Choosing the Right Entity for Asset Protection

We frequently encounter the same two questions posed to us by both lawyers and their clients:

  1. Which entity is best for asset protection?
  1. Which jurisdiction is best for an asset protection entity?

Answering these two questions properly requires that we first define several key terms both to identify planning objectives and to define success.

Asset Protection:      “Asset protection” is a term used to describe legal planning that shields a client’s assets from the unanticipated claims of creditors.  Asset protection planning employs any number of techniques in isolation or in conjunction to achieve this objective.

Asset Protection Planning:  A competent asset protection plan assumes that, at some point in the future, the client may be in some form of legal jeopardy obligating the client to account to his creditor those assets that are within the client’s control.  Therefore, most asset protection planning techniques incorporate the separation of client control from the assets being protected.  The predominant theory is that what a client does not own or control cannot be delivered to the creditor.

Success:  Perhaps the most controversial aspect of asset protection planning is determining whether a plan has succeeded.  Technically, if a client’s debt of $1,000,000 is resolved for $999,999 as a result of an asset protection plan, the plan has worked to some small degree.  We suggest that success should take into account both tangible and intangible factors, including (i) the amount by which the creditor’s claim compares to the cost of implementing the asset protection plan and (ii) the degree of client comfort and control achieved through the asset protection plan.

At Lighthouse, we are known for a set of principles that guide us in asset protection planning.  Two of those principles are:

  • No asset protection jurisdiction is necessarily superior to another; each jurisdiction has its own comparative advantages and disadvantages.
  • No single asset protection planning technique is appropriate for all forms of assets; different assets require different solutions.

In evaluating the suitable jurisdictions for asset protection trusts, we consider a number of factors, including several mentioned throughout this article.  We are not beholden to a single jurisdiction but offer our clients the freedom and flexibility to select the jurisdiction that works best for them, including those in which Lighthouse is a licensed trustee.

The History of Asset Protection – Offshore Trusts

For generations, families have used foreign trusts to protect assets from creditors, relying on foreign law or the foreign legal climate, or a combination of both, to serve 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 the 1859 decision of Corlett v. Radcliffe, held that fraudulent transfer claims would be handled on a facts-and-circumstances basis and that future unanticipated creditors could not set aside a transfer in trust made when the debtor was solvent.  Corlett v. Radcliffe was reaffirmed as recently as 1999 in the case of In re: Heginbotham, again affirming that transfers made when solvent cannot be set aside when the debtor later becomes insolvent.

Asset protection trust law in the Isle of Man is based on common law (i.e., “judge-made law”).  Over the past 30 years, several countries as wells as American states have attempted to replicate the perceived certainty in trust planning in the Isle of Man.  Jurisdictions such as Belize, the Cook Islands, Nevis, and Anguilla have enacted trust laws meant to codify certain common law principles emanating from the Isle of Man, or to offer their own particular limitations on creditor claims.  This inevitably leads to comparisons among jurisdictions as to which country has the better asset protection trust law.

Fraudulent Transfers & the Asset Protection Trust

It is important to understand how fraudulent transfer laws work, and how the asset protection trust has developed as a method for cutting off fraudulent transfer liability.  The law of fraudulent conveyances developed in England as a set of statutes known as the Statute of 13 Elizabeth in 1571. At the behest of deep-pocketed banking interests, England’s Parliament enacted a law criminalizing fraudulent transfers, awarding half the value of the transfer to the creditor and the other half to the crown.  English courts, however, chose instead to interpret the statute as providing a private remedy, giving the creditor the ability to ignore the transfer and proceed directly against the property.  While English law evolved over the generations to eventually disband the practice of criminalizing fraudulent transfers, the pro-lender bias of the Statute of 13 Elizabeth persists in modern fraudulent conveyance law in many common law countries

A number of asset protection trust jurisdictions have modified their fraudulent transfer laws to confer greater protection on transfers to asset protection trusts registered locally.  These revisions typically incorporate one or more of the following:

  • The period during which the creditor must bring a claim is significantly curtailed.
  • Transfers made before the creditor’s claim arose are protected.
  • Transfers made after a certain period of time (e.g., two years in the Cook Islands, one year in Nevis) are protected.
  • ”Actual intent” fraudulent transfers must be established by direct evidence rather than anecdotally (e.g., such as through consideration of the “Badges of Fraud” under the Statute of 13 Elizabeth).
  • ”Constructive intent” fraudulent transfers are not recognized.
  • The burden of proof lies on the creditor, who must prove a fraudulent transfer beyond a reasonable doubt.
  • A prospective creditor must post a bond prior to bringing a claim against a trust.
  • Foreign judgments are not recognized.
  • Creditor remedies may be limited to setting aside whatever property is left from the original transfer.

Modern Challenges to the Asset Protection Trust

We have said many times that asset protection trusts have the potential to become the victim of their own success.  As more and more jurisdictions enact APT laws, and as more families engage in asset protection planning to guard their wealth, creditors and the judiciary will innovate to disrupt traditional APT planning practices.

Mareva Injunctions

One such line of attack used with offshore APTs is the Mareva injunction.  Named after a famous 1975 ruling in the United Kingdom, Mareva Compania Naviera SA v International Bulkcarriers SA, 2 Lloyd’s Rep. 509 (1975), the Mareva injunction is a form of “temporary restraining order” that freezes trust assets pending the outcome of a trial.  The Mareva injunction permits a creditor to obtain a court order freezing assets of an asset protection trust.  Once the trust assets are frozen, the trustee and the trust settlor often do not have the financial resources to challenge the creditor’s action in court, meaning that the creditor has won the war without ever having to go to battle.  Therefore, it is important to consider whether the jurisdiction used for APT planning entertains Mareva injunction requests.

Some APT jurisdictions, such as the Cook Islands, recognize the Mareva injunction.[1] By comparison, Belize and Nevis have precluded this risk by eliminating this form of creditor remedy altogether.  See SEC vs. Swiss Trade and Commerce Trust, Ltd., Banner Fund International, Lloyd Winburn et al. (Belize Sup. Ct. 1994); Nevis International Exempt Trust Ordinance, Cap. 7.03 § 23(9) (2015).

Gratuitous Transfers

Another line of attack focuses on the inherent weakness with any asset protection trust:  Transfers to a trust are, by their very nature, gratuitous transfers.  A creditor bringing a timely claim can set aside the transfer under the Uniform Fraudulent Transfer Act, the Federal Bankruptcy Act, and other Federal and state laws governing transfers for no consideration.  For this reason, we have always considered domestic asset protection trusts to be folly and have advocated that asset protection trusts only be established offshore.

Consistent with these concerns, one recent court ruling is likely to bring an early end to the use of domestic asset protection trusts as well as impact the popularity of offshore trusts.  In Kilker v. Stillman,[2] the California Court of Appeal for the 4th District ruled that transfers made to a Nevada asset protection trust were per se fraudulent transfers in respect of a future creditor not anticipated at the time the trust was funded.  A similar finding was made in a Colorado bankruptcy case, In re Kendall,[3] where the court cited the debtor’s establishment of a Cook Islands trust as evidence of actual intent to defraud a creditor.

Paper Trusts

A trust that is formed on paper and never properly funded is often described in the asset protection trust industry as a “paper trust.”   Oftentimes, jurisdictions that are historically known for serving as havens for asset protection trusts are utterly devoid of the capability to custody trust assets.  While no one factor is determinative of the “best” jurisdiction for asset protection planning, financial infrastructure is of utmost concern.

The discerning creditor knows how to pick apart a paper trust and seize assets.  At commercial litigation conferences, attacking APTs – both domestic and offshore – is a popular topic, and many lawyers offer their skills and experience to guide creditors in pursuing APT assets.  The competent asset protection plan should take into account the practical ability of the foreign trustee to gain custody of trust assets and properly situate them in the trust jurisdiction.

Asset Protection Using LLCs

Limited liability companies (“LLCs”) have become popular asset protection planning devices in the United States and other jurisdictions for a variety of reasons.  There are two prominent features of an LLC most frequently cited as reasons for their asset protectiveness:

  1. The dissociation of ownership from control of LLC assets; and
  1. The limitation of creditor remedies to a charging order.

Dissociation of Ownership from Control of LLC Assets

In an LLC, there are members and there are managers.  A member has rights of an owner of the LLC, much like a shareholder in a corporation.  A manager, by contrast, has the rights and duties of a business manager.

A manager does not have any right to ownership of the LLC assets by virtue of his or her title as manager.  Likewise, a member has no right to manage the affairs of the LLC unless the member is named as a manager. A client seeking to protect assets may contribute them to an LLC in exchange for a membership interest, while engaging someone else (such as a professional management company in an asset protective jurisdiction) to act as the manager of the LLC.

The Charging Order Remedy

Most LLC jurisdictions provide that a judgment creditor may obtain by court process a charging order in respect of a member’s interest in an LLC.[4]  These same statutes generally describe the charging order remedy in terms that are substantially identical to the rights of an assignee of a membership interest.

For example, a charging order may only permit the creditor to receive distributions otherwise destined for the member.[5] In most jurisdictions, the creditor is not permitted to interfere with the LLC’s management or obtain direct recourse against the property of the LLC, much less compel a distribution.[6]

Asset Protection Evolved:  Offshore LLC Legislation

Beginning with Nevis in 1995, several offshore jurisdictions known for their APT legislation have implemented complimentary LLC legislation, including Belize and the Cook Islands.  These jurisdictions offer a number of modifications to standard LLC law found in the United States so as to make their local LLC legislation more asset protective:

  • Creditors of a member are limited to a charging order.
  • Charging orders sunset after a period of time and are non-renewable.
  • The period during which the creditor must bring a claim is significantly curtailed.
  • Transfers made before the creditor’s claim arose are protected.
  • Transfers made after a certain period of time (e.g., three years in in Nevis) are protected.
  • ”Actual intent” fraudulent transfers must be established by direct evidence rather than anecdotally (e.g., such as through consideration of the “Badges of Fraud” under the Statute of 13 Elizabeth).
  • ”Constructive intent” fraudulent transfers are not recognized.
  • The burden of proof lies on the creditor, who must prove a fraudulent transfer beyond a reasonable doubt.
  • A prospective creditor must post a bond prior to bringing a claim against a trust.
  • Foreign judgments are not recognized.
  • Creditor remedies may be limited to setting aside whatever property is left from the original transfer.

Challenges with the Asset Protection LLC

While the asset protection LLC is sound on paper, there are several practical limitations that need to be considered before implementing such a structure.

Charging Order Paralysis

In those jurisdictions that limit a member’s creditor to a charging order, the LLC is protected from creditor interference and may continue to operate.  However, the LLC cannot make distributions to the members without payment to the member’s creditor under the charging order.  In a single-member LLC, this means that the sole member does not have access to cash flow from the LLC through distributions.  While other avenues for cash may be available (e.g., a salary), payments construed as disguised distributions may entail liability for the LLC manager.  LLC managers may therefore be extremely reluctant to consider any form of payment during the pendency of a charging order.

In the context of a multi-member LLC, a charging order against one member may frustrate the ability of other LLC members to gain access to cash.  If distributions are to be made proportionately among LLC members, this can create tension with a debtor-member who does not want distributions to be made while a charging order is pending.  Moreover, disproportionate distributions to non-debtor members may be challenged in the U.S. courts by creditors who view such distributions as creative avoidance of their charging orders.

The limitations presented by a charging order to members of an LLC should be compared with similar proceedings in which a trust is involved.  In leading offshore APT jurisdictions, creditors have no remedy in the form of a charging order and must instead resort to a fraudulent transfer claim against the trust itself.  Alternatively, the creditor may rely on a garnishment order against trust beneficiaries back in the USA.  Absent fraudulent transfer liability in the APT jurisdiction, the trustee remains free to apply the assets of the trust to benefit trust beneficiaries, helping to minimize the impact of any garnishment order.

Liability for Commingling

The trust with a single settlor presents a straightforward sets of facts for analyzing fraudulent transfers.  A multi-member LLC provides a more complex puzzle, where capital contributions and loans to the LLC are commingled in one large business entity solution.  The consequence may be to invite the adventuresome creditor to attach LLC assets to which no debtor-member has ever claimed ownership.  The creditor may bring this claim against the LLC itself or even against non-debtor LLC members.

Comparison Chart

With so many options to consider in asset protection planning, we have prepared the following chart to help compare jurisdictions and entities. Please keep in mind that the summaries listed below attempt to define the impact of legislation containing important limitations and exceptions which exceed the scope of a chart.  Prospective trust settlors and LLC members are cautioned to consult with qualified counsel for definitive advice.

 

Belize Trust Belize LLC Nevis Trust Nevis LLC Cook Islands Trust Cook Islands LLC Advantage
How long does a creditor have to set aside a fraudulent transfer? Fraudulent transfer claims not recognized against a Belize trust Capital contributions cannot be challenged as fraudulent transfers; one year from LLC formation for all other transfers; two year statute of limitations One year fixed window; transfers in trust before, or more than one year after, creditor’s cause of action arose are protected Three year sliding window:  transfers in trust before, two years after, creditor’s cause of action arose are protected; transfers within two years require creditor to bring claim within one year Three year sliding window:  transfers in trust before, two years after, creditor’s cause of action arose are protected; transfers within two years require creditor to bring claim within one year No limit; Statute of 13 Elizabeth applies Belize Trust
Must a creditor post a bond in order to sue the entity in local court? N/A – no creditor claim recognized Yes – Greater of BZ $50,000 or 50% of claim amount Yes – EC $270,000 Yes – EC $100,000 No bond is explicitly required, but a court may request a bond No Belize LLC
Are foreign judgments enforceable against the transferor or entity? No No as against the member; no as against the LLC. Yes as against the settlor; no as against the trustee. Yes as against the member; no as against the LLC. Yes as against the settlor; no as against the trustee. Yes as against the member; no as against the LLC. Belize Trust or Belize LLC

 

 

Belize Trust Belize LLC Nevis Trust Nevis LLC Cook Islands Trust Cook Islands LLC Advantage
What remedies may a creditor obtain against the entity? None Charging order against debtor-member’s interest; judgment against the trustee for a fraudulent transfer – return of contributed property. Judgment against the trustee for a fraudulent transfer – return of trust property. Charging order against debtor-member’s interest; judgment against the trustee for a fraudulent transfer – return of contributed property. Judgment against the trustee for a fraudulent transfer – return of trust property. Charging order against debtor-member’s interest; judgment against the trustee for a fraudulent transfer – return of contributed property. Belize Trust
Is the entity protected from a party acting under duress? No Yes Yes No No No Belize LLC or Nevis Trust
Are transfers to the entity per se fraudulent under the Uniform Fraudulent Transfer Act or Federal Bankruptcy Law? Yes under U.S. law – Kilker v. Stillman No Yes under U.S. law – Kilker v. Stillman No Yes under U.S. law – Kilker v. Stillman No Belize LLC, Nevis LLC, or

Cook Islands LLC

 

 

Belize Trust Belize LLC Nevis Trust Nevis LLC Cook Islands Trust Cook Islands LLC Advantage
Can a creditor obtain an order from the local court freezing the assets pending the outcome of a hearing? No No No No Yes Yes Belize Trust, Belize LLC, Nevis Trust, or Nevis LLC
Is there a substantial non-asset-protective business purpose for transferring assets to the entity? No Yes No Yes No Yes Belize LLC, Nevis LLC, or

Cook Islands LLC
Can the entity be used to transfer assets to family members at death? Yes Yes Yes Yes Yes Yes –
Can the client manage the assets of the entity? No Yes No Yes No Yes Belize LLC, Nevis LLC, or

Cook Islands LLC

 

 

Belize Trust Belize LLC Nevis Trust Nevis LLC Cook Islands Trust Cook Islands LLC Advantage
Must the client engage the services of a local fiduciary to manage the assets of the entity? Yes No Yes No Yes No Belize LLC, Nevis LLC, or

Cook Islands LLC
May the entity gain access to Swiss banking facilities? Yes Yes Yes Yes Yes Yes –
Is there a sunset on charging orders or judgments? N/A – no creditor claim recognized No No Yes – Three years, non-renewable No Yes – Five years, non-renewable Belize Trust, Nevis LLC, or Cook Islands LLC
Can the entity be used to effect asset transfers to family members at valuation discounts for transfer tax purposes? No Yes No Yes No Yes Belize LLC, Nevis LLC, or

Cook Islands LLC

 

 

Belize Trust Belize LLC Nevis Trust Nevis LLC Cook Islands Trust Cook Islands LLC Advantage
Can the trustee/LLC manager apply assets while a judgment or charging order is pending against a trust beneficiary/LLC member? Yes No Yes No Yes No Belize Trust, Nevis Trust, or Cook Islands Trust

Analysis

The foregoing chart demonstrates the challenge of selecting one type of entity in one particular jurisdiction to accomplish asset protection planning goals.  Not only do the laws vary among jurisdictions and entity types, but no one jurisdiction or entity can serve as a complete solution for every possible asset protection planning goal.  We can, however, infer the following from the above chart:

  • Belize and Nevis for Trusts: Belize offers blanket protection against fraudulent transfer claims. While Nevis offers creditors an incredibly narrow window to set aside a fraudulent transfer, the procedural hurdles and protective rules under Nevis’ recently-amended trust law offer even greater protection in some cases.
  • Belize for LLCs: Not only does Belize not recognize foreign judgments, but they require the creditor to post a bond of 50% of the claim amount. Nevis is a close second with its 2015 amendments.
  • Trusts Are Better in Foreign Litigation But Not Domestic Litigation: Transfers to an offshore APT are likely to be characterized in a U.S. court as “per se” fraudulent. However, trustees can pay the debtor’s bills when asset protection LLCs would be tied up by a charging order.

FOOTNOTES

[1] See Bank of America v. Brian Weese et al., Case No. 03-C-01-001892 (Cir. Ct. Baltimore County) (2001).

[2] 2012 WL 5902348 (Cal.App. 4 Dist., Unpublished, Nov. 26, 2012).

[3] 2013 WL 1890660 (10th Cir.BAP, Unpublished, May 7, 2013).

[4] See, e.g., 6 Del. Code § 18-703(a) (Delaware law on charging orders).

[5] Id.

[6] See:  6 Del. Code § 18-703(e); BILLC Act § 57.