[This article was originally printed in the Barrister, a publication of the Camden County Bar Association in November, 2014.]
Many business and professional people, including lawyers, have worked a long time and accumulated significant assets. There is an old saying: “It not what you earn, it is what you keep.” We live in a litigious society. Business and professional people have significant exposure to claims from creditors, because of the activities in which they engage and because they have assets and, therefore, make good targets. This is the first of a three-part article exploring strategies to protect hard-earned assets from claims of creditors. There are steps that can be taken to protect assets from these claims, if they are taken in a timely manner. An individual cannot wait until a claim is filed, or even until an incident has occurred that may lead to a claim, before taking action. Steps must be taken in advance. The Fraudulent Transfer Act is discussed below. This article will discuss the strategies for asset protection from simple to complex. Useful strategies include obtaining the proper insurance, proper titling of assets, retirement plans, structuring business assets, Domestic Asset Protection Trusts (DAPTs), and Off-Shore Trusts. Finally, an analysis will be made as to whether an individual is a good candidate for asset protection planning.
STRATEGIES
There are a number of strategies available to protect assets. Some are quite simple, and others are complex.
INSURANCE
The basic first step for asset protection is insurance. Basic insurance includes automobile, homeowner’s insurance, and life insurance. The purpose of auto insurance and homeowner’s insurance is obvious. Life insurance is critical to help protect assets in the hands of surviving family members. Life insurance proceeds are generally free from the claims of creditors. Every professional should have adequate malpractice insurance. The amount of the insurance will depend on the professional’s exposure to risk. If commercial real estate is owned, fire and casualty insurance, together with liability insurance, is important. For business owners or individuals serving on boards of directors of for-profit entities, and non-profits, it is essential to obtain officer’s and director’s liability insurance. Personal umbrella insurance is extremely inexpensive. A personal umbrella insurance policy supplements the liability limits on standard policies. The insurance company issuing the umbrella policy will have certain minimums for the underlying policies and will cover liability in excess of those limits. Business interruption insurance is available to provide operating monies while a business is not operating due to certain casualties.
TITLING OF ASSETS
Proper titling of assets can be a useful strategy in asset protection planning. Litigation-prone professionals or business persons may choose to title the bulk of their family assets in the name of their spouse. This may offer some creditor protection, but it could hinder estate planning. If a primary residence is owned as tenants-by-the entireties, a judgment creditor cannot enforce a lien against the debtor so long as both spouses are residing in the home. Assets can be titled in the names of children. The problem is if the children are subject to claims of their own creditors, the transferred assets are at risk.
RETIREMENT PLANS
ERISA plans include employer-sponsored 401ks and defined benefit and defined contribution plans. These include both pension plans and profit-sharing plans. ERISA plans provide protection against all types of creditors. It should be understood that while creditors cannot assert a claim against funds while they are in the retirement account, they can make a claim on any distributions. In New Jersey,[1] IRA accounts are protected against the claims of creditors. The funds are protected while they are in the account, and distributions from the account are also protected. Under the Federal Bankruptcy Act, federal bankruptcy provides complete protection if the IRA is a rollover from a qualified ERISA plan. Under federal bankruptcy law the protection is limited to $1,000,000 if the IRA is not a rollover from an ERISA plan. An inherited IRA is not protected under federal bankruptcy law.[2]
ASSETS USED IN PROFESSION OR BUSINESS
There are a number of business entities that provide protection of business assets from claims of creditors. These include corporations, LLCs and LLPs. In utilizing these entities, it is often useful to establish separate entities for separate purposes. A corporation, properly operated, should protect business assets from claims of business creditors. For all intents and purposes, an LLC offers essentially the same creditor protection as a corporation with the same trap for the unwary (i.e., personal guarantees). Limited Liability Partnerships offer significant protection for limited partners. However, the general partner is exposed to claims of creditors. A general partner has unlimited liability for acts of the partnership. A solution to this problem is to form a corporation to serve as general partner. A good strategy is often to use separate business entities to own separate business assets. For example, a corporation might be formed to operate a business while a separate LLC might own business equipment and another LLC might own business real estate. Equipment and real estate could be leased to the corporation operating the business. The claim against one entity may not jeopardize assets owned by separate entities. It is critical in operating separate entities that funds not be mixed between or among those entities. Funds generated by the operating company must remain in the operating company. Funds generated by the leasing companies must remain separate in the leasing companies. If the operating company runs low on money, it should not borrow from the leasing companies.
Next month’s column will discuss Domestic Asset Protection Trusts and Off-Shore Trusts.
[1] N.J.S.A. 25:2-1.
[2] Clark v. Rameker, 573 U.S. ____ (2014).
