Basics of Asset Protection

I don’t have enough assets to protect.  I’ve been operating just fine for years, and nothing bad has happened.  I haven’t done anything wrong; I’m an honest business person, so my assets are safe.  These are the most common knee-jerk reactions people have when thinking about “asset protection.” 

First, asset protection is not only for the mega-wealthy.  Asset protection is relevant to all stages of life and wealth.  Entrepreneurs need to safeguard against future ventures, professionals with a high degree of liability (doctors, lawyers, real estate investors/developers, landlords, etc.) need to safeguard against certain lawsuits, and even retirees need to preserve assets against costs such as medical care. 

Second, asset protection is really just another form of insurance.  Some things are out of your control.  No matter how well you maintain your home, there is always a risk that the proverbial (and literal) lightening will strike.  That’s why you have home insurance.  No matter how well you maintain your business or how carefully you save your funds, there is always a risk that a tenant could slip and fall, a client could file a frivolous lawsuit, and so on.  You hope for the best, but should plan for the worst.

Third, asset protection does not have to be overly complicated!  The core principle is ownership—there are certain ways to own your assets that maximize asset protection. 

Tenancy by the Entirety

Tenancy by the entirety (TBE) is a form of ownership reserved solely for a husband and wife.  Where an asset or interest is owned or held TBE, the asset is not considered as owned by wife and/or husband individually, but rather as a “fused marital unit.”  Therefore, neither a creditor of wife individually, nor a creditor of husband individually, may reach an asset owned TBE—only a joint creditor may reach such an asset.

In Illinois, you can only own your primary residence as TBE.  In certain other states such as Delaware, you can own many types of assets as TBE.  A relatively simple asset protection strategy is to form a trust under Delaware law where the beneficial interest is held as TBE, and transfer assets to that trust.

Owning Assets in an Entity 

It is generally beneficial to segregate ownership of assets.  Where you, individually, incur a liability, anything you own in your individual name can potentially be reached to satisfy that liability.  Owning an asset in an entity, rather than your name, helps shield it from creditors’ reach.  

Suppose you own a rental property in your individual name.  A tenant slips and falls and sues you.  Tenant wins a monetary judgment against you and seeks out assets on which he can collect.  He can potentially reach your bank account, other real estate, personal property, etc.

But, if you had transferred those assets to LLCs, your creditor would have to first attach to your LLC membership interests to try to reach them.  LLC membership interests have a special asset protection feature built-in under most state statutes known as “charging order protection.”  A charging order is a remedy granted to a creditor, and is similar to a lien in that the creditor gets to attach to your LLC membership interest.  But, a creditor cannot foreclose upon the interest.  The creditor is only an assignee of your economic rights, with no management or voting rights.  The end result is, the creditor can take your share of any distributions that are made, but the creditor has no power to force distributions—you, as manager, maintain control over all the assets you own in the LLC.

Certain states have better charging order protection statutes than others.  Delaware and Nevada, for instance, have superior statutes to Illinois.

Remember, “Substance Over Form”

It is often thought assets are protected against one spouse’s liabilities by simply transferring them to the other spouse completely.  This is usually not the case.  Most courts would hold that if the couple is still treating the asset as if beneficially owned by the spouse with the liability (e.g., if that spouse is making all decisions, receiving all income, or using his/her income to pay for expenses related to the asset), creditors of that spouse could still lien on the asset.  TBE is generally much more effective asset protection planning that moving assets to one spouse.  

Beware of Fraudulent Conveyances

One legal limitation on any asset protection planning is the concept of fraudulent conveyances.  If assets are transferred solely to thwart a creditor after the creditor’s liability has accrued, the creditor could argue that a fraudulent conveyance has occurred and “unwind” the transfer.  Fraudulent conveyances are assessed on a creditor-by-creditor basis; thus, even if you have an existing creditor, it may be beneficial to implement a plan as to future potential creditors.  

NOTE: Proper asset protection planning is customized for each person’s specific situation.  This material is for informational purposes only with no warranty as to applicability/accuracy to a particular set of circumstances.  You should consult with an attorney before acting on anything contained herein.