the unknown creditor; the creditor with whom the client has not yet done (or contemplated doing) business at the time of the transfer. See, e.g., Oberst v. Oberst, 91 B.R. 97 (D.C. Cal. 1988), where the court distinguished between transfers prompted by a desire to place property beyond the reach of potential future creditors and transfers intended to defraud creditors entitled to protection under applicable fraudulent transfer laws. See also Hurlbert v. Shackleton, 560 So.2d 1276 (Fla. 1st Dist. Ct. App. 1990), where the court distinguished between “probable” and “possible” future creditors, the former being entitled to fraudulent transfer law protection, while the latter were not so entitled.
3. In fact, protecting a client’s assets from creditors has been called “A Planner’s Job” in CCH Financial & Estate Planning Ideas & Trends, Report 95/Issue 185, December, 1987 (now out of print).
4. See also Florida Rules Regulating The Florida Bar, Rule 4-1.2(d).
5. But see State v. Baker, 539 S.W.2d 367 (Tex. Civ. App. 1976); People ex rel. Chicago State Bar Ass’n v. Lotterman, 353 Ill. 399, 187 N.E. 424 (1933). In both of these cases the courts permitted a “good faith” exception to apply where the lawyer’s acts were contrary to professional ethics.
6. 32 Cal.2d 592, 197 P.2d 326 (Cal. 1948).
7. 534 So.2d 392 (Fla. 1988)
8. See, eg., Florida Rules Regulating The Florida Bar, Rule 4-1.1.
9. See Oberst v. Oberst, 91 B.R. 97 (D.C. Cal. 1988).
10. See Townsend v. State Bar of California, 32 Cal.2d 592, 197 P.2d 326 (Cal. 1948).
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