For centuries business structures have been utilized for Asset Protection Planning. A corporation is normally a very effective way to shield one’s personal assets from liability resulting from the operation of a business. Normally, the shareholders of the corporation are only liable to the extent of their investment in the corporation. However, Situs PKV officers, directors and employees can be personally liable for their conduct relative to the operation of the business and, therefore, may want to consider other alternative means of Asset Protection with respect to their personal assets. Over the last few decades, expanding theories of liability and the proliferation of litigation has given increased emphasis to Asset Protection Planning above and beyond the corporate shield of protection. Potential liability is a major concern to doctors, dentists, other professionals and persons of high net worth engaged in business or real estate activities.
Inside and Outside Debts
Inside creditors are those creditors whose claims are directed against the business operation or real estate which is operated and owned inside of business entity:
Outside creditors are those creditors whose claims arise outside the purview of the business entity and are generally asserted against the professional, business or real estate owner personally.
Corporations protect against inside debts against the business as do limited liability companies (“LLCs”). LLCs are state chartered entities that provide a shield of protection similar to the corporate shield, but are treated for tax purposes as either a sole proprietorship or partnership. LLCs are extensively used to hold real estate assets because they combine the protection aspects of a corporation with the tax benefits of a partnership or proprietorship. Because of the tremendous liability potential of real estate activities, serous consideration has to be given to holding real estate (especially income producing real estate) in LLCs.
Although corporations and LLCs protect against inside debts, we have already indicated that many professionals and business and real estate owners are concerned about outside debts or personal debts such as malpractice claims, negligence claims for accidents and other kinds of personal liability claims that are engendered by aggressive plaintiffs lawyers. The questions then becomes how do we protect against the outside claims (personal liability claims)? This is where the combination of an LLC with the an Asset Protection Trust can be a very beneficial strategy.
The LLC and the Charging Order
The basic remedy of a creditor of a member or owner of an LLC is to obtain a charging order against that member. The charging order prevents the creditor from reaching the LLC assets. The creditor is limited to a court order charging the interest of the member/debtor so that if any distributions are made from the LLC to the member, they have to be distributed to the creditor. Normally, the creditor gets only the economic rights to the distributions not the voting rights or other non economic rights of the LLC Member. The application of the charging order in any particular case will depend on the state’s statutory provisions and case law treating the charging order subject. The benefit of the charging order remedy to the owner of the LLC is that the assets within the LLC are protected from the outright seizure by the creditor who is limited only to distributions that may not be made pursuant to the discretionary right of the manager to withhold such distributions. In other words, assets that would be otherwise attractive to a judgment creditor become much more unattractive if they are held within a limited liability company where the charging order is the exclusive remedy.
Domestic Asset Protection Trusts
The general rule in most states is that creditors can reach the interest of the trustor (the maker of the trust) of domestic self settled trusts. However, recently, several states have adopted legislations somewhat similar to various offshore jurisdictions that provide by statute various degrees of asset protection for a trustor’s interest as a beneficiary in a self settled trust. Alaska, Delaware, South Dakota and Nevada seem to have the best laws in this regard.
If properly set up and maintained, the domestic asset protection trust will be a significant barrier to creditors and will afford significant leverage to the debtor with respect to its negotiations with the creditor. This is especially true if the assets of the trust that need to be protected are domiciled in a state which is a domiciliary of the Asset Protection Trust.
The problem is that the courts of the non domiciliary states may not give effect to the Asset Protection features of the Trust. However, there is no question that a significant degree of protection is afforded by using the domestic Asset Protection Trust especially when it comes to negotiating for a settlement with the creditor.