Ethical and Effective Asset Protection Planning

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By Lee S. McCullough, III

When is it Ethically Appropriate to do Asset Protection Planning?

The law allows business owners to create corporations and other forms of business entities is to separate the personal assets of the owners from the liabilities of the business.  This type of planning is done every day, and most everyone would agree that there is nothing unethical about creating a corporation for this purpose.  Other situations where asset protection planning may be appropriate include the following:

  1. You want to separate the assets and liabilities of one business or property from the assets and liabilities of other businesses or properties.
  2. You come into some money and you want to set aside a rainy day fund to provide financial security for you and your family.
  3. Your are contemplating a new marriage or business partnership and you want to keep certain assets separate and protected from the new venture.
  4. You are asked to sign a personal guarantee, or take on joint and several liability with partners, and you want to limit the amount of assets you put at risk.
  5. You are willing to pledge sufficient assets to provide security for a new loan, but you don’t want to jeopardize more assets than are required by a lender.
  6. You want to discourage frivolous lawsuits, time consuming litigation, and expensive settlement payments by removing the incentive that comes with having “deep pockets.”

 

On the other hand, there are many situations where asset protection planning could be considered unethical or illegal.  Asset protection planning may be inappropriate in the following situations:

  1. Your business is going downhill and you desire to abscond with the remaining funds, default on your creditors, and file for bankruptcy.
  2. You want to give all your assets to your children, qualify for government assistance, and live off the government for the rest of your life.
  3. You have a desire to avoid your obligations, protect what you have, and shift your losses to your partners, lenders or others.
  4. You feel it is your constitutional right to refuse to pay taxes and to hide your income and assets from the government.
  5. You are contemplating divorce and you want to place some of the marital assets beyond the reach of your spouse.
  6. You have run a successful ponzi scheme and you can see that your time is running out.

 

It is interesting to note that when asset protection planning is done in an ethical and legal manner, it is generally very effective.  Also, when asset protection planning is done in an unethical or illegal manner, judges often find ways to ensure that the planning is not effective in protecting assets.  Consider the following recent cases that demonstrate these principals:

 

Lakeside Lumber Products, Inc v. Renee Evans, Dan R. Evans, et al., 2005 UT App 87 (Utah App. 02/25/2005).

In 1989, Dan and Renee Evans created a trust agreement that included a separate trust for Renee Evans and conveyed their home to this trust.  The trust agreement specifically provided that any property in that separate trust was the exclusive property of Renee Evans and that Dan

R. Evans waived all interests therein.

In 1996, Dan Evans personally guaranteed the debts of his company, E.S. Systems. In 1998, E.S. Systems filed for bankruptcy and a creditor, Lakeside Lumber Products, obtained a judgement against Dan Evans.  In 1999, Dan Evans filed for bankruptcy.

Lakeside Lumber Products filed a complaint against Dan and Renee Evans seeking to obtain an interest in the couple’s home.  The district court granted summary judgement to the Evans concluding that the transfer to the trust was not a fraudulent transfer and that there was no wrongful conduct on the part of the Evans in creating and funding the trust.  The appellate court affirmed this decision.

The creditors of Dan Evans were not able to reach the home titled in his wife’s trust for the following reasons:

  1. The transfer to the trust was done long before the debt was incurred, and long before a default or bankruptcy was anticipated.
  2. The transfer to the trust was motivated by appropriate reasons, including traditional estate planning motivations.
  3. A couple has a right to divide properties between themselves and to separate the assets of one spouse from the potential future liabilities of the other spouse.
  4. Renee Evans has a right to own property independent of her husband or any other person.
  5. The creditor had the opportunity to obtain appropriate security when it entered into business dealings with E.S. Systems and Dan R. Evans.
  6. Dan Evans did not hide assets, conceal information, or fail to use his personal assets to meet his obligations.

 

Because the court concluded that the Evans actions did not constitute “wrongful conduct,” the court upheld the asset protection planning done by Dan and Renee Evans.

 

In re Lawrence (S.D. Fla. December 12, 2006); In re Lawrence, 279 F.3d 1294 (11th Cir. 2002).

Stephan Jay Lawrence was a highly successful big stakes options trader.  When the stock market crashed in 1987, he found himself with more debt than assets.  He transferred $7,000,000 to an offshore trust two months before an arbitration settled his liabilities at $20,400,000.  A bankruptcy court found that the assets of the trust should be included in his bankruptcy estate.

The court ordered Mr. Lawrence to retrieve the assets from the offshore trust and Mr. Lawrence refused to do so, claiming that he had no control over the trust.  Mr. Lawrence was sentenced to jail for contempt of court on October 5, 1999 and remained in jail for six years because he continued to refuse to turn over the assets.  The court refused to give Mr. Lawrence a discharge in bankruptcy and the court continues to pursue collection from Mr. Lawrence.

Because the court determined that Mr. Lawrence had made a fraudulent transfer, and because the court determined that he “lied through his teeth” about his motivation for the transfer and his ability to retrieve the assets, the court found a way to make life very difficult for Mr. Lawrence.

 

Herring v. Keasler, 150 NC App 598 (01-1000) 06/04/2002.

Mr. Herring owed some money to a bank on a defaulted loan.  In 1996, the bank obtained a judgment in the local court but the bank did not pursue collection activities.  In 1999, Mr. Herring and some other unrelated parties formed several limited liability companies (LLCs) for the purpose of investing in real estate.  Mr. Herring transferred property to the LLCs in exchange for an interest in the LLCs.

In 2000, the bank assigned its claim to Mr. Keasler who attempted to collect on the judgement against Mr. Herring by foreclosing on his membership interests, selling them, and having the proceeds applied towards the satisfaction of the judgment.  The trial court denied the plaintiff’s request for the seizure or sale of Mr. Herring’s membership interests in the LLCs, but it granted the plaintiff’s motion for a charging order. The charging order provided that the LLCs must deliver to the plaintiff any distributions that Mr. Herring would be entitled to receive on account of his membership interests in the LLCs; but the plaintiff would not obtain any rights in the LLCs.

The attorney for the plaintiff had this to say, “The real problem with this decision is that it enables defendants to hide their assets from judgment creditors basically forever…. The decision takes assets that are potentially subject to execution and turns them into something you cannot get to. If you’re a member and manager of an LLC, you never have to give yourself a distribution or you don’t have to do it until the judgment runs out. [The defendant] owns at least seven or eight LLCs that were formed years after the judgment with his assets and I can’t get to them. If they were shares in a corporation, we could sell them.”

Presumably, the plaintiff was unable to get to the assets in the LLC for the following reasons:

  1. Mr. Herring received interests in the LLCs that were proportionate to the assets that he transferred.
  2. It appeared that Mr. Herring had good business reasons for making the transfers, in addition to protecting the assets from a creditor.
  3. The LLCs had other unrelated partners.  If Mr. Herring had owned 100% of the LLCs, the creditor may have been able to liquidate the LLCs.
  4. The LLCs were filed in a state whose laws did not allow foreclosure of an LLC interest.
  5. The operating agreements of the LLC must have included proper limitations and wording in order to keep the creditor from liquidating the interests in the LLC.

 

 

SEC v. Bilzerian, 131 F. Supp. 2d 10 (D.C. 2001).

In 1989, Paul Bilzerian was convicted of securities violations and sentenced to four years in prison. He filed for bankruptcy but it was determined that he owed $130,650,328 in a non-dischargeable debt.  Sometime between 1994 and 1999, Mr. Bilzerian transferred substantial assets to a complex structure involving partnerships and offshore trusts.  The court found that the transfer was made to purposefully insulate his assets from the reach of his creditors and ordered Mr. Bilzerian to turn over the assets that had been transferred.  When he refused to turn over the assets, the court sent him to jail until he complied.  After spending over a year in jail, he settled his claims with the government by paying over a substantial portion of his assets.

On February 5, 2002, the St. Petersburg Times reported, “After nearly a year in prison ­including some memorable days sharing a cell with a bullet-scarred buy named ‘Queenie’- Paul Bilzerian is back inside his family’s $5.7 million Tampa mansion.  The former corporate raider was freed from a maximum security lockup in Miami on January 16 after his wife, Terri Steffen, agreed to hand over millions of dollars in stock and other property to the federal Securities and Exchange Commission.”  Bilzerian said that his most recent stint in prison was “horrifying,” and “People just don’t understand how awful those places are.”

 

What are the Keys to Ethical and Effective Asset Protection Planning?

In determining whether asset protection planning is ethically appropriate, and whether it will be effective, there seem to be three critical factors that make or break an asset protection plan. The first factor is the timing.  The more time between the date when the plan is put in place and the date when the liability is incurred or the judgement is executed, the better.  The second critical factor is the purposes for the planning.  If your only purpose in doing a transaction is asset protection, it is not nearly as effective as if you have business purposes, estate planning purposes, or other valid purposes in addition to asset protection.  A third factor is proper documentation and operation of the entities involved in the plan.  In other words, if you don’t have the correct documentation and if you don’t operate things correctly, your asset protection plan will look more like a sham than a valid and enforceable business arrangement.

 

Lee S. McCullough, III, operates a private law practice in Provo, Utah, exclusively focusing on estate planning and asset protection. Lee is an adjunct professor, teaching estate planning at the J. Reuben Clark Law School at Brigham Young University.