Editor's Note: The following article is a summary of a presentation Rothschild will give at the 44th Annual Heckerling Institute of Estate Planning conference in Orlando, Fla., on January 27.
Many clients consider today's social and economic environment more litigious and more hazardous to the preservation of wealth than in years past. This view is supported when one observes the ever-expanding theories of liability, the rise in jury awards, the increasingly result-oriented courts and the high incidence of divorce. By reason of these problems, traditional forms of protection may be inadequate. Moreover, certain classes of beneficiaries may have greater exposure to risk than others. These include, but are not necessarily limited to, professionals subject to malpractice exposure, directors and officers of publicly held companies, investment advisors and owners of real estate.
I've frequently exhorted that it is a primary obligation of estate planning advisors to consider their clients' potential need for timely asset protection planning. In fact, some commentators have suggested that there may be significant malpractice exposure for professionals who neglect this important aspect of financial planning. Although, obviously, not every client's circumstances will require asset protection planning, every estate planning professional should be prepared to advise clients whose circumstances warrant such consultation.
Due Diligence
The
first step in advising a client with respect to asset protection is to
ensure that the client will not be engaging in a fraudulent transfer.
Asset protection planning must be sensitive to avoiding circumstances
where the transfer of property appears to have been made with the
intent to hinder, delay or defraud creditors. Certainly, no transfers
can be made which would have the effect, after consideration is given
to any pending or threatened litigation, of rendering the transferor
insolvent. Under all other circumstances, the issue boils down to how
close in time the transfer was to the subsequent creditor claim. It is,
therefore, imperative that asset protection planning be undertaken as
far in advance of a potential creditor claim as possible.
The attorney must carefully assess the client's situation by obtaining a net worth statement and identifying any contingent liabilities or claims that the client may be subject to in the foreseeable future. Furthermore, appropriate independent due diligence should be undertaken by searching the Web and services such as LexisNexis and Accurint to confirm the client's representations. The engagement letter should clearly set forth that the client is not contemplating bankruptcy and understands that the attorney will not assist with any fraudulent transfers. The attorney who undertakes such planning without the recommended due diligence may find him or herself involved in civil or criminal litigation as well as a possible disciplinary proceeding.
Exempt Assets
Once
the client intake has been cleared, the next step is to identify assets
that are inherently exempt under state law and assess the possibility
of converting non-exempt assets into exempt assets. For example,
maximizing retirement plan contributions and purchasing life insurance
and annuities, where such assets are exempt from creditors, may provide
significant asset protection at minimum cost. Additionally, where the
client is married and residing in a state that provides protection to
tenancy by the entirety property, consideration should be given
thereto.
Transfers To Others
One
of the most basic techniques used in asset protection planning is the
simple expedient of transferring assets to one's spouse or to (or in
trust for) one's children or other family members. Although generally
protective, such transfers involve surrendering all rights to control
the transferred assets, and any certainty that the transferor can
continue to enjoy the benefits of the transferred assets. Such
transfers also subject the owner to loss in the event of divorce.
Additionally, transferring assets to one's spouse (for
less-than-adequate consideration) has sometimes been held to be subject
to attachment by the transferor's creditors where the transferor earned
most or all of the family's income. Using a legal fiction known as a
"constructive trust," the courts have sometimes held that the
transferee spouse is merely holding the property as a trustee for the
benefit of the transferor spouse. Finally, to the extent that the
transfer is later deemed a "fraudulent conveyance," the courts will
unwind the transfer and the transferred property will be paid over to
the transferor's creditors.
Each of these techniques, however, is limited in its protectiveness; the details of which are beyond the scope of this article.
LPs And LLCs
Another
fairly common asset protection technique is the transfer of assets to a
limited partnership or limited liability company. Under this technique,
the owner of the property contributes it to a limited partnership in
which he or she is the general partner, wherein other family members
(including the transferor) are named as limited partners. As the
general partner, the transferor retains control over the assets in a
fiduciary capacity for the benefit of all of the partners. At the same
time, the assets are generally secure from the claims of the creditors
of any individual partner since the assets are owned by the entity,
rather than by the individual partner. Under what is known as the
"charging order" protection, a creditor of a limited partner is
generally only entitled to attach the interest of the limited partner
in the partnership and thereby receives distributions only if and when
distributions are made. (Some states, however, provide that the
charging order is the sole and exclusive remedy. Where such is not the
exclusive remedy, the creditor can seek to foreclose against the
debtor's interest).
Of course, if the general partner of the limited partnership is a family member, he or she is unlikely to make any such distributions until after the debtor partner has successfully settled the creditor's claim, which itself provides the debtor partner with the necessary leverage to do so.
In addition to the asset protection benefits that a limited partnership can provide, it can also prove beneficial for more traditional estate planning purposes, such as saving estate and gift taxes. For example, if a parent is the general partner and transfers a limited partner's interest in a limited partnership to his or her children, the value of the transferred interest will likely be entitled to a discount from the value of the underlying assets of the entity since the transferred interest is non-controlling, and has no public market. Moreover, since the parent, as general partner, retains total management control over the assets held within the entity (albeit in a fiduciary capacity for the benefit of all of the partners), the oft-cited fear of a child getting access to substantial sums of money immediately upon attaining majority (as would be the case with a Uniform Gifts to Minors Account or a Uniform Transfers to Minors Account) is not an issue.