There has lately been a renewed interest by clients in asset protection planning. A problem for these clients and their planners who are unfamiliar with asset protection planning is that there is nothing like a standardized methodology for doing such planning. Information regarding asset protection planning is plentiful, but also contradictory and often outright false ― so much so that the odds of one finding quality information about asset protection is somewhere between slim and none. Goodness help the unititated trying to make some sense out of this field.
Many of these problems arise from the fact that many of the planners themselves have little or no experience with creditor-debtor litigation and so therefore are little more than guessing how their planning creations might pan out. This leads to some very fundamental misconceptions about what asset protection is really all about or how it should be conducted. We shall, therefore, discuss some of the major misconceptions that permeate asset protection planning.
To a significant degree, this will be a “fireman to the architects” discussion considering that my daily law practice is largely spent piercing asset protection plans for creditors or defending such plans against creditors. Suffice it to say that asset protection planning looks very different inside a courtroom than it does in a conference room. Judges want to see judgments paid and thus can often take a very dim view of asset protection planning. Appellate courts have been no more favorable about the subject. That doesn’t mean asset protection planning cannot be done, but such planning has to be easily and rationally explainable to the court if it is to survive. Now to the misconceptions.
Asset Protection Is Different
The first and by far largest misconception is that asset protection should somehow be treated differently than other legal planning. Which is to say that in other areas of legal planning, attorneys will carefully review the applicable statutes and court rulings to create a roadmap, or at least some guardrails, as to how their planning will be shaped. This is very difficult for asset protection planning because so many bodies of law must be considered, such as the laws relating to bankruptcy, judgment enforcement, creditor exemptions, fraudulent transfers, alter ego and veil piercing both forwards and backwards, trusts, limited liability companies and partnerships, and so on. All these considerations are critical. When asset protection plans fail, and they frequently do, it is usually because the planner overlooked some applicable body of law. Or, to use the law school phrase, somebody “missed an issue”.
Why is asset protection treated differently in this respect? The culprit is that asset protection planning had its origins in offshore planning. The strength of offshore planning is that the assets are outside the jurisdiction of the U.S. courts and thus it is largely irrelevant what U.S. laws say about anything. That was fine so long as asset protection planning stays offshore, but when that planning moves onshore then all those bodies of law become critically applicable. Yet, the deep legal analysis almost never happens.
Furthermore, there is a intellectual laziness which permeates asset protection planning. There is too much to learn to do it correctly. Thus, instead of individual planners burning the midnight oil doing their own research, too many are willing to simply follow what somebody else in the field is doing ― with the presumption that these other planners know what they are doing. Far too often this has proven to be an unsafe presumption.
The best example is that of the late Denver lawyer Barry S. Engel who was the real godfather of asset protection planning. It was Barry who started the entire asset protection sector by convincing the Cook Islands to adopt the self-settled trust laws which allowed for the development of comprehensive foreign asset protection trusts (“FAPTs”). For well over a decade, most protection planners slavishly leaned on every word that Barry uttered and simply duplicated his planning techniques.
Alas, Barry presumed that no U.S. court would ever cast an FAPT settlor into jail for contempt to force a repatriation of the trust’s assets because of something known as the “Impossibility Defense”. This presumption was proven false in two 1999 cases (Affordable Media LLC and In re Lawrence) where the settlors in those cases were ordered to jail until the assets of their trusts were repatriated. It didn’t make a damn to the respective courts as to whether the trust settlors had any power to bring those assets back or not. In essence, Barry’s mistake was that he did not foresee that the so-called Impossibility Defense was itself nearly impossible to prove in court. Yet, literally tens-of-thousands of FAPTs had been formed based on Barry’s false presumption. It was thus remarkable when Barry himself largely ceased planning with FAPTs and went off into other, more exotic offshore techniques.
The point being that all the planners who set up FAPTs might not have done so had they themselves done the hard research and spotted the problem with the Impossibility Defense. But few actually did so, creating an example of why planners must do their own research and not simply take somebody else’s word for whether a particular technique works or not. Very simply, asset protection issues are not exempt from being researched to determine how they actually fare when the rubber hits the road. Simply swallowing whole what somebody wrote in an article or discussed at a CLE is not a valid substitute for this research.
Onshore Is Better Than Offshore, Or Offshore Is Better Than Onshore
The next major misconception deals with onshore versus offshore planning. Basically, there are two camps, the first consisting of those who believe that domestic planning never works and that offshore planning is the only truly efficacious planning, and the second camp consisting of those who believe that domestic planning is best and that offshore planning is always doomed have somebody end up in jail.
Both camps are right to degree, and both camps are wrong to a degree. As usual, the truth lies somewhere in the middle. The most important thing to understand is that while onshore asset protection planning and offshore asset protection look very similar, they could hardly be more different.
Offshore planning is a brute-force technique, with the primary protection coming from the fact that the assets are no longer within the jurisdiction of U.S. courts or amendable to the enforcement of U.S. judgments. This is accomplished by placing the assets in one of the many offshore havens which have enacted laws that are so unfriendly to creditors that it is not worth the time or expense for a creditor to attempt to collect the judgment there. All this is quite true: Assets in an offshore debtor haven are at very little risk of being tapped by creditors.
But there is a fly in the ointment, being the one that Barry Engel proved to be so wrong about. While the assets may be offshore, the person who settled the offshore trust may still be in the U.S. and thus subject to the contempt remedy of the U.S. courts to cause those assets to be repatriated (this is what that Impossibility Defense stuff was all about). Thus, for offshore planning to ultimately work, it is usually necessary for the person of the debtor to also be outside the contempt remedy of the U.S. courts, i.e., to flee overseas.
For many people, particularly those who immigrated to the U.S. for work or who still have substantial family connections abroad, this isn’t that big of a deal. Consider a doctor who is originally from India: If things get too hot here, the doctor can always return to his homeland. This defines the sort of person who can use offshore planning most effectively. On the other hand, if somebody doesn’t have true international connections and would be uncomfortable perhaps permanently livng outside the U.S., then offshore planning should probably not be in their cards.
In stark contrast, for domestic planning to work, the planning needs to strictly comply with the applicable U.S. laws and even that may not be enough to defeat creditors. Take, for instance, the domestic asset protection trust (“DAPT”). If probably drafted and structured (and few ever actually are), a DAPT will provide substantial asset protection ― but only if certain conditions are met. For a DAPT to be effective in court, both the DAPT assets and the person of the debtor/settlor must be resident in a DAPT state at the time that the trust is challenged. This means that DAPTs will rarely if ever be effective for those living outside DAPT states.
Also, for a DAPT to be generally effective, the debtor/settlor must avoid bankruptcy whether voluntary or involuntary unless at least 10 years has passed from the date the trust was created to the date the bankruptcy case was commenced. Voluntary bankruptcy is the debtor’s choice, but involuntary bankruptcy is the choice of creditors. It can make a difference how many creditors exist as usually it takes multiple creditors to make an involuntary petition stick. But that is hard to predict: That car you just smashed into, did it have more than one passenger? Because if it had more than one passenger, then an involuntary bankruptcy might be in the cards. Will one bank call a personal guarantee, or will several banks call their personal guarantees? You get the point. The situations where DAPTs will be effective is probably much smaller than even most DAPT planners think and cannot be predicted in advance.
Still, just as FAPTs can be useful in some limited situations, DAPTs can likewise be useful in some limited situations, such as retiring professionals who are concerned about “tail” liability arising from their practice. Such retirees will not have to file for bankruptcy protection to shield their future practice income, and there is unlikely to be more than a single creditor so as to forestall an involuntary bankruptcy filing.
Creditors Will Not Sue If The Debtor Has An Asset Protection Plan
Another major misconception about asset protection planning is that if a debtor has an asset protection plan, then creditors will not bother suing. This is often referred to as the “deterrent effect”. It is far more myth than reality.
First, creditors (including tort plaintiffs) very much have a sue first and investigate assets later mentality. Unless the debtor is clearly indigent, most litigators will not spend a second considering if the judgment is collectable, much less hiring a private investigator first to determine if this is so. Thus, the only way that such a creditor would know in advance of a lawsuit that the judgment might be uncollectable would be if the debtor went out of her way to tell the creditor that. But that brings us to the next point.
Second, creditors affirmatively like to see that a debtor has engaged in asset protection planning because then they positively know that there are assets out there which might be used to satisfy the judgment. It then becomes a question by the creditor as to whether the asset protection plan can be busted, but the experience of most creditor rights attorneys, including Yours Truly, is that most asset protection plans are poorly conceived, poorly implemented, and often have been compromised over time by the debtor not properly keeping them up. Also, as happens in many collection actions, perhaps approaching a majority, creditors can find pressure points outside the asset protection plan that will force the debtor to voluntarily invade the asset protection plan to fund a settlement. Thus, anybody who seriously believes that a creditor will see an asset protection plan and then run away screaming is utterly delusional since usually the opposite is more often true: The creditor will be salivating at the thought of busting through the asset protection plan to the treasures beyond.
It is true that the existence of an asset protection plan can sometimes drive down settlement value, much more with offshore planning than domestic planning, but that is just one of many factors which goes into the parties’ settlement calculations.
There Is An Asset Protection Plan That Is Better Than All Others
The myth of the “Silver Bullet” asset protection plan began with the supposed invincibility of FAPTs. It then somehow survived even after the Affordable Media and Lawrence cases. But it is still a myth. There is no asset protection plan that will work perfectly in all situations for all clients against all creditors. There are some asset protection plans that will work better for some debtors in some situations against some creditors, but that is what planning is all about.
The myth of the “best” asset protection plan derives from estate tax planning where there are certain recognized techniques that if properly implemented will avoid some or most of the gift and estate taxes that would be due in the absence of such planning. This is due to a singular body of law embodied in the U.S. Tax Code and implementing Treasury Regulations that promise certain benefits if their criteria is met.
There is no such analog in asset protection planning. Which is to say that if you do X, Y and Z that the assets will be unavailable to creditors (the exception to this, of course, is creditor exemption planning). To the contrary, and as mentioned above, asset protection planning requires the application of myriad laws to give the putative debtor a mere chance at a favorable outcome. Since not all client situations are the same, these myriad laws will not apply the same to every client. Thus, asset protection plans must be specifically designed for each client in a bespoke fashion and that forecloses the use of one-size-fits-all solutions as are so commonly found in estate tax planning.
Caution also the Do-It-All structure, which is a single entity (usually a trust) that purports to take care of all assets. There are very good reasons not to put all one’s eggs into a single asset protection basket. Good asset protection will utilize a variety of structures and techniques, such as that the residence will go into a QPRT, liquid assets might go into a PPLI policy, and so forth. In fact, the more diverse the planning the better. In litigation, it is often that some things will fail while others will survive. Better to have some survive than to lose all. But this takes hard work (Gasp! Actual planning!) and some planners would rather just enjoy the quick and easy of being able to mail it in with a single one-size-fits-all structure.
If Everybody Else Is Doing It, Then It Must Work
This is the Lemming Effect where somebody has pronounced that they have come up with a wonderful asset protection solution that everybody can use and sleep happily knowing their assets will be protected from creditors. These are generally cookie-cutter plans where every client basically walks out the door with the same plan. Not knowing any better, the rest of the planner lemmings follow and use this technique. Never mind that these product-pushers cannot point to a situation where their planning has actually survived the scrutiny of an appellate court. If they market the solution heavily enough then there will be a hoard of lemmings right behind them.
The obvious problem here is that if everybody is doing the same thing, if the technique fails for one person then that failure will likely cascade through the rest who followed that particular technique. The product-pusher (or some other product-pusher) will then come up with the next marvelous thing and the cycle repeats.
Adjunct to this is the claim that a particular asset plan “works” although it has never been tested by an appellate court in an opinion the rest of us can read about. The promoter of this plan will claim that they have done hundreds of these plans and they have always worked. But “works” in this context is largely akin to an unfired bullet: If the bullet was never fired, did it work?
The truth is that a minutely small number of asset protection plans are ever actually tested in court for the simple reason that the client never suffered an adverse judgment. If an asset protection planner puts together 500 asset protection plans for clients, there is a very good chance that none of those plans will ever be tested in court. Or maybe one. These planners will look back with satisfaction that their asset protection plans have all worked. But did they really? Truth is that I could sell bogus Certificates Of Nonsuitability to these same clients and in retrospect it would have worked just as well. Which is to say that the vast majority of asset protection plans will end up as nothing but very expensive legal placebos. The point is to beware these sorts of dubious claims.
Moreover, creditors have very frequently obtained the descriptive materials of planners about their asset protection planning, whether from websites, CLE presentations, social media, and every other available source. The creditors then use these materials to tell the court “what is really going on here” and thus defuse the plan. Which is all to say that the better asset protection solutions will not look like anybody else’s asset protection solutions, or even an asset protection solution at all. Or, it will be something so commonplace (say, a straightforward children’s trust) that it doesn’t arouse suspicions.
Some added advice along this line: If you were to come up with some really nifty solution, don’t spread it around but rather keep it to yourself. Once something is identified as an asset protection technique, that makes it all the easier for creditors to bust it. This also means avoid the flavor-of-the-day solutions and in asset protection there is always a flavor-of-the-day solution floating around.
Some Locations Are Better Than Others
While there is a kernel of truth in this misconception, it is still largely a lie. The law that will usually be applicable to a creditor’s attempt to collect against a debtor is that of the jurisdiction of the debtor’s residence. Attempting to “import” law from another locale doesn’t work in all but the rarest of circumstances as we have seen with the several failures of DAPTs.
The best example is offshore planning. Did you know that there has never been a reported court case where the outcome turned on some unique nuance of an offshore haven’s laws, even in the courts of any such haven? Truth is that the strength of offshore planning, as mentioned above, derives simply from the assets being outside the U.S., though with the slight caveat that you don’t want them in a country where it is too easy to register a U.S. judgment. The Cook Islands, Cayman Islands, Nevis, Bahamas, Isle of Man, etc. & etc., are all alike and utterly interchangeable — there is no meaningful difference between these jurisdictions other than that some are much easier to visit than the others. Yet, some planners will drone on and on about how good the laws of X jurisdiction are, though that is all just wasted breath. It also tells me that deep down they don’t really know what they are talking about and are probably just repeated something they heard from somebody else.
The same is largely true for domestic planning, albeit there are sometimes slight advantages between the laws of one jurisdiction over another. Again, the real trick is getting the local court to apply the laws of some other state. That’s like pulling teeth. Most of those alleged advantages are totally illusory too, the best example being the laws of charging orders where the laws of all states are functionally equivalent to all the others. I get frequently asked what is the best state to form an LLC, and in all but the rarest of circumstances my answer is, “the one you are in.”
Even if there is some nuance of some state’s laws that will make a difference in the choice of domicile, that is usually one of the last issues considered in asset protection planning and nothing like the first. A good asset protection plan will be as effective under the laws of any state and will not rely upon a court’s application of complex conflict of law rules to apply the laws of any desired state so as to reach a particular result.
Conclusion
I could ramble on and on about these issues, but this covers some of the most pervasive and pernicious misconceptions about asset protection planning. Folks looking for asset protection planning should not allow themselves to be taken in by the black box approaches of some planners, which is to the effect of this is so complicated that you can’t possibly understand it, so just pay me my fees and wait for your documents to arrive in the mail. That implies that the planner understands what is in their black box, which is almost always untrue. As with any other planning, an asset protection plan should be able to survive the scrutiny of a second legal opinion. That is why second opinions in this area are as valuable as they are in any other area of legal planning.
Which is all to say that asset protection planners must do a better job too of really learning about the applicable areas of law for themselves and not just taking somebody else’s word for it. Otherwise you end up with a blind leading the blind sort of situation, which sadly describes probably greater than 99% of all the asset protection planning being done. If you don’t know why something is done a certain way, find out for yourself. Don’t simply assume that it is the right thing because everybody else is doing it.
Lemmings over the cliff.