PROTECTION FROM WHAT?

Asset protection is the proverbial ounce of prevention that's worth a pound of cure. Business owners should consider protecting their assets from at least four different constituencies:

1. Non-negotiated business liabilities

Bank loans are one thing; crafty plaintiffs lawyers creatively using the law to obtain money for their clients (often keeping 1/3rd for themselves) are quite another. Scorned employees are another common source of unexpected liabilities.

2. Business Assets from Personal Liabilities

For a business owner, the business is the goose that lays the golden egg. The business, its assets, and the ability to turn a set of assets into cash flow, must be protected from the individual liabilities of the owners, particularly where there is more than one owner.

3. Personal Assets from Business and Personal Liabilities

Placing business operations in a limited liability entity such as a limited partnership, limited liability company or corporation is a key asset protection strategy to protect personal assets from business liabilities, but it is only half the battle. Placing certain personal assets in a separate legal entity such as a limited partnership or limited liability company may add protection of personal assets from both business and personal liabilities.

4. Business Co-Owner's Liabilities

The wrong business structure can subject one co-owner to the debts of another. Better planning also reduces or eliminates the ability of a non-owner to involuntarily obtain ownership.

CONTROL, VALUE AND OWNERSHIP

Asset protection involves splitting ownership, value, and control. When you own an asset, you have title to it, control over it, and the value of that asset is in your estate. It is often better not to have one or more of these characteristics.

The Main Disadvantage of Value: The Government Taxes it Upon Death

The Main Disadvantage of Asset Ownership: Creditors May Seize Them

This leaves control. Control over assets is the key. It is often more beneficial to have control over assets without also holding their value directly by owning their title.

THE 4 BASICS OF ASSET PROTECTION

Rule No. 1: Use one of the limited liability entities.

This separates business matters from personal matters, and vice versa. Possible options are limited partnerships, limited liability companies, corporations and trusts.

Rule No. 2: Separate different streams of income into separate legal entities.

If a liability interrupts one income stream, the others may not be affected.

Rule No. 3: Separate assets from operations.

Operations generate liabilities, as do people. The mere act of a legal entity holding assets, and no more, dramatically reduces the chances anyone has to create a liability that may attach to those assets.

Rule No. 4: Reduce the number of non-exempt assets you own.

This prevents a judgment creditor from "cherry picking" the best assets you have and, ideally, requires that creditor to make only one or two choices, both of which have negative ramifications to the judgment creditor, as explained below.

EXEMPT VS. NON-EXEMPT ASSETS

Assets fall into one of two categories:

(1) Exempt Assets, and

(2) Non-Exempt Assets.

A judgment creditor can seize non-exempt assets to satisfy a judgment. You would lose the ownership, value and control of the assets seized by the judgment creditor. The judgment creditor would obviously pick and choose the "best" assets you have in order to collect the judgment. They also would look to wreak the most emotional damage, by going after the assets most valuable to you from an emotional standpoint too, such as stock in a closely held business. Exempt assets, on the other hand, cannot be seized by a judgment creditor to satisfy a judgment. It is safe to own title to exempt assets in your individual name.

EXEMPT ASSETS
Texas state law lists "exempt assets" which cannot be seized by any creditor to satisfy their claim. For a family, exempt assets are:

Your Homestead
Qualified Retirement Plans
Current Wages for Personal Services (except for enforcement of child support)
Professionally Prescribed Health Aids of a debtor or a dependent of the debtor
Alimony, Support, or Separate Maintenance received by the debtor
Up to $60,000 in net aggregate value of the following types of assets:

Home Furnishings, including family heirlooms
Provisions for Consumption
Farming or Ranching Vehicles and Implements
Tools, Equipment, Books, and Apparatus, including Boats and Motor Vehicles Used in a Trade or Profession
Clothes
Jewelry (not to exceed $15,000)
Two Firearms
Athletic and Sporting Equipment, Including Bicycles
A two wheeled, Three-wheeled, or Four-Wheeled Motor Vehicle for Each Member of a Family who Holds a Drivers License or Who Does Not Hold Drivers License But Who Relies on Another Person to Operate the Vehicle for the Benefit of the Non-licensed Person
Two Horses, Mules or Donkeys and a Saddle, Blanket and Bridle for Each
Twelve Head of Cattle
Sixty Head of Other Types of Livestock
One Hundred Twenty Fowl
Household Pets

NON-EXEMPT ASSETS

Everything else you own is subject to being seized by a judgment creditor. All business assets are non-exempt assets. Your ownership of the business (such as in the form of stock or partnership interest) is most likely a non-exempt asset.

PROTECTING NON-EXEMPT ASSETS

Often, title to non-exempt assets is moved out of individual ownership into either a limited partnership or a limited liability company. This is because of a special rule in Texas law. The remedy for a judgment creditor for a limited partnership interest or limited liability company membership, is a "charging order" (Section 7.03 of the Texas Revised Limited Partnership Act, Article 4.06 of the Texas Limited Liability Company Act).

A charging order is an order entered by a court which orders the limited partnership or limited liability company to pay to the judgment creditor any distribution (but not wages) that is to be distributed to the owner, until the judgment is paid.

The effect of a charging order is:

MAKING A JUDGMENT CREDITOR PAY GOOD MONEY AFTER BAD

What really stings a judgment creditor about a charging order, however, is the IRS's position regarding the judgment creditor. Limited partnerships and limited liability companies file informational tax returns, and then pass through to the owners the items of income and expense, usually in proportion to their ownership. Each owner then reports the income allocated to them, respectively, on their 1040 return and they pay any tax due individually. If a partnership or limited liability company allocates income to an owner on whose interest a judgment creditor has obtained a charging order, that income is reported on the judgment creditor's 1040, not the debtor owner's 1040, and the judgment creditor must pay income tax on the allocated income. Since the judgment creditor receives no distributions from the partnership or limited liability company, they must use their own money to pay any additional income tax.

LIMITATIONS ON ASSET PROTECTION PLANNING

Asset protection typically involves transferring ownership of assets and may include converting non-exempt assets to exempt assets. However, Texas has fraudulent transfer and other creditor-protection statutes. The effect of some of these statutes is to void the transfers of property, which usually results in bringing non-exempt ownership back to the individual, making that asset subject to seizure by the judgment creditor. For this reason, implementing an asset protection plan must be undertaken while there are no threats of claims to the business owner. Once a threat or possible debt emerges, it is too late to protect assets, at least from that claim.

Additionally, Texas fraudulent transfer statutes (Chapter 24, Texas Business and Commerce Code) have a "look back" period, which can be up to four years. This is a period of time, looking back from "today", whatever day that may be, checking for improper transfers of property. Again, the effect of these statutes is to void the transfers of property within this time period. As a result, assets should be transferred as soon as possible to begin these periods of time running.

FORECLOSURE VS. CHARGING ORDER

Section 7.03 of the Texas Revised Limited Partnership Act was revised effective in January of 1999 to also provide for "foreclosure" of the limited partnership interest. However, the Bar Committee comments to this section state that a foreclosure sale only conveys the right to partnership distributions permanently, as opposed to temporarily until the judgment is paid in full. The debtor partner still remains a partner and retains the partner's rights in the partnership other than to distributions (i.e. limited management). The notes also state that the reason the charging order and limited foreclosure rights are exclusive is to avoid the confusion and resulting interference with partnership business that might otherwise result from multiple remedies such as garnishment and attachment.

BADGES OF FRAUD

Fraudulent transfer law prohibits transfers with actual intent to hinder, delay or defraud a creditor. Since most people will not admit to their bad intentions, the law has established these factors, which are commonly known as "badges of fraud" since their presence tends to indicate actual intent (warning: this is a recitation of the statute, Section 24.005(b), Texas Business and Commerce Code, and contains many very technically defined terms):

Generally, then, having a logical reason, other than asset protection, for transferring assets increases the probability of the transfer standing up to any challenge. Implementation of these strategies for your specific assets and estate, while also taking into account fraudulent transfer and other creditor-protection statutes, is what makes our expertise valuable to you.

ONE EXAMPLE OF AN ASSET PROTECTION SCHEME

For an example of one asset protection strategy, please download our free booklet entitled The Family Limited Partnership Business and Estate Plan on our Business Owner's Resource Center.

CONTACT US

Please E-mail us for more information, or if we may be of service to you in planning your estate.