Asset Protection The Advisor s Role (Part I)

Transcription

1 Course Objective This multi-part course was created to teach advisors (CPAs, EAs, accountants, attorneys, financial planners and insurance advisors) about a much overlooked area of consulting, asset protection. Advisors are supposed to assist clients in some or all of the following areas: estate plans, personal and business taxes, insurance and finances. While an advisor could help clients with all of these, the best estate/financial plan in the world could be rendered meaningless if a client with any significant net worth is not asset protected. One large jury award for negligence could turn a multi-million dollar client into one in bankruptcy. This multi-part course will cover why clients with wealth need asset protection and how to get that accomplished using existing laws. The course will teach advisors how to help their clients be proactive in using domestic and offshore asset protection tools to protect their wealth. Finally, the course will help advisors show their clients how to avoid potential pitfalls when designing an asset protection strategy. Introduction Asset Protection The Advisor s Role (Part I) By: Roccy DeFrancesco, JD, CWPP Founder, The Wealth Preservation Institute A huge concern facing high income/high net worth clients today (especially physicians, attorneys, CPAs and financial planners) is what to do about runaway malpractice/e&o claims and high jury verdicts that could be potentially devastating to a client s overall personal wealth. In many states, malpractice insurance for physicians is becoming so expensive that they are being forced to lower their coverage from $1,000,000 down to as little as $100,000. At the same time, many insurance companies are dropping physicians due to poor claims experience, and those physicians sometimes are forced to go without any coverage because they cannot find a carrier to insure them. Copyright 2005, The Wealth Preservation Institute ( 1

2 While CPAs, attorneys and financial planners do not have the same worries about high premiums as physicians, the issue of asset protection and the potential once-in-a-lifetime large jury award is still very troublesome. Why Would an Advisor Want to Learn Asset Protection? The simple answer is because you can show value to your most important clients (i.e., the wealthy clients in your practice who pay their bills in a timely fashion). The problem for most advisors is that their clients don t think they are being proactive when it comes to helping them with their personal finances, estate plans and, increasingly, their lack of an asset protection plan. By becoming a quasi expert in asset protection planning, an advisor can differentiate him/herself in a local marketplace from the other advisors. Word travels fast among affluent clients; and once it is known that a particular advisor (or office) in town is being proactive in asset protecting clients wealth, the advisor should see an increase in new clients being referred to his/her office. If you are simply an hourly advisor who cranks out bills for tax or legal work, learning about asset protection will still make you a more well rounded advisor. If you are an advisor who makes some or all of your money from commission based product sales, then learning about asset protection is an absolute must. Why? Because a high income/high net worth client cannot have their estate or financial plans in order unless they are also asset protected. Preface In the following material, you will learn real world asset protection in plain English that you can use to advise your clients. Real world advice differs from what many asset protection specialists pitch to clients (which seems to revolve more around what is good for the advisor ($) than for the client). While asset protection is an important issue to anyone who has money, the biggest problems face physicians, attorneys, financial planners and CPAs (all of whom have personal liability for the advice given). Instead of listing CPA, financial planner attorney, and physician over and over in the material, I have simply written this material as though it is only for the physician client (who is by far the client with the most asset protection problems). There is nothing unique about a physician that does not also apply to a CPA, financial planner or attorney when it comes to screwing up on a client. While the professional advisor does not cause physical injury (which would give Copyright 2005, The Wealth Preservation Institute ( 2

3 rise to monetary damages), they can cause millions of dollars in monetary damages to clients because of poor advice in different areas (estate planning, tax planning, payroll, ERISA, and so on). Again, because a physician is the client we are most worried about, I have chosen to write the following materials using a physician as the client. The liability problems apply to any client who has professional (personal) liability. Why Should a Physician Protect his/her Assets? When I lecture around the country on the issue of asset protection and when the PowerPoint slide comes on the screen asking physicians why they need asset protection, I typically receive several good chuckles or laughs from the audience. I suppose the reason is that asking physicians why they need asset protection seems like a silly question to them. If the question is Should a physician get asset protected?, most physicians see the question as more of a rhetorical question than a normal question looking for a response. The odds are against physicians Depending on what publication you read, you will hear statistics like one out of every four physicians will be sued this year or six out of ten physicians have been sued at least once during their careers. Statistics can be misleading; but in layman s terms, what all the statistics show is that physicians get sued a lot. I like to break things down to what is realistic for physicians to worry about. If the physician is a surgeon of any kind, an anesthesiologist, or a radiologist, the likelihood of being sued sometime in a career is almost 100%. Why do I say that? Because with surgery, there is rarely a perfect outcome, thereby always leaving the door open to a potential lawsuit (even if it is frivolous from a technical standpoint). With a surgeon doing hundreds of surgeries a year and having a career that lasts several decades, the law of averages will take over, and a lawsuit will ultimately happen. Frivolous lawsuits Larry Smarr of the Physician Insurers Association of America testified in Congress at hearings on medical malpractice caps (in January of 2003) and had the following to say: Copyright 2005, The Wealth Preservation Institute ( 3

4 Over 70% of all claims made against physicians are without merit. When the doctor goes to trial, the doctor wins 80% of the time; but our studies show that 50% of all the money available to pay claims goes to fund the attorneys' lottery system. Attorneys, author excluded, of course, know how to use the legal system to their benefit and that of their clients. Most personal injury attorneys know that, if a case can get past summary disposition (where it is determined by the court if there is a material issue of fact that needs to be decided by a court or jury and, therefore, a case has merit and needs to go to trial), there is a good chance the insurance company representing the physician will settle the case at some point. The settlement might not be for a huge amount, but the fact that a settlement is available in many cases that are not dismissed gives attorneys incentive to seek out and file medical malpractice cases against physicians. Non-specialized attorneys For the most part, the general public does not think too highly of attorneys. My saying is that no one likes an attorney until you need one (and then you still wish you could avoid calling one). While most people do not like attorneys, most do believe attorneys, in general, are smart people due to the three extra years of schooling and the two-day bar exam necessary to practice law. The fact of the matter is that there are attorneys who are very smart, and there are attorneys who are not only less than smart but would be considered terrible attorneys by their peers. The vast majority of medical malpractice lawsuits filed that a physician would consider frivolous are filed by an attorney who has no business taking a medical malpractice lawsuit in the first place. Good personal injury attorneys who specialize in medical malpractice cases are interested in those where the physician screwed up and there are significant damages. If those qualified attorneys were the only attorneys taking cases, the number of filed medical malpractice cases would decrease by a significant amount. How can an attorney file a medical malpractice case, which is on a subject they know nothing about? It is simple if you have a client and a law license, you can file a lawsuit. The following is an example of a typical medical malpractice case that should not have been filed. A client walks into the office of an attorney after seeing an ad in the yellow pages stating that the attorney does wills, trusts, real estate transactions, and personal injury claims. The client tells the attorney that he went to the doctor to get a knee looked at and, to Copyright 2005, The Wealth Preservation Institute ( 4

5 make a long story short, the doctor did surgery, screwed up the knee, and knew the client could not walk right for the rest of his life. The attorney sees a several-hundred-thousand-dollar settlement after listening to the 20-minute story, and then has the client sign a contingent fee contract stating that, in the event of a recovery, the attorney gets to keep 33%. (By the way, attorneys, in general, might not be that bright, but they can all divide by 3). The attorney does minimal due diligence on the case, finds a professional physician to say that the treating physician breached the standard of care, and then files a lawsuit suing the physician, his office, and the hospital or surgery center where the surgery was performed. As it turns out, the physician did nothing wrong; and after the insurance company spent $35,000 defending the claim, the case settled out of court with NO payment to the patient and was dismissed with prejudice. How could the above scenario happen in any society that has some legal sanity? Like it or not, the American system of law allows just about anyone to file a lawsuit against anyone else with only minimal good faith needed that a plaintiff had been harmed or wronged by a defendant. This is different than the British legal system, which makes the loser of a lawsuit pay the costs of the prevailing party. The theory behind the difference in the American justice system and the British is fairly simple in America, we did not want to create a barrier to filing suit by the indigent. If the losers of all lawsuits had to pay the costs of the prevailing party, poor people with meritorious claims would rarely file suit for fear that a loss would push them into the poor house or into bankruptcy. Again, how could the prior scenario happen even under the American legal system? I call it the lottery syndrome. The local, unseasoned attorney (as far as medical malpractice claims are concerned) who usually sticks with real estate and divorce matters sees a medical malpractice client as his/her way to Easy Street. That non-personal injury attorney believes that, once in their legal career, a home run medical malpractice case is going to walk in their door; and when that day happens, the case is going to allow them to retire ten years earlier than normal. Copyright 2005, The Wealth Preservation Institute ( 5

6 The problem is that most of the medical malpractice cases filed by an attorney not experienced in medical malpractice cases should never have been filed in the first place. That is little consolation to a physician who has five frivolous claims and is now losing his/her medical malpractice insurance, not for high payouts, but for a high volume of claims. The big screw up If, most of the time, medical malpractice cases settle, or conclude with a jury verdict paying nothing to a patient/plaintiff, then why would a good physician need asset protection? To avoid having personal assets taken by the patient who truly was injured because of a mistake when treating or operating on the patient. According to a survey by Jury Verdict Research in 1994, the median award for compensatory damages in medical malpractice lawsuits was $362,500. By the year 2000, it was $1 million (and that number is only going to go up). As we all know, if you screw up in a malpractice case, usually you screw up big and, therefore, that once-in-a-lifetime screw up could be a $5,000,000 verdict. That means a good portion of the verdicts were in excess of $1,000,000. (As a side note, a malpractice screw up that causes patients to be crippled for life is usually much worse than actually killing a patient. The jury verdict for a patient who was turned into a quadriplegic is going to be many times larger than the jury verdict for a screw up that caused the death of a patient). If a physician gets the $5,000,000 verdict against him/her and only has $1,000,000 worth of insurance coverage, that is when there is a great need for asset protection. Deep pockets Physicians are good targets, in general, to sue because they are perceived to have deep pockets (lots of money). Personal injury attorneys almost always sue everyone they can get their hands on in a lawsuit and, most certainly, the defendant with the deepest pockets (even if liability might not flow to the deep pocket). You have probably heard of cases where the physician who everyone thought committed malpractice did not have insurance, and the hospital, which no one really thought did anything wrong, ended up getting sued and paying the malpractice claim of the patient. Copyright 2005, The Wealth Preservation Institute ( 6

7 Why is that? Deep pockets and sympathetic judges and juries. Understand that local judges are elected officials who have it in their best interest to keep their constituents happy. Letting a patient who has a terrible injury go uncompensated because a physician did not have insurance does not sit well with the public; and, because of that, a hospital that might be 1% liable, could end up getting stuck with the several-hundred-thousand-dollar verdict because it had money and insurance. Other claims besides medical malpractice Besides the obvious claims against a physician for medical malpractice, physicians, and ANY OTHER CLIENT WITH ASSETS, need to worry about regular negligent claims from the general public. Any client who owns a home, has teenage children, owns a boat or an automobile or a vacation rental, is liable to have a claim some day for traditional negligence. Examples: Homeowner As a homeowner, you typically will throw a few parties each year for your friends. If you serve alcohol at those parties and one of your guests leaves the party after drinking too much and gets into a car accident and kills three passengers in the other car (or worse turns them into quadriplegics), guess who is going to get sued for negligence? The homeowner. Most people think that an umbrella liability policy of 1 million dollars will protect them; but, if you can be linked to a death or serious injury through your negligence, your 1-million-dollar umbrella is not going to go very far. After your insurance pays 1 million of the 3 million-dollar verdict, the attorney for the plaintiff is going to go after all of your personal assets. (You will read in an upcoming section (Part II) about owning a home as tenants by the entireties as a way to asset protect the marital home. Owning a home as tenants by the entireties will work in most states against most creditors; however, that protection is not available against joint creditors of both spouses. In the above example, and the ones to follow, the injured person(s) would sue the spouses jointly and, therefore, tenants by the entirety typically will not protect them). Teenage Children If you have teenage children, chances are, at some point, you will go out of town and your children, whom you left home (the year olds), will have a party or have Copyright 2005, The Wealth Preservation Institute ( 7

8 friends over. Since the statistics say that over 50% of teenagers drink on a regular basis (many times binge drinking), the chances are high that there will be alcohol at the party at your house. If your children are the ones who procured the alcohol (and maybe even if they did not) and the attendees at the party get drunk and then drive around and get hurt or hurt others, guess who is going to be sued? The parents. Again, the 1-million-dollar umbrella policy from your homeowner s policy is not going to go very far to protect you. Boat or automobile If you own a boat (or wave runner) or an automobile, then you have the normal liability problems that go along with negligent driving of the boat or automobile. If you or a dependent family member are driving in a negligent manner and cause harm to another person, the owner and the driver of the boat or automobile will be sued with the same damage potential and shortfall of insurance problems illustrated in the previous examples. Vacation rental If you own a condo or house as a vacation home and rent it out, you have other liabilities to worry about which are more problematic than just owning your own home. As an owner of a rental property, you have a duty to keep that property in good enough physical condition to prevent injuries to tenants and their guests. Going into the detail of that liability is outside the scope of this book; but as a landlord, you need to worry about lighting of the stairwell, shoveling snow, handrails, and a whole host of other issues that can cause liability claims for negligence if someone is injured. Why isn t normal negligence a problem for everyone and not just physicians? It is, except most of the normal public does not have the wealth necessary to satisfy a million-dollar jury verdict. Many indigent people who can barely afford to buy an automobile will not be able to afford insurance. They are not worried about the million-dollar verdict because they have nothing to lose. A physician, on the other hand, has sometimes millions of dollars in assets to protect. Anyone can be sued for negligence, but only those clients with assets have to worry about asset protection. A quick note on why insurance to cover negligence is not always adequate. Copyright 2005, The Wealth Preservation Institute ( 8

9 Underinsured As discussed above, you could get a jury verdict for negligence that is above your insurance coverage (typically the $1,000,000 umbrella). Exclusions You could be sued for something that is not covered by your insurance policy. A good example is intentional torts where you were found to do something intentional. Many insurance carriers will not cover you for intentional torts. Another example is a criminal act. Most insurance carriers will not cover you for acts that are deemed to be criminal. Insurance company goes bankrupt As medical malpractice insurance companies struggle to stay profitable, your clients could be one of the unfortunate few who are insured with a company that goes out of business. Many physicians are aware of PIC, in Ohio, which went bankrupt, and more recently with PHICO. What happens if your clients are with an insurance company that goes out of business? The company usually pays out its money pro-rata to settle all claims, and any shortfall is left to the client and possibly state insurance pools, which are there to protect clients for just such an occurence. Divorce Protection Besides protecting assets from typical creditors, your clients might want to protect their assets in the event of a divorce as well. I discuss that topic in the estate planning section of the seminar material. Long Term Care Insurance Besides death, the one thing clients need to protect themselves against most is long-term expenses. This is a huge concern right now as more and more people are going into assisted living centers, and yet it is the one thing that most clients just refuse to pay for and plan for. Long Term Care will be covered in detail in the separate educational module on the topic. Estate Taxes You might not normally think of avoiding estate taxes as asset protection; but when you save your clients heirs sometimes millions of dollars in estate taxes, you are helping them asset protect their wealth from the government. You Copyright 2005, The Wealth Preservation Institute ( 9

10 will learn how to reduce estate taxes of clients in the estate planning in the separate educational module on the topic.. What Assets Should a Physician (or any client) Protect? Most of the time, when a client lists ALL of their assets on a piece of paper, they are surprised at how much needs to be protected. If your clients own any of the following, they are good candidates for asset protection: Family Home or Condominium Rental Property Non-Rental Property IRA Stocks or Mutual Funds Life Insurance Bank Account or CD s Planes, Boats, Automobiles, Wave runners or Motorcycles Other business entity (especially S or C-Corp stock) Collectible items that have significant value Accounts Receivables (at the medical practice) * Other personal real property of value Future Inheritance for Family * Most medical practices are worth very little to a personal injury attorney trying to satisfy a judgment for medical malpractice. Most of the value in a medical practice is in the good will, which comes from the physicians themselves. Typically, the ONLY major asset of a medical practice is the office s accounts receivables (A/R). For a physician to be completely asset protected, the A/R in the medical practice must be protected. We will coverer this in depth in Part III of this section of the course as well as in an in a stand alone educational module on the topic. Conclusion of Introduction to Asset Protection For physicians, there are very few things that are more important than protecting assets. Physicians work hard and long hours to accumulate wealth; and with one medical malpractice claim or general negligence claim, the majority of a physician s wealth can be taken from him/her by a creditor (patient). Copyright 2005, The Wealth Preservation Institute ( 10

11 A good asset protection plan can be implemented for $2,500-$10,000, and this would be some of the best money a physician could spend. Asset protection protects the physician s family wealth and can give peace of mind when living what is an otherwise stressful and hectic life. For an advisor looking to build relationships and provide value to high-end clients, learning about asset protection and helping a client become asset protected will go a long way towards building a practice of long-term and very loyal clients Asset Protection Planning Introduction Asset protection, in general, is about erecting barriers to make it difficult or impossible for creditors to get personal and business assets. Asset protection is NOT about hiding or concealing assets, or about committing fraud to conceal assets from creditors. Good asset protection discourages lawsuits to the point where a client can bluntly state to a personal injury attorney that he/she has millions of dollars in legally protected assets; and, if sued, the attorney will not be able to reach any of those assets. When I start talking about asset protection, many clients and their advisors expect that I am going to tell them how to move assets offshore so no one knows about those assets (including the U.S. government). Concealing assets is fraud and is illegal, and attorneys who advocate plans which hide assets are not helping their clients, and, instead, may be subjecting them to further litigation in a fraudulent concealment proceeding. Good Asset Protection can Prevent Lawsuits It is my opinion that having abnormally high malpractice limits is like putting a bull s eye on the back of a physician for personal injury attorneys to see the higher the malpractice coverage, the higher the potential payoff for the personal injury attorney. The same analogy holds true with asset protection the more personal assets that are not asset protected, the more likely a personal injury attorney can satisfy a judgment; and, therefore, the personal injury attorney is more willing to go after the client who is not asset protected than one who is. Copyright 2005, The Wealth Preservation Institute ( 11

12 Imagine the following two scenarios: 1) A cardiologist screws up in the operating room, causing a substantial injury to a patient. After some time, the patient, due to the negligence of the cardiologist, has several more surgeries to correct the problem; and now the patient is totally disabled for life and has $1,000,000 worth of medical bills. The cardiologist s bedside manner is not very good; and when the patient runs into a personal injury attorney, the attorney talks the patient into signing up with him/her to look into a potential medical malpractice claim. The attorney files the needed paperwork to start the discovery process and finds, after minimal discovery, that the cardiologist has $1,000,000/$3,000,000 in malpractice coverage and several million dollars in personal assets, which include a brokerage account of $1,000,000 and real estate personally owned worth $2,000,000. The personal injury attorney files suit and asks for $5,000,000. 2) Same scenario with the damages of scenario number one except, this time, when the personal injury attorney does his discovery, he/she finds out that, while the physician has $3,000,000 of personal assets, those assets are fully asset protected and are not going to be available in a malpractice suit. Because the medical bills are $1,000,000 and the malpractice coverage limits for the cardiologist are $1,000,000 per claim, the personal injury attorney decided not to spend the $85,000 + in expenses it would take to get the case to trial and tells the patient/client that, while it is clear malpractice took place, the case is not financially viable; and, therefore, the attorney could not take the case. The only difference in the two scenarios above is that the physician s $3,000,000 personal assets were totally asset protected from lawsuits. Copyright 2005, The Wealth Preservation Institute ( 12

13 Physicians Who Are Bare (no malpractice coverage) Scenarios 1) and 2) in the prior section become much more magnified if the physician has no malpractice coverage. If a physician has no malpractice coverage but has significant personal assets that are not protected, the personal injury attorney will still take the case and will go after those personal assets to satisfy a judgment. There are two big differences that arise. a) All defense costs will be paid out of the physician s pocket (which could be over $50,000 per case for frivolous claims); b) Any judgment will be paid from dollar one out of the physician s personal assets. If, right out of the gate when a malpractice case is brewing, the physician fully discloses to a personal injury attorney that all of his personal assets are protected (and that the physician has no malpractice coverage), the personal injury attorney is not likely to take the case at all, or will try to settle the case very early in the process for less money. Either way, the physician who is asset protected is in a position to discourage lawsuits from the outset; and, even if a lawsuit is filed, the personal injury attorney is much more likely to settle the case early on for a lower amount, thereby saving the uninsured physician defense and settlement costs. I know this to be the case because I personally know a physician who went 20+ years without insurance; and although he did have potential claims, the attorneys suing him had very little interest in spending their own money to chase a physician who has no insurance and all assets are protected. Asset Protection Cannot Guarantee Clients Will Be Lawsuit Free While the previous examples seem to indicate that good asset protection will prevent lawsuits; that is not always the case. Good asset protection will discourage lawsuits, but any attorney (or any client acting without an attorney) can sue whether the defendant s assets are protected or not. Copyright 2005, The Wealth Preservation Institute ( 13

14 The goal with asset protection is to protect a client s assets before a lawsuit and keep the assets after the lawsuit is over. In the coming pages, you will learn the tools necessary to asset protect your at-risk clients so that after a lawsuit and the collection process is over your clients will still own the assets they started with. Legal Asset Protection Correctly structured asset protection plans are ones that use existing laws and are 100% legal in the eyes of the U.S. government (and foreign governments if offshore planning is needed). It might sound obvious that an asset protection plan should be legal; but as you will find if you research asset protection planning, some of the strategies being offered are what I would call a bit edgy, or based not in law but in the absence of law. Unlike a lot of issues dealt with in estate planning, investment planning, and income tax reduction planning, proper asset protection is a fairly black and white legal issue. There are certain ways to put an asset protection plan together; and when an advisor is recommending something you or your local attorney cannot look up, chances are there is something not on the up and up with the recommended plan. Reasonable minds might differ when it comes to determining what the best asset protection plan is; but asset protection attorneys should not differ when it comes to determining if the asset protection plan options are, in fact, legal. Keys to Asset Protection Planning Do not wait - Clients (and their advisors) are famous for procrastination. Due to the busy professional and personal lives of most clients, it is not easy to find the time necessary to sit down with a qualified attorney to put together an asset protection plan. Do not go cheap on your attorney - I have already said that no one likes an attorney (until you need one), and it will be impossible for you to set up an asset protection plan without a qualified expert. It is okay to go cheap on a lot of experts you will use in your life, but going cheap on an asset protection attorney will get you nothing but grief. Chances Copyright 2005, The Wealth Preservation Institute ( 14

15 are good that, if you live in a decent-size city (200,000 or more people), you will be able to find an attorney who specializes in asset protection. - CPAs/accountants should not be doing legal work. Therefore, it is important that every CPA/accountant who wants to become more hands on when it comes to advising clients on asset protection find an attorney (local if possible) to work with. While it does not have to be expensive to implement an asset protection plan, having clients go to the attorney who did their last divorce or the attorney who helped them set up their practice is probably not going to get them a technically correct asset protection plan. Do your due diligence. Be comfortable with the attorney you recommend; and, if you cannot find one you feel comfortable with, please call The Wealth Preservation Institute for a referral to a competent asset protection attorney. Keep an open mind - The best asset protection plan for any client completely removes all the assets from their name. The worst asset protection plan has all assets held individually by the client. A good asset protection plan is typically somewhere in between, and you need to work with an asset protection attorney to find a happy medium for your clients. Support of the family - Most of our clients over age 35 are married and have children. It is important to involve those in the family who will be named in the asset protection plan. Many times the spouse and the children, through limited liability companies or family limited partnerships, will be part of the asset protection plan; and so it is important to get their support from the outset. Do not wait - I started this list with Do not wait, and I ll end it with Do not wait. If, after reading this material you know you have clients who need help, don t wait. Helping your clients implement a plan after a claim has been filed will do them little good when trying to protect against that impending claim. Hindsight is 20-20, and you do not want to look your clients in the face after procrastinating for months only to have them say to you Why did you wait to bring this to my Copyright 2005, The Wealth Preservation Institute ( 15

16 attention? There is little consolation for knowing that you should have done something, and that, because you did not, it put millions of dollars of your client s assets at risk. Fraudulent Transfers Fraudulent transfer laws have been around almost as long as there have been people trying to perpetrate frauds. Unlike a lot of laws that have taken years and sometimes centuries to implement, fraud laws were enacted very early in the creation of the legal system; and the reason is fairly simple fraud, once discovered, is an obvious crime (or tort) that can cause significant harm. What is a Fraudulent Transfer? The Asset Protection News in 1995 gave the following definition of fraudulent transfer: In lay terms, a fraudulent transfer is a transfer of an asset (or incurring an obligation) with the actual intent to hinder, delay, or defeat a creditor's claim (actual fraud), and, regardless of intent, making a transfer while insolvent or which renders the transferor insolvent (constructive fraud). Actual fraud Actual intent is proven in two ways: By the transferor's own statements, such as: "I knew Mr. X was going to sue me, so I gave the brokerage account to my wife," or, more commonly, by a review of the facts surrounding the transfer. Over the last several hundred years, the court cases have identified a list of factors, sometimes referred to as "badges of fraud," which may be taken into consideration in determining a transferor's intent. These factors include, among others: being sued or threatened with suit before the transfer, removing and concealing assets, concealing the transfer, transferring substantially all of the debtor's assets, and whether the transferor was insolvent at the time of the transfer, or became insolvent shortly after the transfer was made. How does this translate into real life? You have been called by a person who says that he has a claim against you for one reason or another (no suit has been filed). You remember the person; and even though you think he has no basis to make a claim, you decide to play it safe and make "gifts" of your assets to your spouse and children. If the claimant is successful and obtains a judgment against you which he cannot collect, the transfers will likely be held to be a fraudulent transfer by the court unless significant non-asset protection motives can be proven for the transfer (remember it is a question of intent). Copyright 2005, The Wealth Preservation Institute ( 16

17 Classic example: Dr. Smith goes into the operating room where he is supposed to amputate a diabetic patient s right leg. Dr. Smith did not notice that the surgery techs prepped the wrong leg; and, in fact, he amputated the wrong leg. Dr. Smith figures this out in post op.; and instead of sticking around to console the patient and his/her family, he calls his local attorney to immediately start drafting an asset protection plan. Dr. Smith and his attorney immediately transfer his brokerage account and vacation home (value $2,000,000 collectively) to separate limited liability companies in hopes that this move will protect Dr. Smith from the lawsuit he is sure will arise from his amputating the wrong leg. Sure enough, Dr. Smith is sued six months later by the patient for $10,000,000 (which seemed to be a just price to the personal injury attorney now that the client has NO legs after the second amputation). Dr. Smith has a 1-million/3-million-dollar medical malpractice insurance policy. During a deposition, Dr. Smith testifies truthfully that he transferred all his major assets to limited liability companies one week after the surgery but before the lawsuit for malpractice was filed. The attorney for the patient asks for and receives a temporary restraining order to freeze the assets in Dr. Smith s limited liability companies until a resolution of the case is complete. The case goes to trial and the jury comes back with a $7,000,000 verdict in favor of the patient/plaintiff. What is the outcome of Dr. Smith s asset protection plan? Dr. Smith has violated the fraudulent transfer rules, and the court reverses his transfers and directs him to liquidate his brokerage account, sell his vacation property, and hand over every penny to the patient (who is now a creditor of the physician). The rule that comes out of this story is that a physician should not wait to create an asset protection plan and should not make fraudulent transfers. If Dr. Smith had his vacation rental and brokerage accounts asset protected prior to amputating the wrong leg, those assets would have been protected and the court would not have been able to tell Dr. Smith to liquidate the assets and give the money to the patient. Copyright 2005, The Wealth Preservation Institute ( 17

18 Constructive fraud Fraud generally is difficult to prove. It is not often that you will find the classic example as just outlined. It is more likely that a fraud will be more subtle such as selling an asset 1) for less than its fair market value, 2) when a claim for damages against the seller is known, or 3) that makes the seller insolvent. 1) Fair Market Value Selling an asset for less than fair market value (FMV) is just that. You have an asset that, in the current marketplace, is worth $100,000. If you had a fire sale because you needed money, you might sell it for 30-40% less than what it is worth; but no one in their right mind would sell it for more than a 50% discount (The exact discount that would be deemed below FMV for constructive fraud will vary depending on the individual circumstances and state law). The typical scenario would begin with the fact that a physician knows he screwed up on a case, and knows he/she is going to lose his unprotected assets in a lawsuit, and would rather sell assets at a discount to someone they know so the asset can be enjoyed by a friend (or maybe sold back to the physician at a later time at that same discounted price). 2) When a claim for damages against the seller is known Again, it is not likely that a physician who intentionally is trying to defraud a claimant is going to admit under oath that the transfer was made with the intent to defraud the claimant. In a situation where the physician will not admit to the fraudulent transfer, the claimant will assert constructive fraud based on the circumstances, which would include the fact that the physician just happened to make the transfer of property with knowledge that a claim for damages is known. 3) Insolvency Insolvency is not something that most high-end clients will be able to accomplish in a reasonable manner to avoid paying malpractice or negligence claims; therefore, I will not spend much time on constructive fraud. If a physician transfers assets to become totally insolvent before a patient sues, then he has real problems. Just know that, if a client intentionally becomes insolvent when a potential claim is at hand and is known, the transfers can be reversed. In general, the law states that a person should not be able to make gifts when insolvent, or make gifts that would make the person insolvent (if there is pending litigation that can give rise to money damages). Creditors have rights Copyright 2005, The Wealth Preservation Institute ( 18

19 that must be protected, and not allowing a person to make himself insolvent, or allow an insolvent person (with a pending claim) to gift assets away (which would harm a creditor) is a public policy decision by the states that have enacted such laws. This scenario is most likely when a client with children is divorced, and the client would rather sell or transfer property to the ex-spouse in an effort to sort of keep the assets in the family (for the children) rather than have a patient/claimant get the assets. Defenses to fraudulent transfers -Legitimate business purpose If the transferor of property (in what looks like a fraudulent transfer) can prove that the transfer was made for a legitimate business purpose; that is generally the most viable form of defense to combat a fraudulent transfer claim. Transferring assets to family members often can have a legitimate business purpose (with estate planning it is done all the time). The problem with family transfers of property in a fraud situation is that transfers to family members are looked at much more closely, so it creates an interesting paradox for the court to deal with. -Transfer before liability incurred (which is the main way to avoid the problems involved with fraudulent transfers) If you can prove to the court that the transfer was made before the liability occurred, that will be a very strong defense against a fraudulent transfer. The only problem with this defense is if the plaintiff can prove that the defendant intended to create claims (by harming people) and, in anticipation of causing harm, the defendant wanted to divest him/herself of all assets. Conclusion Fraudulent transfer laws will prevent a client from removing assets from the estate after a potential claim for damages arises and is known. The only certain way to prevent transfers of assets from being overturned by a court is to make the transfers before any liability occurs. Even if a creditor cannot prove actual fraud, the client still needs to worry about constructive fraud when making transfers of assets after a claim for damages has occurred. Copyright 2005, The Wealth Preservation Institute ( 19

20 Bottom line help your clients get asset protected now by using experts in the field who will help them shield all their major assets from lawsuits whenever they arise. Existing Laws Help Protect Your Assets Introduction In a later section of the asset protection part of this course, I will discuss the various techniques that are used to protect assets. Those techniques are used and created under existing laws but are really thought of as new techniques. What this section of the material will discuss is the use of normal asset protection techniques. Homestead Exemption They say a man s home is his castle, but is that really true? Most states provide some sort of creditor exemption for a personal residence. Each state has different rules and limits for what that exemption is, and you should check with your local advisors (or call The Wealth Preservation Institute) to determine just how much the homestead exemption is in your state. The homestead exemption came from public policy concerns to protect the family. The theory is fairly simple the legislatures wanted to protect some portion (in some states it is unlimited) of the family residence so families (even those riddled with debt and hounded by creditors) have a safe haven. -Interest protected The homestead exemption is a statutory right to protect homestead property. This is typically the real estate owned by a person as his/her personal residence. Again, the states vary on their definition; so be sure to check with your local advisors to make sure the piece of property you are concerned about is covered. Interestingly, 21 states now specifically include mobile/manufactured homes. Also of interest is that some states do not require that a client occupy the home or even have the intent to occupy the home to claim homestead. Copyright 2005, The Wealth Preservation Institute ( 20

21 - Homestead exemption value The amount of homestead exemption in each state varies widely. States such as Rhode Island, Delaware, New Jersey, Pennsylvania, and the District of Columbia have no homestead exemptions. States such as Texas, Florida, Iowa, Kansas, and Oklahoma have unlimited homestead exemptions. Some states have a different amount for married couples, some vary the amount by the number of dependent children an individual or couple has, some states raise the exemption if someone incurs significant hospital or medical debts, and some states increase the exemption in the case of bankruptcy. In general, states that have an exemption that is not unlimited will exempt between $5,000 and $50,000 (depending on if you are married or single). -Debt exclusions Certain debts in all states are excluded from by the homestead exemption. In almost all states, consensual liens, mechanics liens, and property taxes are not covered by the homestead exemption. Many states now are adding debts for child support or spousal support. The IRS also does not fall under the homestead exemption. So, if a client owes a significant amount of taxes he/she cannot pay, the IRS can take the client s home. (One possible exception to IRS claims not discussed here is the innocent spouse doctrine). -Procedural issues It does little good for someone to have a homestead exemption if the property can be sold before an exemption is asserted. In many states (18), the homestead exemption is automatic. Some states allows a person to waive the homestead exemption (this almost universally requires the spouse s consent if married). The homestead exemption, if limited, will not always prevent the sale of the property. The rules for how homestead property is sold, even when the exemption is applied, vary dramatically. Sometimes a house can literally be sold for any price above the homestead exemption, which could allow the home to be sold for thousands less than its fair market value. The amount of the exemption will still be reserved for the homeowner, but the rest of the profit from the sale of the home can go to pay creditors. Copyright 2005, The Wealth Preservation Institute ( 21

22 -Practical example of how the homestead exemption would work if sued Assume a patient sues Dr. Smith, and a jury verdict comes back for $1,000,000 over the limits he has with his medical malpractice carrier. Further, assume that Dr. Smith is single and has a home worth $1,000,000 with $500,000 in equity. If Dr. Smith lived in a state with an unlimited homestead exemption, the patient, through the collection process, could not force a sale of the $1,000,000 home to satisfy the judgment. If Dr. Smith lived in a state with NO homestead exemption, the patient, through the collection process, could potentially force a sale of the $1,000,000 home to satisfy the judgment. If Dr. Smith lived in a state with a $50,000 homestead exemption, the patient, through the collection process, could potentially force a sale of the $1,000,000 home to satisfy the judgment. In this last example, the patient/creditor could receive all the proceeds from the sale of the house above $50,000. That first $50,000 is the exempted amount and stays with Dr. Smith. Conclusion on Homestead Exemption Having a homestead exemption in most states (the states without an unlimited exemption) does a high-end client with the potential for million-dollar creditors very little good. You should determine the exemption amount for the states in which your clients have their principal residence. Life Insurance and Annuities All assets are not created equal. This is proved by the fact that life insurance and annuities are specifically protected from creditors in many states (by state law). Like many laws, those protecting life insurance and annuities are rooted in public policy. The legislatures in some states believe a life insurance and/or annuity benefit is essential for citizens and/or their families to maintain at least a minimum level of financial well-being, and, most importantly, to keep them from becoming wards of the state. Copyright 2005, The Wealth Preservation Institute ( 22

23 The state s interest to avoid paying for the indigent is tempered by a creditor s right to collect a legal debt; but, as you can understand from the government s point of view, it is always better for someone to support themselves than for the government to dig deep into their pockets to support even more needy citizens. Life insurance When discussing the protections afforded to life insurance owned by a physician, I typically address how to protect that asset from a patient who could sue the physician. Due to the public policy arguments surrounding life insurance contracts, the bankruptcy laws have specifically addressed giving protection to life policies even if individual states have not. I am not going to get into all the protections afforded to life insurance by the bankruptcy laws, but I would like to point out that the federal government has specifically addressed the issue. - State laws Like the homestead exemption, state laws vary widely when it comes to protecting life insurance. Some states give an unlimited exemption to life insurance policies that have cash value (Florida and Texas), and some states give none. South Carolina, for example, provides limited protection for cash value in the amount of $4,000. (The death benefit in almost all jurisdictions is exempt from creditors who would be left to sue the estate of the deceased debtor/physician). Hawaii specifically exempts the death benefit and the cash surrender value of policies, provided that the policy is payable to a spouse of the insured, or to a child, parent, or other dependents of the insured. - Estate taxes In this section of the material, we have been discussing asset protection as it usually pertains to protecting assets from creditors like a patient who sues for malpractice. Besides that potential danger, the biggest way to lose a significant portion of your life insurance proceeds is for your heirs to pay the government 50% of the death benefit for estate taxes. While clients have an unlimited ability to have death benefits paid to a spouse, any other death benefits paid to other people (children) have a significant chance of being taxed at the 50% bracket to pay for estate taxes. We Copyright 2005, The Wealth Preservation Institute ( 23