Asset Protection for Real Estate Professionals

Colorado Real Estate Journal, May 7, 2003

Asset protection is a component of a carefully structured risk management program. Risk management includes making business decisions in such a way as to assure a positive outcome, carrying adequate insurance, implementing training programs and other procedures to manage risk (fire drills would be a good example of this, or continuing professional education), devoting adequate human and monetary resources to a particular venture, and performing appropriate strategic planning and disaster planning to prepare for, minimize, and address potential risks.

The best advice on asset protection is to do it early, don't overdo it, and do it for some reason other than creditor protection per se. That is not to say that a plan that involves transferring assets into a trust that has no reason for existing other than asset protection would not be an effective asset protection tool; done right, it would work. For that matter, even if a transfer is contrary to the fraudulent conveyance law, it is not a tort or a crime, it's just a transfer that could be set aside by a protected class of claimants. Whether or not they would try is another question entirely.

Under the Colorado Uniform Fraudulent Transfer Act ("CUFTA"), a transfer is voidable if: it is made with actual intent to hinder, delay or defraud present or future creditors or if it is made without receiving reasonably equivalent value in exchange for the transfer and the debtor was engaged in or was about to engage in a business or transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction, or if reasonably equivalent value was not given and the debtor intended to incur, or believed, or reasonably should have believed, that he would incur, debts beyond his ability to pay as they become due.

Real estate can be the subject of a number of asset protection strategies, and it often is, even without a deliberate plan. Real estate lawyers routinely structure transactions so that individual real estate assets are isolated into separate entities, with the investors' other assets shielded by limited partnership and limited liability company law. Assuming no piercing of the veil, this is a simple and almost always effective way to protect the other assets of the property owners. In addition, the constructive notice afforded by the recording statute is a helpful benchmark for when the creditor should have known about a real property transfer, starting the statute of limitations, which can help with the "do it early" tactic.

There are four basic strategies for avoiding liability: secured debt, third-party ownership, exemption, and foreign haven. Used alone or in combination, liability can be avoided if the debtor is willing to accept the consequences of doing so, and if the situation is not so extraordinary as to give enforcers an extra "edge" for their efforts. For example, the "Exxon Valdez" was owned and operated by Exxon Shipping Company, a $100,000,000 subsidiary of Exxon Corporation. Theoretically, the 9 billion dollars of liability for that disaster could have been confined to the shipping company and its 100 million dollar net worth. But within 24 hours of the spill, Exxon Corporation said it would take full responsibility. To do otherwise would probably have been futile, and almost certainly would have made matters worse for Exxon.

The secured debt strategy is simply a matter of over-leveraging. It creates a situation where there is no property available to pay unsecured debt. Liquidating a debtor is theoretically possible for an unsecured creditor, but, since all the money would go to the secured creditors, it would be a waste of time and money. If the sum of all debts, including that owed to the judgment lien creditor, exceeds the value of the assets, then there is nothing to satisfy the judgment. If the strategy fails for some reason in state court, the debtor can file for bankruptcy protection, and it will succeed in bankruptcy. Many businesses use this strategy without even knowing it. They just call it "financing."

Ownership strategies separate ownership of the assets from the activities that generate liability. The liability-generating entity is sparingly capitalized, and the asset-owning entity does not engage in activities that expose it to liability. This can be combined with securitizing, or leveraging, assets. This has the added advantage that the owners of the operating company and the investors who purchased shares in the asset-owning entity can be completely different. Any income-producing asset can be securitized: office buildings, shopping centers, accounts receivable, leases, management contracts, etc. Any asset can be sold to a separate entity, then leased back. The income stream from that lease makes the asset an income-producing asset, which can then be securitized. If it isn't a sham, and real value is given, the unsecured creditors cannot reach it.

The strategy of converting non-exempt assets into exempt ones is an effective asset protection tool, especially if it is done early and in the ordinary course of the debtor's life. The exemption laws reflect a policy decision to make sure that, no matter what, a debtor will not become absolutely destitute and unable to make a living. Different states have different exemption policies and laws, but most have at least one category of asset with no cap on how much the exempt asset is worth, or what percentage of the debtor's estate it represents. In Colorado, retirement plans and pension plans of all kinds, not just "qualified plans," are exempt from foreclosure by a judgment lien creditor, and there is no limit on the amount.