Limited liability entities such as corporations, limited partnerships or limited liability companies are often the first step to protect your personal assets from liability or creditors. But what other steps can be taken to protect your hard-earned assets from lawsuits or claims? This article addresses the use of LLC's and asset protection trusts to obtain greater protection. To evaluate and understand the alternatives, we need to first understand the difference between business and non-business claims.
Business and Non-Business Debts
- Business creditors are those creditors whose claims are directed against the business operation or real estate which is operated and owned inside of business entity.
- Non-business creditors are those creditors whose claims arise outside the operation of the business entity and are generally personally asserted against the professional, business or real estate owner.
- Corporations and LLCs protect owners from business debts against the business. LLCs are state-chartered entities that provide a shield of protection similar to the corporate shield but are treated for tax purposes as either a sole proprietorship or partnership. LLCs are often used to hold real estate assets because they combine the protection aspects of a corporation with the tax benefits of a partnership. Because of the tremendous liability potential of real estate activities, serious consideration should be given to holding real estate (especially income-producing real estate) in LLCs.
- Although corporations and LLCs protect against business debts, many professionals, business, and real estate owners are concerned about business debts or personal debts such as malpractice claims, negligence claims for accidents and other personal liability claims that are asserted by aggressive plaintiff's lawyers. The question then becomes how do we protect against the non-business claims (personal liability claims). This is where the combination of an LLC with an Asset Protection Trust can be a very effective strategy.
The LLC and the Charging Order
The usual remedy for a creditor of a member or owner of an LLC is to obtain a charging order against that member. The charging order prevents the creditor from reaching the LLC assets. The creditor is limited to a court order charging the interest of the member/debtor so that if any distributions are made from the LLC to the member, they have to be distributed to the creditor. The creditor typically obtains only the economic rights to the distributions, not the voting rights or other non-economic rights of the LLC Member. The application of the charging order in any particular case will depend on the state's statutory provisions and case law treating the charging order subject. The benefit of the charging order remedy to the owner of the LLC is that the assets within the LLC remain protected from the outright seizure by the creditor who is limited only to distributions that may not be made pursuant to the discretionary right of the manager to withhold such distributions. In other words, assets that would be otherwise attractive to a judgment creditor become much more unattractive or difficult to reach if they are held within a limited liability company where the charging order is the exclusive remedy.
Domestic Asset Protection Trusts
- The general rule in most states is that creditors can reach the interest of the settlor (the creator of the trust) of domestic self-settled trusts. However, several states have recently adopted legislation somewhat similar to various offshore jurisdictions that provide various degrees of asset protection for a trustor's interest as a beneficiary in a self-settled trust. Those states include Alaska, Delaware, South Dakota and Nevada which seem to have the best laws for this purpose.
- If properly established and maintained, the domestic asset protection trust may be a significant barrier to creditors and may afford significant leverage to the debtor with respect to its settlement negotiations with the creditor. The greatest protection at this time appears to be for assets domiciled or located in the domiciled state of the asset protection trust.
Foreign Asset Protection Trusts
A Foreign Asset Protection Trust is established in an offshore jurisdiction which has enabling trust legislation that provides substantial protection against creditors of the Trust. One of the greatest advantages of the Foreign Asset Protection Trust is the fact that by its very nature any legal attack against its assets is transferred abroad to a different legal system. Normally, a foreign trustee is necessary for the effectiveness of the Foreign Asset Protection Trust. The biggest advantage in utilizing the Foreign Asset Protection Trust is that assets can be placed offshore beyond the jurisdiction of US courts. Some of the principal advantages of the offshore trusts are as follows:
- Most foreign jurisdictions do not recognize US court decisions as judgments. This may force a new trial on the merits and the foreign situs country.
- Some foreign situs jurisdictions require a much more difficult burden of proof for a creditor to challenge asset transfers to Foreign Asset Protection Trusts.
- Some jurisdictions have a statute of limitations for challenging asset transfers to a foreign asset protection trust that begins to run on the date of transfer.
- Fees and expenses in litigating in the foreign jurisdictions are going to be substantial thereby serving as a strong deterrent to foreign litigation.
Note that foreign trust may subject to greater tax scrutiny and the potential for audit. Many federal tax returns and forms now require the disclosure of any foreign entities or interests.
The Hybrid Bridge Trust
The Hybrid Bridge Trust provides a unique combination of the benefits and enhanced protection provided by a Foreign Asset Protection Trust and the lower cost and flexibility of the Domestic Asset Protection Trust. This enhanced protection of the Foreign Asset Protection Trust is only triggered when actually needed. For many clients, this provides the optimum combination of lower cost and enhanced protection.
The information provided above is a general discussion of these concepts. An effective asset protection plan must be crafted to fit your specific situation including the potential risks, business operations and the nature and location of the assets to be protected. Call our office to discuss the asset protection plan that may be most appropriate to insulate you and your family.