Advanced Asset Protection Strategies

This is the third and final article in our 3-Part Series on Asset Protection Strategies.

In Part 1 we discussed the fact that Asset Protection can be defined as – Structuring your assets and estate in a way to protect them from potential creditors – and we discussed basic strategies that everyone can use to protect their assets.

In Part 2 of this series we discussed the basics of how trusts can be used as an asset protection tool.

Finally, in Part 3 of this series, we are going to first discuss the Uniform Fraudulent Transfer Act and how it can wreck your Asset Protection Planning. We will then conclude by going over Rule #1 of Implementing Advanced Estate Planning Strategies.

What is a Fraudulent Transfer?

A Fraudulent Transfer is when someone transfers title of an asset they own in a way that would prevent a creditor from taking that asset to pay for a debt. The Transfer is done within a Four Year period of a “creditor event” -- when that person would be liable to a creditor via loan; personal injury; medical malpractice, wrongful death, etc.

The theory of “Fraudulent Transfers” is that it is unfair for a person to transfer assets they have to avoid paying creditors they owe on the eve of being sued or incurring a liability.

When something is deemed to have made a “fraudulent transfer” then the creditor can void the transfer itself; attach a lien to the asset, etc. (described more below).

The main point here is that you cannot transfer assets in order to do any kind of estate planning if you are in a situation where you are insolvent and owe money to other people. We are trying to distinguish between legitimate Asset Protection Planning strategies the law allows and “Hiding Assets” to defraud creditors.

If you are in a high risk profession and have a high net worth REMEMBER -- it is too late to do asset protection planning when a complaint has been filed against your – or a judgment has been attached to your assets.

The Illinois Uniform Fraudulent Transfer Act

Most states – including Illinois -- has adopted a Uniform Fraudulent Transfer Act statute that defines when a transfer of an asset is made to defraud creditors. Federal Bankruptcy law also has its own Fraudulent Transfer Rules, but for this discussion – we will only be addressing the Illinois Uniform Fraudulent Transfer Act.

The Illinois Uniform Fraudulent Transfer Act 740 ILCS 160/et. seq. states that you cannot transfer assets within 4 years of a creditor event or else that transfer will be deemed illegal and the creditor may petition the court to avoid the transfer or go ahead and put a lien on the assets that were transferred.

Two General ways to prove Fraudulent Transfer

1. Actual Fraud: Section 5 (a) of the Illinois Uniform Fraudulent Act states that: (a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation: (1) with actual intent to hinder, delay, or defraud any creditor of the debtor.” . . .

There is a 4-year statute of limitations for “Actual Fraud” cases from the date when the transfer takes place. There is also a one year statute of limitations that extends the statute of limitations from the date to “one year after the transfer or obligation was or could reasonably have been discovered by the Claimant.”

With “Actual Fraud” the creditor has to prove that when the debtor transferred his/her assets, the debtor had the actual mental intent of “hindering, delaying or defrauding” a creditor with that transfer.

It’s hard to prove in court the thoughts actually going through someone’s head when they take an action – but over the years the courts have said that if any of these facts are present (aka “badges of fraud”) then there is an inference or presumption of fraud:

(1) the transfer or obligation was to an insider; (2) the debtor retained possession or control of the property transferred after the transfer; (3) the transfer or obligation was disclosed or concealed; (4) before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit; (5) the transfer was of substantially all the debtor's assets; (6) the debtor absconded; (7) the debtor removed or concealed assets; (8) the value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred; (9) the debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred; (10) the transfer occurred shortly before or shortly after a substantial debt was incurred; and (11) the debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.

2. Constructive Fraud: Constructive Fraud is the other way to prove that a Transfer of Assets was fraudulent. With Constructive Fraud, the mental intent of the debtor when transferring property does not matter – all the creditor has to prove is that a certain set of facts exist.

There is a four year statute of limitations that begins to run from the date of the transfer. There is no 1 year “discovery rule” for Constructive Fraud as there is in “Actual Fraud” – discussed above.

There are three ways to prove construction fraud per the Illinois statute:

Construction Fraud #1: The debtor made a transfer or incurred an obligation without receiving reasonable value in exchange for the transfer or obligation and the debtor: made a business transaction for which the debtor’s remaining assets were unreasonably small in relation to the business transaction; or b) the debtor incurred debts reasonably believed to be beyond his/her ability to pay as they became due.

Construction Fraud #2: The debtor made a transfer or incurred an obligation without receiving reasonable value in exchange for the transfer or obligation and the debtor: was insolvent at that time or became insolvent as a result of the transfer or obligation.

Construction Fraud #3: The debtor made a transfer 1) to an “insider” for a debt, and the debtor; 2) was insolvent at that time; and 3) the “insider” had reasonable cause to believe that the debtor was insolvent.

In all three instances – there is a transfer made or an obligation incurred by the debtor which either was already insolvent or the transfer/obligation made the debtor insolvent.

Conclusion on the Uniform Fraudulent Transfer Act

The main point of all of this -- is that you have to do Asset Protection Planning while you are “solvent” and four years prior to creditors suing you for money. You have to do Asset Protection Planning before you would actually need to shield those assets from creditors.

Advanced Asset Protection Strategies

Assuming we can stay clear from any fraudulent conveyance laws and there is a chance to use some Advanced Asset Protection Strategies – it is the important that you understand the #1 Rule for Advanced Asset Protection Strategies.

The #1 Rule for Advanced Asset Protection Strategies that no Strategy is 100% guaranteed to protect your Assets - the goal with Advanced Asset Protection Strategies is to make creditors have to jump through so many hoops to maybe someday get the asset – that they don’t even try or they agree to settle for pennies on the dollar.

For example – let’s assume that John Smith has $1,000,000 sitting in an Asset Protection Trust. The question that a creditor is going to ask themselves is – How hard is it going to be for us to get to that $1 Million?

The question for John Smith is how complex does he want the trust language to be and how much control over the $1 Million does he want to have. Here are examples of how effective different types of Trusts are when it comes to Asset Protection Planning:

1. Standard Illinois Revocable Living Trust – John is the Trustee; John is the Beneficiary while he is living. John has successor Trustees available if he becomes mentally Incapacitated or when he dies.

Comment: This is a standard Revocable Living Trust that is used for estate planning purposes (no Asset Protection Purposes). This Trust would do a great job avoiding probate for John’s estate and it may help with estate tax issues John may have if he has a high net worth. Because John is the trustee and beneficiary of the Trust – he has control of the assets – and a Creditor could attach to these assets rather easily.

2. Illinois Revocable Living Trust with Enhanced Provisions: John is the Trustee; John is the Beneficiary while he is living. John names a Bank or other Third Party as Successor Trustee if he becomes mentally Incapacitated; dies or is otherwise not able to be Trustee. We add ENHANCED PROVISIONS to the Trust that say if there is a “Creditor Event” another person called a Trust Protector – removes John as Trustee of his own Trust and the Bank Trustee is instructed to not pay John any distributions. The Beneficiaries are John’s Children or some other person. The Trust then becomes Irrevocable per the direction of the Trust Protector.

Comment: These Enhanced Provisions make it much harder for a creditor to persuade a court that they should be able to reach the assets in the trust to pay for John’s liabilities. John has no control over the assets and is no longer a beneficiary of the trust. Maybe the Creditor would eventually win in court – after years of litigation – but it is much more difficult and arduous process.

3. Domestic Asset Protection Trust: Same scenario as the Illinois Trust with Enhanced Provisions – except this Trust is formed in one of a handful of states in the United States that have passed laws that greatly benefit a Trust’s Asset Protection capabilities. Nevada and South Dakota are two of these states. Let’s assume John uses a Nevada Trust and transfers his $1 Million in that Trust. John would most likely have to have a Nevada person or entity be the Trustee of his trust and do other things to show that Nevada has jurisdiction over the Trust rather than Illinois.

Comment: Now – in addition to the Enhanced Trust provisions we already discussed, a creditor is going to have to prove to a court that Illinois law should apply to John’s Trust – not Nevada. More favorable Asset Protection Laws of Nevada and the jurisdictional issues are more hoops the creditor has to jump through to get to the $1 million.

4. Foreign Asset Protection Trust: Same Scenario as the Domestic Asset Protection Trust – except instead of the Trust being located in a different state – the Trust and the assets in the trust are located in a foreign country – which has favorable asset protection laws.

Comment: We are not hiding assets from anyone. John still reports income from the trust on his US taxes – it is not a tax shelter. It is just another (very big) hoop the creditor has to jump through – going to a court of a foreign country with favorable asset protection laws -- to get to the $1 million inside that trust. Most creditors are not going to try – or settle for pennies on the dollar.

I hope Part 1, Part 2 and Part 3 of this Asset Protection Planning Series helps you understand what Asset Protection Planning is; the main rules of Asset Protection Planning; the various Asset Protection planning tools that are available (from exempt assets to Foreign Asset Protection Trusts.)

If you are a Physician; Senior Executive; Successful Business Owner or other high risk professional with a high net worth – you should discuss how Asset Protection Planning should or could fit within your general estate planning goals. Protect the nest egg you have worked hard to make and leave a legacy for your family.

This article is a service of Attorney Chad A. Ritchie and the Ritchie Law Office, Ltd.

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