Asset Protection and Fraudulent Transfers

As you may be aware, the United States is one of the most litigious countries in the world. This means more people sue each other in court in the US than almost anywhere else. We have one lawyer for every 252 citizens in the US, as compared to only one lawyer for every 3,484 citizens in Japan. This is a big disparity. Because of this, more and more people are concerned about structuring their business and financial affairs to protect their assets from frivolous lawsuits.

Asset Protection is a necessary and growing component of 21st Century estate planning. In the old days, a power of attorney, a will, and a revocable trust were sufficient for most people, and it seemed only doctors and wealthy business people were concerned about protecting their assets. Nowadays, whether it’s because of the threat of lawsuits or the threat of nursing home costs, proper modern estate planning incorporates a variety of additional techniques to protect client’s assets. Often, these techniques involve transferring assets away to family members, to irrevocable trusts, and/or to business entities, such as limited liability companies.

For my regular readers, you are probably familiar with the 5-year lookback period that applies to assets transferred before applying for Medicaid for nursing home costs. Transfers of assets during that period without adequate compensation can result in a penalty before qualifying for Medicaid. But there is another law that can affect the safety of your assets even after you’ve transferred them away out of your name to your family members, a business entity, or to an irrevocable trust. This is the Uniform Fraudulent Transfer Act found in Hawaii Revised Statutes Chapter 651C.

Usually when we hear the word “fraudulent” we think of criminal fraud. That is not necessarily the case with fraudulent transfers. This law is designed to protect creditors in a situation where a debtor gives away assets for less than fair market value in order to avoid paying off debts owed to creditors. When the creditor files a lawsuit against the debtor, they can usually “claw back” any assets that were given away as fraudulent transfers one year (or in some cases four years—and sometimes even longer) before the time of the law suit.

It’s difficult to prove actual fraudulent intent of the debtor so the courts have developed a test that looks for “badges” or signs of fraud. The more badges present, the greater likelihood the court will find the transfer to be a fraudulent transfer, undo the transfer by taking it back from the recipient, and then use it to pay off the creditor. These are some of the main badges of fraud:

• The transfer was to an insider
• The debtor kept possession of the property after transferring legal title
• The transfer was concealed rather than disclosed
• The debtor was sued or threatened with a lawsuit before the transfer
• The transfer was substantially all of the debtor’s assets
• The debtor was insolvent at the time of or shortly after the transfer

In 2014, the Hawaii Supreme Court decided in Schmidt vs. HSC Inc. that the one-year statute of limitations on some fraudulent transfers does not begin until the creditor not only knows about the transfer, but also knows that it was fraudulent! In other words, it’s not enough that the creditor knew that the transfer happened to start the statute of limitations—the creditor must also have known or had reason to believe the transfer was fraudulent in order to start the one-year clock ticking.

However, in some cases, the court can look back much farther than the statutory one (or, for some transfers, four years). For example, in the Florida bankruptcy case In re: Donald Jerome Kipnis (case number 1:14-bk-11370), the court decided that if one of the creditors is the IRS, then the 10-year statute of limitations (“claw back” period) allowed under IRC Section 6502(a)(1) applies to transfers made by debtors. This makes it much harder to plan ahead to protect assets if one of the future creditors might be the IRS. (And let’s face it, when people run into financial trouble and can’t pay their creditors, the IRS is usually one of them.)

All of this underscores the main point: You must do asset protection planning well in advance—before a claim ever arises from a creditor. Unfortunately, most clients come to seek legal advice for asset protection after they learn of a lawsuit or a creditor claim. Once you’ve incurred a liability, been sued for malpractice, caused a car accident, or become unable to pay your debts, it might be too late. If you have been thinking about asset protection, you really should get a consultation with an expert sooner than later. That means now!