Asset Protection 101 – What Every Agent and Manager Must Know
Ike Z. Devji, J.D. © 2008
Your clients depend on you to be a source of information on a wide variety of complex topics. They assume, rightly or wrongly, that you are at least informed about every area even marginally related to your core business. One of the areas in which professional athlete clients are increasingly seeking guidance from their management team is in the area of Asset Protection.
Professional athletes are natural targets for lawsuits on a variety of issues for a number of reasons including:
They are, or are perceived to be, holders of large amounts of liquid wealth that can lead to frivolous lawsuit against them;
They are visible and easily identified and as public personalities with lavish lifestyles and spending habits;
The exact amount of wealth they have accumulated is often public knowledge as in the case of their contracts;
They earn large amounts of money in relatively short periods of time;
Any one of these factors on their own would be a legitimate source of concern to most professionals. Add to that the uncertainty of injuries, performance related compensation and relatively short amount of time that any individual might have in their peak earning years and the need to ensure and protect assets and future income stream becomes even more glaringly obvious.
As a trusted advisor you probably already seek to put your clients in touch with professionals who can create safe steady growth and avoid losses and exposures to things like market risk and income and estate taxes. A natural extension of that stewardship is making sure that the growth you are fostering, as well as the balance of your clients’ assets, are safe from exposure to an increasingly predatory and hostile litigation system. Some of your clients have obvious exposures, such as those based on their lifestyles and visibility. Other sources of exposure are more insidious, such as merely being wealthy and visible, owning income property, or something as simple as owning and driving a car every day. The numbers are staggering; we are at a point in our litigation system where we have over 70,000 lawsuits filed per day in the United States alone, many without any real merit. Unfortunately being “right” is not enough to keep our clients safe.
Why are your clients concerned?
As illustrated by the numbers below, awards continue to spiral out of control, fueled by litigation attorneys who have become partners in lawsuits and who are economically incentivized to create and magnify adversarial relations between parties who might otherwise reach some reasonable, if not amicable, settlement.
WHAT ESTABLISHES THE NEED?
Facts about our litigation system for you:
– We live in a society that files some 70,000 lawsuits per day, many without merit;
– The average legal costs of settling a frivolous lawsuit is $91,000 – plus the actual settlement amount itself;
– Only the top 5% of Americans have a net worth of over $1MM. Using that as a baseline, it’s pretty easy to see where even a client who is worth only a few million dollars fits in on the food chain.
COMMON RISK FACTORS – some combination of any of the following:
-They are high net-worth, high liability, or they will be soon
-They are highly visible, traceable, and or collectible
-They have assets that would be difficult to replace if lost or reduced
-They have employees
-They own their own business
-They have professional liability
-They own liability generating assets, i.e. rental property
– They have children
– They are single and need to back up their pre-nup planning.
What we and our clients must take to heart is that litigation attorneys are in business. Just like any business, including yours, they have weekly meetings in which they examine growth, cash flow, revenue goals and new leads or opportunities. This economic motivation is a key and explains in part why we see awards rising and why plaintiffs’ attorneys regularly seek and obtain awards above the limits of applicable liability insurance policies. The average medical malpractice policy, as just one example, is $1MM, whereas the average national malpractice award is about $3.9 million. This leaves the physician holding the bag for the other several million dollars. Could your average client survive that kind of a loss and maintain their financial goals? Likely not.
Can’t we just insure their way to safety?
No, unfortunately, for a number of reasons. First, it’s impossible to insure yourself against every possible contingency and exposure. There will always be many exposures for which no insurance exists or which are not adequately covered by the amount of coverage the client has in place or can afford.
Second, the liability insurance business model is simple: Take lots of premiums in and pay as few claims as possible. The difference equals profit. When an insured contacts their own carrier to report a claim, a number of the questions asked by the insurance company seek to determine if coverage can be reduced or excluded due to the contributory negligence of their own insured. Think about the questions, “Were you wearing your seatbelt? Were you smoking or on your cell phone at the time of your accident? Do you wear corrective lenses? Have you ingested drugs or alcohol within the previous 24 hours?”
Third, the holy grail of the “umbrella policy” and policy limits are rarely fully understood by clients and advisors. To the consumer, “umbrella” means “everything”. To the insurance company it means specific occurrences to specific limits under specific conditions. Add to that the fact that many liability insurance polices are inclusive of defense costs and the actual amount left for the award is reduced, again exposing the insured person personally. For example, your client has a $1 million liability policy in place and gets sued. The insurance company spends $400 thousand on defense costs and loses, resulting in an award of $1.2 million. In this scenario, only $600 thousand is available from the policy to put towards the claim itself. Our advice: buy as much insurance as you can afford, assume it won’t work and have a good back up plan.
A little proactive medicine goes a long way
We are all aware that there is a ton of offense out there. You can’t drive across town without seeing ads for contingency fee attorneys plastered on billboards, bus stops and without hearing their ads on the radio. “Were you injured at no fault of your own? Have you been treated unfairly at work? Did you take a medication that may have injured you? Call us; we will get you compensated at no cost to you”. An interesting experiment is for you to Google “personal injury” and add the name of your city. The number of listings for attorneys will be staggering to you, especially when you consider that all those attorneys are in their offices right now waiting for the phone to ring, or thinking of ways to make it ring.
The question is what kind of defensive planning have your clients examined? They insure their homes, cars, personal property, health and even their very lives, but what level of planning and forethought have they, or you, invested in insuring their net worth? Typically very little forethought, other than liability insurance, has gone into this area. This lack of planning can be disastrous, especially for clients who have reached the pinnacle of their career and who are looking towards retirement. What options would your 38 year old client have if he or she lost a substantial portion of their net worth to a car accident in which there was a fatality, because their child had a party and another teenager died or was injured, or because they were accused of sexual harassment by a disgruntled employee (all issues I’ve addressed for clients recently). Think you or your locality are immune? Just turn on the nightly news and realize that every fatal accident you see reported that day will likely be accompanied by a seven figure lawsuit.
A great deal of the defensive planning involves the proper titling and compartmentalization of assets into acceptable and easily manageable units of risk. It’s easier than it sounds but still needs experienced guidance. The mantras I teach my clients are simple:
1. Own nothing, control everything;
2. What you don’t own can’t be taken from you;
3. The best defense is being an uncollectible target, take steps to remove the economic incentive to pursue you.
As is illustrated below, moving the title of assets to various appropriate and legitimate entities can dramatically reduce the amount of the exposure the client faces, and can actually help make the liability insurance they have in place more effective. How? It removes the economic incentive to pursue the defendant beyond the limits of the policy and forces settlements into a reasonable range. Why pursue someone for more than the limits of their policy through a long and expensive court proceeding if they didn’t have any assets that can be reached? For the plaintiff’s attorney this is a losing proposition and he will likely encourage his client to settle so that he can move on to the next case after taking his share of the award.
In most cases, collectible assets can be sheltered or reduced by over 90% with the use of well tested and established tools like LLCs, Limited Partnerships, Asset Protection Trusts and Receivables and Income Protection plans, to name just a few examples.
As you can see, the vast majority of the client’s collectible assets are accounted for and sheltered in this example. The best tools used are legal, tax neutral and have a legitimate business purpose. The numbers scale easily up or down. Remember, what each client has is all they have, so their $500 thousand may be as important to their long term goals as another clients’ $5 million is to them.
My client already has a “Revocable Living Trust”. Doesn’t this make them safe?
No, this is a dangerous misconception that the majority of your clients are working under. The Revocable Living Trust or RLT is a wonderful estate planning tool. However, like most tools it has a specific purpose, in this case primarily avoidance of probate and estate taxes.
The RLT is, as the first word in the title suggests, REVOCABLE during the client’s lifetime. This means that during a client’s lifetime they can easily be ordered to revoke the trust and tender trust assets for the payment of a judgment by a court. This is a common occurrence. The trust becomes irrevocable only upon the client’s death. Thus, during their lifetime it does not shelter them from any sort of law suit exposure. Conversely, Asset Protection does not replace or duplicate good estate planning, but rather works in conjunction with it.
What exactly can be protected?
Non-qualified investments, cash, stocks, both personal and investment or commercial real estate, business equipment, intellectual property, interests in non-liability generating businesses, valuable collection such as art and cars and even future income and business receivables are just a few examples. We typically exclude the personal checking accounts, personal “daily driver vehicles” and personal property.
Some Basics of Good Asset Protection Planning
Realize your value as a target and do something now, this is pre-planning. You cannot do any effective or legal planning after a lawsuit has been filed or a demand has been made. The time to act is now when waters are calm. Hoping that that it won’t happen to you is not a plan.
Be realistic about the possibility of exposure and about the effect that a six or seven figure judgment would have upon the financial plan in place. The most common mistake made by advisors is telling clients who are worth “only” a few million dollars that they are not big enough to justify doing this kind of planning. This is possibly the worst advice possible. Of course a client worth five or ten or even $100 million needs this type of planning. But who will be affected more? The ten million dollar client can take a hit for a million or two and keep the cars, house, lifestyle and put the kids through college, but your more average client would be financially devastated. They need it even more.
Use the right tools. Asset Protection is part art part science, just like your business. There are certain proven methods and tools that work and others that do not. Be wary of promoters, do it yourself kits and promises of domestic jurisdictions that will make you safe and save you money on taxes. Each tool has a specific business purpose that protects specific types of property, they are not all interchangeable.
No, Nevada Corporations do not work. In fact, they are increasingly viewed as presumptively fraudulent due to a long history of abuse and tax fraud. Thousands of consumers have purchased them under false promises of secrecy, bearer share anonymity and tax advantages. Almost all these promises are completely fictional. Our information shows us that the term “bearer shares” does not even exist in the statutes of the state of Nevada. Unless you or your client live there, do business primarily from or in the state of Nevada and have the assets in question housed in the state, a Nevada LLC will not help you, especially if it lacks a real business purpose as explained below.
Maintain a legitimate business purpose for all legal tools. We commonly see good tools misused by clients and inexperienced planners which do more harm than good. In order to take advantage of the full protection the law affords we must maintain an essential business purpose for the tools we use. The use of limited partnerships for investment management and LLCs to hold investment or commercial real estate are two examples of well proven and tested business usages
No, transfers to a spouse, child or relative are not effective. This is especially true if the transfer is made after an exposure has occurred. A thinly disguised “gift” will easily be reversed and the property seized by the court in the event of a judgment. Further, these types of transfers are rarely legitimized by the appropriate recording and tax reporting formalities. If you gave your 17 year old your $1 million home at full equity you better have a gift tax return illustrating that, and it better have been done well in advance of the harm complained of. Even if the gift is effectively made, all you have done is given away something you want to protect and exposed it to another person’s liability.
“Just” an S-corp. or an LLC is not enough. Single member or closely held corporations with just one or two owners are exactly they type of entity you commonly hear referred to when you hear the phrase “piercing the corporate veil”. If a business has only one or two owners who closely manage and control the operations of the business on a daily basis, or even worse, which are also directly responsible for a harm or injury, it is relatively simple for a court to pierce the veil and grant access to the owner’s personal assets. This is especially true with successful small businesses and family businesses that often don’t maintain the formalities of keeping personal and business expenditures completely separate, bolstering the argument that the person and the corporation are one and the same.
Get professional, individual help. There are a wide variety of skill levels in every profession, including the law. Many so called Asset Protection professionals are not attorneys, or are attorneys who apply bits and pieces of knowledge from other fields of practice that may actually diminish legal protections in existence. Every plan must be uniquely tailored to the individual, their activities and the unique nature of their assets. There is no one size fits all solution, even though clients with similar assets may have similar looking plans.
The legal tools used are typically tax neutral. Don’t try to combine tax planning and Asset Protection. In most cases, the tools used are taxed neutral and do not provide tax advantage or tax liability. Many times abusive tax structures are disguised as Asset Protection, often promising tax free growth offshore in various trusts or captive insurance plans. As a financial professional you already know that putting money into a plan tax free, growing it tax free and pulling it out tax free is rarely if ever possible. The one general exception to this rule is in the application of certain receivables protection plans.
Don’t forget about income and receivables – protect the source. Very often we see individuals that are concerned about protecting everything they have been fortunate enough to accumulate while ignoring ways to protect their future income. We find that many clients, even those with a very high net worth, often have fixed business and personal overhead commitments based on the expectation of a certain income level. If many of them suddenly had that cash flow tap turned off, they would not be able to sustain their current monthly expenditures. This scenario would force them into a situation where they were either selling off assets, going into qualified plans early and making substantial lifestyle changes. There are options available for qualified clients that can securitize that income stream.
Don’t draw liability in. In many cases clients unintentionally escalate their value as a target. For instance, how many of your clients have vehicles that they or their spouse drive titled in the name of their business? Which of the following three defendants is most exciting to a plaintiff: John Smith; Dr. John Smith, or Smith Cosmetic Surgery? As you can see the corporate defendant is often the most exciting, deepest pocket. In order to fix this we simply transfer the vehicle back to the client’s name and have them take a car allowance from the business. Remember, with a good plan in place your client won’t have substantial exposed assets anyway.
This article just scratches the surface of Asset Protection and provides some generally applicable rules and issues to be aware of. When you and your clients are ready to explore the solutions available, seek qualified counsel that has a proven record of experience in this specific field.
Ike Z. Devji, J.D. – Executive Vice-President, The Wealthy 100,
Of-Counsel, Lodmell & Lodmell, P.C.
JUST ONE EXAMPLE OF PROFESSIONAL RISK:
1. Pro Athletes who Deliberately Injure Another Player Should Face Criminal Prosecution, Says New FindLaw Survey