We talk a lot of theory about asset protection, and everyone seems to have their own opinion about what works and what doesn’t. These are some real-life experiences that have shaped my perspective:
1. I worked for a law firm that set up a lot of family partnerships. One client put a substantial amount of assets in his family partnership and made annual gifts to his children. One child had financial problems and went bankrupt. Because the child’s interest in the family partnership was included on her tax returns and among her assets, she had to include it as an asset on her bankruptcy questionnaire. The bankruptcy trustee demanded an accounting from the partnership and a liquidation of the partnership interest for the benefit of the child’s creditors. We insisted that the bankruptcy trustee was limited to a charging order, and the court agreed. The bankruptcy trustee continued to monitor the dealings of the partnership and question the actions of the general partners to ensure that they were fulfilling their fiduciary duties to the partners and not simply using the partnership for their own benefit. The client eventually negotiated a settlement and agreed to buy the child’s interest from the bankrutpcy trustee for a fourth of its real value. Even though the client was able to buy the child’s share for pennies on the dollar, the client said, “I lost tens of thousands of dollars to my child’s bankruptcy, and you call that asset protection!”
2. My friend from law school works for a law firm that is well known for promoting Cook Island Trusts. He tells how one client formed a Cook Islands Trust and transferred millions of dollars to the trust. Later, the client went bankrupt and failed to include the trust assets on his bankruptcy questionnaire. The Bankruptcy Court reviewed the client’s tax returns and easily discovered the offshore trust. The Bankruptcy Court said this was bankruptcy fraud & ordered the client to turn over the assets of the trust. The client claimed that he had no power to turn over the trust assets. The Court did not believe the client and said that if the client disobeyed its order, the Court would send the client to jail for contempt of court and impose a fine of $10,000 per day until the money was turned over. The client found a way to retrieve the money and threatened to sue the law firm for malpractice. The lawyers were also accused of conspiracy to commit fraud.
3. My client put $4,000,000 in a special power of appointment trust (“541 Trust®”) in 2004. In 2007, he entered into a business deal with a wealthy investor. The client and the investor agreed to share the risks and the profits. The deal went bad and they both lost all of the money that they had invested. The investor sued my client for millions of dollars. My client went to the pretrial conference and explained that he had no assets, and that if he lost the case, he would simply go bankrupt. The investor hired a private investigator who did an asset search and a review of his tax returns and found nothing. The case was dropped without going to trial and the assets continue under the protection of the 541 Trust®. My client feels that he acted honestly because he funded the trust well in advance of the deal, the investor went into the deal with an accurate understanding of the risks involved, and my client had every right to set aside assets for the security of his family before entering into that deal.
4. Another client set up a 541 Trust® in 2003. He was recently sued and he had to give an asset statement under penalties of perjury. He also had to give tax returns for the past 3 years and sign an affidavit that he had not made any transfers in the past 3 years. The client answered everything honestly and the 541 Trust® and its assets were never discovered.
In the two cases described above, an offshore trust would have been easily discovered in a review of the client’s tax returns. The offshore trust still may have worked, but it would have been frightening to explain and defend the offshore trust to the judge.
In my experience, the safest course is to do asset protection planning well in advance of a problem, do it in way that avoids any discovery, do it in a way that avoids tax problems or issues of any kind, do it in a way that can be easily amended, and do it in a way that is acceptable and defendable even if it is discovered. That is why I think the 541 Trust® is the best asset protection solution.