Choosing the Right Entity for Asset Protection

“Asset protection” describes legal planning that shields a client’s assets from the unanticipated claims of creditors, employing any number of techniques in isolation or in combination. A competent plan assumes that, at some point in the future, the client may be in legal jeopardy obligating him to account to a creditor for those assets within his control. Most techniques therefore incorporate the separation of client control from the assets being protected, on the settled principle that what a client does not own or control cannot be delivered to a creditor.

The most contested question is whether a plan has succeeded. Technically, if a debt of $1,000,000 is resolved for $999,999 as a result of the plan, it has worked to some small degree. The better measure weighs both tangible and intangible factors: the amount by which the creditor’s claim is reduced against the cost of implementing the plan, and the degree of comfort and control the client retains throughout.

The firm is not beholden to a single jurisdiction. In evaluating suitable jurisdictions for asset-protection trusts it weighs a number of factors — several of them discussed below — and offers clients the freedom and flexibility to select the jurisdiction that works best for them, including those in which the firm is itself a licensed trustee. The comparison that follows is offered in that spirit: no jurisdiction, and no entity, is a complete solution.

For generations, families have used foreign trusts to protect assets from creditors, relying on foreign law, the foreign legal climate, or both, as a barrier between the creditor and family wealth. The Isle of Man developed a cottage industry in asset-protection trusts after its courts, in Corlett v. Radcliffe (1859), held that fraudulent-transfer claims would be decided on a facts-and-circumstances basis, and that future unanticipated creditors could not set aside a transfer in trust made while the debtor was solvent. The principle was reaffirmed as recently as In re Heginbotham (1999).

Over the past several decades, a number of countries — and several American states — have attempted to replicate the perceived certainty of Manx trust planning. Jurisdictions such as Belize, the Cook Islands, Nevis, and Anguilla enacted trust laws codifying common-law principles emanating from the Isle of Man, or offering their own limitations on creditor claims. This inevitably invites comparison as to which country has the better asset-protection-trust law.

The law of fraudulent conveyances developed in England as the Statute of 13 Elizabeth (1571). At the behest of deep-pocketed banking interests, Parliament criminalized fraudulent transfers, awarding half the value of the transfer to the creditor and half to the Crown. The courts chose instead to read the statute as a private remedy, letting the creditor ignore the transfer and proceed against the property. English law eventually abandoned the criminal treatment, but the pro-lender bias of the Statute of 13 Elizabeth persists in modern fraudulent-conveyance law throughout the common-law world.

Several asset-protection-trust jurisdictions have modified their fraudulent-transfer laws to confer greater protection on transfers to locally registered trusts — shorter limitation periods, a heightened burden and standard of proof, and the exclusion of creditors not in existence when the trust was funded.

As more jurisdictions enact trust legislation and more families plan, creditors and the judiciary innovate. One line of attack is the Mareva injunction — named for Mareva Compania Naviera SA v. International Bulkcarriers SA (1975) — a form of temporary restraining order freezing trust assets pending trial. Once frozen, the trustee and settlor often lack the resources to challenge the creditor, so the creditor wins the war without going to battle. The Cook Islands entertains the Mareva injunction; Belize and Nevis have eliminated the remedy altogether (see Nevis International Exempt Trust Ordinance, Cap. 7.03 § 23(9)).

A second line of attack exploits the inherent weakness of any trust: a transfer to a trust is, by its nature, a gratuitous transfer. A creditor bringing a timely claim can set the transfer aside under the Uniform Fraudulent Transfer Act, the Bankruptcy Code, and cognate state law. For this reason the firm has always regarded domestic asset-protection trusts as folly and has counseled that trusts be established only offshore. The point is borne out by Kilker v. Stillman, which treated the selection of Nevada law as itself fraudulent as against a future creditor, and by In re Kendall, where a court cited the debtor’s Cook Islands trust as evidence of an actual intent to defraud.

The third is the paper trust— a trust formed on paper and never properly funded, often in a jurisdiction devoid of the capacity to custody trust assets. The discerning creditor knows how to pick such a trust apart. Financial infrastructure — the foreign trustee’s practical ability to take custody of assets and situate them in the trust jurisdiction — is of the utmost concern, and no single factor better separates a working plan from a decorative one.

Two features of the limited liability company are most often cited for its asset-protectiveness. The first is the dissociation of ownership from control. An LLC has members, who hold the rights of owners, and managers, who hold the rights and duties of business managers. A manager has no right to the LLC’s assets by virtue of the title; a member has no right to manage unless separately named a manager. A client may therefore contribute assets in exchange for a membership interest while engaging a professional management company in an asset-protective jurisdiction to act as manager.

The second is the charging-order remedy. Most LLC statutes provide that a judgment creditor may obtain a charging order against a member’s interest, and describe that remedy in terms substantially identical to the rights of an assignee: the creditor receives only distributions otherwise destined for the member, if and when made, and may not interfere with management or reach the LLC’s property, much less compel a distribution (see 6 Del. Code § 18-703).

Beginning with Nevis in 1995, several offshore jurisdictions known for their trust legislation — among them Belize and the Cook Islands — enacted complementary LLC statutes, modifying standard U.S. law to make the local company more protective. The LLC is sound on paper, but two practical limitations deserve attention before it is deployed.

The first is charging-order paralysis. Where a member’s creditor is confined to a charging order, the company is shielded from interference and may continue to operate — but it cannot distribute to the members without paying the charged member’s creditor. In a single-member LLC, the sole member loses access to cash flow through distributions; payments dressed up as something else may expose the manager to liability. In a multi-member LLC, a charging order against one member can frustrate the others, and disproportionate distributions to non-debtor members invite challenge as a creative avoidance of the order.

The second is commingling. The trust with a single settlor presents a clean set of facts for analyzing a fraudulent transfer. A multi-member LLC is a harder puzzle: capital contributions and loans are commingled in one enterprise, which may invite the adventuresome creditor to attach assets no debtor-member ever owned — a claim pressed against the company itself, or even against non-debtor members.

No single entity in a single jurisdiction accomplishes every planning goal. The laws vary by jurisdiction and by entity type, and each answers some objectives while failing others. The discipline lies in matching the instrument to the objective — frequently by combining a trust and an LLC across more than one jurisdiction — rather than searching for one vehicle to do everything.

The trust answers the fraudulent-transfer creditor in a leading jurisdiction that recognizes no charging order and no Mareva relief; the LLC answers the charging-order creditor with a business-purpose defense that a gratuitous transfer to a trust cannot assert. Prospective settlors and members are cautioned that the summaries above describe legislation containing important limitations and exceptions, and that definitive advice requires qualified counsel. The right plan, more often than not, uses both.