30 September 2005

Asset Protection and Fraud

As an estate planning attorney and professor, I am familiar with how one can protect one's assets from creditors. Some approaches are state sanctioned, like using a homestead exemption to protect equity in a residence, or saving for retirement. Other approaches are tolerated because they appear to flow from general principles in the law, even though they have less direct justification. For example, it is standard practice to place assets which are unlikely to lead to legal liability, like mutual funds or real estate, in one entity, and assets which are likely to generate legal liabilities, like an operating business which may lease or borrow those very "cold assets" for use in the business, in another.

One of the main tools used to prevent abuse efforts to hide one's assets from creditor's claims is the fradulent transfers act. It provides that creditors may ignore transfers made with an actual intent to hinder or defraud creditors, often with no statute of limitations on the date of the actual transfer.

Promoters of asset protection tools like self-settled domestic and foreign asset protection trusts argue that you can't have an intent to hinder or defraud creditors, if you are solvent immediately after a trust is funded. This is simply wrong. The marketing of the trusts, both to clients and to attorneys, makes clear that the primary purpose of such trusts is to hinder the efforts of future, as yet unknown, creditors to collect their claims. Just about the only other purpose of entities in jurisdictions known to be asset protection friendly is to evade taxes, although much as that side of the business is illegal and not handled by legitimate attorneys. Most asset protection trusts for individuals have few, if any, legitimate tax benefits.

Why do governments in the United States not take a strong stand against this form of subtle fraud? It is certainly not for lack of an ability to do so, as I'll outline in a moment. It is primarily due to lack of political will. Asset protection trusts are tools used primarily by the wealthy, who can also fund political campaigns. The laws are also carefully drafted so that the victims are faceless at the time the frauds are committed, which makes developing an organized opposition more difficult. But, it would certainly be possible to take a stronger stance. For example:

* Anyone who is a beneficiary of a trust could be denied the right to have their debts discharged in bankruptcy.
* Anyone with a self-settled asset protection trust, domestic or foreign, could be imprisoned in contempt of court at any time they have a judgment outstanding, until their debts were paid, with asset protection trust assets conclusively presumed to be available to the settlor, with a failure to provide verifiable information regarding the assets of an asset protection trust which is proved to exist deemed rebuttable proof of the funds available in the trust.
* Any asset held in the United States by an asset protection trust, or an entity which holds assets for one or more asset protection trusts, could be made available for seizure by any creditor of a person with assets in that country. Currently, asset protection trusts and similar devices hold trillions of dollars of U.S. assets.
* A national law could be enacted declaring any self-settled trust, or any trust created by a debtor for the benefit of a member of settlors family for whom the debtor has a duty of support, to be null and void.
* A tax of say 10% of principal per annum could be imposed on any assets of a U.S. citizen held in a self-settled foreign trust outside the reach of the U.S. courts.
* Asset protection and tax havens could be threatened with military force if they failed to comply, a threat that could be backed up with a relatively trivial show of military force, since most are small islands with little other economic base.
* Tax laws concerning U.S. controlled foreign assets could be tightened.

If we are going to have a civil law system that enable people to use the courts to vindicate their rights, we ought to have the courage of our convictions to make those judgments enforcable against people who do, or could have but for efforts to hinder and defraud creditors, have an ability to pay their creditors. The bankruptcy law enacted last year went part way, increasing the statute of limitations for fraudulent transfer claims against asset protection trusts in bankrutpcy, but it didn't go far enough.

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