Asset Protection Law Journal : Asset Protection Lawyer & Attorney : Kenneth J. Laino : Schneider Smeltz Ranney & LaFond Law Firm : Trusts, Estate Planning

A debtor’s personal residence is a natural target of his or her creditors. Some states (Florida, in particular) provide special protection for your home against claims of creditors. Currently, Florida’s protection is so strong that some debtors have re-located to Florida solely to take advantage of this protection. Texas also provides a very strong homestead exemption. Ohio, however, currently provides little statutory protection. Until very recently, the Ohio homestead exemption was only $5,000 -- one of the lowest in the country.  The exemption was recently raised to $20,200 (Ohio Revised Code Section 2329.66).  Furthermore, Ohio law does not permit residents of Ohio to utilize the federal bankruptcy exemption, which would be a higher amount. Even in bankruptcy, therefore, Ohio residents have only a $20,200 homestead exemption. There are huge variations in state homestead exemptions.   Texas and Florida are essentially unlimited; Nevada is currently $550,000. Other states -- like Ohio -- offer very limited exemptions.  

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 has significantly curtailed the previous ability to move from state to state to take advantage of a better homestead exemption. Essentially, the federal law provides that the state homestead exemption is limited to $125,000 if the debtor moved within 3 years and 4 months of the bankruptcy and in certain other limited circumstances. This limitation applies only in bankruptcy, however, and not to a creditor’s action outside of bankruptcy.

In several states, debtors may benefit from re-titling their residence as “tenants by the entireties.” Ohio, however, does not currently recognize this form of home ownership. While “joint” ownership is sometimes used to avoid probate, it is not helpful from an asset protection standpoint. Creditors of either joint tenant may be able to reach the entire property to satisfy debts of the joint tenant.

In light of the fact that Ohio provides such a low statutory homestead exemption, we look at alternative means of protection for our Ohio clients. We can sometimes gain some protection for clients through certain trusts. Not all trusts provide creditor protection. Certain trusts, however, may provide some protection for a residence. We also frequently advise re-titling the house in the name of the spouse who is least likely to face future litigation.

Issues relating to your personal residence cannot be analyzed in isolation. They should always be considered in connection with an over-all asset protection strategy.

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Irrevocable life insurance trusts (ILITs) can be a great estate planning tool under the right circumstances. ILITs have the added benefit of providing significant asset protection. 

Life insurance owned by an ILIT is not generally part of the insured’s estate (for both federal and Ohio estate tax purposes).  An ILIT will be most effective if it is formed prior to acquisition of the life insurance policy.   The ILIT directly purchases the insurance policy or policies. If the ILIT is formed properly creditors of both the settlor (the person establishing the trust) and the beneficiaries should have no rights in either the cash value or the death benefits of the insurance.

Assets of an ILIT should also generally be immune from claims in a divorce or dissolution of marriage. An ILIT (unlike certain other trusts such as so-called marital deduction trusts, credit shelter trusts and/or QTIP trusts) may also provide for termination of a spouse’s interest in the event of remarriage.

Whether or not an ILIT is suitable depends on the particular facts and circumstances. Moreover, the insured has to effectively give up control of the assets held in this type of trust; and the fees and expenses to set up such a trust also have to be considered. In some circumstances, however, an ILIT can be a valuable estate planning tool, and also provide significant asset protection opportunities.

An ILIT is definitely not going to constitute a complete asset protection plan.  But it may be very useful as one of the components of such a plan.

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A limited liability company (LLC) will generally provide better asset protection to its owner than a corporation.

A limited liability company (“LLC”) is a hybrid type of legal entity that has some characteristics of a corporation and some characteristics of a partnership. Owners of an LLC are called members; they can elect to receive pass through tax treatment like a partnership or an S corporation, or to have the LLC taxed like a C corporation; they have limited liability like in a corporation; and they have a great deal of flexibility in management structure. Thus, many business owners now prefer to form an LLC instead of a corporation when the need for an additional entity arises.

LLCs provide significant asset protection advantages. A creditor of an owner of a corporation (that is, a creditor of a stockholder) often can gain control of a corporation by getting control of the owner’s stock. Shares of stock in a corporation are assets that can be “attached” or otherwise taken by a creditor to satisfy a judgment against the owner of the shares. Once the creditor has control of the shares, it can generally vote the shares and possibly gain control of the business entity. Thus, if you own all the stock of ABC Corporation and one of your creditors is able to take that stock, the creditor will control (and own) ABC Corporation. A membership interest in an LLC, however, is treated differently. A creditor of the owner of an LLC, generally cannot gain control of the member’s interest, because LLCs have what is called “charging order protection." If and when the LLC makes a distribution to you, the creditor can take it. However, the creditor generally cannot force a distribution or gain voting control of the LLC. The bottom line is that a creditor of the owner of an LLC membership interest has much less leverage than a creditor of an owner of stock in a corporation. 

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There are many asset protection strategies, and the more expensive and complex ones are not always the best.  I like the comment made by Jay Adkisson (a nationally recognized asset protection planner) in the May 11, 2009 issue of Forbes Magazine.  He basically says the best ways are the old ways.

While that is a big generalization, there is a lot of truth in it.  Offshore trusts, so called "domestic asset protection trusts" (permitted by statute in states like Alaska and Nevada) and other more exotic asset protection techniques may all have their place --  given the right circumstances.  But for most executives, small business owners, physicians, and others in need of asset protection, more traditional devices should be considered first.  Simply dividing certain assets between spouses may be helpful.  Many  traditional trust arrangements, including an irrevocable life insurance trust (ILIT), can often provide significant protection.  So can one or more limited liability companies.  They are easy to set up and provide excellent protection when properly utilized.   Using a family limited liability company in conjunction with a revocable trust can be a relatively inexpensive way to protect assets, and potentially provide significant estate tax savings.

I advise clients to focus initially on traditional, relatively less expensive asset protection strategies.  If those appear inadequate, then consider other alternatives.  But do not start with the assumption that you need an offshore trust in order to reasonably protect your assets.  Many more ordinary arrangements may provide all the protection you reasonably need -- without many of the drawbacks of more complex arrangements.

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Corporations and limited liability companies (LLCs) provide significant liability protection to their owners.  Shareholders of corporations and members of limited liability companies generally are not responsible for debts of the corporation or LLC.  A recent Ohio case, however, serves as a reminder that creditors may attempt to "pierce the corporate veil" and hold an owner individually liable for debts of the entity. 

In RCO International Corporation v. Clevenger, 180 Ohio App.3d  211 (2008) the Plaintiff brought a breach of contract action against an LLC and its two members.  While the lower court granted summary judgment in favor of the owners, an Ohio appeals court held that the creditor may have made sufficient allegations against the owners, to sue them personally.  While the Plaintiff did not allege fraud, it did allege an illegal act (the company's sending a false invoice).  On the surface, the facts of this case did not seem to present a strong case for "piercing the corporate veil".  The decision, however, may have rested on certain procedural issues.  In any event, this recent case is a good reminder that simply forming a corporation or LLC does not in and of itself automatically give the owner limited liability in all circumstances. 

What can be done to prevent a creditor from "piercing the corporate veil" and holding an owner personally liable?

• Make sure your corporation or LLC is properly set up.  If you are setting up an entity without the help of an attorney, you may not be taking all the necessary steps to make sure that the entity is properly formed.
• Observe formalities once the entity is formed.  Corporations should hold annual meetings of shareholders.  There should be meetings of the Board of Directors.  An LLC should have an Operating Agreement, and the terms of that Operating Agreement should be followed.  Your entity should have a separate bank account and be treated as a separate entity.
• Your corporation or LLC should have usual and customary insurance for whatever business it is conducting.  A court is far more likely to try and "pierce the corporate veil" if the owner has intentionally failed to provide customary insurance for the entity's activities.
• Follow good business practices.  Forming an entity will not shield an individual owner from fraud or illegal acts.

The leading court decision in Ohio, Belvedere Condominium Unit Owners Association v. R.E. Roark Companies, 67 Ohio St. 3d 274 (1993), as well as decisions in many other states, make clear that if usual and customary practices are followed, a corporation or an LLC should provide limited liability protection for its owners.

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