Michael T. Sawyier
The most basic rule of asset protection is to avoid unnecessary liability for other persons’ liabilities. For example, even if a prospective lender purports to require a guaranty of a loan to another person or entity (including a business entity owned or controlled by the prospective guarantor), there is ordinarily no need for such a guaranty to be unlimited or to contain draconian waivers of the ordinary rights of guarantors.
Still less is there ordinarily any need for a prospective guarantor to co-sign the note or security agreement securing the note, thus making that person jointly and severally liable on both the note and the security agreement. Just as every person is well advised to read carefully any contracts as to which that person is the contract “principal” and to seek to limit personal liability on any such contracts to the maximum extent possible, so every person should also take only the most cautious approach to guaranties or co-signatures for the benefit of others.
Another extremely important way of avoiding unnecessary liability for other persons’ liabilities is the conduct of all business ventures with other persons (including employees) only in a limited-liability form. In this connection, everyone should be aware of the danger of incurring personal liability for others’ actions as a general partner (or “joint venturer”) even if none of the participants in a risk-creating venture intended to enter into a partnership.
Such arrangements occur all the time and are the opposite of sound asset protection planning: unnecessarily expanding the scope of the partners’ personal liability beyond the consequences of their own actions to include the consequences of all the other partners’ actions, too.
The second basic rule of asset protection is to have and maintain adequate liability insurance (as well as property and casualty insurance). Many people, perhaps most, not realizing all the ways in which they can incur personal liability and the potential extent of such liability, fail to carry adequate liability insurance. Given the relative inexpensiveness of “umbrella” liability insurance for very large amounts of coverage over the base amount covered by a primary liability insurance policy, this common failure of planning – again, the opposite of sound asset protection planning – is a classic example of being “penny wise but pound foolish.”
However, even when adequate in amount, liability insurance typically comes with many exclusions and limitations of coverage. For one common example, it would not cover any intentional tort. For another, it would typically exclude motor vehicle accidents while the insured was under the influence of alcohol or drugs.
For these reasons, in this litigation-prone country, sound asset protection planning requires the use of limited liability entities for most business ventures. Even though a person can not avoid liability for his own torts by use of a limited liability entity, he or she can thereby avoid personal liability for all the contractual obligations of the entity itself or the tort liabilities of any of its other members.
Such entities must be properly organized and operated in order to ensure the desired asset protection, but if they are, that protection will definitely be available because of the strong public policy in favor of limited liability entities as a means of encouraging business formations and business activity.
Beyond limited liability entities, the type and form of ownership of a person’s assets can also provide crucial asset protection.
One well-known example of a type of asset that is protected from judgment execution is retirement plans (to the extent that the interests in them are owned by the plan participants or their spouses). Another is the proceeds of life insurance policies.
As for the form of ownership, tenancy by the entirety – which in Illinois extends only to homestead property (including land trusts and “matrimonial trusts” of such property) owned jointly by a husband and a wife during the term of their marriage – generally shields any assets so owned from the claims of the creditors of either of the spouses though not the joint creditors of both the spouses. This kind of ownership or “estate” can thus provide considerable peace of mind for married homeowners. Moreover, in some states such as Indiana, this protection extends to all real estate owned by a husband and wife, while in others such as Florida, tenancy by the entirety even extends to intangible personal property such as bank or securities accounts.
Proper asset protection planning can also involve the gifting of assets to others – not after, but before claims arise against the owners. Such transfers must not be “fraudulent transfers” (a complex subject to be discussed in a subsequent article in this series). However, a married couple, for example, can accomplish a great deal of property and asset protection by the simple expedient of equalizing the spouses’ estates – something that a divorce court would do, anyway, if their marriage came apart.
At the extreme of asset protection by form of ownership are foreign asset protection trusts. A number of the features of such trusts make them almost invulnerable to the claims of judgment creditors, at least outside of bankruptcy.
Domestic asset protection trusts established in a handful of other states, Nevada or Alaska, for example, can also afford some uncertain but definitely lesser degree of asset protection against the claims of creditors of their “settlers,” i.e., the persons who set them up. However, the general rule in the United States is that such creditors may always reach the assets of such a “self-settled” trust to the maximum extent that the settler possibly could. That remains the rule in Illinois.
It should also be borne in mind that in bankruptcy the trustee has the power to recover on behalf of the creditors of transferors into any such “self-settled” asset protection trusts, even those established in other countries, any such transfers made within the ten-year period preceding the filing of the bankruptcy petition.
On the other hand, one of the unique asset-protection benefits of trusts in general is the protection against potential claims of creditors of the trust beneficiaries (except for the settlers). An outright gift, unless it is promptly and properly disclaimed, can in effect quickly become a boon to the creditors of the person who receives it, whereas a gift in trust generally can not. This is another hugely important aspect of asset protection that is not often fully appreciated.
In the end, asset protection planning is an integral part of estate planning. Several of the upcoming articles in this series will explore all these matters in greater detail.
Michael T. Sawyier
