You can’t fix the roof when it’s raining…

… and you can’t do much to protect your assets from creditors after you’re already in financial trouble. But just like the fellow who never thought about his leaky roof when the sun was shining, many of us never consider our potential vulnerability when things are hunky-dory.  With a little planning during sunny times, though, your assets can be made much less vulnerable to judgments resulting from unanticipated lawsuits, downturns in the market leaving you “upside down” in real estate investments (and thus subject to deficiency judgments), or unexpected medical bills.

There are some viable asset protection mechanisms available, but the key is to take steps to protect your assets when you are not in, or even anticipating, any financial trouble.  If you are already in trouble with the tax man, falling behind in your payments, or have just been involved in a car accident, it’s probably TOO LATE to obtain any substantial protection.  Any attempt to shift ownership or control of assets at that point can probably be set aside by a creditor as a “fraudulent transfer”.  In most states, it is safest to take asset protection steps at least four years before trouble starts brewing; in some situations, creditors can reach back as far as 10 years to undo a transaction!

Many people get into serious trouble by trying to devise and implement their own “asset protection” ideas. People trying to hide assets in a divorce, or when they anticipate a lawsuit, sometimes enter into an informal agreement with a friend or relative to hold title to property “until the coast is clear”. While somewhat appealing on the surface, this all-too-common arrangement can have disastrous consequences. What if the title holder gets into trouble himself, and the asset is seized by HIS creditor? What if the friend is involved in a car accident and a big judgment is entered, which automatically becomes a lien on the property? What if he hasn’t paid his taxes, and the IRS slaps a big lien on “your” property?

There are several different ways that you can legitimately protect your property without falling into these traps. The simplest is, of course, insurance – purchase coverage for possible occurrences that could create a risk of losing your property. Another very good way to protect assets is to actually have someone else do it for you – if you anticipate receiving property from an inheritance or gift, talk to the donor about giving the property to you in the form of a trust that has ‘spendthrift’ protection. While you can’t usually shield assets that you already own in this way, others can provide you with very effective protection when they give you property by gift, or through their will or trust when they die. (You can also do this for your beneficiaries, protecting the things they inherit from you against claims by their creditors, and even potential divorce-related claims by their future-ex-spouses. Talk to your estate planner about how to do this.)

Using ‘limited liability’ entities – LLCs (limited liability companies) and corporations –  with proper structure, formalities and sufficient capitalization, can very effectively shield your “outside” assets (assets you own personally, not within the entity) from “inside” liability (liability generated by the activities or assets of the entity). For example, if your rental property is owned and operated by a corporation, and someone slips and injures themselves on the property, they can recover a judgment against the corporation, but your personal, non-corporate assets will not be available to satisfy that judgment.

In some circumstances, these entities can also provide protection for the “inside” assets (owned by the entity) from your “outside” liabilities (those you incur personally, not related to the entity’s business or operations). This is not complete protection – depending on the way the entity is set up, and the jurisdiction in which it is established, your creditors may be able to reach some or all of the property owned by the entity. But in some cases, if done correctly, it can be fairly effective, and will certainly create an additional hurdle for the creditor to clear before being able to take your property.

This brings us to an important distinction between two different types of asset protection – what I like to call “complete” (or almost complete) protection, and “hurdle” protection. With a mechanism that provides complete protection, if the right steps are taken, at the right time (WELL BEFORE there is any indication of financial trouble), the creditor will simply not be able to access the asset at all. With “hurdle” protection, you’re not putting an impenetrable wall around the asset, but merely making it more difficult, expensive and time-consuming for the creditor to access it. This often induces the creditor to settle the debt for a lower amount, sometimes substantially lower.

An important thing to realize about asset protection is that generally, the more protection you want to obtain, the more control you must relinquish over the assets being protected. So if you are willing to give your assets away completely, and do so well before any creditors loom, the creditors will most likely be unable to access them – but so will you! The trick is finding the right balance of protection and control. Properly using a trust or other entity specifically designed for this purpose – particularly in a jurisdiction where the laws have been crafted to provide superior protection from many kinds of creditors – can sometimes provide that balance. But that level of protection is neither cheap, nor necessarily foolproof.

Other strategies that can be successful, depending on the circumstances, are shifting assets to forms that are protected from many types of creditors (such as life insurance, certain retirement plans, homestead property or the ‘tenancy by the entirety’ form of ownership in states that shield such property, etc.); or using trusts and other kinds of entities, even in states that don’t shield such assets completely, as “hurdle”-type protection.

But if you are worried about protecting your assets from FUTURE claims, NOW is the time to seek competent advice about how to do so.  Once a lawsuit is filed, or bills, judgments, and foreclosures are raining down, it’s way too late to fix this potential “hole” in your planning strategy.

Published in: on June 20, 2010 at 9:40 am  Leave a Comment  

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