Lawsuit boom pushes people into protecting assets

The Associated Press recently reported on how the increased amount of lawsuits being brought against doctors, accountants, business executives and other professionals has prompted a many people to go on the defensive by putting their money where creditors can’t get to it.

A key technique being used is the asset protection trust. The idea is to put a big amount of your money into an irrevocable trust, which in turn is run by an independent trustee, who may opt to give you payments from time to time. If properly set up, this trust — which has to be located in a jurisdiction that has passed special laws — generally can’t be touched by creditors should you be sued or file for bankruptcy protection.

For a number of years now, doctors have been set up asset protection trusts to protect themselves from malpractice lawsuits. But with the latest round of corporate scandals and the passage of the Sarbanes-Oxley Act, which makes top executives and directors accountable for their company’s financial results, more executives are looking into asset protection trusts.

Currently, no one is tracking as the number of asset protection trusts being drafted each year, especially since many are located in exotic offshore jurisdictions. But both attorneys and trust companies are saying that interest in them seems to be increasing.

The majority of asset protection trusts are located offshore, in locales like the Cook Islands, Nevis and Gibraltar. These small countries have attracted sizable trust business because of the laws enacted by them to protect trusts from U.S. creditor claims.

However, the number of U.S.-based trusts is picking up as states change their laws, in part to lure people who worry about sending their wealth abroad. The states of Alaska, Delaware, Rhode Island, Nevada and, recently, the state of Utah, permit these trusts for residents and nonresidents alike. It’s been estimated that, since 1997, over 1,500 domestic asset protection trusts holding over $2 billion in assets have been created.

A key reason for this is the rise in malpractice insurance rates. For example, in the state of Florida, climbing premiums have forced many physicians in forgoing coverage altogether, and instead use other asset-protection techniques. An asset protection advisor from that state recently said that about 60 percent of his physician clients “go bare” and drop malpractice insurance because of the high cost and limited coverage of policies. This is a significant increase from 10 years ago, when only 20 percent of his clients practiced without insurance.

In a recent a survey of those having over $1 million in assets, it was found that 35 percent had some form of asset protection plan, compared with only 17 percent of respondents in 2000. And nearly 61 percent of the respondents who didn’t have an asset protection plan wanted one created, up from only 43 percent in 2000.

There is some controversy about domestic asset-protection trusts. This is mainly due to the fact that they haven’t yet been tested in court and it is still unclear how well they’ll hold up. Article IV of the of the Constitution states that each state should have “full faith and credit” in legal judgments made in other states. This makes attorneys worry that a plaintiff who wins a judgment in a New York court might be able to enforce the ruling against an asset protection trust created in Delaware.

People setting up asset protect trusts are strongly advised that they pay attention to avoid running afoul of the law. While creating an offshore asset protection trust sounds sketchy, they’re legal as long as they are not being used for income tax evasion; the assets and income in the trust have to be disclosed to the Internal Revenue Service.

Another caveat: No one should ever set up an asset protection trust knowing that they have a potential legal action looming on the horizon. The Courts will likely to rule against such a trust, known as a “fraudulent conveyance,” if it is initiated before a lawsuit, bankruptcy or divorce.

Domestic asset-protection trusts can also be used to ease estate taxes. Because you are giving your assets to the trust, the funds are out of your estate for estate-tax purposes. However, the trust can’t make payments to you on a regular basis, because doing so could possibly invite the scrutiny of the IRS.

Asset protection trusts don’t come cheap. To set up an average offshore asset protection trust costs anywhere between $20,000 to $50,000 to set up. Included with this is annual administrative fees of $2,000 to $5,000 and asset management fees of about 1 percent on the assets placed in the trust. Domestic asset-protection trusts cost less, running anywhere from $3,000 to $10,000 in attorney’s fees, plus asset management fees of roughly 1 percent.

Because of these high fees, asset protection trusts may not make sense unless someone is willing to put at least $1 million in them. However, a few financial service companies are catering to smaller trust accounts of around $500,000, which is very attractive to professionals who are beginning their careers.

If you would like more information regarding asset protection, trusts, family limited partnerships or the subject of this article please call or email our office.