During the estate planning process a question we are frequently asked relates to the best way to protect assets from creditors. The easy answer, although not the most satisfactory, is to give the assets in question away, before any claims arise. If you do anything to impair the rights of your unsecured creditors, then the Courts will simply undo what you have done. All states and the federal government have statutes governing fraudulent transfers. Basically, once a creditor issue arises, it is too late to transfer assets. Asset protection planning must be done before debts are incurred arise. Other points to consider:

• If you make a gift to keep an asset away from existing creditors, but you really still control the gift, then the gift may be considered a fraudulent transfer.
• If you make a gift which renders you insolvent, then that gift may be considered a fraudulent transfer.
• A transfer to an asset protection trust, whether established offshore or in the United States, may be ineffective if there is even a potential claim, i.e., an event has occurred generating a potential malpractice action, and the transfer may be set aside pursuant to the fraudulent transfer statutes if there is a subsequent judgment. In addition, the Patriot Act has made it much easier for plaintiffs to discover information about assets transferred to an off-shore asset protection trust.
• Transfers for valid consideration are not fraudulent transfers.
• Transfers into limited partnerships or corporations are not fraudulent transfers in and of themselves, because the transferor receives limited partnership interests or stock in exchange.

Some Strategies:  At the business level, the most basic of liability protection strategies is to operate a business through a limited liability entity, rather than as a sole proprietorship. Some entity choices include the corporation, limited partnership and the limited liability company. But regardless of the type of entity used, a limited liability entity will not provide liability protection if the “corporate formalities” are not respected. For example, contracts should be in the name of the entity; separate bank accounts should be maintained for the entity; there should be no inter-mingling of personal and entity funds. Most importantly, there must be adequate insurance coverage.

At the individual level, the best asset protection strategy is to hold property jointly with a spouse. When a husband and wife hold property jointly, the form of ownership is known as “tenancy by the entirety.” This type of property is generally protected against claims by a creditor of only one of the spouses.  Not all jurisdictions recognize tenancy by the entireties, although Pennsylvania is still a strong tenancy by the entireties jurisdiction. Generally, the relevant law will be determined by the jurisdiction where real estate is located, and by the law of Pennsylvania for a Pennsylvania resident with respect to personal property wherever located. However, there may be countervailing factors for putting property in joint names. For example:

• Jointly held property is marital property in a divorce situation.
• Property may be at odds with the estate-planning goal of having sufficient property in each spouse’s name to make full use of each spouse’s unified credit amounts.
• Right of survivorship prevents the first spouse to die from designating any interest in the property to pass by will to another person, such as a child by a prior marriage.

Note also a variation – title assets solely in a spouse’s name. So long as not a fraudulent transfer, this should provide enhanced liability protection; but it also comes with obvious “non-liability” risks.

The Pennsylvania Judicial Code contains a number of exemptions from execution on judgments, including wages, salaries, and commissions “while in the hands of the employer.” Generally, a participant’s account under a federally tax-qualified retirement plan maintained by a corporate, partnership (to include an LLC), or sole proprietor employer, as well as a regular, Roth, or Education Savings Accounts, is exempt from creditor attachment or execution on a judgment. However, the fact that an IRA beneficiary has control over the IRA assets may leave the IRA vulnerable to a future attack by a judgment creditor, at least where the debtor does not have other substantial assets. Other excluded assets include a certain amount of personal property, annuities not allowing assignment, and certain types of life insurance.     

Another strategy is to make outright gifts to family members. As a general rule, the transferred property would not be subject to claims by a creditor of the transferor as long as the gift is made before the claim arises. Another exception is if the donor did not really relinquish control over the property.

One way to make gifts while retaining some control is to make gifts through a trust or family limited partnership. Trusts are typically used in an estate-planning context, although they can be used in other areas as well, such as trusts for the benefit of “special needs” children. A family limited partnership (FLP) is an entity used as an estate-planning vehicle. In a typical FLP transaction, owners of appreciated property will form the FLP, contribute the property to the FLP, and after a time make gifts of FLP interests to family members.

Another strategy is to transfer property to an asset protection trust. A key difference between an asset protection trust and a regular trust is that the settlor may retain interests in the trust property without – in theory – the interests being subject to creditors’ claims. However, it must be emphasized that an asset protection trust offers poor – or nonexistent – protection against claims existing before the transfer to the trust. The essence of an asset protection trust is that the trust assets are held by an out-of-state trustee, usually a bank, that is protected by the laws of the other state. An “off-shore” asset protection trust is a trust created in a non-U.S. jurisdiction (such as the Cook Islands or the Cayman Islands) with a foreign trustee that might refuse to enforce the judgment of a U.S. court or where the costs of seeking to enforce a U.S. judgment would be prohibitive. Creating an off-shore asset protection trust is a more aggressive (and expensive) technique than creating a domestic trust. There is a loss of control over the assets and also the fact that non-U.S. law would apply to the assets.

Lastly, if worse comes to worst, there is bankruptcy. A Chapter 7 bankruptcy is a liquidation by a trustee (under court supervision) of the debtor’s “equity” in non-exempt assets. There are broad exemptions currently available to the debtor under the Bankruptcy Code, including specific monetary amounts for real estate, motor vehicles, etc. In a Chapter 7 case, the debtor is discharged from most unsecured debt, subject to certain exceptions (e.g., some types of tax claims, alimony, spousal or child support, etc.). A Chapter 13 bankruptcy is designed for individuals with regular income who desire to make monthly payments to a trustee pursuant to a court-approved plan. A debtor’s interest in an ERISA-qualified plan is generally excluded from the bankruptcy estate, and with some exceptions, is not subject to the claims of creditors or bankruptcy trustees in Chapter 7 or Chapter 13 cases.