As partnership and LLC law has evolved, the various related uniform acts have allowed for the foreclosure of a charging order. Some states, such as California and Nevada, have adopted these changes, while other states, such as Oklahoma’s LLC Act, have adopted legislation that appear to forbid or restrict the effects of such foreclosure. Still other states have yet to adopt these changes one way or another.

Some individuals, and even some of the less-informed asset protection planners, fear the foreclosure of a charging order undermines the protection that COPEs have previously provided. A careful reading, however, shows this to not be the case.

To illustrate, let’s examine section 703(b) of the RULPA.

“(b) A charging order constitutes a lien on the judgment debtor’s transferable interest. The court may order a foreclosure upon the interest subject to the charging order at any time. The purchaser at the foreclosure sale has the rights of a transferee.” [Emphasis is ours.]

The key sentence here is that a purchaser of a foreclosed charging order has the rights of a transferee. What are those rights? Section 702 of the Act tells us:

“(a) A transfer, in whole or in part, of a partner’s transferable interest:

…

(2) does not by itself cause the partner’s dissociation or a dissolution and winding up of the limited partnership’s activities; and

(3) does not, as against the other partners or the limited partnership, entitle the transferee to participate in the management or conduct of the limited partnership’s activities, to require access to information concerning the limited partnership’s transactions except as otherwise provided in subsection (c), or to inspect or copy the required information or the limited partnership’s other records.

(b) A transferee has a right to receive, in accordance with the transfer:

(1) distributions to which the transferor would otherwise be entitled; and

(2) upon the dissolution and winding up of the limited partnership’s activities the net amount otherwise distributable to the transferor.

(c) In a dissolution and winding up, a transferee is entitled to an account of the limited partnership’s transactions only from the date of dissolution.

(d) Upon transfer, the transferor retains the rights of a partner other than the interest in distributions transferred and retains all duties and obligations of a partner.” [Emphasis is ours.]

The foregoing illustrates that foreclosing a charging order only gives the purchaser the rights of a charging order in perpetuity. In other words, a charging order is effective until the judgment is satisfied, but a foreclosed charging order extends those rights indefinitely. No other rights or powers arise from the foreclosure.

So how bad is it for someone to now hold a perpetual charging order interest? If the entity is structured correctly, then a foreclosed charging order will rarely be worse than an unforeclosed one. This is because, due to IRS Rev. Rul. 77-137, the holder of a foreclosed charging order will almost certainly receive the tax bill for his share of company profits, even if he never receives those profits. In other words, having a foreclosed charging order not only doesn’t ensure its holder will ever receive anything from the partnership, it also does ensure he’ll receive the tax bill for whatever it is he didn’t receive! Structuring an entity so as to lay this trap for unsuspecting creditors is discussed in Chapter 19.

Of course, if a foreclosed charging order ends up being all pain and no gain for the creditor, he will want to get rid of it, meaning that the foreclosed charging order will almost certainly not be in effect indefinitely.

Never confuse secrecy or concealing assets with asset protection. Financial privacy can be helpful, but once you’re sued you can no longer rely upon secrecy because a judgment creditor can compel you to disclose your assets. If you truthfully disclose your assets, you lose secrecy. If you conceal your assets, you commit perjury. That’s not legitimate protection. You want a plan that lets you fully disclose your assets, confident that they’ll remain safe from your creditor. A judgment creditor can force financial information disclosure through deposition, interrogatories, requests to produce documents or subpoena your records and information from third parties.

Judgment creditors can and do find debtors’ assets. Loan and credit applications, bank records, tax returns, court cases (such as prior divorce that discloses assets) and insurance policies all provide clues. The paper trail is revealing. Computers expose our financial lives. Judgment creditors and prospective litigants often use professional asset search firms to find concealed assets. These firms can financially profile you with stunning accuracy. Forensic accounting firms trace deviously and secretively deployed wealth. So avoid “hide the assets” games. Your creditor will probably find your assets.

The sounder policy? Tell your claimant early in the game exactly what assets you own and how they are titled. Most importantly, explain precisely why they are beyond creditor reach. Make asset protection your selling tool. Convince a claimant that you’re simply not worth suing.

The cold hard reality of litigation, from an attorney’s perspective at least, is that it’s almost always all about money. Attorneys work for a living. They have bills to pay like everyone else. Although they often represent clients on a contingency fee basis, they’ll normally do so only if they believe they’ll get paid. If a potential defendant has no exposed assets, the attorney won’t get paid. Most plaintiffs’ attorneys first do an asset search on a potential defendant before taking on a contingent fee case. If their search reveals few unprotected assets, the attorney is then uncertain whether he will get paid for his efforts. Even if the asset protection plan is pierced, the process may be lengthy, expensive, and uphill. The attorney will then insist on an up-front retainer before accepting the case. This shifts the risk of suing a defendant and losing (or being unable to collect) to the plaintiff, who now realizes their lawsuit can be an expensive, risky undertaking!

Other than lawsuits with the potential for large judgments against wealthy (albeit asset protected) individuals, attorneys and would-be plaintiffs usually opt for easier prey. This is basic human (and even animal) nature. A pack of predators stalking a herd go for the easiest kill.

With that said, people who think they are well-protected may not be. The predator/litigant determines that an apparent defense is only smoke and mirrors. The defendant is surprised to lose his or her assets. They learned too late that you can’t have illusory protection. You need solid, effective asset protection!

As asset protection planners, we see many well-protected clients threatened with litigation, only to have the threat fizzle. The effectiveness of protection is most striking when several co-defendants are sued. The protected clients are dropped from the suit which proceeds full-steam against the unprotected, deep-pocket defendants.

Corporate stock is not in and of itself safe from a stockholder’s creditors. Therefore, additional steps must be taken ensure the stock’s safety. Your options include the following:

• Married couples may transfer their corporate shares to the less vulnerable spouse, who would then own the stock and control the corporation. This is very easy to do, but is probably not the best solution, since gifting is vulnerable to a fraudulent transfer ruling, and since doing so places you at greater risk of losing the corporation should you divorce your spouse. However, since one may make unlimited tax-free gifts to his or her spouse, at least this is a tax-neutral option.

• Transfer the shares to an LLC or limited partnership. If done before creditor threats materialize, this is an excellent strategy that has several advantages. First, a transfer to an LLC or limited partnership (which could be domiciled either in the U.S. or offshore), if done as a capital contribution, is a tax free event. Second, the ownership interest of a properly structured LLC or limited partnership may not be seized by a creditor. Third, in most instances you may act as manager of the LLC or LP, and thus retain control of your corporate stock while still protecting it. You may also remain a director or corporate officer of the corporation if you desire. There is one caveat to this approach, however: only an entity that is structured so as to be disregarded for tax purposes from its owner (which must be a natural person who is a U.S. citizen) may own the shares of an S corporation (any entity may hold a C corporation’s stock). However, it is possible to structure even a multi-member LLC or LP so that it is taxed as a ‘disregarded entity’ and the IRS has allowed such an entity to hold S corporation stock without endangering the corporation’s subchapter S tax election. Note that it is not possible to structure a family limited partnership (FLP) as a disregarded entity if one wishes to avail themselves of the estate tax reduction benefits of such an entity.

• Transfer the corporate shares to an irrevocable trust set up for your children or other beneficiaries. This tactic, of course, means in most states you could no longer receive the benefits of stock ownership (such as voting rights and cash dividends) in either a direct or indirect manner. If you continue to benefit, even indirectly, from stock ownership, then the trust would essentially be self-settled (a self-settled trust is a trust where the person who transfers assets to the trust continues to benefit from the assets). Self-settled trusts by law do not provide asset protection in 42 of the 50 states.

• Title your shares as tenants by the entirety. Tenancy by the entirety is a type of joint ownership, allowed in about half of the states, wherein a husband and wife may jointly own property. If one spouse dies, the other automatically becomes the sole and complete owner of the property (this is called ‘right of survivorship’). Neither spouse can sell or otherwise transfer their interest in the property without the other’s consent. In many states that allow this type of ownership, the property may be attached only when both spouses are subject to creditors. If you co-own your shares with your spouse in a state that allows tenancy by the entirety interests, then this strategy may give your stock ownership sufficient protection when only one spouse has creditors. However, tenancy by the entirety does not offer complete protection (it will not protect an asset from the IRS, for example) and therefore an even better (and perhaps optimal) arrangement would be to transfer the stock to an LLC or limited partnership, and then hold the LLC or limited partnership’s interest as tenants by the entirety.

• Assess your shares. If your shares are not fully paid or if the shares are assessable by the corporation, then a creditor who seizes your shares takes them subject to your obligation to pay the assessment. Obviously, a potential assessment by the corporation reduces the value of the shares to your creditor by the amount of the potential assessment. An ‘assessment’ can be a particularly effective ‘poison pill,’ and we frequently include ‘assessment provisions’ in corporate documents as an anti-creditor device.

• Issue irrevocable proxies. A proxy is an assignment of your right to vote your shares. For example, you may issue a proxy to a relative, etc. A creditor who seizes your shares cannot vote your shares because the voting powers have been irrevocably assigned to the proxy holder. This, too, will significantly lessen the stock’s value to the creditor, since the creditor would gain no voting rights in the corporation (and therefore be unable to vote to liquidate the corporation, even if they seized 51% or more of its voting stock). If you are sued, you may exchange voting shares for non-voting shares, which will also be of less value to creditors.

• Dilute your stock ownership. If you own a controlling (>50%) interest in a corporation, dilute your ownership. If and when it becomes necessary, you can have the corporation sell additional shares to other family members or to family controlled entities (trusts, limited partnerships, etc.). This is an issuance of new stock rather than a transfer of stock, and as long as it’s done within normal operating business parameters, such a strategy is not considered under fraudulent transfer law. A creditor who seizes a minority ownership interest in the corporation cannot, of course, control the corporation. As a minority stockholder, the creditor only has the right to vote his or her shares and await whatever dividends may be declared. It is sometimes wise to spread the stock ownership in a family owned corporation between family members so that no one family member owns more than 49% of the voting shares. The bylaws would empower the remaining 51% to control the corporation.

You cannot be too proud to accept your limitations and call for help from the growing cadre of consultants, lawyers, accountants and other workout specialists who each offer essential skills and resources needed to save your business. Timing is critical. Ignore your problems and you prolong retaining professional help. When you finally do seek help, your business may be beyond the point of no return. Troubled owners may see calling for professional help as admitting failure or an inability to solve their own problems.

A turnaround consultant must often play psychiatrist, convincing struggling business owners that there is no shame in leaning on stronger shoulders. Business owners are not infallible, and the smartest managers use every resource at their disposal to survive and build a stronger business. Money to hire professionals is a barrier when you cannot even meet your payroll. You find it difficult to welcome a $300-an-hour consultant or lawyer. Professionals are then seen not as a vital investment, but as an unaffordable cost. A reluctant client once blurted, “I don’t need a high-priced consultant to tell me I’m running out of money,” but he did. More importantly, he needed someone who was objective, forceful and had the skills to show him how not to run out of money. Spending money on professional fees can save you a hundred times more money, and it can save your business. Reverse your viewpoint. Think about fees as a necessary investment, not a cost.

As the owner of a small or mid-size business, you are probably less familiar and less comfortable with working with outside professionals than are corporate executives who more frequently hire consultants. You may not fully understand the many ways the right professionals can help you. Success or failure often depends on finding the correct professional talent. Keep one point in mind. It was you who got your business into trouble. Why do you think that you can get out of trouble on your own?

Technical ability is only one of the skills offered by a consultant, attorney or accountant. Most important is that these professionals can think and act impassionately and objectively. As difficult as it is to navigate the thriving business, a complex turnaround demands the professional’s unique skills and techniques that defy conventional management practices. Pros who put together broken companies play by rules that only others within the insolvency field understand.

While managerial and professional skills are invaluable, professional objectivity is critical. Your view may also blur when you are deeply involved emotionally and financially. Independent professionals are untainted by existing biases. They enter the picture with the fresh ability to see things as they are, not how you see them. You may have the right answers and correct solutions to your problems, but still need an outside professional as a sounding board to confirm that you are right. A manager’s intuition about what must be done usually is correct, but unless you have been through one or two turnarounds, you may lack confidence in your own game plan. A pro who ratifies your decision gives you the confidence to follow through and more forcefully press action.

In sum, outside professionals do for you what you cannot do for yourself. They tackle the dirty work of firing people, standing up to creditors or tackling those other messy jobs for which you have no stomach. The dirty work is my job. There are resources your advisors can suggest: Insolvency consultants, attorneys and accountants. My firm, for example, offers a nationwide roster of hundreds of other consulting firms and law firms, each outstanding in its specialty. We routinely match hard-to-find professionals with financially-troubled business owners. Other professionals similarly maintain close affiliations with banks, lenders, liquidators, business brokers and the cadre of other specialists who serve troubled firms.

Of course, no two companies need precisely the same professional aid. If your business is unprofitable but solvent, you need a consultant who can help you to regain profitability. An insolvency attorney is of no value at this point. If you have poor financial controls or a weak marketing strategy, your professionals must bring to you those specialized operational skills; broad turnaround experience may not be enough. Your most important decision is to determine precisely the assistance you need from:

• Turnaround consultants
• Business or operations consultants
• Insolvency attorneys
• Auditors and accountants

Key personnel

The criteria governing when corporate officers may be held directly liable for torts committed in the course of a company’s business varies widely from state to state. For example, Delaware corporate law states:

• “No suit shall be brought against any officer, director or stockholder for any debt of a corporation of which such person is an officer, director or stockholder, until judgment be obtained therefore against the corporation and execution thereon returned unsatisfied.”

Compare this to Nevada law, which allows a suit directly against a corporate officer or director if the corporation is their alter ego, even if a judgment against the corporation has not yet been awarded:

• “Except as otherwise provided by specific statute, no stockholder, director or officer of a corporation is individually liable for a debt or liability of the corporation, unless the stockholder, director or officer acts as the alter ego of the corporation.”

Now compare the previous two statutes to California law, which allows a claim to proceed against a corporate director, if the plaintiff alleges the director acted in bad faith (however the director will only be liable for corporate debts if he did indeed act in bad faith as a director.)

Unfortunately, except in the case of Delaware, in almost all states it is possible for a plaintiff to, at least initially, bring suit against a corporate director or officer as well as the corporation itself. This is an extremely common litigation tactic, and is used as a means to pressure the corporation’s principals into a settlement.

After all, it’s one thing to drag business activities through the discovery process, and quite another to subject one’s personal conduct to discovery, which depending on the facts of the case may be quite embarrassing. Such a tactic is also used against the managing members or general (managing) partners of an LLC or limited partnership, respectively. Furthermore, no state’s corporate laws will protect a company’s manager, officer, or director if the person is involved in a tort such as fraud or sexual harassment.

The fact of the matter is, no matter where the manager or the corporation is domiciled or does business, there is always at least some exposure to liability. Therefore, risk of such liability should be dealt with by doing one or (preferably more) of the following:

• Buying director’s liability insurance.

• Implementing an asset protection program to protect the director’s personal assets.

• If possible, have another person, or at least an LLC or other limited liability entity manage the company’s affairs as much as possible (this will shield directors and managers from some but not all claims.)

I understand that it will allow me to get new credit identification by using a new social security number. Skin shedding creates a new credit identity. Two systems are commonly used: One way is to change social security numbers. For instance, one may find the name of a child with a similar birthday or someone who died 10-20 years earlier. By using that child’s social security number, you have a new identity. The government issues notices of cancelled social security numbers to credit bureaus when a person dies. However, this system is extremely inefficient because it relies on reporting from funeral homes, benefits paid to survivors, closed bank accounts, and returned mail. Even if you succeed in having the Social Security Administration assign you a new social security number (usually because of a religious objection), the credit bureaus’ computers may still link you to your old number. A new social security number will then not give you a new identity.

But keep in mind that fraudulently using someone else’s social security number violates the Social Security Act, and the Justice Department will prosecute. The penalty is up to 5 years in prison or a fine of $50,000, or both.

A second tactic feeds false information. Here one contacts the credit bureau where they have a negative report and advises them that there is incorrect information in the consumer identification section. Perhaps they claim that the name or social security number is incorrect. They then supply new ‘correct’ information which is actually false. The credit bureau then “corrects” the file. Several weeks later the individual contacts the credit bureau to request a credit report. They then inform the credit bureau that none of the information is correct, and that the report must belong to someone else with the same name. The credit bureau must verify this information. Since the information they will attempt to verify has nothing to do with the applicant, it cannot be verified and the entire credit file is then deleted. Finally, these same individuals wait several more months to again contact the credit bureau using their correct name, social security number, etc. and instruct them to re-correct the information. This returns them to their original credit report which shows a clear credit history. The bureau has inadvertently made their entire original credit report unverifiable, and effectively wiped it clean to produce a new credit history.

There are many other illegal scams to repair credit. Follow only sound, legal credit repair practices to achieve your goals. Don’t risk committing a crime.

Sections 4 and 5 of the UFTA determine whether a transfer is fraudulent. From these sections, we may derive 3 types of fraudulent transfers:

• Transfers that are constructively fraudulent as to present (already existing) creditors only;
• Transfers that are constructively fraudulent as to both present and future creditors;
• Transfers that are not fraudulent in and of themselves, but are fraudulent because they were made with intent to hinder, delay or defraud present and/or future creditors.

Items 1 and 2, above, are determined by bright-line tests. In other words, these tests consist of clearly defined standards with little room for interpretation. The bright-line tests do not consider intent; one may commit a fraudulent transfer under these rules, even if one had no intention of hindering, delaying, or defrauding a creditor.

There are two primary criteria used to determine if a fraudulent transfer occurred under the first bright-line test. The first criterion requires that the debtor be insolvent at the time of the transfer, or becomes insolvent as a result of the transfer, or becomes insolvent shortly after the transfer. Solvency, more or less, is defined as a person’s ability to pay their debts. If they are unable to pay their debts, or are currently not paying their debts even if able, then they are deemed insolvent. It is important to note that, for purposes of determining solvency, any claim to one’s assets could be considered a debt, even if the claim has not yet been reduced to judgment.36 Therefore, if someone threatens to sue you for $1 million, their “claim” on your assets may be considered a liability for the purposes of determining your solvency. In other words, if you have net assets worth $900,000, and are threatened with a $1 million lawsuit, you may be considered insolvent under the UFTA, even though you don’t actually owe the $1 million (yet). Fortunately, solvency is not the only criteria for determining whether a transfer is fraudulent under the bright-line tests; one must also transfer the asset for less than reasonably equivalent value in addition to being insolvent.

The second criterion examines whether the debtor received an asset of reasonably equivalent value in exchange for the transfer. Reasonably equivalent value is generally considered to be cash or an item of equivalent cash value that is equal to the fair market value of the asset being transferred. The term ‘reasonably’ does give us some wiggle room, however an exchange (except in the case of a non-collusive foreclosure) will usually not be considered to have reasonably equivalent value if the consideration for the transfer is worth less than 70% of the transferred asset’s fair market value. Furthermore, an unperformed promise may not be considered to have reasonably equivalent value. Therefore, if a promissory note is given in exchange for the transfer, it must be considered within the ordinary course of business of the lender (e.g. a bank giving a loan), or their should be at least a partial up front payment made, and ongoing cash payments should be made on the note so that it fits within the realm of a standard business transaction.

With the foregoing in mind, we can fully understand how the first bright-line test determines whether a transfer is fraudulent. This test stipulates that if a debtor is (or is about to be) insolvent, and he transfers an asset without receiving something of reasonably equivalent value in exchange, then the transfer is fraudulent. In this instance the transfer is fraudulent even if the creditor has no claim on the debtor’s assets at the time of the transfer. A creditor could actually have no claim until just before the statute of limitations under the UFTA (or other applicable law) expires, and yet they could then still file a claim and the transfer would be deemed fraudulent. This statute of limitations could be 4 years or longer after the transfer occurs, depending on the circumstances and local laws the matter is subject to.

For us to fully understand the 2nd bright-line test, we must define what an insider is. The full definition of ‘insider’ is found in §§1(1) and 1(7) of the UFTA. However, a simplified definition of an insider is anyone who is a relative of the debtor, any company the debtor has significant control or influence over, or, if the debtor is a company or trust, anyone who has significant control over the company or trust. The foregoing, however, is not an all-encompassing definition of what an insider is. A court could conceivably consider anyone over whom the debtor has significant influence or control to be an insider.

With the foregoing in mind, the 2nd bright-line test involves a much narrower set of circumstances. This test, which only applies if the creditor challenging the transfer has a claim before the transfer occurred, shows a transfer to be fraudulent if the transfer was made to an insider to pay a debt that existed prior to the transfer, the debtor was insolvent at that time, and the insider had reasonable cause to believe that the debtor was insolvent. This, of course, does not mean payment of a debt to a non-insider is a fraudulent transfer. On the contrary, paying off such a debt, as long as the debt is valid, is a great way to reduce the exposure of one’s assets after the threat of litigation or other hostile creditor attack materializes.

There are literally hundreds or even thousands of variations on the theme, but most entities and strategies conceptually, at least, fall within one of these firewall types. For example, limited liability partnerships (LLPs) and limited liability limited partnerships (LLLPs) are variations on limited partnerships.

Neither does every possible firewall fall within one category or another. For example, exposed cash may be used to buy a deferred annuity that will create an income stream many years hence. While the annuity payment may theoretically be claimable by the creditor (assuming its ownership falls under a jurisdiction that does not exempt such payments), how much is it worth to a creditor who must wait years to collect?

Although this book is comprehensive in that it examines all major protective strategies, as well as some highly effective yet lesser-known strategies, we don’t aim to survey every nook and cranny of the asset protection world.

The best defense is a good offense. This truism applies to asset protection as well as to other conflicts. There are a number of ways to impose liability on a creditor who attempts to seize assets. For instance, a creditor who obtains a charging order (which may include foreclosing on the order) on a limited partnership or LLC interest may incur a tax liability while receiving nothing from the entity with which to pay the tax. Or, a creditor who wishes to commence litigation against a Nevis entity may be forced to pay a $25,000 bond before they can do so. There are any number of liability- imposing features that act as quills on the porcupine. It makes pursuit that much less attractive.

Seldom do the counter-offensive capabilities of a particular strategy control its adoption, but they may influence it. The goal is to present the creditor with a downside to pursuing the asset. In a nutshell, defense-in-depth and diversification strategies discourage a creditor from chasing assets by making the chase more difficult and the outcome uncertain, while counter-offensive strategies may make a creditor financially worse-off than if he had not attempted collection in the first place.

How do we discuss the failed company when ‘failure’ defies precise definition? For example, your firm can be a managerial failure, financial failure or legal failure, but these are not interchangeable terms. Your company may become a managerial failure well before it becomes a financial failure, and it may linger as a financial failure without becoming a legal failure. Managerial failures never reach their potential. The great myth is that managers are successful if they turn a profit.

How much profit is seemingly unimportant. Conversely, unprofitable managers who sidestep far greater losses due to their skilled management are condemned. Who is the true managerial failure – the manager who earns a $1 million profit for a company that could easily have earned $5 million, or the manager who limits losses to $1 million for a company ordained to lose $5 million? The lesson: It is not enough for your business merely to be profitable. You must make it the profit maker it can be. Anything less is managerial failure. Many companies, whether large or small, are managerial failures long before they turn into financial failures. They lose money, or earn so little, that their stockholders would fare no worse stuffing their investment under their mattress. This reality prompted Will Rogers to quip, “I’m more concerned about the return of my investment than I am the return on my investment.” Stockholders of many companies and who want productive use of their money, have an objective their managers never achieve. Will Rogers had another quip for this: “Executives who do not produce successful results hold on to their jobs only about five years.

Those who produce results hang on about half a decade.” Study the earning records of today’s businesses and you can easily spot the managerial failures that will become tomorrow’s financial failures. Will your business be among them? For every firm that drowns in a sea of red ink, hundreds more are merely doused. Each year, nearly half of the nation’s businesses lose money. These firms strive to be average. Two-thirds of the profitable firms earn less than what a secure savings account earns. Only one corporation in seven performs better. The press exposes the larger corporations that are the managerial failures, while most family businesses shuffle along, handing something less than a fair week’s pay to their owners. Of course, it is impossible to accurately measure the profitability of the smaller business, which represents two-thirds of the twenty-five million American companies, because their owners can so easily hide profits. Only they know whether they are truly making or losing money. Managerial failure advances to financial failure when the business has chronic and serious losses or becomes insolvent with more liabilities than assets. Troubled companies usually suffer from both unprofitability and insolvency. Continuing losses, of course, weaken any organization. Financial failure, as an indicator of a company’s economic condition, may overlap with managerial and legal failure.

Financial failure bridges the subperforming company (managerial failure) and the company formally declared alegal failure (bankruptcy). There is legal failure when a company’s liabilities exceed its assets, yet a company can operate for years with more debts than assets because of creditor leniency and patience. Many ‘upside-down’ companies eventually turn the corner, produce a profit and brighten their balance sheets, much to the relief of their patient creditors. Few debt-ridden firms survive without creditor patience and rapidly improved profits.

A company is also defined as a legal failure if it cannotmpunctually pay its debts. Of course, if you follow this archaic test, most American companies are bankrupt. This rigid standard is undoubtedly a throwback to an era when businesspeople  actually paid their bills when due. The fact that a business closes its doors does not necessarily indicate that it is a legal failure. Illness, retirement and other personal reasons force many closings. Even the unprofitable business that closes is not a legal failure if it fully pays its debts. Many companies that are financial failures endlessly linger without becoming legal failures. Others file bankruptcy – an admission of legal failure – but emerge from bankruptcy with a new balance sheet and new lease on life. They are no longer legal failures; however, they will stay financial failures until they become profitable. Failure, then, is relative, a term that exists in the abstract. The performance of your company can be measured against other businesses, comparable companies within your industry, its own potential, or its prior performance. How you measure success or failure depends largely on who wields the ruler.

Multi-LLC planning strategies are not exclusive to LLCs alone. These same strategies may be used with limited partnerships or corporations. However, corporations don’t have charging order protection, and limited partnerships don’t have limited liability for the general partner, although we can compensate for this shortcoming by using an LLC as the general partner. Therefore, the following planning strategies are usually most effectively used with LLCs.

The 1st strategy is very simple: we put various assets into separate LLCs so as to segregate certain assets from the potential liability produced by other assets in. This is called “liability segregation” and is especially useful in protecting non-liability producing or “safe” assets, such as investments, from high-risk or “dangerous” assets, such as a vehicle or business that contracts with the public. If a vehicle or high-risk business is in one LLC, then, a lawsuit against that LLC will not threaten the assets in another LLC. Likewise, a lawsuit against an LLC’s owner will not threaten assets in his LLC, and will not affect his interest in an LLC beyond the creditor possibly obtaining or foreclosing on a charging order. The figure below illustrates the concept of liability segregation.

Although a multi-LLC approach is effective, it is not without its drawbacks and vulnerabilities. First, multiple LLCs generally mean multiple tax returns, administrative costs, added complexity, and higher overall governmental fees (such as annual reports, or franchise taxes such as the infamous $800 minimum California LLC tax and fee levied on each LLC registered or doing business in California.) Furthermore, although one LLC’s assets are not exposed to liability arising from another LLC’s liability, an LLC that is sued could still potentially lose all its assets to the creditor who is suing it. There are ways to overcome or minimize this weakness, including equity stripping, and also the strategy we discuss next.

A weakness is that multi-LLC strategies have a small chance of having their LLCs’ veils pierced if they are structured incorrectly. This type of piercing does not involve a creditor being able to attach the assets of an entity’s owners; rather it involves a creditor being able to disregard the segregation of liability between multiple entities. In other words, a creditor may be able to reach the assets of all related entities for the liability of one entity. Veil piercing in general is “an extreme measure, sparingly used”, and in most cases separate entities will not be treated as one for purposes of what a creditor may attach, however if there is an egregious act of bad faith, gross negligence, or fraud, then a judge may consider whether an alter ego argument is appropriate. In such an instance, the courts will consider the following:

• Using the same offices and employees
• Identical managers for each entity
• Commingling of funds and other assets between the entities
• The holding out by one entity that it is liable for the debts of the other
• Using entity one as a mere shell or conduit for the affairs of the other
• Failure to keep separate company records
• Identical equitable ownership in the two entities

Keep in mind that a judge may use the above only as factors to help him decide if disregarding separate entities’ limited liability is appropriate. Disregarding one or more of the above may not lead to a veil-piercing. However, when structuring multiple related entities, it is wise to avoid as much of the foregoing as possible. The first four criteria are especially damaging and may be easily avoided in almost all circumstances. The other criteria are often avoidable without too much trouble. For example, it is not hard to set up separate P.O. boxes for different entities. Two entities may have the same majority owner but different minority owners (perhaps the minority owners own as little as 1-5% in a company.) If there are 2 multi-member LLCs, then one member could manage entity A and the other could manage entity B. Structuring in this manner minimizes any excuses a creditor might use to make a veil-piercing argument in court.

We must often do more than shelter non-exempt assets by titling them to one or more protective entities. We then have additional firewalls. One method is to “strip the equity” from real estate and personal property. Unencumbered, vulnerable wealth converted to debt-ridden wealth becomes worthless to a plaintiff.

We use many different mortgages and lien arrangements to equity-strip real estate or personal property. As the property owner, you or your protective entity retain title or legal ownership to the property, but you effectively transfer the asset’s economic value to the mortgage holder; in this instance, to reduce the equity for seizure by creditors or litigants. Nothing discourages prospective litigants more than the reality that you are mortgaged to your eyebrows. You can own millions in assets, but if the mortgages against your assets equal their value, you are indeed a poor lawsuit candidate. Prospective litigants want equity to seize. When you pledge your assets to other creditors, your poverty becomes negotiating power.

Equity stripping for asset protection is its own specialized niche. We have developed many creative ways to structure “friendly” liens against assets. But you want bonafide liens. Sham mortgages can be set aside by the courts when you have a more aggressive creditor. You must also protect the loan proceeds. The devil is in the details. Again, that’s why you need a good asset protection lawyer.

You’ll notice that all of the above strategies fall into the category of either transfer-based asset protection (transferring an asset out of a creditor’s reach) or transformational asset protection (transforming the asset into something a creditor couldn’t get or wouldn’t want). For example, part of your salary can be placed into an ERISA-governed plan (401(k), etc.) that is exempt from creditors. Although this involves exemption planning, it also involves transferring cash into an ERISA-governed plan, and is, therefore, transfer-based asset protection as well. Another method involves using exposed cash to prepay certain expenses or repay favored creditors (as long as those creditors aren’t “insiders” under applicable fraudulent transfer or fraudulent conveyance law). For example, one could take exposed cash and use it to pay in advance for a five-year commercial lease. Such a technique results in the right to use an asset (the leased property), a right most creditors wouldn’t want. This is transformational asset protection.

Nearly every asset protection strategy relies upon one or more of these three core strategies, while simultaneously utilizing either transformational or transfer-based methods. These are the “firewalls” from which you build your strongest financial fortress.

We mostly use one of three strategies, or “pillars of protection.” The first pillar is to title only exempt assets to your personal name. The simplest way to protect yourself is to personally own only assets with federal or state statutory protection against lawsuits and creditors. These are exempt assets. Own no assets in your own name that are not exempt and self-protected. Unprotected assets owned individually are assets your creditors can easily claim. This book will highlight those assets that are most commonly creditor-sheltered. You usually don’t need to do nothing more to protect them. Many people rely strictly on their homestead laws, wage and pension exemptions, bankruptcy exemptions and other protective federal and state laws to keep their individually owned assets safe from creditors.

Four types of assets that are typically exempt:

• Personal residences (a.k.a “homesteads”)

• Personal effects (such as furniture and clothing)

• Pensions and retirement funds (IRAs, 401(k)s, annuities, etc.) and

• Life insurance

To maximize your protection, you’d convert non-exempt (unprotected assets) into exempt self-protected assets. If you live in a more debtor-friendly state, you have several options. If you live in a less protective state, you might “jurisdiction shop” and relocate to a state that’s more protective, or you might swap with a liability-free spouse your interest in unprotected assets for your spouse’s interest in protected marital assets of equal value. But be careful. Transforming non-exempt assets into exempt assets has its limitations. In some states, “last minute” conversions are a fraudulent transfer if you already have a creditor.

How protective are these exemption laws against lawsuits? The answer varies by state. State exemptions can be extremely valuable or relatively meaningless. Exemption law efficacy depends not only upon what liability you need protection against, but also upon your state laws, your assets, and the equity in the asset to be protected.

Protecting yourself with the federal and state exemption laws can seem like a simple exercise, but it’s quite tricky. You’ll definitely need professional advice here, so you are confident that your state laws will fully protect your assets under your specific circumstances. You may have misconceptions about your exemption laws and assume certain assets are self-protected, but this may not be the case.

A greater difficulty with the exemption laws involves the interplay between the state exemptions and the federal exemptions (those which apply in bankruptcy). Pro-creditor changes in the new bankruptcy code have disadvantaged affluent debtors who will now find their state law exemptions less helpful if they go into bankruptcy. The homestead exemptions are one example. Conversely, the new bankruptcy law better protects certain other assets, most notably retirement accounts.

The threshold question in exemption planning then is whether you expect to resolve your legal problems with or without bankruptcy. Only when you have this answer can you determine which exemptions would apply. Nor can you always avoid bankruptcy. Because the new bankruptcy law is generally more favorable to creditors, we might expect more creditors to petition debtors into involuntary bankruptcy, causing these debtors to lose their more liberal state exemption protection.

A further complication is that not every state lets you apply the federal exemptions in bankruptcy, though most states allow a bankrupt individual to choose between the federal and state exemptions. (When you file bankruptcy you must choose exemptions. You cannot combine federal and state exemptions.) Though you must choose between the federal or state exemptions where you have the option, the exemption laws of certain states allow you to also apply supplemental federal exemptions, which may expand your protection.

You can choose which specific property to exempt within the terms of the exemption system that you elect. If you apply the federal exemptions in bankruptcy, you and your spouse may each claim the full exemption, but you cannot always double your exemptions under state law.

In either case, your strategy is to own as many exempt assets as possible. The states generally exempt the same assets that the federal system exempts, though their exemption limits vary.

You must then answer a number of questions before you design your one best exemption strategy. You may need both an asset protection attorney and a bankruptcy attorney familiar with your state laws. To conveniently find the federal and state exemptions, visit http://www.bankruptcyaction.com/bankruptcyexemptions.html .

Your FICO® score is a numerical evaluation of your present creditworthiness. The credit score is compiled directly from both the positive and negative entries in your credit report. The score is divided into five categories, allocated as follows:

• Type of credit you use = 10 percent
• Your credit history = 35 percent
• Amount you currently owe = 30 percent
• Length of your credit history = 15 percent
• New credit obtained = 10 percent
  

Equifax’s scoring system ranges between 300 and 850 points; TransUnion’s between 150 and 934; Experian’s 340 to 820. For example, under Experian’s Beacon scoring system, a FICO® score of:

• 340-600 = highest risk to the lender (lowest score)
• 601-660 = medium-high risk
• 661-720 = medium risk
• 721-780 = medium-low risk
• 781-850 = lowest risk (highest score)

Together with your numerical FICO® credit score, you will also receive a national percentile ranking which reflects the percent- age of the US population with credit scores higher or lower than yours. For example, an Experian credit score of 800 places you into the 92 percentile. Eight percent of the population has higher scores, and 92 percent are lower.

A higher score, of course, indicates a lower potential delinquency rate – or the rate at which 100 borrowers in a specific range will default on a loan, declare bankruptcy or fall 90 or more days behind in payment. Thus, a delinquency rate of 50 percent means that for every 100 borrowers, 50 will represent one or more credit problems.

Credit experts agree that a 720 FICO® score is necessary to be considered a good credit risk. A lower score may cause you either to be denied credit, or your credit will be on less favorable terms. If you follow the recommendations in this book, you should increase your score at least by 50-100 points.

Before we discuss when not to do asset protection, we should examine when asset protection planning is safe. As long as the asset protection does not involve fraud or blatant illegal acts (such as hiding assets offshore without filing the required reports with the U.S. government), it is safe to do asset protection while the creditor seas are calm and the debtor is not insolvent as defined by §2 of the UFTA. In doing so, even flawed asset protection programs may have a fighting chance of holding up when challenged.

Once creditor threat has arisen, asset protection may still be done, although our available options are now somewhat diminished. Nonetheless, the U.S. Supreme Court case Grupo Mexican v. Alliance Bond Fund states, “[we] follow the well-established general rule that a judgment establishing the debt was necessary before a court of equity would interfere with the debtor’s use of the property.” Another court even noted that an attorney who represents a client under creditor attack should “protect [the client] from the claims of creditors, to the fullest permissible extent.” This obviously gives us some wiggle room, and an attorney may even have an obligation to recommend asset protection for his client in certain situations, however the key phrase is we must do our planning “to the fullest permissible extent”. This means planning while under creditor duress should only be done while fully considering the UFTA. Furthermore, there are several pitfalls (as discussed below) that should be avoided at all costs.

This brings us finally to circumstances where asset protection should not be done. Planning done in these instances can not only cause a program to fail, but could result in additional fines and penalties against the debtor, the planner, and possibly professional discipline against the debtor’s attorney. Such circumstances can be broken down into four categories:

1. Planning against a creditor who has a direct interest in the property;

2. Planning against a post-judgment creditor;

3. Planning that involves dishonesty, misrepresentation, or committing a fraud against the court; and

4. Planning that is a blatant and egregious fraudulent transfer under the UFTA.

Almost without exception, planning should not be done to protect an asset that a creditor has a direct interest in. Doing so could give rise to a civil conspiracy claim if two or more individuals are involved (which is almost always the case, since protecting assets typically involves a transferor and transferee.) For example, in Miller v. Lomax, an estate’s executor (Mr. Lomax) conspired with the decedent’s children to transfer assets out of the reach of the estate’s beneficiaries. Because this was done to cheat the beneficiaries of an asset they had a specific right to, the court noted that the defendant was guilty of civil conspiracy as well as committing fraudulent transfers. This stands in stark contrast to planning done to protect assets from a litigant who is not a secured creditor, and who does not have a claim to any specific property of the debtor. In another case, Lane v. Sharp Packaging System, Inc., the Wisconsin Supreme Court held an attorney liable for conspiring to transfer assets out of the reach of his client’s former employee. Although the employee had a contractual right to a stock option purchase as a part of his employment agreement, the attorney advised his client to gradually transfer assets out of the company so as to make the purchase impossible. This was of course not only a fraudulent transfer of assets the employee had a direct interest in, but a breach of contract and a bad faith act by the company’s board of directors. A third example an Arizona court of appeals case, McElhanon v. Hing. In this case, an attorney conspired with his clients (who were two of three stockholders of a corporation, of which each stockholder held a one-third interest) to render their corporate stock worthless via a bankruptcy proceeding, which essentially defrauded the third stockholder of his interest in the company. The court found both the attorney and his clients guilty of civil conspiracy.

The second instance where asset protection planning should not be implemented is after a creditor obtains a judgment, except when the debtor arranges to pay the creditor and only does general planning, or planning to protect against other threats that have not yet been reduced to judgment. Again we quote from Grupo Mexican v. Alliance Bond Fund, which states that “before judgment (or its equivalent) an unsecured creditor has no rights at law or in equity in the property of his debtor.” This of course means that once a creditor has a judgment, then s/he does have rights to property of the debtor, and an attempt to thwart those rights will be viewed in a much harsher light than if asset protection was done pre-judgment, wherein “the debtor has full dominion over his property; he may convert one species of property into another, and he may alienate to a purchase.” Instances of post-judgment planning gone sour include Morganroth v. Delorean (where sanctions were imposed on both the debtors and their attorneys for attempting to evade a post-judgment claim of another law firm’s legal fees), Fischer v. Brancato (where an orthopedic surgeon diverted his income post-judgment to his wife’s corporation, and was thus held liable on civil conspiracy as well as fraudulent transfer rulings), and Professional Collection Consultants Inc. v. Griffis (which found the defendant guilty of civil conspiracy and committing several fraudulent transfers post-judgment via a series of title transfers, encumbrances via deeds of trust, and foreclosure sales of various real properties).

The third “don’t” of asset protection does not involve a circumstance, but rather involves a type of asset protection planning. In a nutshell, no type of asset protection should be done if it involves the necessity of lying, misrepresenting facts, or committing a fraud upon the court. This is far different from dual-purpose asset protection (which is asset protection that has an estate, business, tax, or retirement planning objective in addition to asset protection), or asset protection that benefits from attorney/client privilege. This is asset protection that essentially involves perjury or the equivalent. Such activities may be dealt with harshly by the courts. For example, in In re Complaint as to Conduct of Verden L. Hockett, an attorney was sanctioned for having his clients transfer assets to their spouses via expedited divorce proceedings. These divorce proceedings required the spouses to lie under oath as to the purpose for the divorce, which essentially meant they committed a fraud upon the court. In In re Depamphilis,69 153 A.2d 680 (N.J. 07/31/1959), an attorney was sanctioned for advising his clients to transfer cash to their uncle, purportedly to pay a pre-existing debt that in actuality did not exist. This of course involved misrepresentations under oath as to the nature and validity of the transfer. (Ironically, after the transfer was set aside as fraudulent, the sanctions arose when the attorney’s client sued him for malpractice, meaning the sanction arose from an action brought by the very client he was trying to protect.) The fact of the matter is, a good asset protection plan does not require one to commit perjury or deceive a creditor. It also never relies exclusively on secrecy, and the privacy aspects of the planning are only used to prevent or discourage litigation. In other words, solid planning is always done so that, if required in order to comply with a discovery request or debtor’s exam, the entire plan and all transfers are fully disclosed to the court. If the planning is solid, then the assets should remain outside a creditor’s grasp even if the mechanics of the plan are fully exposed.

Finally, although rare, particularly blatant violations of the UFTA (that do not otherwise involve one of the three foregoing “don’ts”) can lead to sanctions above and beyond setting aside a fraudulent transfer and paying the plaintiff ’s attorneys fees for doing so. Such instances historically have always involved transfers done without consideration while the debtor was insolvent, and there are often harsher sanctions against attorneys who are well-versed in the law and therefore, in the courts eyes, should have known better. In In the Matter of Breen, a Florida attorney was disbarred for trying to protect his assets by filing four bogus liens against his property, and transferring assets to his friend (again, without receiving consideration in exchange for the transfer.)

In light of the above, some clients may be hesitant to do asset protection of any type once a creditor threat has materialized. This would be a grave mistake, as failing to do so at this point could cause them to lose their entire life savings — everything they have worked so hard their entire life to accumulate. Except when a debt has been reduced to judgment, or when doing asset protection would involve defrauding a creditor of their direct rights to property, it is not a question of whether to do asset protection so much as it is how to do asset protection. Because of the complexity of fraudulent transfer law (both under the UFTA, associated case law, and the variations of the UFCA and UFTA between states), a competent, experienced, and skilled planner should be engaged, especially when creditor attack is imminent. Asset protection is like brain surgery: it is not a “do it yourself ” endeavor.

There are endless possibilities for credit declination, but here are the six most common reasons according to the credit bureaus:

1. Delinquent credit obligations: Late payments, bad debts, or legal judgments against you obviously make you a higher risk credit customer, and lower your chances for credit.

2. Incomplete credit application: If you omit important information on your credit application or make other errors on your application, there may be a significant discrepancy between your application and your credit file, which can hurt your chances for credit. Creditors want a consistency of information.

3. Excessive ‘inquiries’: Every creditor inquiry is noted on your credit record. Inquiries happen whenever you apply for credit and the prospective creditor requests information about you from the credit bureau, and when you request your own credit report, it also generates an inquiry, but it is not an adverse entry on your record. As few as four credit inquiries within a six month period may be viewed as excessive credit activity, and prospective creditors may then presume that you are trying unsuccessfully to find credit elsewhere.

4. Errors in your file: Errors arise. Unfortunately, even simple clerical mistakes (confusing your name with someone with a similar name or recent address change, etc.) can create credit problems. Because credit bureaus handle millions of files, there is always that possibility of error. Your goal is to find and correct these errors, which means that you must periodically and carefully review your credit file for accuracy, and then take whatever steps are necessary to correct those errors.

5. Insufficient credit history: Your ‘credit history’ may also be too scanty for the type or amount of credit you request. You must then further build your credit to qualify for the credit-line you require.

6. Tax liens, bankruptcy, judgments, foreclosures or repossessions are all ‘red flags’ that automatically damage credit, and sometimes eliminate the possibility of obtaining any significant credit.

There’s no “one right firewall,” “one right strategy,” “one right plan,” or “magic bullet.” You need a customized asset protection plan. What is best for you in your specific situation?

Since “one-size-fits-all” plans don’t work, avoid “so-called” asset protection planners pushing that “one quick fix” or “magic bullet.” For example, you can find plenty of assembly line planners who push Nevada corporations as “everybody’s” asset protection answer. Others do only offshore trusts or limited partnerships. They oftentimes are good firewalls, but are they good for you?

Your asset protection planner must give you the widest range of protective options, because any one firewall is only one possible tool in the planner’s toolbox. No one firewall is everybody’s lawsuit-proofing answer.

Your planner must also expertly use each protective tool. Unfortunately, these more versatile planners are difficult to find. Few planners offer both offshore and domestic (U.S.- based) protective strategies. But high net-worth individuals frequently need both a domestic and offshore plan component. Your planner must skillfully provide both. Or your planner may protect only specific assets because that’s how the planner makes money. Insurance professionals sell insurance/accounts receivable factoring programs to physicians and business owners, suggesting that through these financing plans they can protect their receivables against lawsuits. Such financed insurance programs may make sense for you. But even when it’s good to shelter your accounts receivables, how will it protect your many other assets?

The planner who doesn’t give you the complete arsenal of protective firewalls reduces your options and your protection. Your planner can only customize your best plan by considering every factor unique to you, including:

• What are your state laws?
• What assets must you protect?
• What liabilities do you need protection against?
• Do you need preventative or crisis planning?
• What are your financial (estate planning, investment and tax) goals and present plans?
• What strategies would you most comfortably adopt?
• What are the costs, both immediate and ongoing?
• What is your personal situation (age, marital status, etc.)?

We customize your plan by expertly blending these factors. Then it’s only your best plan at that point in time. Your future plan may change.

One of our favorite methods of equity stripping is via LLC capitalization, a method developed to rectify the shortcomings of other equity stripping programs. The concept goes like this: two people form a Limited Liability Company (LLC) in order to run a business (which could be some legitimate, yet easy-to-do activity such as investing in stocks and bonds.) Under the LLC Acts of every state, each member (member being the LLC equivalent to partner) can obligate the other, per a written agreement, to contribute capital (assets) to the company so that it has a means to operate. One of the members contributes a smaller amount of assets up front to capitalize the company, in exchange for a small but significant ownership interest (usually 1-5%). The other member promises to make a large capital contribution over time, in exchange for an upfront large interest in the company (95-99%). Because the first member contributed his capital up front, but the second one did not, the 1st member has a valid reason for making sure the 2nd member makes good on his promises. Therefore, the LLC places a lien on the second member’s property to ensure he fulfills his obligation to capitalize the LLC over time. As long as the LLC is not considered an insider under applicable fraudulent transfer law, and the obligation is valid, its fulfillment demonstrable, and it “makes sense” in a business context, a rock-solid lien has been created on the 2nd member’s property.

It’s important to note in this scenario that Member 2’s promised contribution could take many forms. It could be a promise to contribute cash, services, equipment, or other property. And after the lien expires, the members could dissolve the LLC and typically all returns of capital will revert back to them tax free. Furthermore, almost any type of asset could be equity stripped via this method, whether it be A/R, real estate, or personal property. Indeed, the flexibility of equity stripping via LLC capitalization is so great, that practically any type of asset could be protected, according to practically any terms that fit within the realm of normal business practice.

No. You still have options. For example, you can try to convince the credit bureau that you are correct. However, the credit bureau is not there to referee whether you or your creditor is correct on a disputed credit entry. The creditor need only provide the credit bureau reasonable evidence or information to verify or defend their negative credit entry against you. Once they do, the credit bureau can keep the negative mark on your record.

Though the credit bureau need not arbitrate disputes between you and your creditor, a credit bureau must act fairly and take reasonable care to make certain that it reports only truthful and accurate information. Therefore, the credit bureau must correct or delete information on your report to the extent that you can convince the credit bureau that a negative entry against you is erroneous, misleading – or even possibly so.

Build your case! Advise the credit bureau why the information is erroneous. Submit documents (cancelled checks, letters, etc.) which help prove your case.

Perhaps you have provided this detailed information when you first disputed your credit report. If the creditor defended the negative entry, your second letter may challenge specific points made by the creditor. However, a first protest letter should still only summarily challenge the negative mark with a brief explanation. Of course, if the creditor does not verify the reasons for the negative entry, the entry must be removed. Only when the creditor verifies your negative entry should you reply with a stronger case to convince the credit bureau that you – not your creditor – is correct.

If the credit bureau still refuses to change your credit report, another option is to talk directly to your creditor. Most creditors are reasonable and will listen and possibly agree that they made an error or in some other way unfairly penalized you with poor credit and will assent to the removal of the negative credit entry.

As far as annuities and life insurance are concerned, such policies are only exempt in some states. Even in states that protect these asset types, they are often only exempt if structured properly. In some states we must not only pay attention to who the policy’s insured person, owner, and beneficiaries are, but we must also examine the wording of the policy before we can say with any certainty that the policy is exempt. For example, Utah protects life insurance proceeds, but only if the beneficiaries are the insured person’s spouse or children. Alabama law protects life insurance from the claims of creditors of a policy’s beneficiary, but only if the beneficiary is someone other than the insured person and the policy states that the proceeds are exempt from creditor attachment. Not surprisingly, many insurance policies don’t include such protective language. To further muddy the waters, some states address to what extent cash proceeds are exempt from attachment, and other states don’t. If a state is silent on whether proceeds are protected, does that mean the policy is only safe from attachment before it’s converted to cash? How long are the proceeds safe after receiving them? If statutory law is silent, we must then look to case law, which of course will vary by state. In any case, to be as safe as possible we should never commingle insurance proceeds with other funds. They should be kept in a separate account so that they’re clearly identified and thus afforded the maximum protection under law.

Finally, we should consider fraudulent transfer law if planning is done after creditor threat has already materialized. Some states have adopted fraudulent conversion laws to specifically address whether transforming an exempt asset to a non-exempt asset in order to avoid creditors is fraudulent. If such is done after creditor threat has arisen, fraudulent conversion law (if a given state has such a law) tends to operate differently than fraudulent transfer law. This means that even if a transfer is not fraudulent under fraudulent transfer law, it may be fraudulent under fraudulent conversion law. In states with fraudulent conversion laws, whether a transfer is fraudulent will vary from state to state. For example, the purchase of a homestead in Florida, even if done to intentionally thwart creditors, cannot be undone as a fraudulent transfer or conversion. Nonetheless this may not be the case in other states.

Because the exemptions for annuities and life insurance are very state specific, one must be very careful when doing this type of planning. However, in a state that lacks fraudulent conversion laws, protects life insurance and/or annuities, and has no case law that sets precedent for undoing the purchase of a life insurance or annuity contract as a fraudulent transfer, life insurance/annuity exemption planning even after creditor threat has materialized may very well work.

There are many ways that privacy can fail, which could include, among other things, a disgruntled ex-spouse spilling the beans, to carelessness in operating the business, to being forced to reveal one’s connection to an entity in a post-debtor examination (or otherwise commit perjury, which the authors strongly discourage). Every asset protection plan needs a solid legal structure underneath that will survive creditor attack regardless of whether its privacy holds up or not.

However, as one of several layers of protection, financial privacy does have its benefits, such as avoiding the appearance of being a “deep pocket”, which helps prevent litigation. Such privacy is often the primary benefit espoused in the many marketing promotions of Nevada corporations, and to a lesser extent, Wyoming and Delaware corporations. Most of these promotions say that a corporation may be set up with “nominee” officers to shield the identity of who actually controls the business. (This is great for the nominee officers, since they can now charge the client each year for their nominee services.) Furthermore, in most states the identity of shareholders is not a matter of public record. It is true that this strategy provides some financial privacy. At the same time, complete financial privacy is more difficult to obtain than one might think, and as a result many clients forego such privacy measures, and instead focus mainly on a solid asset protection structure. For example, if one is a signer on a corporate bank account, they are linked to the corporation (and although this does not signify complete control over or ownership of the corporation, it is a starting point for an investigator to unravel one’s financial privacy program), and thus for complete privacy a nominee must be used for all banking purposes. Many individuals may not trust someone else to have exclusive control over their company’s bank account. Furthermore, for complete privacy a corporate bank account may not receive any deposits from any account that could be linked to the client, nor could payments (other than cash withdrawals) be made to any account or to pay any expense that would link the bank account to the client. Using a corporation in this manner is possible, but it may be more difficult to do than one initially supposes.

Furthermore, an S corporation must file an income tax return annually (form 1120S), and reveal its stockholders to the IRS via schedule K-1. A creditor may be able to obtain these forms during the discovery process, or especially during a post-judgment debtor’s examination, in order to link the client to the corporation. If the corporation is taxed as a C corporation, and the client takes any dividends from the corporation, then he will be linked to the corporation when filing his or her annual 1040 return (schedule B), and a creditor may be able to obtain these returns in the same manner as they would with an S corporation.

An LLC formed in certain jurisdictions may in some instances reduce the requirements for obtaining financial privacy. Such LLCs are called “anonymous LLCs” because the state never asks who its members or managers are.177 The more popular anonymous LLC states include New Mexico, Missouri, Oklahoma, Delaware, and Indiana. Some states, such as Indiana, never even require an LLC organizer to provide a principle place of business address. Other jurisdictions, such as New Mexico and Missouri, do not require annual reports to be filed by the LLC. Therefore, LLCs are generally more flexible and easier to operate in a private manner than corporations, and a nominee officer or manager may not be required in some (but not all) instances. Furthermore, if the LLC holds non-income producing property, then unlike a C or S corporation, no income tax return need be filed. Nonetheless, obtaining a “private” bank account normally entails a process similar to that used with obtaining private corporate accounts.