The best protection - asset protection for the modest estate
The author records his grateful thanks to Michael Sullivan, a Toronto chartered accountant, who has made many helpful suggestions on the content of this article.
Offshore tax havens (as they used to be called) have an exotic ring. Before our first meeting, many of my new clients have read lots on the internet about offshore trusts; foundations; IBCs and, of course, long beaches, filled with pristine white sand. For those clients with net assets of less than USD2 million, the cost of offshore structuring may prove to be disproportionate. That said, many individuals do not care how much they pay, relative to the size of their estate, as long as a potential creditor cannot get their hands on their assets.
For the modest estate of a sensible client, much can be done to asset protect domestically, as part of a bona fide long-term business/estate plan.
Many clients will ask ‘what about transferring my house to my wife/husband/child/lover’. They ask this because their friend/drinking partner/former cellmate told them it was the best thing to do, and they know hundreds of people who made themselves judgment proof in this way. Are they correct? Well: ‘yes’ and ‘not quite’.1 Merely transferring title to the house to one’s spouse, on the eve of bankruptcy, will usually fail in its intended purpose of preventing the asset being clawed back by the trustee.2 That said, if such transfer is properly affected, well in advance of attack from creditors, it can be effective for the following reasons. Firstly, transfer to a spouse for ‘natural love affection’ is a recognised legitimate transaction – particularly where one spouse remains a homemaker. Secondly, most western jurisdictions provide for matrimonial property regimes that permit a ‘stay at home spouse’ to obtain a share, on divorce, of the estranged spouse’s assets. Generally, the putative share increases with the duration of the marriage. So, all things considered, an early transfer of house (or other assets), well ahead of problems with creditors, can be a successful asset protection device.
Provided a marriage (legal or common law) is stable, the matrimonial home should be purchased, at the beginning, on a joint tenancy. Absent further asset protection fine tuning, between purchase and bankruptcy, the trustee in bankruptcy is left trying to deal with one half share, with the spouse very much in residence. Some excellent bargains are to be had by the spouses of bankrupts, in purchasing their spouse’s former share off their trustee in bankruptcy.
Certainly, it is always open to a creditor or bankruptcy trustee to utilise tracing remedies to advance a claim to unscramble such property ownership regime. It will be open to them to contend that since the funds used to purchase, or maintain, the house in question derived from one spouse, then the other spouse, who has legal title, should hold it subject to a resulting or constructive trust. Yes, definitely possible, but… and a big but is: complexity and expense. For all but the most bitter and partisan creditor, cost is a weighty factor in deciding whether to proceed or settle. Once legal title is gone, a creditor faces a double hurdle to prosecute and collect. Most cases settle for this reason. Asset protection can never be absolute, but the more a creditor has to navigate an expensive obstacle course, the more likely they are to settle: for a much lower amount.
Other than transferring title to a house or other assets, thought should be given, where genuine debts exist, to secure them by mortgages or other charges or liens against your client debtor’s property. For example if the debtor is an employee of a family-owned corporation, it is conceivable that loans have been advanced to him. These could be secured by mortgage against his house, thus reducing his equity therein. If your client is a company, then its assets, be they machinery, receivables or cash in the bank, can be secured by floating charges, or other national or provincial variations. With many (often family) companies, one should question the wisdom of a company with assets being exposed in the ‘front line’ (trading). Multiple company structures, including a management company, that hold no assets, can effectively shield the corporate repository of wealth.
Family companies with substantial retained earnings and other liquid, or easily realisable assets, can become sitting targets for hostile litigants. Substantial borrowing on the security of company assets can remove the attractiveness as a target. At the high end of the scale of encumbrance, the process is known as ‘equity stripping’.
Unfortunately, professionals in many jurisdictions are not permitted to incorporate, or if they are, there are restrictions on the degree to which liability may be limited. Prudence dictates that before looking at any form of structuring, inquiry should be made as to adequacy of professional indemnity insurance. Many professional bodies seem to provide tacit encouragement and facilitation of complaints by the public. Such a climate is unlikely to change soon, so professionals should ensure that they have adequate indemnity insurance in place. Base cover is often insufficient in today’s litigious climate, so it may be worthwhile advising such clients to investigate enhancement.
Typically, a client will come in to see you and ask for, or expect to be ‘prescribed’, an offshore trust. When advised that their total wealth makes offshore structuring perhaps uneconomic, the rejoinder is frequently: ‘what about an onshore trust?’ The answer is a ‘yes’, but a qualified ‘yes’. Certainly, domestic trusts in which trustee and beneficiaries are resident onshore are widely used and can be a very effective means of asset protection. This is true in regard to protecting the assets of the settlor, as well as protecting the interests of minors, spendthrifts and disabled family members. On the negative side, one should remember that the actual disposition into trust may be attacked in the same way as transferring title to a house. Onshore trustees and protectors are always more easily controlled by courts in aggressive onshore jurisdictions. Generally, though, multi-generational discretionary trusts, established years previously, are much safer from attack than those more recently established.
Insurance and pensions
Life assurance and pensions are very valuable weapons in the asset protection armory. Their privileged position in the author’s home jurisdiction (Canada), and many others worldwide, comes as a result of the interaction of law and pragmatic morality. Symbolically, life assurance serves to protect widows and orphans. Pensions: to protect the aged living. In both cases, if the life assurer looks after such people, the state (meaning the rest of us) is relieved of the burden. Accordingly, in many jurisdictions, pensions and life assurance products receive substantial protection from creditors and trustees in bankruptcy. The societal preference that gave rise to such legislation was the exercise of a choice –the creditor loses or the rest of society has to pay. In those jurisdictions where this value judgment is entrenched, valuable asset protection opportunities are available using savings products, the composition of which extends far beyond the traditional insurance product rubric.
Finally, a word on personal guarantees given to financial institutions as a condition for granting a loan to a company. The act of calling of such guarantees by a lender is one of the most common causes of personal bankruptcy amongst small businesses. Refusal to provide a personal guarantee will likely result in a loan being declined, however it may be possible to limit the extent of the guarantee, so at least one can arrange to shelter assets on a worst case scenario.
In summary, then, with careful planning over the long term, in a context of genuine business and estate planning; modest-size estates can be effectively and cheaply structured onshore, to provide legitimate protection of clients from hostile creditors.
- 1. Whilst the law is addressed from an Ontario perspective, the principles are similar in much of the common law world. For example, most former British Colonies have a local equivalent of the Statute of Elizabeth directed at fraudulent dispositions and encompass equitable tracing remedies. The reader is requested to view this article in the context of local relevant legislation.
- 2. A detailed analysis by the author of the strident approach adopted by Ontario courts appears in the October 2009 edition of STEP Journal: ‘Setting Aside Fraudulent Conveyances– A New Judicial Trend’. Having regard to the array of international jurisprudence cited, it possible such approach may be followed in other common law jurisdictions.
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