Protecting Assets Requires Plan

Colorado Real Estate Journal, July 4, 2001

Asset protection planning is a strategy, using traditional business planning, estate planning, and tax planning techniques, that is intended to preserve family wealth for the use of family members by placing assets out of the reach of creditors whose claims arise after the transfer. To work as intended, an asset protection plan is implemented when it is not needed, that is to say, when there are no claims. A "claim" is any right to payment, whether or not reduced to judgment, and whether or not it is liquidated, matured, disputed, secured, legal or equitable. Unfortunately, people often don't think of sheltering assets until it is too late.

The Colorado Uniform Fraudulent Transfers Act, §38-8-101 et seq. ("CUFTA") provides that certain transfers and obligations are "fraudulent." In this context, "fraudulent" does not mean "fraud" in the criminal or tort sense, but that the transfer is not valid as to a creditor, and may be set aside, making the asset available to satisfy the claim. A transfer made or obligation incurred with actual intent to "hinder, delay or defraud" a creditor is fraudulent. In addition, a transfer made or obligation incurred without adequate consideration is fraudulent if it is made under one of the following conditions: (1) the debtor is left with unreasonably small assets for a transaction or for the business in which the debtor is engaged, or (2) the debtor intended to incur, or believed he or she would incur, debts exceeding the debtor's ability to pay, or (3) the debtor was insolvent at the time or became insolvent as a result of the transfer or obligation. Only current creditors whose claims exist at the time of the transfer may set aside transfers under (3) in the preceding sentence. Both present and future creditors may set aside transfers described under (1) and (2). Certain transfers to "insiders" may also be challenged by both current and future creditors.

Asset protection has a rather unsavory reputation, sometimes deservedly so, but the concept of limited liability is neither new nor disreputable. If I own stock in Ford Motor Company I can reasonably expect not to have to pay my share of a massive Ford Explorer recall. My investment in the stock may become worthless at some point, but my other assets would not be affected by a "worst case" outcome of my investment in Ford. The principle of limited liability is one of the cornerstones of asset protection planning.

Another legal principle that aids asset protection planning is the concept of exemptions. Under both federal bankruptcy law and state law, certain classes of property are not available to satisfy the claims of creditors. Although most exemptions are evidently intended only to assure a minimum standard of living and continued ability to earn a living, most states recognize at least one category of asset that is exempt in an unlimited amount, and many states afford extremely generous exemptions. Often, though not always, converting or "transmuting" assets from nonexempt forms to exempt forms will be successful, even if they violate CUFTA, because the social value of not making people and their families destitute "trumps" the laws giving creditors access to property in satisfaction of claims.

All real property in Colorado occupied as a home by the owner or his or her family is exempt from execution and attachment arising from any debt, contract or civil obligation up to forty-five thousand dollars ($45,000) actual cash value in excess of any liens or encumbrances. The exemption is routinely waived in voluntary encumbrances and with respect to the homeowners association assessment lien for common interest communities. The waiver does not operate for the benefit of other creditors. A judgment lien does not attach to a homestead until there is at least $45,000 in equity.

Pension plans and retirement plans in Colorado present attractive asset protection possibilities. The exemption took effect May 1, 1991 and covers "property, including funds, held in or payable from any pension or retirement plan or deferred compensation plan" whether or not payments are currently being made. §13-54-102(1)(s), C.R.S. Unlike some states, which have a dollar limit on the exemption or restrict the exemption to an amount "reasonably necessary" for the support of the debtor or his or her dependents, Colorado does not impose any limits. The exemption appears to cover all kinds of annuity contracts, even private ones, and all kinds of deferred compensation plans, whether or not they are ERISA-qualified plans.

Contributions to State College Savings plans under Section 529 of the Internal Revenue Code are now exempt under the Bankruptcy Reform Bill if they do not exceed the maximum allowable contribution and were made at least 720 days before filing. Contributions up to a limit of $5,000 made fewer than 720 days but at least 375 days before filing are also protected.

Sometimes clients attend asset protection seminars and decide they should put their IRA, their house, and all their bank accounts into an offshore trust. There is no "one size fits all" asset protection plan, but competent advisors will advise against violating CUFTA, transferring assets that are exempt already, or spending more money on the plan than it is worth. A lot of "asset protection" can be achieved simply by buying more liability insurance, which is often quite inexpensive. Another simple strategy is to separate the assets of a business (such as the land and building) from the liability-generating activity (the factory or other business that occupies the building.) This can be done by using a sale-leaseback structure. Further protection can be achieved by borrowing money secured by the lease payments, either from a private lender, such as a family member, or an institutional lender. Another simple strategy is to use a family limited partnership. The creditor can only get a charging order to be paid any distributions owed to the judgment debtor, and has no ability to acquire an interest the assets of the partnership.