Due to the difficult financial times we find ourselves in, many people who have never been sued or had problems with their creditors before are now facing lawsuits and other problems.  Many businesses are failing and the owners are facing suits on personal guarantees.  People are unable to make their mortgage payments or find themselves hopelessly upside down and unable to se ll or refinance their homes.  If those homes go into foreclosure or a short sale, people can find themselves facing a suit from their lender to recover the unpaid balance of the mortgage, if money has been taken out of the house in a “cash out” refinance.

Even in good times, we are always at risk of being sued in our litigious society no matter how risk free it seems our lives are.  Examples of some recently reported jury awards include:

• Negligent maintenance of balcony railing - $2,400,000;
• Negligent loading of scrap metal onto a truck - $6,098,000;
• Homeowner negligence for allowing a child to distract a workman using a saw - $300,000;
• Failure to maintain tree overhanging onto sidewalk - $681,831;
• Trip and fa ll on raised flagstone - $450,000; and
• Person knocked down by golden retriever - $437,427.  

It seems Dr. Seuss is right.  So accidents do happen and we need to be prepared when they do.

People often say to me “I am so glad I set up that trust so I know my assets are protected from my creditors.”  Unfortunately, placing assets in a revocable trust does not protect assets from the creditors of the trustors (creators) of the trust.  Often when an estate plan is created, the focus is on avoiding probate, reducing or eliminating estate taxes, and controlling distributions to children and other beneficiaries.   These are a ll worthy goals. But once an estate plan is in place that accomplishes these objectives, additional steps should then be taken to protect those assets from creditors.

So if trusts won’t protect our assets from creditors, what will?  It’s not that trusts can’t provide asset protection, it is just that the trusts in most estate plans aren’t designed to do so.  In Arizona, the general rule is that if the trustor has free access to the assets titled in a trust, so does the trustor’s creditors.  Revocable trusts are designed so that the trustors have unrestricted access to the assets they place in trust.  For example, in a typical estate plan Bob and Mary create a revocable living trust naming themselves as the trustees and beneficiaries. The trust states that while they are alive, they can receive a ll income from the trust estate and can also withdraw any of the principal to use as they desire. They can also amend or revoke their trust and transfer title back to their individual names. Since they are the trustees of their trust, they have complete control over how the assets are managed, invested and spent. Under this type of trust, if Bob and Mary are sued and the creditor obtains a judgment against them, the creditor can satisfy that judgment from the trust estate.   

However, if Bob and Mary create an irrevocable trust rather than a revocable trust, the assets they place in that trust may be exempt from attachment by their creditors.  The difference with this type of trust is that Bob and Mary are neither the trustees nor the beneficiaries.  They have named an independent third party as the trustee and their children are the beneficiaries. An irrevocable trust generally cannot be revoked or amended. This type of trust can have some drawbacks if not utilized carefully, since control of the assets is placed in the hands of an independent trustee and the assets generally are not available to the trustors.  However, these problems can be overcome with careful planning and a properly structured estate plan that includes an irrevocable trust in addition to the revocable trust can help provide effective asset protection planning.

A level of asset protection can also be added to an estate plan through the use of limited liability companies (“LLC”).  Assets held in a properly formed LLC cannot be attached by creditors of the members (owners) of the LLC.  Rather, if a member of an LLC is sued, the creditor can only obtain a “charging order” against the LLC that allows the creditor to attach income paid out of the LLC to the member.  A properly drafted operating agreement wi ll provide that distributions to members are discretionary with the manager so funds can be safely kept in the LLC and not paid out to the members until the matter has been resolved.  Do not assume, however, that a ll LLCs are created equal.  For an LLC to be effective, it must be properly formed, the operating agreement must be properly drafted with certain types of provisions, the LLC should have more than one member, and the membership interests should be held in trusts. A “do it yourself” LLC kit often results in an LLC that is not an effective deterrent to creditors and has adverse tax consequences for its members.

Other tools and techniques are also available to add asset protection to an estate plan.  Usually a combination of tools and techniques are used.  Asset protection planning is designed to discourage creditors from filing suit in the first place and to encourage a favorable settlement with those who do get a judgment and attempt to collect it.

One of the most important principles in creating effective asset protection is to have the planning in place we ll before problems arise.  Attempting asset protection planning after trouble is already on the horizon can result in the asset protection plan being set aside or other liability under the fraudulent conveyance statutes.

A good revocable trust is a powerful estate planning tool that accomplishes many estate planning goals.  But it is just the starting point of a comprehensive estate plan that includes asset protection. 

If you are interested in discussing how your estate plan can be enhanced with asset protection techniques, please contact our office to schedule a free consultation.