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YourOnLine This Course This course provides a review of the issues involved in Asset Protection Planning. Created and Presented by

EDWARD L. PERKINS, JD, LLM (Tax), CPA Partner Gibson&Perkins, PC Adjunct Professor – Villanova Law School Graduate Tax Program

The ABCs of Asset Protection Planning

The ABC’s of Asset Protection Planning I.

Introduction A.

Start Planning Before a Claim Arises

1. Many things you can do will effectively provide asset protection before a claim or liability arises, but few things will afterwards. 2. transfer” law.

That’s because what is done after a claim rises could be undone by “fraudulent

3. Moreover, the point at which a claim arises is earlier than a layman might think—it is, for example, usually much earlier than when a demand letter or a process server shows up at the door. B.

Late Planning Usually Backfires

1. Asset protection planning after a claim arises is apt to make matters worse; think of it as getting a flu shot while you have the flu, and the shot itself making you even more woozy. 2. It is a common misconception that the only thing a judge can do is to unwind a fraudulent transfer, leaving a debtor who unsuccessfully tried late planning no worse off than if he had done nothing. 3. To the contrary, both the debtor and whoever assisted in the fraudulent transfer can become liable for the creditor’s attorney fees, and the debtor can lose the hope of getting a discharge in bankruptcy. C.

Asset Protection Planning Is Not A Substitute For Insurance

1. Asset protection planning should not be a substitute for liability and professional insurance, but rather should supplement insurance. 2. It is a myth that asset protection plans invariably scare away plaintiffs, and an asset protection plan doesn’t pay legal fees to defend against a lawsuit. Insurance also supplements asset protection planning, since it can help a debtor survive a claim a fraudulent transfer claim. 3. If you get sued, let the insurance company pay to defend it and pay to settle it — that’s what you’re paying the premiums for. D.

Don’t Count On Bankruptcy

1. Once upon a time, bankruptcy was akin to a nice warm shower that allowed a debtor to wash all debts away while still retaining a goodly amount of assets. Not anymore. 2. In 2005, the bankruptcy laws changed to become a cold acid bath that leaves debtors with bare bones and little flesh. 3. State homestead exemptions have been substantially limited, and other new provisions in the bankruptcy code and new bankruptcy case law can make parts of asset protection plans very difficult to protect in bankruptcy. Plus, bankruptcy judges have some of the strongest powers to make debtors cough up assets. E.

Usually Everything Sees the Light of Day 1

1. Asset protection planning should be based on the presumption that the entirety of the planning and its purpose will eventually become known to creditors, because one way or another it usually does. 2. Asset protection plans that require secrecy will face a plethora of problems, from how not to disclose the structure or activity on tax returns, to how to keep a mad ex-spouse or disgruntled employee from talking to creditors. 3. And don’t even think about going into bankruptcy without making a full disclosure about assets and transfers. The failure to make a full disclosure will usually lead to a denial of discharge, and the failure to make a truthful disclosure can amount to charges of perjury and bankruptcy fraud. II.

Fraudulent Transfers A.


1. Fraudulent transfer statutes vary from state to state, but share the common purpose of prohibiting property transfers which have the effect of hindering delaying or defrauding unsecured creditors. 2. The basic remedy is generally undoing the transfer undo the transfer and make the transferred property subject to the creditors’ claims. 3. Most state statutes follow one of two uniform statutes – the Uniform Fraudulent Conveyance Act (the “UFCA”), or the Uniform Fraudulent Transfer Act (the “UFTA”).1 B.

A “Fraudulent Transfer” under the Uniform Fraudulent Transfer Act (the “UFTA” or the

“Act”). 1.

Definition a.

Transfers Fraudulent as to Present Creditors.

Under the UFTA, a transfer made or obligation incurred by a debtor is fraudulent if the creditor’s claim arose before the transfer was made, and: (1) The debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation; or (2) If the transfer was made to an insider for an antecedent debt, the debtor was insolvent at that time, and the insider had reasonable cause to believe that the debtor was insolvent. b.

Transfers Fraudulent as to Present and Future Creditors

A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor's claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation: The UFCA was promulgated by the National Conference of Commissioners on Uniform State Laws in 1918 and remains in effect in only six jurisdictions. The UFTA was approved by the National Conference of Commissioners on Uniform State Laws in 1984 and is in effect in 37 jurisdictions. 1


(1) debtor; or

With actual intent to hinder, delay or defraud any creditor of the

(2) Without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor (A) was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction, or (B) intended to incur, or believed or reasonably should have believed that he would incur, debts beyond his ability to pay as they became due. c. In determining “actual intent” consideration may be given, among other factors, to whether: (1)

The transfer or obligation was to an “insider”2,

(2) The debtor retained possession or control of the property transferred after the transfer, (3)

The transfer or obligation was disclosed or concealed,

(4) Before the transfer was made or obligation was incurred, the debtor had been sued or threatened with suit, (5)

The transfer was of substantially all the debtor’s assets,


The debtor absconded,


The debtor removed or concealed assets,

(8) The value of the consideration received by the debtor was reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred, (9) The debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred, (10) The transfer occurred shortly before or shortly after a substantial debt was incurred, and (11) The debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor. 2.

Insolvency - Definition a.

“Insolvency” is defined as

“Insider” includes: (A) If the debtor is an individual, (i) a relative of the debtor or of a general partner of the debtor, (ii) a partnership in which the debtor is a general partner, (iii) a general partner in a partnership described in subparagraph (ii), or (iv) a corporation of which the debtor is a director, officer or person in control; (B) if the debtor is a corporation, (i) a director of the debtor, (ii) an officer of the debtor, (iii) a person in control of the debtor, (iv) a partnership in which the debtor is a general partner, (v) a general partner in a partnership described in subparagraph (iv), or (vi) a relative of a general partner, director, officer or person in control of the debtor; (C) if the debtor is a partnership, (i) a general partner in the debtor, (ii) a relative of a general partner in, a general partner of, or a person in control of the debtor, (iii) another partnership in which the debtor is a general partner, (iv) a general partner in a partnership described in subparagraph (iii), or (v) a person in control of the debtor; (D) an affiliate, or an insider of an affiliate as if the affiliate were the debtor; and (E) a managing agent of the debtor. 2


(1) A debtor is insolvent if the sum of the debtor’s debts is greater than all the debtor’s assets at a fair valuation. (2) A debtor who is generally not paying his debts as they become due is presumed to be insolvent. (3) A partnership is insolvent if the sum of the partnership’s debts is greater than the aggregate, at a fair valuation, of all the partnership’s assets and the sum of the excess of the value of each general partner’s non-partnership assets over the partner’s non-partnership debts. b. Assets under this section do not include property that has been transferred, concealed or removed with intent to hinder, delay or defraud creditors or that has been transferred in a manner making the transfer voidable under the Act, inclusive. c. Debts do not include an obligation to the extent it is secured by a valid lien on property of the debtor not included as an asset. 3.

“Transfer” – Definition

“Transfer” means every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with an asset or an interest in an asset, and includes payment of money, release, lease and creation of a lien or other encumbrance. 4.

“Creditor” - Definition a.

A “creditor” means a person who has a claim.

b. A “claim” means a right to payment, whether the right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured. c. Several courts have drawn a distinction between those future creditors who might not, currently have a matured claim against the debtor, but whose claims can be reasonably anticipated, and those future creditors who were not, and perhaps could not, have been contemplated by the debtor at the time of the transfer. (1) Future creditors falling into that latter group might be called “potential future creditors” or “uncontemplated creditors.” (2) This distinction is important because it has a direct impact upon whether, in effecting the transfer, the debtor could have possibly possessed the required actual intent to hinder, delay, or defraud creditors; the more remote the future creditor, the less likely that the debtor can be found to have the necessary bad intent. (3) In other words, if a creditor is not an existing creditor at the time the transfer is made, the creditor must show that the debtor made the transfer with an actual intent to hinder, delay, or defraud the creditor, and moreover, will be at a natural disadvantage in doing so since the creditor was necessarily nonexistent at the time of the transfer. B.



1. The UFTA provides for several alternative remedies where a fraudulent transfer is alleged to have been made. 2.

Those prospective remedies include:

a. Avoidance of the transfer or obligation to the extent necessary to satisfy the creditor's claim; b. An attachment or other provisional remedy against the asset transferred or other property of the transferee; and c. An injunction against further disposition by the debtor or a transferee, or both, of the asset transferred or of other property of the transferee or any other relief the circumstances may require. 3. Where, however, the creditor has obtained judgment on a claim against the debtor, the creditor, if the court so orders, may levy execution on the asset transferred or its proceeds. 4. A ceiling imposed upon the relief available where a fraudulent conveyance has been found is that the defrauded creditor can obtain no greater relief in the face of the fraudulent conveyance than such creditor might have obtained had the fraudulent conveyance not been made. C.


1. A transfer or obligation is not voidable against a person who took in good faith and for a reasonably equivalent value or against any subsequent transferee or obligee. 2.

A transfer is not voidable if the transfer results from:

a. Termination of a lease upon default by the debtor when the termination is pursuant to the lease and applicable law; or b. Enforcement of a security interest in compliance with Article 9 of the Uniform Commercial Code. 3.

A transfer is not voidable:

a. To the extent the insider gave new value to or for the benefit of the debtor after the transfer was made unless the new value was secured by a valid lien; b. If made in the ordinary course of business or financial affairs of the debtor and the insider; or c. If made pursuant to a good-faith effort to rehabilitate the debtor and the transfer secured present value given for that purpose as well as an antecedent debt of the debtor. 4. Notwithstanding voidability of a transfer or an obligation under, a good-faith transferee or obligee is entitled, to the extent of the value given the debtor for the transfer or obligation, to a.

A lien on or a right to retain any interest in the asset transferred;


Enforcement of any obligation incurred; or 5

c. D.

A reduction in the amount of the liability on the judgment.

Bankruptcy Issues

1. Section 548 of the Bankruptcy Code generally provides that the trustee of the bankruptcy estate is empowered to avoid certain prior “fraudulent” transfers of the debtor (as well as certain prior “fraudulent” obligations incurred by the debtor), which were made or incurred on or within two years before the date of the filing of the bankruptcy petition; if the debtor voluntarily or involuntarily; a. Made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted; or b. received less than a reasonably equivalent value in exchange for such transfer or obligation; and (1) Was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation; (2) Was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital; (3) Intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor's ability to pay as such debts matured; or (4) Made such transfer to or for the benefit of an insider, or incurred such obligation to or for the benefit of an insider, under an employment contract and not in the ordinary course of business. 2. Under §548(e) the power of the trustee of the bankruptcy estate to avoid transfers is extended to encompass transfers made within 10 years before the date of the filing of the bankruptcy petition if the debtor made the fraudulent transfer to a “self-settled trust or similar device.” 3. The referenced “fraudulent” transfers and obligations closely mirror the definitions which exist for fraudulent transfers under the UFCA and the UFTA. III.

Exemptions and Pre-Bankruptcy Planning A.

Conflict of Laws

1. In the case of an individual debtor, §522 of the Bankruptcy Code carves out certain property interests as being exempt from the debtor's bankruptcy estate under the premise that such property interests are necessary to the debtor if the debtor is to be given a “fresh start” following the conclusion of his or her bankruptcy case. 2. The federal exemption scheme is set forth under §522(d) of the Bankruptcy Code and is generally considered to be extremely parsimonious. 3. However, under §522(b) of the Bankruptcy Code, the states are given the ability to “opt out” of the federal exemption scheme set forth in §522(d) of the Bankruptcy Code and substitute in its place their own more or less generous exemption scheme. 6

4. Moreover, where a debtor's state has not opted out of the federal exemption scheme, the debtor can choose between the federal exemption scheme or the exemptions which may be available under federal and state nonbankruptcy law. 5. If the debtor's domicile has not been located in a single state for 730 days immediately preceding the date of the filing of the petition, then the state where the debtor was domiciled in the 180-day period preceding the 730-day period (or the longer portion of such 180day period) controls. 6. Significantly, under current law a debtor is generally permitted to convert nonexempt property into exempt property before filing a bankruptcy petition. The practice is not fraudulent as to creditors, and permits the debtor to make full use of the exemptions to which he or she is entitled under the law. B.

Exemptions 1.

Homestead Exemptions.

a. 48 states provide an exemption from the claims of creditors for all a debtor’s principal residence.3

some or

b. The federal Bankruptcy Code provides an exemption is limited to $7,500 in value, indexed for inflation, if the debtor is unmarried or double that for a married debtor. c. The Exemption is not without limitations; certain classes of creditors may attach the property, including: (1)

Federal tax liens:


Non-dischargeable domestic support obligations;


Exemptions obtained under fraudulent circumstances;4

d. The 2005 Bankruptcy Abuse Prevention and Consumer Protection Act, however, imposed restrictions to the homestead exemption in a bankruptcy case. (1) Section 308 of the 2005 Act amended 11 USC §522 to reduce the value of a debtor's interest in certain property that may be claimed as exempt under certain circumstances. (2) Where nonexempt property is converted to: (i) real or personal property that the debtor or a dependent of the debtor uses as a residence; (ii) a cooperative that owns property that the debtor or a dependent of the debtor uses as a residence; (iii) a burial plot; or (iv) real or personal property that the debtor or dependent of the debtor claims as a homestead, within the 10-year period preceding the filing of the bankruptcy case, the exemption must be reduced to the extent such value was acquired with the intent to hinder, delay, or defraud a creditor. In six states Florida, Iowa, Kansas, Oklahoma, South Dakota, and Texas the exemption is unlimited”; onlt Pennsylvania and New Jersey do not have a house stead exemption. 3

Note however that the Supreme Court of Florida has held that the exemption of a Florida homestead under article X, §4 of the Florida Constitution applies even where the debtor acquired the homestead using nonexempt funds with the specific intent of hindering, delaying, or defrauding creditors in violation of Florida's fraudulent transfer statutes. 4



Protection Planning –

(1) In states where an unlimited homestead exemption is unavailable, the homestead exemption is nonetheless an extremely significant and potentially valuable tool from an asset protection standpoint, even where it is obtained or enhanced through pre-bankruptcy planning. (2) In order to maximize the use of the exemption, a client may consider moving, subject to the 730-day requirement of §522(b)(3) of the Bankruptcy Code, to a jurisdiction which allows a relatively generous homestead exemption prior to filing for bankruptcy. (3) Alternatively, where the client is already domiciled in such a jurisdiction, or where the client wants to make the best use of the limited homestead exemption which might be available in the client's current domicile, the client might be well advised to pay down the mortgage on the property or to improve the property. (4) Provided that these steps are not taken under circumstances which may be demonstrative of an actual intent to thereby hinder, delay, or defraud creditors, there is a good potential that such steps will withstand creditor attack even if large amounts of wealth are thereby sheltered from the claims of creditors. 2.

Wage Exemptions

a. a debtor.

Each of the states does provide some level of exemption for the income of

b. No “wage” exemption generally applies to a self-employed individual (although another, more or less equivalent exemption, may exist). Note: For self-employed individuals consider rearranging his or her employment circumstances so as to be deemed an employee subject to the protection of the applicable wage exemption. c. The level of the wage exemption varies from state to state; e.g., Delaware is only 85%; for South Carolina and Texas, the exemption is 100%. d. Under the Consumer Protection Act, for federal purposes an exemption for the greater of 75% of a debtor's disposable net earnings and an amount equal to 30 times the federal minimum hourly wage per garnished week is allowed. 3.

Annuity Exemptions.

a. The federal bankruptcy exemption for annuity payments is found at 11 USC §522(d)(10)(E) and, like many federal exemptions, is neither overly generous nor does it lend itself to asset protection or pre-bankruptcy planning. b. Specifically, the federal annuity proceeds exemption provides that payments may be exempted only if payable by reason of “illness, disability, death, age, or length of service” and even then, only to the extent that such payments are “reasonably necessary” for the support of the debtor and any dependent of the debtor 8


Retirement Accounts –

a. Qualified Retirement Plans - A retirement plan that is “qualified” under the Employee Retirement Income Security Act of 1974 (ERISA)298 is absolutely protected from the plan participant's creditors pursuant to the 1992 decision of the U.S. Supreme Court in Patterson v. Shumate. b. Individual Retirement Plans - The 2005 Bankruptcy Abuse Prevention and Consumer Protection Act,327 amended the Bankruptcy Code to provide protection for IRAs. 5.

Life Insurance –

a. The federal bankruptcy exemptions for life insurance policies owned by the debtor are found at 11 USC §522(d)(7) and (8). b., The federal bankruptcy exemptions for life insurance shield unmatured policies owned by the debtor (other than a credit life insurance contract) and up to $12,625 of the debtor's aggregate interest in any accrued dividend or interest under, or loan value of, an unmatured life insurance contract, if the insured is either the debtor or an individual of whom the debtor is a dependent. c. However, since federal bankruptcy law broadly defines a dependent as including a spouse, regardless of whether the debtor's spouse is dependent on the debtor, the exemption will apply without further inquiry so long as either the debtor or the debtor's spouse is the insured. 6.

Miscellaneous Exemptions: a.

The debtor's interest, not to exceed $2,575 in value, in one motor vehicle.

b. The debtor's interest, not to exceed $425 in value in any particular item or $8,625 in aggregate value, in household furnishings, household goods, wearing apparel, appliances, books, animals, crops, or musical instruments, that are held primarily for the personal, family, or household use of the debtor or a dependent of the debtor. c. The debtor's aggregate interest, not to exceed $1,075 in value, in jewelry held primarily for the personal, family, or household use of the debtor or a dependent of the debtor. d. The debtor's aggregate interest, not to exceed $1,625 in value, in any implements, professional books, or tools, of the trade of the debtor or the trade of a dependent of the debtor. e.

Professionally prescribed health aids for the debtor or a dependent of the

debtor. IV.

Corporations A.

Shareholders Liability

1. The traditional reference to asset protection in the corporate context is to the limitation on the liability of shareholders for debts of the corporation.


a. Thus, in the usual case (absent a personal guarantee of corporate obligations), a shareholder will not be personally liable for the debts of the corporation, and thus, the shareholder's personal assets are protected from the creditors of the corporation. b. This type of protection is referred to as “inside-out” protection because the shareholder's personal assets (which are outside of the corporation) are protected from the corporation's creditors (whose claims arose inside of the corporation's business dealings). 2. The reverse, however, is not also true, and if the shareholder is sued personally, the shareholder's interest in the corporation (in the form of his or her shares) will be reachable by the judgment creditor and, in the case of a sole or even a majority shareholder, a personal creditor would be able to reach the assets of the corporation in satisfaction of a judgment through the liquidation of the corporation following execution on the shares of the shareholder. 3. For this reason, a corporate entity is inherently less protective than those business entities which also provide the “outside-in” protection that is afforded where a charging order remedy is imposed upon the creditor (such as might be the case with a limited liability company or partnership). B.

Officer and Director Liability

Like the case of a limited partner who is also a general partner, a shareholder serving in the capacity of a corporate officer or director can be held personally liable for certain actions or inactions, although not generally for the operating debts of the entity. C.

Piercing the Corporate Veil 1.


a. In the United States, corporate veil piercing is the most litigated issue in corporate law. b. Although courts are reluctant to hold an active shareholder liable for actions that are legally the responsibility of the corporation, even if the corporation has a single shareholder, they will often do so if the corporation was markedly noncompliant, or if holding only the corporation liable would be singularly unfair to the plaintiff. In most jurisdictions, no bright-line rule exists and the ruling is based on common law precedents. c. In the United States, different theories, most important "alter ego" or "instrumentality rule", attempted to create a piercing standard. d. Mostly, they rest upon three basic prongs—namely "unity of interest and ownership", "wrongful conduct" and "proximate cause". e. However, the theories failed to articulate a real-world approach which courts could directly apply to their cases. Thus, courts struggle with the proof of each prong and rather analyze all given factors. This is known as "totality of circumstances". 2.


a. There is also the matter of what jurisdiction the corporation is incorporated in if the corporation is authorized to do business in more than one state.


b. All corporations have one specific state (their "home" state) to which they are incorporated as a "domestic" corporation, and if they operate in other states, they would apply for authority to do business in those other states as a "foreign" corporation. c. In determining whether the corporate veil may be pierced, the courts are required to use the laws of the corporation's home state. d. This issue can be significant; for example, the rules for allowing a corporate veil to be pierced are much more liberal in California than they are in Nevada. e. Thus, the owner(s) of a corporation operating in California would be subject to different potential for the corporation's veil to be pierced if the corporation was to be sued, depending on whether the corporation was a California domestic corporation or was a Nevada foreign corporation operating in California. 3.

Plaintiff’s Case

a. Generally, the plaintiff has to prove that the incorporation was merely a formality and that the corporation neglected corporate formalities and protocols, such as voting to approve major corporate actions in the context of a duly authorized corporate meeting. b. This is quite often the case when a corporation facing legal liability transfers its assets and business to another corporation with the same management and shareholders. c. It also happens with single person corporations that are managed in a haphazard manner. As such, the veil can be pierced in both civil cases and where regulatory proceedings are taken against a shell corporation. 4.

Factors to Consider a.

Factors - Factors for courts to consider. −

Absence or inaccuracy of corporate records;

Concealment or misrepresentation of members;

Failure to maintain arm's length relationships with related entities;

Failure to observe corporate formalities in terms of behavior and documentation;

Failure to pay dividends;

Intermingling of assets of the corporation and of the shareholder;

Manipulation of assets or liabilities to concentrate the assets or liabilities;

Non-functioning corporate officers and/or directors;

Significant undercapitalization of the business entity (capitalization requirements vary based on industry, location, and specific company circumstances);

Siphoning of corporate funds by the dominant shareholder(s);

Treatment by an individual of the assets of corporation as his/her own; 11

Was the corporation being used as a "façade" for dominant shareholder(s) personal dealings; alter ego theory.

b. It is important to note that not all of these factors need to be met in order for the court to pierce the corporate veil. Further, some courts might find that one factor is so compelling in a case that it will find the shareholders personally liable. V.

Limited Partnerships and Limited Liability Companies A.

Two Aspects of Asset Protection

1. Inside –out Protection- The first, more widely known facet, is the “inside-out” protection available to the limited partners of a limited partnership and to all members of a LLC. a. This asset protection aspect is similar to the protection generally available to corporate shareholders; the personal exposure of a limited partner of a partnership or a member of a LLC for the debts of the LLE is generally limited to that person's investment in the entity. b. Thus, an entity creditor generally cannot execute upon the personal assets of a limited partner or member in order to satisfy the entity's debt. 2.

Out-side In

a. The second asset protection facet of the limited partnership and the LLC is itself two-pronged: b.

One prong is arguably provided by the IRS

c. The other prong is provided by the “outside-in” protection afforded by the charging order concept. d. Simply stated, a creditor of a RULPA partner or LLC member will not be able to satisfy the creditor's claim against the debtor partner or LLC member out of the assets of the LLE since those assets are owned by the LLE as a separate entity, rather than by any one or more of the individual partners or LLC members. B.

Charging Order Concept

1. A charging order is the “exclusive remedy” for a judgment creditor of a partner or member in a LLE. 2. On application to a court of competent jurisdiction by any judgment creditor of a partner or transferee, the court may charge the transferable interest of the judgment debtor with payment of the unsatisfied amount of the judgment with interest. a. transferee.

To the extent so charged, the judgment creditor has only the rights of a

b. The court may appoint a receiver of the share of the distributions due or to become due to the judgment debtor in respect of the partnership and make all other orders, directions, accounts, and inquiries the judgment debtor might have made or which the circumstances of the case may require to give effect to the charging order.


3. The effect of the charging order is that the partner's or member's (for simplicity, the “owner's”) creditor will receive those LLE distributions which would, absent the charging order, have been distributed to the debtor owner if and when such distributions are made. 4. If the debtor owner is an owner in a publicly traded or otherwise widely held LLE which regularly makes distributions, the charging order may be an effective means for the judgment creditor to collect part or all of its judgment. 5. However, where the debtor owner is a member of a family or other closely held LLE governed by a properly drafted agreement, the result may be quite different. C.

Tax Treatment

1. In this regard, the IRS ruled in Rev. Rul. 77-137 that where the limited partnership agreement contained such a requirement, the transferee would nevertheless still be treated as a partner for federal income tax purposes where the transferee acquired substantially all of the dominion and control over the partnership interest. 2. The ruling states that under the irrevocable assignment at issue the transferee shared in the profits and losses of the partnership and received all distributions, including liquidating distributions to which the transferor limited partner would have been entitled had the assignment not been made. 3. In addition, the transferor (who remained a nominal partner under the state's limited partnership act) agreed to exercise any residual powers solely in favor of and in the interest of the transferee. 4. The IRS ruled that as a partner for federal income tax purposes, the transferee would be required to report the distributive share of the partnership items of income, loss, gain, deduction, and credit attributable to the assigned interest in the same manner as would be required if the transferee were a substitute limited partner. VI.

Trusts A.

Self-Settled Spendthrift Trusts 1.


a. A “self-settled spendthrift trust” is a trust in which the settlor has retained a beneficial interest in the trust fund, which interest, in and of itself, does not cause the trust fund to be subject to the claims of the settlor's creditors under the law of the governing jurisdiction. b. Notably, when the term “self-settled spendthrift trust” is used loosely, the trust might often more accurately be described as a “discretionary” trust rather than as a true “spendthrift” type trust. 2.

Asset Protection

a. In most domestic jurisdictions, the efficacy of a trust in providing asset protection depends upon the relationship of the trust to the person for whom the protection is sought, and the nature and extent of that person's interest in and/or control over the trust.


b. A trust which is revocable by the settlor, even one under which the settlor is not a beneficiary, provides virtually no protection from the claims of the settlor's creditors during the settlor's lifetime, although some early cases held to the contrary. c. A court will almost certainly allow the creditors of the settlor of a domestic revocable trust access to the trust assets via a court order compelling the settlor to revoke the trust, in whole or in part, or via an order to the trustee to distribute trust assets. B.

Domestic Asset Protection Trusts 1.


a. With an avowed purpose of providing estate tax benefits through effective domestic self-settled spendthrift trusts, the legislatures of both Alaska and Delaware enacted legislation in 1997 (and other state legislatures have since followed suit), which permit the settlor of a trust to be a discretionary beneficiary thereof without leaving the trust assets subject to the settlor's creditors. b. Thus, the transfer of assets into the self-settled spendthrift trust would be treated as a completed transfer for federal estate and gift tax purposes. c. The asset protection benefit of domestic asset protection trusts, at least as originally envisioned, is merely incidental. d. However, the efficacy of domestic asset protection trusts as an asset protection device, and hence as an estate tax planning device, has yet to be determined; some of the most significant open issues relate to the impact of several constitutional questions, discussed next. 2.

Constitutional Issues a.

Full Faith and Credit Clause

(1) Under the Full Faith and Credit Clause of the U.S. Constitution, “Full Faith and Credit shall be given in each State to the public Acts, Records, and judicial Proceedings of every other State.� (2) Full faith and credit principles are so broadly construed that they generally require the judgment of another state to be recognized and enforced even though the original claim is illegal in, or contrary to the strong public policy of, the second state. (3) In addition, the Full Faith and Credit Clause is also usually thought to require the enforcement of another state's judgments, even where the second state statutorily disallows jurisdiction over the action. (4) In fact, assuming that in personam jurisdiction is obtained over the trustee, there are only two apparent limitations upon the application of the Full Faith and Credit Clause. (5) The first limitation upon application is that “for a State's substantive law to be selected in a constitutionally permissible manner, that State must have a significant contact or significant aggregation of contacts, creating


state interests, such that choice of its law is neither arbitrary nor fundamentally unfair.” (6) The second limitation upon application of the Full Faith and Credit Clause is that the issue has been fully and fairly litigated and finally decided in the court rendering the original judgment b.

Supremacy Clause

(1) Under the Supremacy Clause of the U.S. Constitution, the “Constitution, and the Laws of the United States which shall be made in Pursuance thereof; and all Treaties made, or which shall be made, under the Authority of the United States, shall be the supreme Law of the Land; and the Judges in every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.” (2) Thus, federal law overrides state laws to the extent that federal and state law conflict. In the asset protection trust context, there is concern that the Supremacy Clause might apply, for example, where a federal bankruptcy court issues an order directing the trustee of a domestic self-settled spendthrift trust to distribute assets to a creditor. (3) However, this concern has been mitigated somewhat by the enactment of the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act, which amended §548(e) of the Bankruptcy Code so as to limit the power of the trustee of the bankruptcy estate to avoid transfers to a “self-settled trust or similar device” only if the transfer is a fraudulent transfer, and then only if made within 10 years before the date of the filing of the bankruptcy petition c.

Contract Clause

(1) Under the Contract Clause of the United States Constitution, “[n]o State shall … pass any … Law impairing the Obligation of Contracts.” (2) In the asset protection context, the concern over the Contract Clause, albeit somewhat ill-defined, is that domestic asset protection trust legislation potentially infringes upon the ability of persons to contract with each other by allowing a contracting party to avoid the effect of certain contracts by protecting his or her assets from claims made under the contract through the use of an asset protection trust. 3.

Alaska Trusts

a. General Rule. The general rule which now validates self-settled spendthrift trusts in Alaska, however, remains subject to exceptions where: (1) The transfer to the trust was made with the intent to defraud (but, notably, not to hinder or delay), the particular creditor who is seeking to satisfy a claim out of the beneficiary's interest in the trust (i.e., a fraudulent conveyance); (2) Where the trust settlement provides that the settlor may revoke or terminate all or part of the trust without the consent of a person who has a substantial beneficial interest in the trust which would be adversely affected by the 15

exercise of the power held by the settlor to revoke or terminate all or part of the trust; (3) Where the trust mandates the distribution of all or a part of the trust's income or principal to the settlor; or (4) Where the transfer to the trust was made when the settlor was in default 30 or more days in making child support payments. (5) The Alaska Statute further provides that these exceptions only apply if the creditor seeking to satisfy a claim from the trust is a creditor of the settlor. b. 2003 Amendments. In 2003, Alaska retroactively revised its trust legislation to provide even greater asset protection. (1) As amended in 2003, the Alaska Statute provides that a beneficiary's use or occupancy of real property or tangible personal property held by a trust is not equivalent to the payment or delivery of the asset to the beneficiary if the use or occupancy is in accord with the trustee's discretionary authority under the trust instrument. (2) Also, as amended in 2003, the Alaska Statute, makes it clear that Alaska's asset protection trust statute applies to third-party beneficiary trusts as well as to self-settled trusts (3) The Alaska Statute indicates that the statute applies whether or not the beneficiary is serving as a sole trustee, a co-trustee, or a trustee advisor. c.

Exclusive Jurisdiction.

(1) The Alaska Trust Act also attempts to grant Alaska courts exclusive jurisdiction over an Alaska asset protection trust; an effort which may or may not prove effective, particularly in light of federal constitutional law doctrines. (2) Whether or not the state of Alaska is actually able to obtain exclusive jurisdiction over Alaska asset protection trusts in such manner, however, the simple inclusion of an Alaska choice of law provision alone will not suffice to bring the trust within the purview of Alaska law. d.

Statutory Requirements

Four additional statutory requirements must be met in order to receive the protection of the Alaska Trust Act. (1) First, some or all of the asset protection trust's assets must be deposited within the state of Alaska through either a checking account, time deposit, certificate of deposit, brokerage account, trust company fiduciary account, or other similar account located in the state of Alaska. (2) Alaska law.

Second, one of the trustees must be a “qualified person” under

(a) Under the Alaska Trust Act a “qualified person” is defined as a trust company with its principal place of business in the state of Alaska, a 16

bank with trust powers and its principal place of business in the state of Alaska, or an individual resident of the state of Alaska. (b) As long as one of the trustees meets this requirement, then other co-trustees may be nonqualified persons. (3) Third, the Alaska trustee's duties must include both the obligation to maintain records for the asset protection trust and the obligation to prepare or arrange for the preparation of the asset protection trust's income tax returns, although neither of these duties must be exclusive to the Alaska trustee. (4) Finally, part of the asset protection trust's administration must occur in the state of Alaska, including the physical maintenance of the trust's records within the state of Alaska. e. Nexus. When these nexus requirements are met, an Alaska choice of law provision is deemed, by Alaska law at least, to be “valid, effective, and conclusive for the trust. f.

In re Huber

(1) In May 2013, the U.S. Bankruptcy Court in In re Huber held that Alaska did not have a substantial relation to an Alaska trust established by the debtor with an Alaska trustee, and that Washington did have a significant relationship to the trust. (2) The court came to its decision based on the following factors: (i) the settlor was not domiciled in Alaska; (ii) the bulk of the assets were not located in Alaska; (iii) the beneficiaries were not domiciled in Alaska; (iv) the debtor resided in Washington; (v) virtually all the property transferred to the trust was located in Washington; and (vi) the attorney who prepared the trust documents and transferred the assets to the trust was located in Washington. (3) The court then determined that Washington has a strong public policy against asset protection trusts because Washington state law provides that Self-Settled Trusts are void as against existing or future creditors. (4) The court then applied Washington law to find that the debtor’s transfers to the Alaska trust were void and made the assets of the trust available to the bankruptcy trustee 4.

Delaware a.


(1) Closely following on the heels of the April 2, 1997 enactment of the Alaska Trust Act, on July 7, 1997, Delaware became the second domestic jurisdiction to enact comprehensive asset protection trust legislation when its legislature adopted the Qualified Dispositions in Trust Act (“DQDTA”). (2) As with the Alaska Trust Act, DQDTA generally affords spendthrift trust protections to properly established self-settled spendthrift trusts.


(3) Specifically, the DQDTA allows the settlor to retain a beneficial interest in the trust which the settlor created while at the same time protecting the trust's assets from the settlor's creditors by having the trust settlement provide that: (a) The interest of the transferor or other beneficiary in the trust property or income therefrom may not be transferred, assigned, pledged or mortgaged, whether voluntarily or involuntarily, before the qualified trustees actually distribute the property or income therefrom to the beneficiary, and (b) Such provision of the trust instrument shall be deemed to be a restriction on the transfer of the transferor's beneficial interest in the trust that is enforceable under applicable nonbankruptcy law within the meaning of §541(c)(2) of the Bankruptcy Code b.

Asset Protection.

For a self-settled Delaware trust to be protected from the creditors of the settlor as a “qualified disposition” under the DQDTA, several express statutory requirements must be met. (1) First, the settlor must transfer property to a “qualified trustee” via a trust instrument. (a) For this purpose, a “qualified trustee” is either a resident of Delaware (other than the transferor) or an entity authorized by Delaware law to act as a trustee and “whose activities are subject to supervision by the Bank Commissioner of the State, the Federal Deposit Insurance Company, or the Comptroller of the Currency.” (b) Also the trust must also be irrevocable; a qualified Delaware trustee must materially participate in the administration of the trust; Delaware law must govern the validity, construction and administration of the trust; and a spendthrift clause applicable to the settlor must be included in the document. (c) If a trustee that was once a qualified trustee ceases for any reason to be a qualified trustee, and no remaining qualified trustee is then acting, the trustee is deemed to have resigned at the time the trustee ceases to be a qualified trustee. (d) If no successor qualified trustee is provided for under the trust instrument, the Delaware Court of Chancery shall appoint a successor qualified trustee upon the application of any interested party to the trust (2) The settlor's transfer of property to an otherwise “qualified trust” must not have been intended to hinder, delay, or defraud creditors (i.e., a fraudulent conveyance). (a) The DQDTA is intended to prevent any action brought “for an attachment or other provisional remedy against property that is the 18

subject of a qualified disposition� in trust, subject only to fraudulent conveyance laws. (b) Delaware’s laws allow a creditor four years to bring a claim after a transfer to the asset protection trust. (c) If the transfer was made with the actual intent to hinder, delay or defraud the creditor, the creditor with a claim that arose before the transfer has a year to bring a cause of action after the transfer to the trust was or could reasonably have been discovered. (d) Therefore, it is advisable for the transferor to make only one transfer to the asset protection trust to start the statute of limitations running. If subsequent transfers are made to the asset protection trust, the trustee will need to segregate these new assets and the statute will begin again as to each new transfer. (3) The trust instrument must also be irrevocable, but the trust instrument will not be deemed revocable due to the inclusion in the trust instrument of: (a)

A power in the settlor to veto a distribution from the trust;


A testamentary special power of appointment in the

settlor; (c) The settlor's potential or actual receipt of income from the trust, including rights to such income retained in the trust instrument; (d) The settlor's potential or actual receipt of income or principal from a charitable remainder unitrust or charitable remainder annuity trust; (e) The settlor's receipt each year of a percentage (not to exceed 5%) specified in the trust instrument of the value of the trust determined from time to time pursuant to the trust instrument; or (f) The settlor's potential or actual receipt of principal from the trust if it is either in the sole discretion of one or more qualified trustees or is pursuant to an ascertainable standard contained in the trust instrument. (4) Moreover, under Delaware's Qualified Dispositions in Trust Act, two classes of creditors are expressly exempted from the self-settled spendthrift trust protections otherwise uniformly afforded to qualified dispositions. Specifically, the Act provides that the spendthrift provision will not apply: (a) To any person to whom the transferor is indebted on account of an agreement or order of court for the payment of support or alimony in favor of such transferor's spouse, former spouse or children, or for a division or distribution of property in favor of such transferor's spouse or former spouse, to the extent of such debt; or


(b) To any person who suffers death, personal injury or property damage on or before the date of a qualified disposition by a transferor, which death, personal injury or property damage is at any time determined to have been caused in whole or in part by the act or omission of either such transferor or by another person for whom such transferor is or was vicariously liable. C.

Offshore Trusts 1.


a. Offshore trusts, i.e., trusts that are governed by the laws of foreign jurisdictions, are often used by U.S. citizens or residents to protect assets from creditors. b. The problem with the use of offshore trusts is the uncertainty of the application of the rules of conflict of laws and the uncertainty of the interpretation of foreign laws. (1)

This uncertainty is a two-edged sword.

(a) On the one hand, offshore planning cannot be undertaken with complete confidence in the outcome. (b) On the other hand, creditors face the same problems regarding the application and interpretation of appropriate laws and will likely discount the value of their claims in light of the expense of litigation and the uncertainty of enforcement of their judgments against assets located in a foreign jurisdiction. (2) This suggests that the effectiveness of offshore planning has an inverse relationship to the size of the claim and the extent of offshore assets, that is, the greater the claim and assets, the more economic sense it makes to undertake the process of attempting to collect such assets. c. Commonly used foreign jurisdictions include, without limitation, the Isle of Man, Bermuda, the Cayman Islands, and the Cook Islands. (1) These are generally stable, low- or nontax jurisdictions that have no currency restrictions, although it is suggested that one obtain an agreement with a competent authority that currency restrictions will not apply. (2) The published authority concerning these jurisdictions is generally provided by foreign counsel or foreign trust companies and concludes that a judgment rendered in a U.S. court will not be enforced in the foreign jurisdiction. (3) If the results under foreign law are other than generally represented by counsel, it is doubtful that an action could be maintained in the United States against foreign counsel for malpractice, at least under current law. (4) Whether one would be able to maintain an action against local counsel in the foreign jurisdiction is unknown; but it would not be surprising if such an action could not be maintained.


d. There may be many foreign jurisdictions where a U.S. judgment of a law court or a bankruptcy court is unenforceable. (1)

The Cook Islands is clearly one of the jurisdictions.

(2) There is some doubt as to whether an asset protection trust would be recognized by a U.S. court. (3) Further, the settlor-debtor could face contempt and possible incarceration for failure to deliver assets that he had transferred overseas. (4) In this regard, such assets could be discovered by creditors in both bankruptcy and non-bankruptcy proceedings. In addition, one of the consequences of establishing an asset protection trust is that the settlor-debtor could be denied discharge in bankruptcy. (5) In addition, the cost of maintaining a foreign trust should be considered. It varies considerably depending on the jurisdiction and trustee. Expenses attributable to maintaining the trust and managing trust assets are deductible to varying degrees depending on the circumstances, including the type of income. e. If a settlor wishes to establish an offshore trust notwithstanding the foregoing consequences, various steps can be taken to maximize the asset protection effectiveness of the trust, including, without limitations, the following: − Providing a trust provision that designates the law of the foreign jurisdiction to govern all aspects of the trust −

Administering the trust in the foreign jurisdiction

− Funding the trust with either personal property or intangible property that is located in the foreign jurisdiction − 2.

Selecting an entity that has no U.S. contacts as a trustee

Statute of Limitation.

a. One significant aspect of domestic asset protection legislation that must be compared to foreign asset protection trust legislation is the statute of limitations applicable to fraudulent transfer claims. b. Notably, the statute of limitations governing the time in which a creditor in a foreign asset protection trust jurisdiction can seek to negate a transfer as fraudulent is often of shorter duration than that under domestic asset protection trust jurisdictions. c. For example, each of the Bahamas, Nevis, and the Cook Islands have two-year statutes of limitations governing fraudulent conveyances. d. In at least one foreign jurisdiction, Belize, the limitations period for fraudulent transfers is not merely short, but is completely nonexistent. e. As a basis for comparison, the applicable statute of limitations under the law of the state of Alaska for a creditor whose claim arose prior to the transfer at issue is the longer of: (1) four years from the date that the transfer is made; or (2) one year from the date that the transfer is or reasonably could have been discovered. 21

f. full 10 years. 3.

In the bankruptcy context, the applicable statute of limitations period is a

Other Difficulties for Creditors

a. Even where a creditor is not time-barred from bringing suit against a foreign asset protection trust under a fraudulent transfer claim, other very real difficulties remain for the creditor litigating against an asset protection trust offshore. b. In the first instance, a creditor may find it difficult to retain local counsel in certain jurisdictions due to the fact that most attorneys in many of the foreign asset protection jurisdictions represent the financial institutions that administer asset protection trusts and are, therefore, precluded from representing the creditors of those trusts due to the innate conflict of interest. c. Moreover, the contingent fee arrangements that are extremely popular onshore, and which enable many creditors to pursue claims beyond the point at which they would otherwise be financially feasible, are often precluded by statute offshore as being contrary to public policy. d. In addition, because the law of many offshore jurisdictions provides that the losing party to a lawsuit is required to reimburse the prevailing party for the prevailing party's expenses (including, most significantly, the prevailing party's attorneys' fees), the plaintiff will often be required to post bond prior to suit in order to secure payment of the defendant's expenses in the event that the plaintiff should ultimately prove unsuccessful on its claim. e. Finally, the burden of proof applied to a fraudulent conveyance claim in many offshore jurisdiction is proof beyond a reasonable doubt, while domestically a creditor usually need prove his case only by a preponderance of the evidence, or at most by a “clear and convincing” evidence standard. 4.

Selecting the Off Shore Jurisdiction a.

Legal System


Favorable Trust Protection and Tax Laws


The “health” of the economic environment


The stability of the political and social system;

e. services; and f. 5.

The compatibility of language, the availability and quality of professional The availability and quality of electronic communication facilities.

Selecting the Offshore Trustee a.

A trust company with experience in administering FAPTs.

b. Visit the offices and interview the personnel of the potential trustee company to get a feel for whether personalities will be compatible with those of the client and the planner.


c. Inquire of the potential trustee regarding the number of FAPTs (and the asset value) under its administration and obtain local certificates of good standing, and (if possible), financial statements regarding the potential trust company. d. Determine whether the potential trust company's procedures will dovetail or conflict with the planner's office procedures related to FAPTs, and should obtain a schedule of fees. e. Finally, the trust company should have no U.S. branch operation or significant U.S. marketing program. D.

Protective Provisions 1.

Discretionary Distribution Provisions

a. A discretionary distribution provision vests the trustees with discretion regarding whether to distribute trust income and/or principal to a beneficiary. The discretion may be unfettered, as by the following language: b. The Trustees may, in their sole and absolute discretion, pay or apply the whole, any portion or none of the net income of the Trust to, or in any manner the Trustees deem to be for the benefit of all, or any one or more of, the Beneficiaries. c. The effect of a discretionary distribution provision is to limit the extent of the beneficiary's interest in the trust to make it sufficiently tenuous so that it does not qualify as a property right which is subject to attachment by creditors. In effect, the beneficiary's interest will only come into existence when and to the extent the trustee decides to make a distribution. 2.

Spendthrift Provision

a. A spendthrift provision is a restraint on the voluntary or involuntary alienation of a beneficiary's interest in a trust. The use of the term “spendthrift” in describing this type of provision, however, is an unfortunate misnomer. b. Although the term “spendthrift” is certainly appropriate where the provision is used to protect against the improvidence of a beneficiary, it is also clear that the beneficiary need not actually be a spendthrift for the validity of the provision to be recognized or be effective. 3.

Duress Provision.

a. A trust may empower a person or persons other than the trustees to advise the trustees, or to direct or veto an act or decision of the trustees, and/or a trust may grant a non-trustee the power to remove and replace a trustee with or without cause. b. More commonly utilized in offshore trusts than in domestic trusts, the typical duress clause will direct the trustee to ignore any such advice, order, or instruction where it is given under duress by the person granted such powers under the instrument. c. Since a duress provision is typically utilized in offshore trusts, where the trustee is located in a jurisdiction other than that of the person holding the various powers subject to negation by the clause, the duress provision can have the effect of permitting


the granting of significant control over the trust to non-trustees, while at the same time precluding the forced exercise of such powers. 4.

Flight or Change Situs Provision

a. A change of situs or flight provision (also sometimes called a “flee clause” or “Cuba clause”) empowers the trustees, in furtherance of the objective of preservation of the trust, to change the situs of trust administration or to change the trust's governing law and to transfer trust assets to effect such changes. b. Such a provision is commonly included in an offshore trust to address various situations, including the potential for civil unrest or an unfavorable change in the law or political climate of the situs jurisdiction. c. Such a provision is also useful in the event that the law governing the original trust situs changes to the detriment of the trust beneficiaries or the law of another jurisdiction changes so as to become more appealing than the law governing the original trust situs d. The above clause, coupled with a power of attorney and/or an irrevocable direction in the trust instrument (see below), provides a substantial safety net for a trust in the event of an unfavorable change in the lex domicilii , civil unrest, or political change in the situs jurisdiction, or in the event of an anticipated attack on the trust by a creditor. 5.

Trust Protector Provision

a. The provision for a “trust protector” (sometimes referred to as the “trust advisor,” “trust enforcer,” or some similar term), is commonly found in offshore trusts but is now more and more often also now found in purely domestic trusts. b. The term “trust protector” generally means whatever the trust instrument says that it means, even where statutory authority exists. 6.

Extension Provision

a. This is a provision granting the trustees the discretion to extend the trust term in cases where it would otherwise expire at a point in time, or to otherwise “hold back” an otherwise mandatory distribution of property. b. Such a provision would prove particularly useful in a situation where a trust was about to terminate and distribute assets to a beneficiary who was then battling with a creditor or otherwise faced with a significant liability. c. Since a “hold-back” provision creates, in effect, a discretionary trust at such point in time as a distribution would otherwise have to be made, it should serve to protect the beneficiary's trust interest from creditor claims in the same manner as had the trust been wholly discretionary from the outset. d. However, a nondiscretionary trust with a “hold-back” provision differs from a purely discretionary trust in that it places the onus upon the trustee to justify to the beneficiary, and potentially to the court, as well, the trustee's decision to withhold what would otherwise have been a mandatory distribution. 7.

Principal and Income Allocation Provision 24

This provision grants the trustee the discretion to allocate receipts and disbursements between principal and income in the manner deemed most appropriate by the trustee. 8.

Revision of Beneficial Interests

a. Such a provision would grant the trustee or a third party the discretion to revise the beneficial interests of a trust, even to the extent of excluding one or more persons as beneficiaries or adding other persons as beneficiaries. b. Such a provision would essentially have the same effect as a discretionary distribution provision. 9.

Custodian Trustee Provision —

a. Where permitted by law, a trust (usually an offshore trust) may be settled in one jurisdiction under the administration of a managing trustee and in another jurisdiction with the “custodian trustee.� b. Title to trust assets would be held in the name of the custodian trustee, but it would be expected that any litigation involving the trust would be required to be brought in the jurisdiction where the managing trustee is resident, and under which laws the trust is then governed. c. The trust instrument could further provide that, upon the filing of any action against the trust in the managing trustee's jurisdiction, that the managing trustee is deemed removed as trustee, with the managing trustee position devolving upon the custodian trustee (or the same could be set forth in a letter of wishes). d. Such a provision would be expected to have the effect of requiring the creditor to bring his action at least twice in offshore jurisdictions with separate lawyers, and under separate legal systems. VII.

Joint Ownership of Assets A.

Tenancy by the Entireties 1.


a. A tenancy by the entireties is a special form of joint ownership of property that can only exist between a husband and wife. b. The common-law tenancy by the entireties was characterized by five coincident unities: unity of possession (joint ownership and control); unity of interest (the interests must be the same); unity of title (the interests must originate in the same instrument); unity of time (the interests must commence simultaneously); and the unity of marriage. 2.

Unity of Possession

a. The unity of possession has the effect of requiring a husband and wife (who are historically considered to constitute an indivisible unit), to act together to convey title to tenancy by the entireties property, thereby generally precluding a unilateral severance. b. As a result, in those states that follow the common law rule, the creditor of only one spouse cannot execute upon property held in this form. 25

c. Moreover, property which is exempt from creditors by reason of a tenancy by the entireties under state law will also be exempted from an estate in bankruptcy. d. Where, however, the entireties property is not exempt from the claims of creditors under state law (or other applicable non-bankruptcy law), the trustee may force a sale of the co-tenant's interest, together with the estate's interest, if: (1) Partition in kind of such property among the estate and such coowner is impracticable; (2) Sale of the estate's undivided interest in such property would realize significantly less for the estate than sale of such property free of the interests of such co-owner; (3) The benefit to the estate of a sale of such property free of the interests of the co-owner outweighs the detriment, if any, to such co-owner; and (4) Such property is not used in the production, transmission, or distribution, for sale, of electric energy or of natural or synthetic gas for heat, light, or power. e. Even where the entireties property is exempt from the claims of creditors under applicable non-bankruptcy law, however, the protection may still not be sufficient to overcome claims of state, local, or federal government. 3.

Asset Protection

a. from either:

Where the common law rule is followed, no fraudulent transfer can result

(1) A transfer of one spouse's interest in the tenancy by the entireties property to the other spouse; or (2) A transfer by both spouses of the tenancy by the entireties property to a third party (unless, as noted below in this section, there exists a joint creditor of both tenants, or the creation of the tenancy by the entireties was itself a fraudulent transfer). b. In some states, only real estate can be held in a tenancy by the entireties form. In other states personal property may also be held as tenants by the entireties. c. Any asset protection afforded by this form of ownership will disappear in the event of divorce or death unless, in the case of death, the decedent is the debtor spouse or, in the case of a divorce, the property is awarded to the nondebtor spouse. d. Additionally, a tenancy by the entireties, of course, provides no asset protection to a joint creditor of the two tenants. 4.


a. There are drawbacks to holding property in joint name. One drawback to transferring individually owned property into joint name with a spouse is that the transferee spouse now has rights to that property that may have otherwise been kept as separate, non-marital property.


b. In the event of divorce, which is often a greater risk to someone’s finances than a lawsuit by a third party, the transferred property is now divided one-half to each spouse. (1) When transferring property into joint name with someone other than a spouse, the transferring person must understand whether or not the transfer will be considered a gift for gift tax purposes. (2) Additionally, if the property is transferred into title as joint tenants with rights of survivorship, and if the joint owner survives the original owner, the property will be completely owned by the survivor. (3) Such property will not become part of the original owner’s estate to be divided according to the original owner’s estate planning documents. c. Some people will transfer assets to family members with the idea that the assets will be protected from the transferor’s creditors and that the family member will still take care of the transferor with those assets. This strategy often fails because these assets are not protected from the family member’s creditors. B.

Joint with Right of Survivorship

1. This form of co-tenancy provides minimal asset protection. At common law, since the co-tenancy is unilaterally severable by either joint tenant, the creditor of any joint tenant can reach the undivided interest of such joint tenant. 2. Moreover, as is the case with a tenancy by the entireties, if the nondebtor joint tenant dies during the lifetime of the judgment, the creditor will be entitled to the entire property in satisfaction of his or her judgment. 3. Conversely, the only asset protection afforded through a joint tenancy exists where the debtor tenant dies before the creditor has perfected his or her interest in the property, since the creditor will then be precluded from reaching the property by reason of the right of survivorship in the surviving joint tenant. 4. Finally, it should be noted that the creation of a joint tenancy may result in a taxable gift, depending upon the identity of the co-tenant, where the joint tenancy is not created by the contribution of property of equal value by each joint tenant. VIII.

Liability Insurance Protection A.


1. Liability insurance is a part of the general insurance system of risk financing to protect the insured from the risks of liabilities imposed by lawsuits and similar claims. It protects the insured in the event he or she is sued for claims that come within the coverage of the insurance policy. 2. Liability insurance is designed to offer specific protection against third party insurance claims, i.e., payment is not typically made to the insured, but rather to someone suffering loss who is not a party to the insurance contract. In general, damage caused intentionally as well as contractual liability are not covered under liability insurance policies.



When a claim is made, the insurance carrier has the duty (and right) to defend the

insured. a. The legal costs of a defense normally do not affect policy limits unless the policy expressly states otherwise; this default rule is useful because defense costs tend to soar when cases go to trial. b. In many cases, the defense portion of the policy is more valuable than the insurance, as in complicated cases, the cost of defending the case might be more than the amount being claimed, especially in so-called "nuisance" cases where there is no liability but the case has to be defended anyway. 4.

Types of Coverage

There are many types of insurance policies which can cover a full range of liabilities, including the following: − Homeowner’s Insurance − Business property insurance − General liability Insurance − Liquor liability insurance for businesses that sell or manufacture alcohol. − Professional liability insurance − Workers’ compensation − Health insurance − Disability insurance − Auto insurance B. Insurer’s Duties - Liability insurers have one, two or three major duties, depending upon the jurisdiction:



The duty to defend,


The duty to indemnify, and


The duty to settle a reasonably clear claim.

The Duty to Defend 1.


a. The duty to defend is where the liability insurance policy provides that the insurer "has the right and duty" to defend the insured against all "suits" to which the policies apply. b. It is usually triggered when the insured is sued (or in some instances, given pre-suit notice that they are about to be sued) and subsequently "tenders" defense of the claim to its liability insurer. c. Normally, this is done by sending a copy of the complaint along with a cover letter referencing the relevant insurance policy or policies and demanding an immediate defense. 28



Insurer Options - The insurer generally has four main options at this point, to: a.

Defend the insured unconditionally;


Defend the insured under a reservation of rights;


Seek a declaratory judgment that it has no duty to defend the claim; or


Decline to defend or to seek a declaratory judgment.

Compared to Duty to Indemnify

a. The duty to defend is generally broader than the duty to indemnify, because most (but not all) policies that provide for such a duty also specifically promise to defend against claims that are groundless, false, or fraudulent. b. coverage.

Therefore, the duty to defend is normally triggered by a potential for

c. The test for a potential for coverage is whether the complaint adequately pleads at least one claim or cause of action which would be covered under the terms of the policy if the plaintiff were to prevail on that claim at trial, and also does not plead any allegations which would entirely vitiate an essential element of coverage or trigger a complete exclusion to coverage. d. It is irrelevant whether the plaintiff will prevail or actually prevails on the claim; rather, the test is whether the claim if proven would be covered. 5.

Reservation of Rights

a. If there is a duty to defend, it means the insurer must defend the insured against the entire lawsuit even if most of the claims or causes of action in the complaint are clearly not covered. b. An insurer can choose to defend unconditionally without reserving any rights, but by doing so, it waives (or is later estopped from asserting) the absence of coverage as a defense to the duty to defend and impliedly commits to defending the insured to a final judgment or a settlement regardless of how long it takes (unless the policy expressly provides that defense costs reduce policy limits). c. In the alternative, the insurer may defend under a reservation of rights: it sends a letter to the insured reserving its rights to immediately withdraw from the insured's defense if it becomes clear there is no coverage or no potential for coverage f or the entire complaint, and to recover from the insured any funds expended to that point on defending against any particular claims or causes of action which were never covered or even potentially covered to begin with. d. If the insurer chooses to defend, it may either defend the claim with its own in-house lawyers (where allowed), or give the claim to an outside law firm on a "panel" of preferred firms which have negotiated a standard fee schedule with the insurer in exchange for a regular flow of work. 6.

Declaratory Judgment Against the Insured

a. The insurer can also seek a declaratory judgment against the insured that there is no coverage for the claim, or at least no potential for coverage. 29

b. This option generally allows the insurer to insulate itself from a bad faith claim, in the sense that an insurer acts in good faith when it promptly brings coverage disputes to the attention of a court, even though it also places the insured in the awkward position of defending itself against two lawsuits: (i) the plaintiff's original complaint and (ii) the insurer's complaint for declaratory judgment. c. Indeed, in some jurisdictions an insurer acting in good faith must seek declaratory relief from a court before declining to defend its insured (e.g., Illinois) or withdrawing from its defense pursuant to an earlier reservation of rights (e.g., Georgia). 7.

Decline to Defend

a. Finally, the insurer can decline to defend and also refrain from seeking declaratory judgment. If the insurer is absolutely certain that there is no coverage or no potential for coverage, then in most jurisdictions the insurer adequately preserves its defenses to coverage by sending a letter to the insured explaining its position and declining to provide a defense. b. But this option can be very risky, because if a court later determines that there was a duty to defend all along, then it will hold that the insurer necessarily breached that duty, and may also hold that the insurer is subject to tort liability for bad faith. c. So insurers will often defend under a reservation of rights rather than decline coverage altogether. D.

The Duty to Indemnify 1.


a. The duty to indemnify is the insurer's duty to pay all covered sums for which the insured is held liable, up to the limits of coverage and subject to any deductibles, retained limits, self-insured retentions, excess payments, or any other amounts of money which the insured is required to pay out-of-pocket as a precondition to the insurer's duty. b. It is generally triggered when a final judgment is entered against the insured, and it is satisfied when the insurer pays such covered amounts to the plaintiff who obtained the judgment. c. Most policies provide for payment of monetary damages as well as any costs, expenses, and attorney's fees which the plaintiff may also be entitled to as the prevailing party. 2.

What’s Covered

a. Unlike the duty to defend, the duty to indemnify extends only to those claims or causes of action in the plaintiff's complaint which are covered under the policy, since a final judgment against the insured would normally be supported by a factual record in the trial court showing exactly why the plaintiff prevailed (or failed to prevail) on each claim or cause of action. b. Thus, an insurer could have a duty to defend based on mere allegations that show a potential for coverage, but may not have a duty to indemnify if the evidence supporting a final judgment against the insured also takes those claims or causes of action completely outside of the policy's scope of coverage. 30


The Duty to Settle Claims 1.


a. In some jurisdictions, there is a third duty, the duty to settle a reasonably clear claim against the insured. b. This duty is generally triggered only if a reasonable opportunity to settle actually arises, either because the plaintiff makes a settlement offer, or the insurer is aware of information to the effect that the plaintiff would accept a settlement offer. c. The insurer is neither required to initiate an offer to a plaintiff likely to refuse it, nor required to accept an outrageous offer from a plaintiff who filed a frivolous lawsuit and cannot prevail against the insured under any theory. 2.

Claims in Excess of the Policy Limits a.

Exposure for the Insured

(1) The duty to settle is of greatest import in the scenario where the insured may have some liability exposure (i.e., there is some evidence apparently linking the insured to the plaintiff's alleged injuries), the plaintiff has evidence of substantial damages which may exceed policy limits, and the plaintiff makes a settlement demand (either to the insured or directly to a defending insurer) which equals or exceeds policy limits. (2) In that situation, the insurer's interests conflict with the insured's interests, because the insurer has an incentive to not immediately settle. b.

Insurer Refusal to Settle

(1) That is, if the insurer refuses to settle and the case then goes to trial, there are only two possible outcomes: (a) the insured loses and the insurer must pay the ensuing judgment against the insured up to the policy limits, or (b) the insured wins, meaning both the insured and the insurer bear no liability. (2) If the first outcome occurs, then it is essentially “nothing gained nothing lost” from the insurer’s point of view, because either way it will pay out its policy limits. c.

Liability Exposure

(1) While the insurer may be indifferent in this scenario as to whether it pays out its policy limits before or after trial, the insured is most certainly not. (2) If the first outcome above were to occur, the insured may be held liable to the plaintiff for a sum far in excess of both the pretrial settlement offer and the policy limits. (3) Then after the insurer pays out its policy limits, the plaintiff may attempt to recover the remaining balance of the judgment by enforcing writs of attachment or execution against the insured’s valuable assets. d.

The Duty


(1) This is where the duty to settle comes in. To discourage the insurer from gambling with the insured’s assets in pursuit of the remote possibility of a defense verdict (under which it can avoid having to pay the plaintiff anything at all), the insurer is subject to a duty to settle reasonably clear claims. (2) The standard judicial test is that an insurer must settle a claim if a reasonable insurer, notwithstanding any policy limits, would have settled the claim. (3) This does not require an insurer to accept or pay settlement offers that actually exceed policy limits, but in that instance, the insurer must discharge its duty to settle by at least making an attempt to bring about a settlement in which it would have to pay only its policy limits (either because the plaintiff agrees to lower their demand or the insured or another primary or excess insurer agrees to contribute the difference). F.

Occurrence v. Claims-made Policies 1.

Traditional Approach

a. Traditionally, liability insurance was written on an occurrence basis, meaning that the insurer agreed to defend and indemnify against any loss which allegedly "occurred" as a result of an act or omission of the insured during the policy period. b. This was originally not a problem because it was thought that insureds' tort liability was predictably limited by doctrines like proximate cause and statutes of limitations. c. In other words, it was thought that no sane plaintiffs' lawyer would sue in 1978 for a tortious act that allegedly occurred in 1953, because the risk of dismissal was so obvious. 2.

Long Tail Coverage

a. In the 1970s and 1980s, a large number of major toxic tort (primarily involving asbestos and diethylstilbestrol) and environmental liabilities resulted in numerous judicial decisions and statutes that radically extended the so-called "long tail" of potential liability chasing occurrence policies. b. The result was that insurers who had long-ago closed their books on policies written 20, 30, or 40 years earlier now found that their insureds were being hit with hundreds of thousands of lawsuits that potentially implicated those old policies. c. A body of law has developed concerning which policies must respond to these continuous injury or "long tail" claims, with many courts holding multiple policies may be implicated by the application of an exposure, continuous injury, or injury-in-fact trigger and others holding the policy in effect at the time the injuries or damages are discovered are implicated. 3.

Claims Made Policy Coverage a.


The insurance industry reacted in two ways to these developments.


(1) First, premiums on new occurrence policies skyrocketed, since the industry had learned the hard way to assume the worst as to those policies. (2) Second, the industry began issuing claims-made policies, where the policy covers only those claims that are first "made" against the insured during the policy period. (3) A related variation is the claims-made-and-reported policy, under which the policy covers only those claims that are first made against the insured and reported by the insured to the insurer during the policy period. (4) There is usually a 30-day grace period for reporting after the end of the policy period to protect insureds who are sued at the very end of the policy period. b.

Effect of a Claims Made Policy

(1) Claims-made policies enable insurers to again sharply limit their own long-term liability on each policy and in turn, to close their books on policies and record a profit. (2) Hence, they are much more affordable than occurrence policies and are very popular for that reason. Of course, claims-made policies shift the burden to insureds to immediately report new claims to insurers. (3) They also force insureds to become more proactive about risk management and finding ways to control their own long-tail liability. c.

Insured’s Duty to Report

(1) Claims-made policies often include strict clauses that require insureds to report even potential claims and that combine an entire series of related acts into a single claim. (2) This puts insureds to a Sophie's choice. They can timely report every "potential" claim (i.e., every slip-and-fall on their premises), even if those never ripen into actual lawsuits, and thereby protect their right to coverage, but at the expense of making themselves look more risky and driving up their own insurance premiums. Or they can wait until they actually get sued, but then they run the risk that the claim will be denied because it should have been reported back when the underlying accident first occurred. d.

Ability to Switch Coverage

(1) Claims-made coverage also makes it harder for insureds to switch insurers, as well as to wind up and shut down their operations. (2) It is possible to purchase "tail coverage" for such situations, but only at premiums much higher than for conventional claims-made policies, since the insurer is being asked to re-assume the kind of liabilities which claims-made policies were supposed to push to insureds to begin with. IX.

Homeowners Insurance Coverage A.

Overview 33

1. Most homeowners insurance policies will cover damage caused by such perils as fire, windstorms, hail, lightning, theft or vandalism. 2. There are other homeowners policies that cover additional perils as well. Typically, floods and earthquakes are excluded. 3. For those perils that are not covered, there may be supplemental insurance that can be obtained. B.

What Most Standard Homeowners Policies Provide

1. Dwelling coverage. Pays to repair or rebuild the home - including electrical wiring, plumbing, and heating and air conditioning - if damaged by a covered cause of loss. It's important to buy enough dwelling coverage to cover the cost to rebuild. 2. Other structures coverage. Pays for damages to detached structures like garages, sheds, fences and cottages on the insured’s property. 3. Personal property coverage. Reimburses the insured for the personal items in their home that may be damaged or destroyed by a covered cause of loss, which could include their furniture, clothes, sporting goods and electronics. 4. Loss of use coverage. Pays the additional housing and living expenses if the insured must move out of theirhome temporarily while it's being restored. 5. Liability insurance. Helps protect assets and cover defense costs in the event of a lawsuit because the insured or family members are responsible for causing injuries or damage to other people or their property. 6.

Medical payments a.

Liability insurance also includes Medical Payments to Others coverage.

b. The home owners policy provides for the payment of necessary medical expenses for guests who are accidentally injured on the insured’s property. c.

This is regardless whether or not the insured is legally responsible.

d. There is also coverage in some situations when the accident happens off the insured’s property. 7.

Liability coverage exclusions

a. A home owners policy does not cover all situations for which the insured or a family member may be legally responsible for causing bodily injury or property damage. b. exceptions.

There are many exclusions in the policy and many of them have

c. It's important that the insured read their policy to learn what is covered and not covered. X.

Commercial General Liability Coverage A.



1. Commercial general liability insurance is a broad type of insurance policy which provides liability insurance for general business risks. 2. It specifically excludes certain types of risks, including professional services, pollution, liquor, and directors and officers liability, and separate insurance policies are available to cover these situations. 3. Commercial general liability (“CGL”) insurance is intended to provide coverage primarily for liability arising out of non-professional acts (violations of the personal, business, or property interests of private citizens) that result in bodily injury, property damage, or personal and advertising injury. 4. CGL insurance is designed to cover an insured’s liability arising out of incidents on the insured’s premises or from the non-professional aspects of the insured’s practice. 5. Since CGL coverage covers non-professional negligent acts, it is important to remember the definition of negligence. 6. CGL insurance is designed to cover an insured’s liability arising out of incidents on the insured’s premises or from the non-professional aspects of the insured’s practice. 7. “Negligence” is a civil wrong that is not based on a contract and maybe defined as the failure to exercise the proper degree of care required by a prudent or ordinary person under similar circumstances. There are four basic requirements that must exist for negligence to be established:



There must be a legal duty of the insured to act or not act;


Breach of this duty must be committed;


The act (breach) must be the proximate cause of the injury; and


There must be actual damages.

What’s Covered? 1.


There are three basic coverage areas that comprise a CGL policy: (a) bodily injury and property damage (BI/PD); (b) personal and advertising injury; and (c) medical payments coverage. 2.

Property Damage

a. Bodily injury/property damage provides coverage for the legal liability of insureds for bodily injury or property damage to others arising out of non-professional negligent acts or for liability arising out of their premises or business operations. b. The CGL policy defines property damage as “physical injury to tangible property, including all resulting loss of use of that property.” 3.

Bodily Injury

a. Bodily injury is defined as “bodily injury, sickness or disease sustained by a person, including death resulting from any of these at any time. b. ” Death that results after a period of time from an earlier injury will be covered by the policy in effect at the time the injury was sustained. 35


The meaning of “bodily injury” is open to judicial interpretation.

d. Some courts have held that mental injuries and emotional distress can be considered bodily injuries, even in the absence of physical bodily harm. e. The CGL policy often defines property damage as “physical injury to tangible property, including all resulting loss of use of that property.” 4.

Premises and Operations Liability

a. There are several coverages included under BI/PD that provide protection for an insured against loss from legal liability arising out of the (1) operation, maintenance, or use of the premises and (2) liability arising out of business operations. b. This liability involves the insured’s (1) legal responsibility for bodily injury or property damage to others on the insured’s premises, or(2) liability arising out of the insured’s business operations or work performed by independent contractors on the named insured’s behalf. 5.

What does Personal and Advertising Injury Cover?

a. Personal and advertising injury liability protects an insured against liability arising out of certain offenses, such as: libel; slander; false arrest; infringing on another’s copyright; malicious prosecution; use of another’s advertising idea; or wrongful eviction, entry, or invasion of privacy, which is committed during the policy period and within the coverage territory. b.

What is libel and slander?

(1) “Libel” is a written statement about someone that is personally injurious to that individual. An example of a libelous situation would be I fun complimentary comments are made by an architect in a letter to a newspaper about a construction contractor’s performance or quality of work on a project in general. (2) “Slander” is similar to libel in that it is a spoken statement that is injurious to an individual. An example of slander would be if an architect verbally degrades the reputation or past work of another architect to a client in order to secure a project from that client. The act of speaking defamatory words by one architect to sway the client, whether justified or not, affects the other architect’s means of livelihood, business, and reputation, which is a personal and advertising injury offense. (3) Truth is always a defense to libel and slander so statements should be based on facts or couched as a professional opinion based on the facts presented. 6.

What medical payments are covered by a CGL policy?

a. Coverage for medical payments includes payments for injuries sustained by members of the public caused by an accident that takes place on the insured’s premises or when exposed to the insured’s business operations. Injuries must be reported within one year of the accident. 36

b. Medical payments coverage can be triggered without legal action from a third party. This provides for prompt settlement of smaller medical claims without litigation. c. It is included in the CGL policy and pays for all necessary and reasonable medical, surgical, ambulance, hospital, professional nursing, and funeral expenses for a person injured or killed in an accident arising out of the premises or business XI.

Umbrella Insurance Coverage A.


1. Umbrella insurance is extra liability insurance. It is designed to help protect someone from major claims and lawsuits and as a result it helps protect the insured’s assets. 2.

It does this in two ways:

a. Provides additional liability coverage above the limits of homeowners, auto, and boat insurance policies. This protection is designed to kick in when the liability on these other policies has been exhausted. b. Provides coverage for claims that may be excluded by other liability policies including: false arrest, libel, slander, and liability coverage on rental units owned by the client. 3. Beyond the possibility that the insurer will seek to deny coverage, if coverage is available for a claim, it will of course be capped by the policy limits. a. exposed.

If the claim is in excess of those limits, the client's personal assets are

b. Finally, if coverage is available, and if the claim is within the policy limits, there may be a question as to whether the insurer will be solvent and able to pay the claim. c.

Umbrella insurance is a type of personal liability insurance.

d. Also, called “excess liability insurance,” it’s indispensable when the insured find him or herself liable for a claim larger than homeowners or auto insurance liability will cover. 4. Umbrella insurance even covers certain liability claims that those policies may not, such as libel, slander and false imprisonment. And if the insured own rental property, umbrella insurance provides liability coverage beyond what homeowners policy covers. B.

Do You Need Umbrella Insurance?

1. As a general rule, it might be recommended that a client should purchase umbrella insurance if the total value of the client’s assets, including ordinary checking and savings accounts, retirement and college savings and investment accounts, other investment accounts and home equity, is greater than the limits of the client’s auto or homeowners liability. 2. The idea behind this advice is that the client should have enough liability insurance to fully cover their assets so they can’t lose them in a lawsuit. 3. This recommendation doesn’t quite make sense, though, because jury awards can easily exceed insurance policy limits.


4. The real question that should be addressed, is whether the client is at risk of being sued? Everyone is, so in a sense, umbrella insurance makes sense for everyone. 5.

But some people are more likely to need an umbrella policy than others.

a. If the client engages in some activity that puts them at greater risk of incurring excess liability, they are a good candidate for an umbrella policy. b. Personal liability risk factors include owning property, renting it out, employing household staff, having a trampoline or hot tub, hosting large parties and being a well-known public figure. c. Having a teenage driver also puts a client at increased risk, as does owning a dog or owning a home with a swimming pool. D.

An Example of How Umbrella Insurance Works

1. Assume the client’s homeowners insurance has a personal liability limit of $300,000. The client throws a large holiday party, and one of their guests slips and falls on the client’s icy front steps. She ends up with a concussion and some astronomical medical bills and decides to sue the client. In court, the jury sides with the party guest and awards her a judgment of $1 million. This judgment is $700,000 higher than the client’s homeowners insurance liability limit. 2. Without a personal liability umbrella, the client will have to pay that $700,000 out of pocket - if the client had a $1 million in umbrella insurance, the umbrella policy would cover the portion of the judgment that the homeowners insurance does not. The umbrella policy will also cover any attorney fees and other expenses related to the lawsuit that weren’t covered by the homeowner’s policy. That coverage is in addition to the $1 million. 3. So if the client’s policy had a $5,000 deductible on their homeowner’s insurance, they’ll pay that amount out of pocket. Then, their homeowner’s policy will pay the next $295,000, which gets the client to the $300,000 policy limit. If the umbrella insurance doesn’t have a separate deductible in this case, because the homeowner’s policy covered part of the loss. The umbrella policy pays the remaining $700,000 of the judgment plus legal expenses, so the client is only out of pocket $5,000 for the $1 million judgment. XII.

Professional Malpractice Insurance A.

Reasons for Securing Professional Liability Insurance 1.

Why should a professional maintain malpractice insurance?

a. First and foremost, it drastically reduces the chance that a malpractice claim will result in severe financial hardship to the professional or his or her firm. b. In addition, it will save the professional the time and aggravation in dealing with (and defending) the claims which may arise. c. Finally and perhaps most important it will protect the client if he or she has a credible claim. 2. B.

The rules of governing the conduct of the professional may require it.

Applying for Coverage 1.

Application for New Coverage 38

a. If the professional is not currently covered – or the professional is seeking new coverage – a detailed questionnaire will have to be completed. b. This questionnaire permits the insurer to determine whether to insure the professional or not, and (if the insurer chooses to provide coverage) helps them determine what the level of the premium will be. 2.

Contents of the Application a.

The information requested on the application may include the following: − Background information on the attorney and firm; − The firm or attorney’s areas of practice; − Existence of the attorney’s outside business interests; − Past coverage status; − Office procedures of the firm; − Prior claims, potential claims, and disciplinary record.



This section will contain questions concerning the applicant’s knowledge of potential claims that are likely to result in a coverage dispute.


The insurer does not want to assume the risk of covering an existing claim.


This question typically asks “whether or not the applicant is aware of any incident that could reasonably result in a claim.”


The applicant’s level of “awareness” is discussed below.

Misrepresentations in the Application

a. Alleged misrepresentations in applications can result in significant coverage disputes, and even allow the insurance carrier to deny coverage. b. There are two factual situations in which coverage is denied due to misrepresentations: (1) (2) the insurer.

Intentional deception and fraud; and, A misrepresentation that “materially increases” the risk of loss to

c. If the misrepresentation “materially increases” the risk of loss, it may not matter whether the mistake was innocent or not. d. If coverage is rescinded for misrepresentation, no claims under the policy will be covered. C.

The Policy 1.

Read the Policy


a. For many professional, professional malpractice insurance is a necessary evil, and an increasingly expensive one. b. The choice of coverage is often based more on price rather than a reasoned decision as to what the policy provides in the way of actual coverage protection. c. The professional should the policy before he or she agrees to the coverage and know that in many cases, the professional can negotiate the terms. 2.

What Time Period is Covered? a.

Claims Made Policy

(1) Most policies will extend coverage to claims arising from acts which occurred prior to coverage, so long as the attorney was unaware of facts that could support the claim. (2)

Many policies contain a “prior knowledge provision”. (a)

This provision is not there to protect the professional!

(b) The provision allows the insurance company to deny coverage if the professional had a “reasonable basis” to believe that a claim would be made against the professional, even if the professional did not believe that the claim would be made. (3)

An additional refinement is the “continuity clause.”

(a) This clause allows the insurance carrier to deny coverage if the professional had knowledge of the potential claim prior to the first policy issued by the carrier, rather than prior to the current policy period. (b) The wording of the “prior knowledge provision” is one provision the professional should attempt to negotiate to limit the terms to a more objective standard. (c) In addition, the professional should try to include a “notice of circumstance” provision which allows the professional to notify the carrier of circumstances which may lead to a claim, and have those circumstances treated as an actual claim during the coverage period, even though no actual claim has been made. b.

Prior Acts Coverage

“Prior Acts Coverage” excludes coverage for acts prior to a certain date. This “prior acts” date or “retroactive date” will be set forth in the policy and may change if a gap in the coverage occurs. c.

Tail Coverage

“Tail coverage” can be purchased to limit the exposure that exists after the expiration of a policy. For a claim made under the policy, tail coverage will extend the period for reporting covered claims under an expiring policy for errors occurring prior to the policy’s expiration. 2.

What Acts are Covered? 40


“Professional Services”

(1) A malpractice policy covers the professional in regard to his or her mistakes while rendering “professional service.” (2) An important question to consider, however, is exactly how the policy defines “professional services.” For example, if the professional serves as a trustee or executor of an estate, such services may not be covered. (3) The question of coverage may also depend upon whether or not the claim actually “arose out of” the rendering of those professional services. b.

Exclusions (1)


Professional liability insurance policies will generally specifically exclude from coverage certain risks and damages. Some of the more typical exclusions are the following: (2)

Bodily Injury

Professional liability policies largely exclude from coverage damages of bodily injury, sickness, and death. However, a Minnesota court has held that negligent infliction of emotional distress, unaccompanied by physical manifestations of harm, is not considered “bodily injury” and is therefore coverable. (3)

Property Damage

The policy exclusion for property damage will generally remove from coverage a claim for damages based upon the loss of tangible property. (4)

Business Activity

Most policies do not insure against the business activity of the insured attorney outside of the business interests in the attorney’s law firm. An attorney’s actions as an officer or board member of a company other than his or her law firm will also generally not be covered. (5)


This exclusion precludes coverage for claims based upon securities transactions. Some policies also exclude “other investments” in addition to securities in order to remove from risk coverage other investment type activities. (6)

Moral Risk—Dishonest and Fraudulent Activities

These exclusions stem from public policy considerations against insuring willful acts. Some jurisdictions do not consider constructive fraud and acts or omissions deemed fraudulent to be excludable. Other moral-based exclusions include claims for discrimination and sexual harassment. 3.

What Damages are Covered? a.

Policy Language


(1) “Damages” typically include only the payment of money. An attorney is not covered under his or her policy if the plaintiff seeks specific performance or injunctive relief, claims for restitution, or, the attorney faces criminal or disciplinary proceedings. (2) “Damages” vs. “Loss”- some policies cover only “loss” suffered by the plaintiff. Under such policies, an attorney’s breach of fiduciary duties which causes no actual loss to the client, but necessitates damages, will not be covered under a “loss” policy. b.

Liability Caps (1)

“Per-claim” – The policy may limit coverage on a per-claim basis.

(2) Aggregate Caps - Most policies will also contain a policy period aggregate limit, under which they only cover claims for a particular policy period, up to a set amount for that period. c.

Cost of Defense

Some policies deduct the cost of an attorney’s defense from the insured’s coverage limits, thus increasing the insured’s potential personal liability if an award is granted to the plaintiff. XIV.

Attorneys Due Diligence

A. ABA Guidance. - Attorneys should consult the ABA Good Practices Guidance and the ABA Formal Opinion 463 when performing due diligence for asset protection planning. B.

Due Diligence - Attorney’s due diligence may include:

1. A statement of the settlor’s profession or business and how long the settlor has been engaged in that endeavor 2.

An Affidavit of Solvency


A statement of where the settlor’s wealth derived

4. All professional licenses held by the settlor and a statement about whether the settlor has been the subject of a disciplinary proceeding or whether a license was revoked or suspended 5.

A current financial statement of the settlor


A list of all states and countries where the settlor has lived

7. Federal and State income tax returns for the prior three years• If an interest in a closely held business will be transferred to the APT, the governing documents, a current financial statement of the business, and Federal and State income tax returns for the prior three years for each entity 8. A statement about any current or pending litigation or administrative proceedings and an estimate of the potential liability 9. A list of all assets to be transferred, the value of each asset and how each is currently titled 42


Appendix 1 – Forms and Compliance with Respect to Offshore trusts The following forms and reporting related acts are relevant in connection with foreign asset protection trusts. − Form 3520: Creation of or Transfer to Certain Offshore trusts Note: Congress directed the IRS to issue regulations that will require Form 3520 to be filed by April 15, with a maximum extension of six months, for calendar year filers.346.1 − Form 3520-A: Annual Return of Foreign Trust With U.S. Beneficiaries347 Note: Congress has directed the IRS to issue regulations to require the due date for Form 3520-A be the 15th day of the third month after the close of the trust's tax year, and the maximum extension will be a six-month period beginning on that day.347.1 − Form 56: Notice Concerning Fiduciary Relationship. − Designation of U.S. agent for the International Retirement Trust, a requirement under U.S. tax law. − FinCEN Form 114, superseding Form TD F 90-22.1: Report of Foreign Bank and Financial Accounts − Form 1040, Schedule B − Form 4790: Currency Transaction Report − Form 1041: Filing for Trustee if the trust is domestic as defined in IRC (The exceptions to the filing requirement are unavailable for such trusts.)348 − Form 1040NR for a foreign trust (as defined in the IRC) Note: A trust that converts from a U.S. trust to a foreign trust, or vice versa, will be required to file dual status tax returns, i.e., Form 1041 for the portion of the year it is a U.S. trust and Form 1040NR for the portion of the year it is a foreign trust.348.1 − Form 926: Return by Transferor of Property to a Foreign Corporation, Foreign Estate, or Trust (A “foreign trust” and “foreign estate” are defined terms;348.1 the IRS will not rule on whether an estate or trust is a foreign estate or trust for federal income tax purpose.348.2 ) − Form 709: Gift Tax Return. It is unclear whether incomplete gifts must be reported. Practitioners have noted the IRS's nonplus reaction when such transactions have been reported. 353 − Taxpayer Identification Numbers354 − FinCEN Form 114 (superseding Form TD F 90-22.1) − Form 8938 - Interest in certain “specified foreign financial assets”