Expanded Worldwide Planning Stories – Continuation
Asset Protection – Part 3
In our asset protection story, Part 3, we learn that Janice Johansen’s advisor for her captive insurer had given over too much responsibility to the captive manager. The captive insurer was woefully underfunded, and would not be able to pay a liability claim for the horrific accident that occurred at one of Janice’s wine shops. This leaves Janice’s $100M profit from the sale of her wine shops as the most likely source of funds to pay the claim.
In our article we discuss the history of trusts, and how trusts are used in asset protection planning. At EWP Financial we employ asset protection as an integral part of each EWP Asset Structure that we create. This asset protection is not something added that involves greater cost and complexity, but it is firmly embedded in the design of a comprehensive EWP Asset Structure.
Creditors vs. Debtors
Historically trusts were employed to shield assets from excessive taxation, unreasonable claims of creditors, and bankruptcy. Trusts were developed in England originally to minimize the impact of inheritance taxes arising from transfers at death. The essence of the trust was to separate “legal” title, which was given to someone to hold as “trustee”, from “equitable title”, which was to be retained by the trust beneficiaries.
In both Roman times and as early as the 14th century in England, the use of trusts to shield lawful claims of creditors was recognized as a practice not conducive to sound public practice. Today we called it fraudulent conveyance.
The Romans utilized a type of trust known as a fidei commissum, which facilitated the transfer of assets at death. The Romans were also aware of the abuses of trust that went against public policy. Their great legal scholars Ulpian and Gaius developed the basic framework for the fraudulent conveyance laws as we know them today.
In England in the late 14th century, two laws were enacted that aimed to end popular types of fraudulent conveyance that were then in practice. One law sought to prevent debtors from conveying their lands to their friends until their creditors had come and gone away. Another law sought to end the practice of temporarily conveying their lands to “Lords and other great Men of the Realm” so as to deter creditors.
Another key component to our own asset protection laws are spendthrift clauses. A spendthrift provision creates an irrevocable trust preventing creditors from attaching the interest of the beneficiary in the trust before that interest (cash or property) is actually distributed to him or her.
These spendthrift provisions first became popular in the U.S. in the 19th century, and were controversial. Not just a few commentators thought that spendthrift clauses were a very bad idea. John Chipman Gray, a Harvard Law Professor whose half-brother (Horace Gray) was a U.S. Supreme Court Justice, registered his objections this way:
“The general introduction of spendthrift trusts would be to form a privileged class, who could indulge in every speculation, could practice every fraud, and, provided they kept on the safe side of the criminal law, could yet roll in wealth. They would be an aristocracy, though certainly the most contemptible aristocracy with which a country was ever cursed.”
Notwithstanding such objections, the spendthrift trust, of course, survived and thrived in U.S. law.
Yet, such trusts had their limitations; for example, some states carved out exceptions for creditors holding judgments for unpaid alimony and child support. By far the biggest restriction was against spendthrift trusts which were self-settled trusts. That great commentator on trust law, George T. Bogert, firmly believed that the spendthrift provisions of self-settled trusts were unenforceable against public policy, and wrote:
“To hold otherwise would be to give unexampled opportunity to unscrupulous persons to shelter their property before engaging in speculative business enterprises, to mislead creditors into thinking that the settlor still owned the property since he appeared to be receiving its income, and thereby work a gross fraud on creditors who might place reliance on the former prosperity and financial stability of the debtor.”
In the late 1980s in the U.S. most legal practitioners were in agreement that spendthrift clauses could protect the rights of beneficiaries of trust, but you could not create a trust that exempted your assets from creditors, a self-settled spendthrift trust.
This leads us to our last segment of our EWP Drama or play of opposites.
The gleaming, antiseptic surfaces in combination with the glare of the fluorescent lights gave Brian a sharp inner chill. Not the chill of cold on his body, but an aching chill in the pit of his stomach. He was about to face the unintended victim who might be the cause of his client’s demise, and his own firing from a lucrative client of his firm.
Several years ago under Brian’s direction, he had helped establish a captive insurance company for Janice. This self-insurance vehicle both saved premium dollars on their current policies, and reduced the company’s taxes. It was a smart decision at the time.
He now realized he had poorly monitored the captive insurer, giving responsibility over to the captive manager. Under the manager’s advice they had established the captive in a state that had minimum capital requirements, and funded the company with minimum surplus requirements. The company’s ability to pay a liability claim for Steve’s fall was wholly inadequate.
Because the captive had been established, Brian advised that they cancel their General Liability and Excess Liability insurance policies. To make matters worse, there was also scant legal defense to mount for the negligent behavior of the store clerk.
Where were the funds to pay for this horrific accident? How would Janice react when he told her that the $100M buyout money would have to be used? He did not want to be anywhere near her when she found out.
Brian’s leather-soled shoes slide at each step along the highly polished floor. He had been directed to a special unit of the hospital, a section that housed patients who needed extreme monitoring after leaving the ICU. Steve was diagnosed with severe traumatic brain injury (TBI), and was in a coma.
On both sides of the hospital bed were the machines that told doctors and nurses that Steve was alive. Digital displays and electronic beeps that would erupt into loud piercing alarms, if his vital signs went wrong. What was now Steve seemed like a frail, foreign object amidst this array of electronic equipment. A very slight rise and fall of the bed cover gave evidence of life.
TBI victims go through definite stages: coma, vegetative stage, minimally conscious state, and post-traumatic confusional state. They might not progress at all from one stage to the next. Each patient was different.
Steve might never emerge from the coma, be impaired, or be severely impaired.
Brian had seen enough. It was now time to prepare himself to be fired, and be further away from becoming a partner at his firm. He had hoped to achieve this in the next year, now that was definitely out of the question.
As he turned out of the hallway to the main entrance of the hospital, he thought he saw an older couple and a tearful younger one entering Steve’s room. Most probably they were his parents and his girlfriend. Meeting them would have been beyond his current emotional state. He had royally messed up. At least he accepted responsibility, and did not try to blame others. There was no one else to blame.
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by Michael Malloy, CLU TEP RFC.
CEO, Founder @EWP Financial
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