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Since our legal system provides very little downside for filing a frivolous lawsuit, we can expect this problem to get worse before it gets better.
One would have had to have been stranded on an island for the past 20 years to miss the evolution of lawsuits in this country.
Fast-food coffee too hot or a psychic suing because she lost psychic ability after a CT scan are two examples. The list would cover pages. The resounding theme in all of these court cases is that someone is looking to make someone else responsible for some real or perceived injury, loss or trauma. Since our legal system provides very little downside for filing a frivolous lawsuit, we can expect this problem to get worse before it gets better.
Once an event occurs that ultimately leads to a lawsuit, the window of opportunity for protecting assets closes.
Most lawsuits would never have been filed if the likelihood of recovery had been small. Very few attorneys would file the lawsuit when working on a contingency basis. They simply would allocate their time to a better prospect.
What is asset protection?
Many people mistakenly believe that asset protection is as simple as putting assets in your spouse's name.
This strategy actually affords little to no protection and may leave the asset owner with a false sense of security.
In general, asset protection involves using the avenues afforded by the laws of the various 50 states, the federal statutes and the laws of foreign countries to protect assets. For example, many of the states (for example, Florida) offer some level of exemption from lawsuits for the primary residence and for life insurance. Likewise, federal statutes exempt pension plan assets.
Asset protection is graded on a scale of -5 to +5. Owning an asset in one's own name would be a -5. Owning an exempt asset like life insurance or a pension would be a +5. Experts rate joint ownership only slightly higher than the -5 given individual ownership.
Categories of asset protection
Generally, asset protection strategies can be classified into the categories of exempt, onshore and offshore.
As discussed above, some or even all of the primary residence may be exempt from lawsuits. Further federal laws exempt ERISA plans from lawsuits in order to protect the pension plan participants. Likewise, various states exempt some or all of the cash value and or death benefit of life insurance. The list of exempt assets available in any particular state is beyond the scope of this article. However, the authors strongly advise that legal counsel knowledgeable in asset protection in the state in question be consulted.
Onshore involves any domestic strategy designed to protect assets that does not include exempt assets. The most common of onshore strategies include limited liability companies (LLCs) and trusts.
For example, creating a single-member LLC and transferring investments to it would afford better protection than owning the assets individually.
Due to recent court cases that have called into question the effectiveness of single-member LLCs, multiple-owner LLCs appear to offer a stronger level of protection.
The main reason for the increased asset protection afforded by LLCs is that most jurisdictions only provide a charging order as the means of recovery. Should a charging order be awarded against the defendant's LLC, the managing member of the LLC would be required to redirect any distribution for the benefit of the defendant to the holder of the charging order. Since the charging order does not require any distributions to be made, the managing member would normally forego distributions. If the LLC is taxed as a flow-through entity such as a partnership or S-corporation, the holder of the charging order would get the K-1 instead of the defendant. This creates an interesting situation in which the defendant (who may also be the managing member) can effectively make the plaintiff pay taxes on the LLC's income while giving no distributions.
Likewise, properly setting up an irrevocable trust and transferring assets to it would result in a very high level of protection unless the court ruled that the assets actually were under the control of the grantor.