They play a relatively minor role. There are hundreds of different trusts, and each has its specific purpose for estate or financial planning. But for creditor protection, the trust must be irrevocable and intervivos – or funded during your lifetime. Until you transfer your assets to the trust, your assets, of course, are subject to the claims of your personal creditors.

There are other limitations to the use of trusts to shield one’s assets. The trust cannot ordinarily be settled for the sole benefit of the grantor. A grantor seeking lawsuit protection can retain no beneficial interest – though some retention of income rights based on some ascertainable standard (health needs, etc.) may still allow the trust to provide protection. Most states disallow self-settled trusts for asset protection. The grantor cannot control the trust nor have any beneficial rights.

Moreover, assets transferred to an irrevocable trust may be subject to fraudulent transfer claims by the grantor’s creditors. Present creditors – known or unknown – can recover fraudulent transfers. That’s why you must transfer assets to a domestic irrevocable trust only when you’re certain you have no present creditors. But how can you ever know this beforehand? For these reasons, unless the trust provides other estate planning or tax benefits, we wouldn’t normally use a domestic irrevocable intervivos trust solely to protect a client’s assets. The LP or LLC is preferable. However, revocable trusts can shield your children’s inheritance and protect your estate. And special purpose trusts, such as irrevocable life insurance trusts, might own your life insurance. For these reasons we generally don’t use irrevocable trusts to protect our clients’ assets from their creditors but do recommend trusts to protect significant trust assets from their beneficiaries’ lawsuits, creditors, and ex-spouses. These beneficiaries are usually the grantor’s children or grandchildren.

This doesn’t diminish the role of domestic trusts in our planning. We do use scores of different trusts and each has its application – whether for estate, tax or philanthropic purposes. And some of these trusts do provide protection. But when we use these trusts it is ordinarily for some purpose other than the protection of the settlor’s assets. Protection becomes a secondary or incidental benefit.

When you do think about trusts for protection, you must consider them from several perspectives: 1) Which trusts can protect the assets from the grantor’s creditors? 2) Which trusts can protect the assets from the beneficiaries’ creditors? 3) How can you improve the protection afforded by a particular trust? 4) What protection can you expect from the more commonly used trust? We will, of course, talk more about trusts, particularly when we talk about how to protect your estate and inheritance.

While we have found there are two main threats to your wealth; litigation and government intervention, the focus for today will be primarily on litigation.  In 2008, there were nearly 1.2M practicing attorneys in the US alone and nearly 400K students in law school.  Costs of litigation consumed 2.3% of the US GDP, or approximately $322B, roughly equivalent to Switzerland’s total GDP.  This is an enormous cost that businesses and wealthy individuals must bear with no end in sight.  In this issue, we will discuss the benefits of an LLC and how it should be a core component of your asset protection planning. 

The Limited Liability Company, or LLC, traces its roots back to the German law of 1892 authorizing Gesellschaft mit beschrankter Haftung, or GmbH.  Once established in Germany, other countries from all around the world followed suit.  In 1977, Wyoming became the first US state to enact a true LLC act modeled closely after the 1892 German GmbH code.  Today, LLC’s, or the local variation thereof, are the most widely used form of business ownership around the world.  They are also the most widely misused.

Most entrepreneurs take great care in starting their company, but forget about the dual nature of asset protection and therefore neglect to properly structure their LLC.  Not only do you want to protect your personal assets from the activity of the business, you also want to protect the business, and thus your income, from your personal activities.

This is where a properly structured LLC comes into play.  If you are registering an LLC in the US to conduct business and/or to own assets there are the 3 main considerations;

• Register in a state that only allows creditors a charging order as the sole remedy by statute
• Register in a state that allows anonymous managers, or at least use a nominee manager
• Make sure you have a rock solid operating agreement

Step one is to register the LLC in a state where a charging order by statute is the sole remedy for a creditor to collect distributions from an LLC.   There are several states that only allow creditors a charging order as the sole remedy, but not all of those states are a good choice due to other factors like excise taxes or capital values tax.  Due to the nature of the charging order (in the proper state), creditors are only entitled to distributions, but cannot force a distribution, take ownership of assets, foreclose on business assets, or be granted membership interest in the LLC.  This means if your assets are held in a properly structured LLC, your creditor can only gain rights to your distributions, but as manager, you can elect to withhold distributions to member(s) leaving your creditor with a tax liability.  In some states, like CA, creditors can foreclose on business assets held in an LLC or even be granted a membership interest allowing them to gain control over the assets.  You don’t want to register in those states.

Step two should be to register your LLC in a state that allows anonymous managers, or at least utilize a nominee manager.  In most cases this veil of privacy is enough to keep the wolves at bay.  Imagine getting into a car crash.  Nowadays the first reaction of the ‘victim’ is the grab their neck or back and claim an injury.  Of course their attorney will run a public record search for your assets to determine his ‘payday’.  If there is no fat piggy bank to smash, in most cases he will not pursue you beyond the limits of your insurance.  By simply making your assets invisible to public record searches, this puts up a significant roadblock. 

And step three is to make sure your operating agreement is rock solid.  Last week I discussed the operating agreement and what constitutes a good one (if you didn’t receive last week’s newsletter, feel free to send an email requesting the April 22 issue).  I can’t tell you how many entrepreneurs that cross my path who either have no operating agreement all, or the one they do have is so inadequate, they might as well not have one.  At least 90% of the operating agreements we review for clients are completely useless.  Most are 7-10 page boilerplate agreements that offer no asset protection whatsoever.  That is just not enough space to spell out a contractual obligation.  Ours is approximately 70 pages.  The operating agreement is the contract between you and your business and is the first thing the court requires for guidance in dealing with your assets.  In the absence of a good contract, you are at the mercy of the court should you find yourself to be a defendant. 

With proper asset protection planning, the LLC can be a very useful tool in minimizing your risk.  There are many creative ways to use LLC’s for structuring your assets like using a Nevis LLC to own your domestic LLC thereby giving you an additional layer of protection and making your assets completely invisible.  You can also use a combination of LLC’s to segregate business assets or strip equity from real estate using liens that you control.  If you have any questions or would like to schedule your free 30 minute consultation, feel free to contact me either by email or phone.

This is a link to an article recently published in Octane, the quarterly magazine for EO (Entrepreneurs Organization).  Any and all comments are appreciated.  Asset Protection for the Entrepreneur