Protecting Assets from Creditors

The CPA Journal, September 1993 | Go to article overview

Protecting Assets from Creditors


It has become exceedingly difficult for business people and professionals to conduct their affairs without exposure to the hazards of litigation and creditors arising both inside and outside their businesses. There are methods by which professionals and others with significant amounts of assets at risk may legitimately protect their personal net worth. An important new private letter ruling from the IRS highlights the International Offshore Estate Planning Trust, perhaps the most flexible of these methods.

LITIGATION PROLIFERATION

Professionals and their insurers and other high-net-worth individuals appear to be deep pockets oflast resort, readily available to compensate individuals, entities, or public bodies for any loss, real or imagined. In addition to tort liability arising out of professional practice, other liabilities arise out of the business activities or personal affairs of the professional or high-net-worth individual. To finance daily operations, professionals and individuals borrow substantial sums from banks and other creditors, loans which the individual members of a firm may be required to guarantee. Individuals also face claims by creditors that arise in the ordinary course of their personal lives or perhaps out of unfortunate investments made in happier times with borrowed funds. Some claims may arise merely from "status." Most notorious o these are environmental claims whereby bare title owners or lessees of real property may be liable to state and Federal agencies for unlimited costs of alleged pollution clean ups.

It is beyond the ability of any individual singlehandedly to divert the current stream of litigation. However, those who are aware of the problem can minimize exposure to attack by the manner in which assets are held.

INVESTMENTS IN EXEMPT ASSETS; GIFTS AND FRAUDULENT CONVEYANCES

Individuals with litigation risk will want to invest to the greatest extent possible in assets which, under applicable state and Federal laws, are exempt from the claims of creditors. Qualified retirement plans governed by ERISA are to a large extent protected in bankruptcy proceedings. (Some plans established by closely held corporations may not be governed by ERISA and thus may not be protected.) Qualified plans include pension plans, profit sharing plans, 401(k) plans, and Keogh plans. Although not governed by ERISA, IRAs in some states are exempt by statute. In some states, a principal residence, no matter how valuable, is completely exempt from creditors. Certain states exempt annuities and life insurance policies from creditors. Again, each high-net-worth individual should consult with experienced legal counsel to obtain a list of those assets exempt under state law from attack by creditors and protected in bankruptcy.

The experienced estate planner is aware most high-net-worth individuals want to give their spouses and children a sense of security by making gifts to them, but the planner also knows a transfer of assets to loved ones, whether outright or in trust, carries with it two major risks. First, those who give vast sums of money to a spouse and children may find themselves without assets, without a spouse, and with unsympathetic children. Second, if a transfer is a fraudulent conveyance, it can be reached by the individual's creditors.

Transfers made when the transferror is insolvent are obviously fraudulent conveyances. It is less obvious, but nonetheless the law, that transfers for the purpose of avoiding foreseeable creditors or hindering and delaying creditors in general may be equally fraudulent. Professionals who assist or counsel such fraudulent conveyances may be in the eyes of an aggrieved creditor joint tort-feasors. In certain circumstances, where the aggrieved creditor is a governmental entity or an agency of a government, the fraudulent conveyance may be criminal. In some jurisdictions, any fraudulent conveyance may carry a criminal sanction. …

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