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Keeping What You Have: Asset Protection Planning

By: Frank Armstrong

By: Frank Armstrong, CFP, AIF

In 1994, 800,000 lawyers filed 14 million civil suits, an increase of 25% over the preceding five years. Seven of 10 adults will be sued during their lifetime, some several times. While certain professions and occupations are at increased risk (see list below), random litigation is an equal-opportunity disaster; even middle-class Americans are targeted. High-profile, deep-pocket defendants are eagerly pursued by greedy litigants. Liability insurance can be a mixed blessing: While it covers legitimate claims, it can also act as a lightning rod for frivolous litigation.

Gunslinging attorneys view inflicting emotional stress, unwanted publicity, time and property loss, and financial ruin as just good clean fun. Emotional jurors may focus more heavily on ability to pay than on actual responsibility. Punitive damages may be viewed as a handy way to promote political causes. Costs of litigation are so high that even “winners” are often wiped out.

The social costs of this problem are huge. For instance, if an obstetrician who delivers 200 babies a year must pay $200,000 in annual malpractice insurance premiums, then each mother must count on paying an additional $1,000 for prenatal care. Worse yet, many physicians may refuse to treat difficult cases in an attempt to avoid litigation. “Defensive medicine” piles on unnecessary tests and procedures to build a record. An atmosphere of mutual distrust grows between patients and physicians. And we all get to pay for it in additional health insurance costs.

A Financial-Planning Trend

So is it any wonder then that increasing numbers of Americans are exploring legal ways to reduce the exposure of their assets to a legal system run amok? Asset protection planning (APP) should be an integral part of financial/estate planning for almost every individual or family, even those of modest means. In the last ten years the field has become a recognized specialty in the practice of law, and it’s growing as a specialty in financial planning as well. “Asset protection planning is becoming almost as big in my business as retirement planning,” says fellow Morningstar.Net columnist and Alpha Group Member Lou Stanasolovich. “And in four or five years it probably will be as big.” Properly accomplished, APP can vastly reduce the threat to wealth that future illegitimate creditors might pose.

The general objective is to retain control and enjoyment of your property while erecting protective legal barriers to future creditors. By controlling in advance where and how litigation will be fought, and diminishing greatly the probability of a successful collection, much litigation can be avoided entirely or settled for reduced amounts.

APP is effective against future litigants or creditors. However, these steps are unlikely to be much help against pending, threatening, or expected litigation. In very general terms, any divestiture or transfer to avoid current creditors is most likely to be viewed as fraudulent. So a key to successful planning is to act before an illegitimate threat or cause of action arises.

Additionally, if after a transfer or divestiture a person acts with wanton disregard for the rights of others, or if transfers left him less than solvent, those transfers can be subject to reversal. Asset protection planning is not a license to act irresponsibly, create a fraud, deliberately make oneself insolvent, or otherwise thumb your nose at the system.

An Island Adventure

Suppose you are a surgeon, and several years ago a friend convinced you to take a small interest in a shopping center construction project. Construction was delayed for years while the local zoning board pondered a giant regional mall across the street from your project. The deal failed. While you were never active in the deal, you are the only deep-pockets participant left standing, and a group of the prospective tenants decides to sue.

However, they soon learn that you have designed your estate to protect yourself against frivolous litigation. Title to all of your assets, including your home, professional corporation, and investment accounts are held by a Cook Islands asset protection trust, way out in the middle of the Pacific Ocean. Your attorney explains to the prosecuting attorney that, even if they get a judgment here in the United States, they must go to the Cook Islands to collect. Unfortunately for them, their U.S. judgment will not be recognized there. So they must hire a local attorney, and they must litigate on the single issue of fraudulent transfer against a statutory requirement deliberately designed to be the most restrictive on the planet. They are very unlikely to remain enthusiastic, let alone prevail.

Coming Up–Simple But Effective Protective Measures

There are a number of steps that Americans can take to reduce their exposure and to protect their property. As you might expect, these solutions vary in complexity, cost, and effectiveness. In the next article we will look at the most basic defenses and protections built into existing laws.

You May Be at Risk of Frivolous Litigation If…

  • you’re a surgeon, ob-gyn, attorney, investment advisor, etc.
  • you’ve had or may someday have a lapse in liability coverage.
  • you’ve chosen not to carry or cannot afford liability or errors and omission insurance.
  • you believe that high levels of liability coverage attract litigation.
  • your business requires you to assume general liability for ongoing projects, such as building contractors, real estate developers, etc.
  • you’ve ever owned real estate that might have a toxic waste problem.
  • you own assets that might trigger liability, such as aircraft, boats, apartment buildings, other real estate, or equipment for lease.
  • you have sold or will sell an ongoing business.
  • you have or have had employees.
  • you sit on a corporate, charitable, or other board of directors.
  • you are a general partner in any enterprise.
  • you are a fiduciary for a pension plan.