It’s no surprise that two of the movies up for best picture this year – Joker and Parasite – tackled the themes of income inequality. In Joker, the origin story of Batman’s nemesis, Joaquin Phoenix’s character champions the common people as they revolt against Gotham City’s wealthy. In Parasite which won the Oscar for best picture and several others, two South Korean families – one rich, one poor – engage in a dark class struggle that ends badly for everyone.
Even though both stories are fictional, the threat of retribution is all too real for many of our high-net-worth clients. A recent survey conducted by ACE insurance company found that wealthy Americans have growing concerns about becoming the target of liability lawsuits. These concerns are well founded as finding a defendant with deep pockets is an essential ingredient of a successful lawsuit.
Common sources of liability for wealthy families include:
· Divorce
· Auto accidents
· Visitors injured on your property
· Injuries that occur after hosting a party where alcohol is consumed
· Household employee liability
· Libel and slander (including digital and social media)
· Risks from being an officer or owner of a company
· Professional risk
· Liability arising from being on the board of a charitable organization
Given this reality, wealthy families need to take precautions. These four asset protection strategies can help.
1. Get at least $10 million in liability insurance.
The simplest way to protect your assets is to have an adequate liability insurance policy, often referred to as an “umbrella policy.” Yet many of the clients we work with start out woefully underinsured, having only a few million dollars of liability insurance. Most wealthy families should have a policy that covers at least $10 million. In many cases, having $20 million or more of coverage is advisable. In the grand scheme of things, getting liability insurance is a relatively inexpensive way to avoid losing major assets in lawsuits.
2. Jointly own your assets.
Going after jointly owned assets usually is not attractive to creditors because they end up owning the asset with another person. To split from the other owner, a creditor would have to file a partition action, which is expensive and time-consuming. That’s why it can be wise to share ownership of certain assets with your spouse or other family members.
Additionally, 26 states have a form of joint ownership called “tenancy by the entireties” in which property owned by both spouses cannot be partitioned. In these states, the law protects assets such as a couple’s homes, cars, and investment accounts from confiscation by the creditors of either spouse (but not both – a joint creditor can gain ownership). For example, if one spouse loses a malpractice lawsuit, the plaintiff cannot seize jointly owned assets to satisfy the judgment.
3. Establish the right trust.
The traditional wealth management strategies of setting up irrevocable or lifetime marital trusts will usually do the trick of protecting your assets from your creditors and the creditors of your beneficiaries, including ex-spouses. For example, funding a discretionary irrevocable trust with a spendthrift clause usually puts such assets beyond the creditors of both you and your beneficiaries. However, one of the limitations of these trusts is that you cannot be both the grantor and a beneficiary. If you want direct access to the assets, you will need to set up either a domestic or offshore asset protection trust.
Nineteen states have Domestic Asset Protection Trust (DAPT) statutes. Under those rules, the grantor of the trust can be a beneficiary, but not the sole beneficiary. The trust must also have an independent trustee who lives in the state that governs the law of the trust. The greatest uncertainty about this kind of trust is whether it will protect you against a liability that arises in a state that does not have a DAPT law. There’s little case law that answers this question. So, this solution may be helpful but not bulletproof.
The second option is setting up a trust in a jurisdiction such as the Cook Islands, Nevis, or the Cayman Islands. Like a DAPT, an offshore asset protection trust allows you to be both the grantor and a beneficiary. And because these countries do not recognize foreign judgments, plaintiffs that win lawsuits against you in the U.S. would have to retry their cases in the country where the trust is located to collect any damages. That makes it very difficult for U.S. litigants to access assets in offshore trusts.
4. Set up a corporation or LLC.
Limited liability entities such as LLCs and Corporations can protect your assets in two ways. First, they shield you from personal liability for the activities conducted by the entity. For example, if you own a rental property inside an LLC and a tenant is injured on the property, the tenant can only recover damages up to the value of the assets owned by your LLC. They cannot go after your personal assets.
However, an LLC can only protect assets related to its purpose. So, if you put your personal residence in the LLC and a guest is injured, it wouldn’t protect you from liability because your home has no business function.
Second, placing assets in an LLC can make them less attractive to creditors because they can only gain ownership units in the LLC. To do so, they would need to get a “charging order” that entitles them to distributions paid to the LLC members, which is much less appealing than liquid investment assets or real estate.
The fine print
Although asset protection planning can be highly effective, there are a few things to keep in mind. The first is that it only works when you don’t already have creditors knocking at your door. Statutes against fraudulent conveyance preclude you from transferring assets out of the reach of existing creditors. So, plan ahead.
Second, I’ve explained some general strategies for protecting your assets from liability lawsuits, but most asset protection laws are state-specific. So, you’ll need to find out which tactics will work best for you and use a qualified attorney to help you with planning.
Lastly, an overarching rule of asset protection is that your creditors can gain the same legal access to your assets that you have. Therefore, effective asset protection requires giving up some direct control or enjoyment of your assets.
