For the last 19 years years the sole focus of my legal practice has been Asset Protection and Estate Preservation planning that has touched literally thousands of clients representing billions of dollars in personal assets. During that time I have seen the best and the worst of the planning available to the American public as well as the most common flaws evident in both self-directed planning and plans executed by professionals who do not practice primarily in this area. Here is a short summary of issues to keep in mind when addressing this crucial issue; please bear in mind that information in forums like this is not specific to you, is written in the broadest terms and is never a substitute for consulting with an experienced professional:
1. FAILING TO ACT (Timing) – Asset Protection is best analogized to “net worth insurance” and like insurance you have the best, most effective and legally supportable options available to you when you implement the planning before a crisis exists. Transfer of assets into plans after you have specific exposures is costly, ineffective and some cases illegal (fraudulent conveyance). The best time to act is always now and every day that passes makes your planning stronger.
2. THINKING YOU’RE NOT RICH ENOUGH – This is a sin I see committed on a weekly basis, often by professionals like lawyers, CPAs and financial advisors. These advisors often tell clients that they are not rich enough to do any planning and that that they should have a net worth north of five or even ten million dollars to consider it. Nothing could be further from the truth, especially if you are in the “Fall” of your earning career. Of course high net worth individuals must implement this kind of planning and always have, but all you have is important to you and there are precautions that can be taken at any net worth level. When should you start? There are many simple ways to analyze this but here is an easy one, answer these questions:
– If you lost what you have today, or some significant portion of it, are you at an age, earning level and financial condition that will allow you to maintain your family’s goals and expenses?
– Do you have assets that would be difficult or impossible to replace given your age, health and economic conditions?
– Are you financially and legally prepared for a lawsuit that is either uncovered by liability insurance or which often produces verdicts above the limit you are carrying?
If you’re not comfortable with your answers, it’s time to take responsibility and action for your financial future.
3. RELYING ON YOUR TRADITIONAL ESTATE PLANNING: Not a week passes when I don’t talk to someone who says, “I’ve got this covered, I think. I have my home, cars, and investments all titled in my Trust.” A little more probing on my part reveals what I expected, that the layperson I am speaking to feels that a transfer of these assets to a vehicle like an estate planning trust, commonly a Revocable Living Trust, is effective protection; it’s not. The first word in the trust is “revocable” and in most cases a judge will simply order you to revoke the trust and tender the assets for a judgment. I’m all in favor of estate planning, the huge new looming estate tax exposure is one of the issues on my client exposure checklist we address every day, but that is death planning. What has been done about your life planning and the exposures you face every day practicing your profession, driving a car, having children (some driving your car), or having employees…?
4. TOO MANY EGGS IN ONE BASKET: Others do take initiative and implement a good tool like an LLC as a barrier between themselves and their investments, but fail to adequately segregate and subdivide assets so that they are protected from the owner and each other. A common example is the case of the residential rental property owner who has single LLC that is legally and financially responsible for a wide variety of properties that have different levels of liability, equity and use. If you call and say you have five to ten thousand dollars down on four new short sale properties in a single LLC, it’s probably OK because your total exposure is theoretically limited to $20-40K, the value of the LLCs assets. On the other hand, if you call and say that you have seven pieces of real estate with a total equity position of six or seven figures, some paid for, some all debt, including a triplex, a lot, and a commercial strip mall, I’m going to start sweating on your behalf. Primarily because any exposure at a new, zero equity property could wipe out your entire portfolio of paid for or partially paid for properties. Assets must be divided based on use and equity as well as into the right kind of legal vehicle, among many other factors, as explained below.
5. SQUARE PEG ROUND HOLE – USING THE WRONG TOOL: Another flaw I often have to untangle is the “funding” of assets into the wrong vehicle. Certain vehicles have great use for specific business functions supported by statute, tax law, and case history. You and your planner must have a good handle on these issues and know what pros and cons each entity presents, what the effect on your liquidity will be and what it will take to maintain and support that stated business purpose as a start (starting to see the detail required?). One good example is the common misuse of Family Limited Partnerships (FLP) to own the client’s personal residence. What is the legitimate business purpose of using a vehicle that is most often created for “family investment management and wealth transfer” to own the house you personally live in? If you’re not paying commercially reasonable rent you don’t have one. In this case the plaintiffs will successfully argue that you are using the FLP as personal piggy bank that is not legally distinct from you and your personal assets and liabilities, and the I.R.S. won’t find it cute either.
6. DRAGGING LIABILITY INTO YOUR PLAN: Similarly, we often see dangerous articles of personal property like your personal vehicles moved into this structure or others like an LLC or S-Corp. that is your primary business, or equally dangerous, into an entity like an FLP that is holding safe and attractive assets like cash, stocks, bonds and other liquid assets. Think about it, if you lease or own your vehicle through your business, you have linked the most dangerous thing you likely do on a daily basis, drive a car, and linked it to either the source of your wealth, your business or in the case of your FLP, the place you keep your wealth.
7. RELYING ON GIFTING TO RELATIVES (SEE ALSO FAILING TO ACT) Transferring all of your assets to your spouse and/or children, especially after something has happened, will not protect your assets from a lawsuit. Even if it did protect you from your lawsuits, transferring your assets to your spouse and/or children opens up another Pandora’s Box. Keeping in mind that there are thousands of lawsuits filed daily due to employment grievances, “slip and fall” and auto accidents, consider this scenario: Let’s suppose that you transfer all of your assets to your 18-year old son who causes an auto accident. Several other cars are involved in the accident and several injuries are incurred. Chances are high that the other parties will come looking for the driver with the deepest pockets. If your son “owns” your house and business, a sympathetic jury will undoubtedly take the possession away from your son in order to teach him a lesson for his reckless driving. The same holds true for spouses, parents and even friends. Also, gifting is limited to about $13K annually, per spouse, per donee. Gifts over that amount must be documented with a gift tax return. Failing to do so will result in you having to answer the question, “Are you lying now re: the date and validity of this transfer or did you cheat the IRS?” A bad place to be in a time of need.
8. USING UNPROVEN, POORLY STRUCTURED TOOLS OR SCAMS LIKE “FRIENDLY LIENS”: Another common scam I see is promoters of LLC mills setting up LLCs that you or a friendly party own and then having that entity record a “lien” against some valuable asset, typically real estate. While validly recorded and executed liens do have great deterrent power against creditors, they have to be backed by a real exchange of value. So if your brother in law owns a Nevada LLC that holds a lien on your home for most of its value, there should have been some exchange or “consideration” roughly equal to the amount of the lien. “Your sister has a $300K lien against the $400K home you live in? Uh, OK…then where’s the $300K she gave you, as a bank would have in a real home equity loan? She didn’t give you anything in return? Great, we’ll take the house.”
9. RELYING ON INSURANCE ALONE OR FAILING TO ADEQUATELY INSURE. WHY CAN’T WE SIMPLY INSURE OUR WAY TO SAFETY?
This is a reasonable and common question we get from clients and advisors alike. In the most egregious cases of arm-chair quarterback misinformation, we actually see uninformed advisors telling their clients that the only Asset Protection they need is a good umbrella policy – THIS IS FLAT OUT WRONG for the kind of successful people we protect. Why? Because they are successful, visible and typically have assets above and beyond just the insurance policy itself, they are good targets from a net-worth perspective.
Our position on Liability Insurance (as distinct from Life Insurance) is pretty simple: Buy as much liability insurance as you can afford, assume it won’t be adequate and have a plan B.
What about my “umbrella” policy? – It is a great idea to have an umbrella policy, but you and your liability carrier have different ideas about what umbrella means. To you it means everything, to your carrier it means specific events in the base policy, covered to specific increased limits, and governed by a specific set of exclusions detailed in the fine print of your policy. Clearly two very different definitions. The lesson here is that there is no real way to insure yourself against a universe of possible exposures and have every single one covered to an unlimited dollar amount, nor is this reasonable to expect of your liability coverage. As just one state’s example, the top ten civil verdicts in the State of Arizona for 2007 ranged in value from $6 million against a pharmacy that dispensed prescriptions that combined to cause a patient’s death to $360,000,000 million on a dispute over a real estate deal. Do you think their E&O coverage applied and was adequate?
Some real examples of the “impossible” that actually happened and resulted in large claims:
– Parents away for the weekend return to find that a teenager died at their home during a party their child had from the drugs he brought with him;
– Chiropractor adjusts a patient’s hip and the woman dies on table from cardiac arrest-he is sued for wrongful death;
– Long time, most trusted employee of medical practice molests a minor female patient during treatment;
– Employees of moving company get drunk and severely beat another employee and lock him in company truck in company yard over weekend;
– LLC for real estate development is pierced and a passive member is held jointly and severally liable for the actions of the other members;
– Dentist works on elderly patient who goes home and dies of unrelated heart attack hours later, dentist sued for wrongful death.
The liability insurance business model is a pretty simple one. Take in lots of premium payments, pay as few claims as possible and the difference equals shareholder profit. That’s right; they make money in part by reducing and limiting the number of claims against the premiums that you and the other insured pay. This is not a value judgment, simply a statement of a simple business equation. As you know, the first thing that happens when you make a claim is that you spend time on the phone with a variety of people at the insurance company who take the facts and make a determination as to whether or not the event is covered under your policy or if it can be excluded from coverage or if the amount of available coverage can be reduced by some percentage because of some contributory negligence by you, the insured. In some of the most egregious cases the insurance companies have even framed their insured and knowingly used vendors like fire inspectors who falsely claimed that fire damage to their insured’s homes and businesses after earthquakes was related to arson and not covered. Another even put, “Deny, Delay, Don’t Pay” on the cover of the training manuals they give their adjusters so that they can “paperwork” people and their valid claims to death.
Does this mean we should give up and not carry insurance or only carry minimal coverage? Of course not, it just means that the insurance system, like most things, is imperfect and that we need to be aware of this.
We want those I help protect to be empowered and to take steps to make the coverage they do have an effective source of protection. Also, if for no other reason, we like seeing the insurance policy in place to cover the costs of defense – which can easily be six figures before the fight even really starts. We have also seen changes in how the coverage limits are calculated such as in some of the malpractice liability policies that many of our thousands of physician clients must carry. These changes include making the coverage limits inclusive of the cost of defense. What this means is that if you have a $1MM insurance policy and the carrier spends $400K defending you, you only have $600K left to pay any resulting actual judgment.
SOLUTION – So how do we help make sure that the coverage is enough? Pretty simple – we buy all the insurance we can reasonably afford, make sure we have the appropriate riders and umbrellas in place then we present a hard, uncollectible target beyond the limits of the policy. Most, if not all, lawsuits are motivated by the potential financial gain to the plaintiff and their attorney.
As just one physician speciifc example, examine the gap between the average national medical malpractice verdict of around $3.9 MM and the average national liability policy in this area of $1MM. What that means is that the defendant was left holding the bag for $2.9MM.
In most cases, plaintiffs and their attorneys don’t chase people beyond the limits of the policy if there is nothing else to take or if there is nothing that they can get their hands on with any reasonable certainty. A properly protected individual is uncollectible, at least for the most-part.
We want to present a deterrent and make it clear to the plaintiff that we have this policy in place that covers this event (we hope!) and that there is nothing beyond that policy of any value that you will be able to take from us by force. You may sue, you may win, but you will never collect. If there is an instance of liability that prompts a properly Asset Protected individual to offer some settlement amount above the policy, great, but the defendant decides to do so and the terms they are willing to make the offer under as opposed to being held up at the point of a gun by a verdict and an unsympathetic jury. When faced with the scenario of an uncollectible defendant what would you do? If you are like most plaintiff’s attorneys, especially those of the contingency fee variety, you settle and move on to the next case and hopefully the next defendant who is an easier target, because you won’t, as the attorney, get paid unless you win and collect. People who are protected in the way we and others in our business suggest have taken the steps they can, addressed the exposure to their family’s wealth in a responsible manner, and move on with their lives and work and practice in their chosen profession as fearlessly as possible.
This article just scratches the surface of what you need to consider when evaluating your exposures, Asset Protection planning and the countless options available. I encourage you to act today, seek experienced counsel, and keep looking for more light and information that will help make sure you and your family get to keep and enjoy the fruits of your labors. Remember it’s not just what you make, it’s also what you keep!
Yours In Service, Ike Devji, J.D.
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