The One Thing You Can’t Do When Protecting Your Assets

By Charles P. Castellon, Esq.

(c) 2018 all rights reserved.

The concept of asset protection is largely misunderstood.  There are many bad things that can happen to good people.  These events often lead to attempts to take away what we work hard to acquire.  An important and effective habit is to consider all the “what ifs” in life and devise plans to protect against their consequences.

What Asset Protection Is and Is Not

Asset protection isn’t about hiding assets, as many believe.  It’s not about stashing money in Swiss bank accounts and evading taxes.  Proper and legal asset protection planning involves structuring and holding title to all kinds of assets in ways that make it difficult, if not legally impossible, for others will hostile motives from taking them.

Because bad things can and will happen, often unexpectedly, we need to expect the unexpected and plan for them.  Everyone doing asset protection planning should understand the legal concept of fraudulent conveyance.  This article will provide an overview of the concept and how it works.  The main takeaway is that when protecting assets, timing is crucial.

What You Can’t Do—Fraudulent Conveyance and the Legal Limits of Asset Protection

A basic and simplified definition of “fraudulent conveyance” is as follows.  If you transfer  assets solely for the purpose of avoiding, hindering or delaying creditor claims, that’s fraudulent conveyance.  If creditors believing you’re trying to avoid their claims challenge your actions under this legal concept, they can overturn what you’ve done and force the assets to be returned to you so they can take them.

A key part of fraudulent conveyance is the debtor’s intent, or mental state, in making these moves.  If there are other legitimate, legal purposes to your asset transfers, aside from evading creditors, your actions are much more likely to hold up to a court challenge.

As the debtor facing a creditor’s court challenge, you’re not required to prove your actions were taken for reasons unrelated to creditor avoidance.  The creditor’s burden is to prove that what you did was legally improper and not designed to advance another legitimate purpose.

One common example of this issue of intent is found when debtors take action for estate planning purposes, such as transferring assets into trusts.  Such strategies may have the effect of shielding assets from creditor claims, but if they have legitimate purposes unrelated to avoiding creditors, they will be harder to overturn.

 We Don’t Need No Stinkin’ Badges of Fraud

In most cases, it’s unlikely that “smoking gun” evidence will be found regarding the debtor’s intent in moving assets.  There won’t likely be contracts or emails explaining that someone is transferring title of an asset to another so that the current owner’s creditors can’t get it.  That’s why courts will review the surrounding circumstances of the situation to try to determine the debtor’s intent behind their actions.

Over time, the courts and the Florida Legislature have come to recognize certain signs of intent, known as “badges of fraud,” to help get inside the minds of debtors.  This list contains common-sense factors that tend to show intentions designed to prevent creditors from getting their paws on assets.  A thorough discussion of this topic is found in Florida Statutes Chapter 726.  The badges of fraud include the following factors the court will consider:

  • The transfer was an insider deal
  • Debtor retained control of an asset after the transfer
  • Existence or threat of a lawsuit
  • Debtor became insolvent as a result of the transfer
  • Timing—if the transfer occurred right before or soon after a debt is incurred
  • Flight—the debtor absconded after the transfer
  • All or substantially all of the debtor’s assets were transferred
  • Concealment or non-disclosure of the transfer
  • Removal or concealment of assets
  • Transfer to a lien-holder who then transfers it to a debtor insider
  • Fair market value of the asset in relation to transfer price

Debtors need not look over their shoulders forever in anticipation of a creditor challenge but the attack, like they say about revenge, may be served cold.  The statute of limitations for a creditor to raise a fraudulent transfer claim is four years from the transfer.  The case may be brought later than four years in some cases.  The creditor can file a case against the debtor up to one year from the time they discovered the transfer or reasonably should have discovered it.

How to Design an Asset—Protected Lifestyle

There are basic guiding principles all consumers, investors and business-owners should understand and execute to have an asset-protected lifestyle.  In Florida, a debtor-friendly state, it’s generally not too difficult to achieve this objective.  Put simply, it’s about doing two things.  The first is to properly separate business and personal assets while putting as many assets as possible into “silos.”  The second thing is to own as much of your net worth as possible in categories of “exempt” assets.

Business-owners and investors should take care to put up barriers between their business and personal assets.  Anyone may be sued for their personal acts unrelated to any business dealings. Being at fault in an auto accident is the most likely and common scenario for most people.  For life and business planning generally, we consider the probabilities of what may happen and prepare accordingly.  The odds are, you’re more likely to be sued for business and investing matters than for what may happen in your everyday life as an individual.

There are over one hundred thousand licensed attorneys in the State of Florida.  That’s enough to fill the Rose Bowl to standing-room capacity.  There is also a great deal of dishonor and many people commit bad acts against each other.  For these reasons and a long list of others, there are many lawsuits filed.  If you’re sued individually, such as for your negligence in an accident, you want your business  assets off-limits to the plaintiff.

That’s why people form businesses entities, including limited liability companies, corporations, limited partnerships and others.  If you hold business assets separately from your personal assets and run your businesses properly and with certain formalities (such as avoiding commingling personal and business funds) it’s difficult for anyone to “pierce” your business to take its assets.  In fact, Florida law goes far in protecting corporate entities against claims from creditors of the individual business-owners, so long as you’re not committing fraud.

A related and effective principle is to separate your assets from each other as much as you can.  This involves putting them into individual “silos” so that a successful claim against an entity holding some assets won’t allow the other side to take anything more.  For example, land trusts are a popular tool for real estate investors.  Instead of holding title to real property individually, the investor can set up a land trust to be the title owner.

If the trust only owns one property, then a lawsuit against that owner, such as for a personal injury on the property, can lead to the plaintiff raiding the equity of that one property alone.  If the trust were to own multiple properties, the others could be affected.

Can’t Touch That—What Assets Are Exempt From Creditors?

The other important thing to do is hold your wealth, however modest or extensive, as much as possible as in ways that are exempt from creditor claims.  This means that under state or federal law and sometimes both, certain types of assets are off-limits to creditor attacks.  We’ll review the most common examples of exempt assets.

In Florida and many other states, marital property is protected against creditors holding claims against only one spouse.  This form of title ownership, only available to legally-married couples, is called “tenancy by the entireties,” or “T by E” in legal jargon.  There are many benefits to being married, both economic and non-economic, but many don’t understand the virtues of T by E ownership.  This type of exempt asset ownership is available for many types of assets, including real estate, bank and investment accounts and others.

A word of warning is that the benefits of T by E ownership do not survive the death of a spouse or divorce.  Once the marriage is over, the protection is gone.

For business-owners and investors in Florida, the limited liability company (LLC) is generally the most effective business entity for asset-protection purposes.  In an LLC, the owners don’t own shares of the company, as they do with corporations.  Instead, they own percentages of membership interests in the company.  Membership interests are harder for creditors to reach than shares the individuals own in a corporation.

Another frustration for creditors of LLC members in Florida is the concept of the “charging order.”  A charging order is effectively a lien that may be obtained against an LLC.  A problem for the creditor is an LLC generally can’t be forced to make money distributions.  This situation could lead to an odd result where a creditor may be taxed for its share of the LLC’s profits by virtue of holding the charging order without collecting any of the money owed to the creditor.

With some limits, retirement investment and savings vehicles, including IRAs and 401k accounts, are exempt from creditor claims.  These accounts, known as “qualified plans,” are protected for the benefit of the account-holders by federal law.

In the U.S., there is a growing crisis of inadequate retirement financial planning.  As the peak of the baby-boomer generation approaches retirement age, it’s only getting worse.  This crisis of the failure to prepare highlights the importance of investing for retirement.  The added benefit of asset protection for our retirement accounts should incentivize all of us to put away as much as we can and effectively grow the nest egg free of creditor claims.

Self-directed retirement accounts are, unfortunately, a well-kept secret in the world of finance.  This is largely because the Wall Street machine doesn’t want us to know they exist.  All investors motivated to grow their retirement accounts, rather than simply “save,” should learn about self-direction.  A good place to start is by contacting Nuview IRA and Trust, located in Longwood, Florida.

Florida law provides some of the strongest protections in the nation for one’s primary residence, known as the homestead.  Anyone in financial distress can take comfort in knowing that, with a few very limited exceptions, creditors cannot take the debtor’s homestead.  The limited exceptions include mortgages on that property and homeowner’s association liens.

Homestead protection in Florida is legally sacred and based on the state Constitution.  The legal protection is so strong that the Florida Supreme Court has ruled that putting one’s assets into the homestead, such as by using cash to pay down the mortgage, isn’t fraudulent conveyance, regardless of the underlying intent.  This means a debtor can freely admit to converting a non-exempt asset into homestead equity for the sole purpose of avoiding a creditors’ claims and that’s ok.

Another category of exempt assets includes financial products such as annuities and permanent life insurance with cash value.  Both the cash value and income streams from these investments are protected against creditors.  It’s always beneficial to make investment decisions that make good economic sense as well as provide asset protection benefits.  Without regard to protection from creditors, these products can make good financial sense.

In particular, whole life insurance policies are worth a close look for any investor.  The versatility of this product makes it the “Swiss Army Knife” of financial instruments through its death benefits as well as investment virtues during life.  The fact that the cash value of whole life insurance is exempt from creditor claims can be considered “gravy.”

Timing is Crucial

The biggest takeaway from this article is that timing is everything.  The reader can understand the basic legal concepts and strategies discussed here, but all that knowledge may be ineffective if the timing is wrong.  The circumstances considered during asset transfers challenges, especially the badges of fraud discussed above, include more than just timing.  When asset-protection strategies are executed, however, is the most important factor is when things are done in relation to the debtor’s troubles.

To design the strongest asset-protected lifestyle, these strategies and tactics should be executed when you don’t have a care in the world.  Consider a spectrum in time.  On one end, everything is rosy and you have no bad debt or financial worries.  On the other end, the walls are caving in all around you, enemies have sued you and won judgments stating you owe them money.  The closer to the former end of the spectrum you are when you build your fortress, the more likely it will stand strong.  The closer to the latter end, the more likely your efforts will fail.

Another important point to know is that in a fraudulent conveyance legal challenge, the burden of proof is on the creditor.  The debtor isn’t required to prove that their actions were legitimate.  Instead, the creditor must show there was no legitimate purpose for the debtor’s actions other than to avoid, hinder or delay the creditor’s efforts to collect.

For this reason, many would feel comfortable taking an aggressive approach to asset protection.  If you start at square one, make some defensive moves that are overturned and the worst thing that can happen is to be put back to square one, it may be worth the effort.  The debtor should, however, be aware that there may be other consequences resulting from losing a fraudulent conveyance challenge which could make the outcome worse than returning to square one.

There may be liability to an innocent third-party who purchased an asset only to have that deal overturned as a fraudulent conveyance.  They may also be ordered to pay the creditor’s attorney’s fees for the legal fight.

Be aware that it’s difficult to become truly “bullet-proof” and litigation isn’t necessarily a zero-sum game.  If you can gain negotiating leverage and contain the damage to settle for less than they tried to take from you, consider it a victory.  That kind of damage-control, mitigation approach is a better way to view asset protection than the ideal of becoming completely immune to creditors.

This article doesn’t suggest anyone should violate the law to avoid creditors.  The reality is that very few of us are so well-insulated as to be immune from one financial or health disaster that can quickly bring down all we’ve worked hard to build.  The point here is to know your rights and plan for bad things to happen to mitigate the harm long before they happen.

Some may argue there is a moral, as well as legal duty, to pay our debts.  The greater moral duty is to protect our families and businesses from financial attack.  Consumers, business-owners and investors should understand the legal protections available and the limits of those protections.  Armed with this knowledge, we can make educated strategic decisions and engage in cost-benefit analysis and calculated risk assessment.  After the battle, lick your wounds and move on to the next fight.  Life is much more about how you respond than what happens to you.

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Celebration, FL 34747.
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Melbourne, FL 32904
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