Wednesday, January 15, 2014

Asset Protection

While this article is titled the "wealthiest" a lot of the concepts spoken of apply to the everyday person. We help you not only protect your assets but make them very difficult to find should that be necessary.

There’s a type of attorney out there that preys on wealthy families.  These attorneys whip up fear about the litigious nature of our society, bleeding heart juries, and slip-and-fall plaintiffs who are out to make a buck.  These particular attorneys typically have a one-size-fits-all solution.  Maybe it is a family limited partnership or an asset protection trust, but the story is much the same.
On the other hand, there are attorneys and accountants and other professionals who are skilled at assisting families protect their assets . . . or assisting families with the broader discipline of risk management.  These professionals take a comprehensive approach and their solutions will be tailored to specific circumstances.  This is the first of a series of articles on the subject of asset protection and risk management.
“Asset protection” has been a catchy term for a number of years.  For some, the term is interchangeable with “risk management.”  Within a family office, the terms are related but are seen as different.  Risk management usually refers to the comprehensive approach to identifying, assessing, and providing for all risks that threaten a family’s wealth.  Asset protection usually refers to the structuring of assets so as to minimize potential losses and is within the broader framework of risk management.
What are the risks that wealthy families face?  While the range of risks present in the world is great, the primary risks that concern wealthy families are typically grouped into business liability, personal liability, risks to assets, and health care risks.  How wealthy families manage their risks is decidedly different from how lower asset families manage their risks.
Fundamentally, there are four things any person or family can do with the risks they face.  One can avoid a given risk.  Whether it is a risk associated with operating a publishing business or driving a car or downhill skiing, one can simply chose to not expose oneself to those risks.  Don’t operate a publishing business.  Don’t drive a car.  Don’t go downhill skiing.  Of course, as a matter of practicality, there are some risks that one can’t avoid.
Family Business Entities
Families with operating businesses are already familiar with some mitigation techniques.  These might include worker safety programs, the adoption of operational best practices, or even being selective regarding customers/suppliers with whom one works.  A more nuanced business risk mitigation strategy might include the drafting of business contracts in a manner that limits the opportunity for litigation and limits damages.  An even more nuanced mitigation strategy in business might include choosing a specific jurisdiction for business organization – say, Delaware.  This would allow the business to choose the governing law of its contracts.  This would also allow the business to contractually identify the venue for litigation or arbitration as opposed to being stuck with the jurisdiction in which the business operates – say, California.  Of course, this can also be a double-edged sword.  While the foregoing focused in on the mitigation of business risks, a family might extend mitigation strategies to each type of risk.
Asset protection, which we loosely defined as the structuring of assets so as to minimize potential losses, is a form of mitigation. Non-operating business entities – that is, those that hold investment assets – are often used to consolidate the management of a family’s assets and for asset protection.  Such a business entity might be a limited liability company, limited partnership, or other structure.  Such a business entity might hold liquid securities, investment real property, etc.  Assuming that one follows all of the legal and financial formalities regarding the organization, liabilities and legal claims that arise within the business entity will be able to look to only the assets of the business entity for satisfaction.  For example, an individual who slips and falls on real property held by a family limited liability company would only be able to assert a claim against the assets of the entity.  Subject to cost, a family would ideally establish a separate business entity for each investment property it owns as well as a separate business entity for securities.
The general discussion that applies to operating business entities also applies to investment business entities.  But, it doesn’t end there.  Let’s say a family member is sued individually and a creditor seeks to obtain title of the family member’s interest in the family business entity via a charging order – whether the business entity is an operating business or for investment.  The governing document of the business entity – operating agreement, partnership agreement, by-laws, etc. – might specify that, in such a forced transfer, the business entity has a first right to purchase the interest from the family member at some low price.  Let’s take it a step further.  Let’s say that the creditor does not obtain title but receives a court order that directs the family member to ask for a distribution from the business entity.  The governing document of the business entity might specify that only a 100 percent vote of interests can force a distribution.  All of this depends on the law of the business entity’s jurisdiction of organization.  Things are complex and nuanced indeed.

Part II will focus on asset protection within trusts.

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