Asset Protection Planning Part 1 of 4
Copyright (c) 2009 Jeffrey Matsen
Asset protection planning has been practiced by attorneys, financial planners and accountants for several decades. Business persons have always had concern over the exposure of their personal assets to claims against the business. The corporate form of business entity with its shield of limited liability has been invoked for centuries. Certainly, protecting one’s assets from the myriad of risk involved in business and personal financial planning is not a novel objective or planning idea.
Since the 1970’s, expanding theories of liability and the proliferation of litigation have given increased emphasis to asset protection planning to the extent that it is now a well recognized area of practice. It certainly comes within the concept of lifetime estate planning involving the protection and conservation of accumulated wealth or asset base.
There is really no recognized body of law called asset protection. Indeed, it is a multi disciplinary practice area that involves estate and tax planning, debtor-creditor law, bankruptcy law and practice, judgments and remedies, business formation and business structuring, contracts and commercial law. A better name for asset protection planning might be risk management planning. Risk management attempts to protect and shield a client from all the various types of risks that the client might encounter whether business or non business related.
II. Fraudulent Conveyance Law
The process of planning for estate preservation and risk management involves the marshaling together of one’s assets in order to protect them from loss or dilution from potential risk and claims to which they would otherwise be subject. One of the biggest obstacles or hurdles an individual faces with respect to implementing a legally efficacious risk management plan is the fraudulent conveyance law. Fraudulent conveyances are conveyances made (or presumed to made) with the intent to delay or defraud creditors. Usually, fraudulent conveyances are characterized by a lack of fair and valuable consideration and/or an attempt by debtors to place their property beyond the reach of creditors. In California, the law of fraudulent conveyances found in the Uniform Fraudulent Transferred Act (“UFTA”) as set forth in Civil Code Sections 3439.01 to 3439.12.
Basically, a transfer made or obligation incurred by a debtor is actually fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation with actual intent to hinder, delay or defraud any creditor of the debtor. A claim means a right to payment whether or not the right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, un-matured, disputed, undisputed, legal, equitable, secured, or unsecured. A transfer means any manner of disposing of or parting with an asset or an interest in an asset whether direct or indirect, absolute or conditional, voluntary or involuntary, and includes the payment of money, a release, a lease and the creation of a lien or other encumbrance. Although most cases involve transfers of assets, California applies the fraudulent conveyance law with equal force to obligations incurred by the debtor.
A creditor need not have a judgment or a matured claim against the debtor to enforce the remedies of the UFTA. The relation of debtor and creditor arises in tort cases the moment that a cause of action accrues.
To determine whether transfers were made with actual intent to hinder, delay or defraud creditors, the focus of the inquiry is on the debtor’s state of mind. The court often infers fraudulent intent from the circumstances surrounding the transfer taking into account the so called “badges of fraud”. These badges of fraud include: 1. A transfer or obligation to an insider; 2. Concealment of the transfer or obligation; 3. The debtor’s retention of possession or control of the transferred property; 4. Transfer of substantially all of the debtor’s assets; 5. The debtor’s receipt of inadequate consideration for the transaction; 6. The debtor’s insolvency before or shortly after the transaction; 7. The incurring of substantial debts shortly before or after the transfer; 8. Pending litigation or threatened litigation against the debtor; 9. Transfer of the essential assets of the debtor’s business to a lienor who then transfers them to an insider of the debtor; and 10. The debtor absconding with his/her property.
Once these badges of fraud are established, then the burden shifts to the transferee to provide a legitimate purpose for the transfers. California, however, seems to say that the presence of badges of fraud does not create a presumption of fraud but constitutes evidence from which an inference of fraudulent intent may be drawn.
The fraudulent transfer law is primarily aimed at people who try to make gifts to other people or entities to avoid their creditors. In order for fraudulent transfers to be avoided, all transactions should be for “fair value”. In addition, the transfer should have economic substance.
Transfers to trusts are extremely suspect because they are not for fair value and often times do not have economic substance. However, transfers to limited partnerships and corporations may be “for value”. It is much more difficult to force a limited partnership or corporation to pay up than the debtor himself/herself.
III. Marital Planning
Prenuptial agreements and marital property agreements can be effectively utilized for risk management purposes. In California, one spouse may transmute his/her separate or community property by written agreement specifically setting forth the intent to transmit the property to the other spouse as his or her separate property. This transfer can be either outright or in trust. This process becomes important because a creditor of a married debtor may reach not only the separate property of that debtor, but the community property of the debtor and his/her spouse. On the other hand, the creditor cannot reach the other spouse’s separate property except to the extent the debts were incurred for the necessities of life. Accordingly, one very fundamental risk management planning tool is to attempt to allocate separate property to the spouse with the least risk. Care needs to be taken in evaluating and implementing the strategy, however, because the fraudulent transfer laws are applicable to marital property agreements, even those entered into in the context of a formal marriage dissolution proceeding.
IV. Use of Trusts in Risk Management Planning
A. Traditional Domestic Trusts
Trusts can be among the useful of asset protection tools. However, many trusts that are created for estate planning purposes are not properly structured to provide protection from creditors. The typical revocable living trust wherein the trustors are the lifetime beneficiaries and retain the power to revoke, amend and invade the principal of the trust provides no protection whatsoever against the creditors of the trustors. Certain spendthrift trusts can provide protection for risk management purposes. Care must be taken in the setting up and drafting of these trusts, however, in order to account for the estate and income tax consequences as well as for asset protection planning.
B. Domestic Asset Protection Trusts
As was stated previously, most self settled trusts are not protected from creditors. However, recently, several states have provided various degrees of asset protection legislation for a self settled trust. The legislation of these trust in Alaska, Delaware, Nevada, Utah and Rhode Island are similar in many respects to the asset protection trust legislation found in several offshore jurisdictions. It should be noted, however, that the courts have not had an opportunity to pass muster on this type of legislation because of its recent enactment and because the statute of limitations in most cases has not expired. Depending on the timeline involved with respect to when the claim has arisen, these trusts can be and should be considered in appropriate circumstances, but only by an attorney who understands all of the ramifications.