“Asset protection” is a term used to describe various legal methods of protecting personal or business assets from lawsuits and judgment creditors. While the strategies listed do not include all asset protection possibilities, the list below provides an overview of some of the types of available techniques. Before we proceed, I want to make sure that it is well understood that in order for asset protection to be effective, it is critical that there is no fraudulent transfer of assets. If a court finds a fraudulent transfer occurred, the court can undo the transfer and force a transfer of assets to the individual’s creditors. The key factors considered in a fraudulent transfer case are:
- Timing – Did the asset transfer occur before or after the “claim” arose? If the claim existed prior to the transfer, the transfer will likely be considered fraudulent.
- Sales and exchanges – Did the transferor receive equivalent value back in exchange for making the transfer? If the individual receives equivalent value back, the risk of a fraudulent transfer determination is lessened.
- Insolvency – If the individual is insolvent (unable to pay debts) before the transfer, the transfer may well be considered fraudulent.
Liability Insurance is the simplest and most common method of asset protection. For many risks, specific types of liability insurance can be purchased.
People usually fear loss of income or capital through death, disability, or long-term illness. Significant protection against such losses may be obtained through adequate health insurance, life insurance, disability insurance, and long term care insurance if the proposed insured is insurable.
Every state and the District of Columbia have statutes protecting certain assets from creditors.
- Many states have enacted homestead exemption laws to protect all or part of a debtor’s primary residence from the claims of creditors. Generally, these laws require that the homestead be personally owned as opposed to being held in a family limited partnership or some other type of business entity. The exemptions vary broadly from state to state.
- Some states have a statute protecting life insurance and annuities from creditor’s claims. Statutes vary from state to state as to the amount of protection of life insurance (cash values and death benefits) and annuities, who must be named as beneficiary, etc. The law of the specific state should be reviewed.
- Qualified retirement plans (e.g., defined benefit, profit sharing, and 401(k) plans, ESOPs, etc.) are generally protected from judgment creditors by virtue of ERISA’s anti-alienation provisions. In bankruptcy, qualified retirement plan assets should be protected from almost all creditors, while IRA and Roth IRAs. This amount is adjusted every three years for inflation and is scheduled to be adjusted in April 2016.
Where assets are not afforded statutory protection, entities can be established to protect assets from creditors as well as maintain control. However, asset protection may be lost if the owners do not follow the business formalities and respect the type of business entity.
- Limited Partnership & Family Limited Partnership - Only the general partners are personally liable for partnership debts. A limited partner’s liability is limited to his/her investment. Each state’s laws vary as to creditors’ rights. In many states, a creditor’s sole remedy against a limited partner is to get a charging order from the court. With a charging order, the creditor can get partnership distributions but has no right to vote or ability to get to the underlying partnership assets.
- Limited Liability Company (LLC) – In general, no member of the LLC is liable for LLC debts unless the member makes personal guarantees. Again, states’ laws vary but, in most states, judgment creditors of an LLC member cannot get to the LLC assets. They can only petition the court for a charging order. As mentioned above, a charging order generally gives creditors no voting power so the creditor cannot normally compel a distribution from the LLC. The creditor only has access if a distribution is actually made. Note that charging order protection varies by state. Some states including California and Florida have enacted legislation that would allow a court to liquidate the LLC interest to the extent necessary to satisfy creditors.
- Corporations – Generally, shareholders are not personally liable for corporate debts unless the shareholder makes personal guarantees. However, corporate stock may be subject to attachment by a creditor of the shareholder. A buy-sell agreement may allow the company or other shareholders to buy out the stock that a court may order distributed to a shareholder’s creditor.
Another possible strategy is to utilize some type of trust arrangement. Generally, the assets of a trust may be protected from judicial claims against the beneficiaries of that trust. For example, a grantor may generally make a complete and irrevocable transfer of assets to a trust for the benefit of family members, and the future creditors of neither the grantor nor the trust beneficiaries can use trust assets to satisfy judicial claims, as long as the transfer is not a fraudulent conveyance or otherwise falls within the bankruptcy trustee’s powers. However, even irrevocable trusts may be successfully attacked in cases when there is an excessive control is retained by the grantor. Again, these are legal matters which require the services of a qualified attorney.
If you have a general question or comment, please contact Michael Pechersky, CFA at Eagle Strategies, LLC by calling (212) 261-0239 (work), (917) 318-5504 (cell), or by e-mail at mpechersky@ft.newyorklife.com
