Asset Protection Goes Mainstream

From our Spring 2006 Newsletter

Once upon a time, asset protection was a seedy little niche practice area whereby money was moved offshore and then hidden in foreign trusts, bearer share corporations, and secret Swiss bank accounts. There were relatively few plan-ners who held themselves out as asset protection planners, maybe less than a couple of dozen nationwide.

Today, things are dramatically different. Asset protection has become a main-stream planning area. Many attorneys, CPAs, and financial planners hold them-selves out to clients as being asset protec-tion planners. Even insurance companies are getting into the business, by actively promoting “Accounts Receivable Financ-ing” programs for the specific purpose of asset protection (and, of course, to gener-ate additional annuity and life insurance sales). Very simply, asset protection has become the sexy hot topic of the other-wise bland estate and financial planning world.

Are clients really being served? The an-swer, sadly is “No”. Even before asset protection became all the rage, it suffered from “productization”, which means that promoters were selling one-size-fits-all cookie-cutter structures to the public with the promise that these structures afforded everyone asset protection regardless of their circumstances.

The problem with standardized asset pro-tection products is simple: If one creditor can figure out how to de-fuse the product, then it is likely that every creditor that follows will use the same technique as the first creditor and also defuse the product. This was the case with the supposedly impregnable foreign asset protection trust (FAPT) – after the Anderson decision in 1999 showed creditors that they could seek a contempt remedy to cast offshore trust settlors into jail until the money came back, creditors have routinely and successfully employed what has become known as “Anderson relief” to defuse these types of trusts.

By far the biggest problem is that most alleged asset protection planners simply do not have anything like a sound under-standing of creditor-debtor law or what happens in collections litigation. Most planners have been to a few continuing education seminars and heard whatever guru regurgitate his thoughts about his pet asset protection structure du jour, and then these planners have set out to try to sell the structures on their own. You would be amazed at how many planners have never even read the Uniform Fraudulent Transfers Act – much less have anything like a working knowledge of it – nor do they fundamentally under-stand such basic concepts as what a charg-ing order really does. They have no clue about what questions a creditor’s attorney will ask at a debtor’s exam. But that doesn’t keep these planners from selling the asset protection structure du jour to their clients.

Take domestic asset protection trusts (DAPTs), for example. They are sold like crazy, being promoted by several trust companies that preach their benefits with-out suggesting any possible weaknesses. Actually, some planners have started re-peating the trust companies’ mantra and themselves are now chanting that DAPTs are currently the greatest and most unde-featable asset protection tool that one can buy.

But how many court opinions validate the benefits of DAPTs? None. There is not a single case that demonstrates that DAPTs work to protect assets from creditors, though to hear the trust companies tell it you would think that they have 100 years of solid precedential opinion showing that DAPTs work. To the contrary, there is 100 years of case law showing that self-settled trusts do not work, at least in the solid majority of states that do not recog-nize DAPTs.

Admittedly, DAPTs might work for peo-ple who actually live and keep their assets in the few states that have adopted DAPT legislation, but there is little chance that DAPTs will work for somebody living in another state. Oh, and if all that weren’t bad enough, last year’s bankruptcy act created a 10-year clawback for transfers to spendthrift trusts that were meant to defeat the rights of creditors. Although the defects of DAPTs are numerous and their benefits are highly doubtful outside of the few DAPT states, they are still being marketed like crazy by the trust compa-nies and without any warning of the DAPTs numerous potential defects.

My point is this: The mere fact that some-thing is being marketed doesn’t mean that it will work, either at all or in a particular client’s circumstances. There is a lot of junk being marketed for asset protection – junk that has little chance of protecting assets in hotly contested litigation. There are also a lot of planners out there who are peddling asset protection even though they don’t have much of a clue as to what they are doing.

This situation is not unique; indeed, it is the precise same growing pains that “es-tate planning” went through in the early 1990s when that became all the rage. There were crazy people with crazy ideas about estate planning then, just as there are crazy people with crazy ideas about asset protection planning now. Just as then, some of these crazy people will ac-tually sell their crazy ideas to the banks, life insurance companies, and trust com-panies who will then see that they are mass-marketed to the general public. And just as then, these ideas will blow up and litigation will result.

Do not think that mere complexity makes something work from an asset protection perspective. The recent opinion of the bankruptcy court in the case of In re Turner, 335 B.R. 140 (Bankr. N.D. Cal. 2005) is instructive. In Turner, the debtor and his wife went to a seminar on asset protection, and thereafter embarked upon a series of sophisticated transfers for the purpose of asset protection. They trans-ferred their home (exactly as some “gu-rus” suggest) to a Nevada LLC that they had set up that was owned 99% by their Bahamas trust and 1% by another Nevada corporation that they formed.

Good planning? Hardly. The federal bankruptcy judge set aside the convey-ances of the home as a fraudulent transfer, and then held that the entire structure was simply the alter ego of the debtor:

“‘Asset protection’ is not illegal and is hon-ored if done for a legitimate purpose. For example, an individual may do business through a corporation or limited liability company and will not be held personally liable for the debts of the entity. The assets of the corporation or limited liability com-pany will not be considered the assets of the individual interest holder. However, an entity or series of entities may not be cre-ated with no business purpose and per-sonal assets transferred to them with no relationship to any business purpose, sim-ply as a means of shielding them from creditors. Under such circumstances, the law views the entity as the alter ego of the individual debtor and will disregard it to prevent injustice.”

What the debtor, and undoubtedly his planner, thought was rock-solid asset pro-tection turned out to be something that was easily sliced through by the courts. As sophisticated as the structure might have seemed, it failed for the very reason that it was concocted for the specific pur-pose of asset protection and lacked any significant other business purpose. If the planner had understood the basics of creditor-debtor law, this type of planning would never have taken place. As it was, the debtor paid for a complex structure only to find out that it wasn’t worth the mound of paper that it took to implement it.

There are many similar asset protection structures out there. People may think that they have implemented a bulletproof plan, but in fact they are surrounded by tissue paper that will dissolve at the first sign of rain. Most planners do not even know whether the stuff they are selling even works or not, but ignorance seems to be bliss so long as their clients don’t get sued. Unfortunately, their clients will not figure this out until it is way too late.

Asset protection is the latest rage in plan-ning for the affluent. It is one of the best attractors of wealthy individuals and their money. But just as estate planning before it, the sector of asset protection planning will keep going through growing pains and goofy schemes until once again sanity reigns. Let’s just hope that not too many people get hurt in the meantime.