A number of offshore jurisdictions have enacted trust laws that provide significant protection for debtors.  One example is St. Vincent in the West Indies.  Its trust laws have a number of separate provisions that make assets held in a St. Vincent trust very difficult for a U.S. creditor to reach.  One such provision is that St. Vincent simply does not recognize foreign judgments with respect to trusts.  If a U.S. creditor has a judgment against a debtor in the United States, the creditor cannot collect assets of that debtor held in a St. Vincent trust without filing a new action in St. Vincent.  That new action will be subject to numerous requirements that put obstacles in the creditor’s path.  Legal proceedings in jurisdictions like St. Vincent often move very slowly.  Several years ago one of my clients was involved in a real estate transaction in St. Vincent.  I learned that navigating various St. Vincent legal requirements was difficult and very time consuming.  Jurisdictions such as St. Vincent also provide very short statutes of limitations for fraudulent transfers, which favor debtors over creditors. 

There are many other choices for offshore trust arrangements including the Isle of Man, the Cook Islands and the Cayman Islands.

While offshore trust can provide valuable asset protection, they are expensive to set up; there will be annual maintenance fees; they all involve loss of control of your assets to some degree; and they have various other risks.  They can also sometimes do more harm than good because many judges are naturally skeptical of entities formed in places most Americans have never heard of.

The bottom line is that an offshore trust arrangement may be an appropriate part of an asset protection plan, especially for certain high net worth individuals.  Generally, however, there will be simpler and less expensive alternatives available. 

Finally, it is important to note that offshore trusts cannot be used to avoid U.S. income taxes.  This continues to be a big misconception that many Americans have about offshore trusts.

There are a number of relatively simple strategies an organization can use to provide significant protection for its assets.

1.                        Separate Entities. Consider creating a separate entity (possibly a limited liability company) to hold real estate, machinery, or assets relating to a new line of business. If there were a future judgment against the corporation, the assets held in the separate entity or entities would likely not be subject to that judgment as long as appropriate formalities were followed. Tax issues can arise in connection with the transfer of assets, and these should be considered prior to any transfers. For example, the transfer of real estate out of a C corporation into a limited liability company could trigger a significant amount of tax, and thus make the transfer impractical. But if additional real estate or a significant piece of machinery or equipment is being acquired, having a new limited liability company purchase it (and then lease it to the corporation) could have significant advantages. 

2.                        Limited Liability Companies. 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; 
  • They have a great deal of flexibility in management structure. 

LLCs can 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. Creditors will have a much more difficult time gaining control of an LLC. Thus, many business owners now prefer to form an LLC instead of a corporation when the need for an additional entity arises.

3.                        Insurance. Review all of your business insurance with both your attorney and your insurance agent. Since your attorney is not selling any insurance products, he or she can often provide an objective review of the types and amount of your business insurance. Having adequate insurance is one of the most important (and generally one of the most cost effective) ways to provide protection for your business.

4.                        Update Corporate Records and Follow Required Formalities. Many closely held businesses do not keep their corporate record books up to date. In the event of a lawsuit against the company, a plaintiff’s attorney can attempt to “pierce to corporate veil”. This means the corporation will essentially be ignored and the owners (shareholders) will be personally liable for the corporate debts.  Following basic corporate formalities, including

  • Holding an annual shareholders meeting;
  • Holding regular meetings of the Board of Directors;
  • Avoiding any mixing of personal and corporate assets; and
  • Keeping corporate records up to date.

will all help to insure that the assets of the owner(s) of the business are insulated from any judgment against the business. One of the many advantages of an LLC over a corporation is that LLCs require fewer formalities in both their organization and operation. However, piercing of the LLC veil is also possible under various circumstances, including inadequate capitalization or failure to maintain a separate indentity (for example, failing to have a separate bank account for the LLC). 

5.                        Business Succession Plan. Many business owners lose sleep worrying about lawsuits and other potential legal claims. While these concerns are often justified, more businesses collapse from lack of a business succession plan than from a lawsuit bought by a party unrelated to the business. Lack of such a plan can lead to fights among family members, including litigation, which can be disastrous at both a business and a personal level. Paying attention in advance to at least some form of succession plan can save an enormous amount of trouble later. Life insurance should be considered as one part of the business succession arrangement. Good business succession planning is also a form of asset protection planning. 

6.                        General Legal Review of Business Operations. Is your business in compliance with applicable employment laws and other regulatory requirements? Has your employee manual been reviewed recently? One lawsuit will likely cost far more than a basic legal compliance review. A legal “check up” is like a medical check up: identifying one or more serious problems and taking care of them now can avoid a much greater problem later. 

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.

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.

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. 

   

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.

 

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.

 

Asset protection planning can bring a lot more certainty to our lives — at least with respect to financial matters.  And there is a lot of evidence that certainty makes us happier.

Personal planning — whether financial planning, estate planning, or asset protection planning — clearly brings a degree of certainty to our lives.  A good estate plan cannot insure that your stock portfolio will do better next year.  But it can give you the comfort of knowing that whatever assets you do have will be distributed the way you want.  Estate planning thus brings a degree of certainty.  Likewise, asset protection planning can give you the comfort of knowing that you have done what you lawfully and reasonably can do to protect your assets.

A recent article by a Harvard psychology professor says that certainty actually makes us happy — even happier than having more money. 

I see this all the time with respect to asset protection planning. Some business owners and individuals (including physicians and other professionals concerned about catastrophic lawsuits) are sometimes more worried than they should be about losing everything in a huge lawsuit.  If adequate insurance is in place, the risk of losing all your assets as a result of a malpractice suit or other litigation may be relatively small.  Nevertheless, worrying about a risk can literally be catastrophic in itself.  After consulting with an asset protection attorney a client knows what strategies are reasonably available and which are not.  Knowing that you have done whatever you reasonably can to protect your assets usually brings a significant amount of relief.  

Professor Gilbert says in the article I referred to above that certainty can bring greater happiness than money.  While asset protection planning will obviously not provide certainty in all aspects of your life, it can significantly reduce the uncertainty about what will happen if you face losses from some catastrophic lawsuit.  And it seems that should make you a lot happier.