ESTATE PLANNING TO PRESERVE ASSETS

FizerBeck
Fizer, Beck, Webster, Bentley & Scroggins
a professional corporation
1330 Post Oak Boulevard, Suite 2900
Houston, TX 77056-3022
713-840-7710
www.fizerbeck.com
 

1. INTRODUCTION

   Estate planning in its broadest sense has always provided assistance in the accumulation, management, and disposition of wealth. Although the focus traditionally has been on asset disposition and minimization of transfer taxes, in recent years, the concept of estate planning has broadened to include providing advice concerning preservation of assets, including the isolation of assets from future third party claimants. In our increasingly litigious society, many clients find themselves faced with the prospect of paying dramatically increased insurance costs, "self-insuring," or restricting their activities in areas involving the highest degree of risk. Estate planning to preserve assets can offer some measure of protection of certain assets from potential future claims by arranging a client's affairs in a way to minimize exposure to future creditors. This outline discusses some of the various asset protection techniques available.

   In reading these materials, keep in mind the interplay between two fundamental principles of the law: (1) generally, absent some constitutional or statutory exemption such as homestead, if a person can use and enjoy an asset, that asset is reachable by that person’s creditors (i.e., “if you can get it, so can your creditors”); and (2) subject to the prohibition against “fraudulent transfers” (discussed below), all assets are freely alienable (i.e., you may sell or give away anything you have and thereby remove it from the reach of your creditors.

2. FACTORS TO CONSIDER IN ASSET PROTECTION

   Several factors are relevant in determining appropriate asset preservation techniques to implement for a client. These factors include the nature of property owned by individuals and its character under Texas marital property and exemption laws, the form of ownership in which assets are held, the nature of the potential claims which may be made against the property, and the extent of any transfers that a client may wish to consider.

1. Types of Property.

1. Marital Property.

   Texas is a "community property" state. Texas law presumes that all income and assets of a married couple are community property, to be used for the benefit of, and to be applied against the debts of, both spouses. In order to prevent the assets of a married couple from being subject to the debts of both spouses, the party asserting protection must establish that the assets qualify for special treatment. Assuming that a spouse asserting protection can establish the character of property, marital property may be broadly categorized into three types:

1. Separate Property. Separate property includes property acquired before the marriage, property acquired during the marriage by gift or inheritance, and property which the spouses agree in writing constitutes separate property.

2. Sole Management Community Property. This includes a spouse's personal earnings, income from separate property, and recoveries for personal injury.

3. Joint Management Community Property. If the sole management community property of one spouse is mixed or combined with the sole management community property of another spouse, the resulting property is subject to the joint management and control of the spouses. Texas law presumes that all assets are joint management community property, unless the parties can prove otherwise.

2. Marital Property Liability.

   The liability of marital property for a particular claim depends upon the timing and character of the claim in question.

1. Different rules apply to claims arising before or after marriage,
2. Different rules apply to claims arising by contract than to those arising by "tort" (injury) to the claimant.

As a general rule, one spouse's separate property is not subject to the liabilities of the other spouse. In addition, a spouse's sole management community property is not subject to liabilities incurred by the other spouse before marriage, or nontortious liabilities incurred by the other spouse during marriage. Also, a spouse’s sole management community property does not become property of her debtor spouse’s bankruptcy estate. See Section 541(a)(2)(A) of the Bankruptcy Code. All community property, however, is subject to tortious liability of either spouse incurred during marriage. These rules may be summarized by the following table:
 

3. Exempt Property.

   Unlike corporations, individuals are entitled to hold certain property exempt from the claims of most creditors (other than certain taxing authorities and creditors who have loaned money for the purchase or construction of the exempt property). Exempt property includes a person's homestead, regardless of its value; eligible personal property having an aggregate fair market value of not more than $60,000 ($30,000 for a single person); pension and profit sharing plans, IRA's and other similar qualified employee benefit accounts; and the cash value and proceeds of life insurance and annuity contracts.

1. Homestead. The homestead consists of one or more contiguous parcels of real estate, including improvements, totaling not more than 10 acres within in a city, town, or village, and for a family, not more than 200 acres if located in a rural area, or 100 acres if for a single adult. See Texas Property Code § 41.002.

2. Certain Personal Property. Eligible personal property includes furnishings; automobiles; tools, equipment and books used in a trade or profession; pets; certain livestock; and other designated assets. The debtor is entitled to designate which eligible property he chose to be exempt, subject to the dollar value limits described above. See Texas Property Code § 42.001.

3. Qualified Plans. Qualified tax-deferred retirement, pension, profit-sharing, and similar plans, as well as deductible contributions to IRA's and IRA roll-overs (as well as the earnings thereon), are exempt from creditors by statute in Texas. See Texas Property Code § 42.0021. No dollar limit applies to the assets in these plans; however, IRA contributions which exceed the amounts deductible under the Internal Revenue Code (and any accrued earnings on such contributions) are not exempt. See Texas Property Code § 42.001(b). ERISA-qualified plans also have been held to be excluded from a debtor's bankruptcy estate and thus, "exempt" in bankruptcy proceedings as well. See Patterson v. Shumate, 504 U.S. 753 (1992); 11 U.S.C. § 541(c)(2).

4. Life Insurance. Texas law provides that proceeds of a policy of life insurance, whether paid in a lump sum or as an annuity, are exempt from the creditors of the beneficiary of the policy. Texas Insurance Code § 21.22. Texas law also exempts a policy's cash value from the creditors of the insured and the beneficiary, without regard to the dollar limits described above. This modification presents a significant opportunity to shelter assets through the purchase of insurance. However, attempting to protect assets through purchasing insurance is an invitation to fraudulent transfer litigation that may render the protection ineffective. That subject is more fully discussed below. Additionally, the exemption under § 21.22 expires on June 1, 2003; however, after that date a substantially identical exemption will be found in Chapter 1108 of the Insurance Code.

2. Types of Claimants.

   Certain claimants are accorded special treatment under the law, and are entitled to reach assets unavailable to other creditors. For that reason, the character of the potential claimants must be determined.

1. Contract Claimants.

   The law assumes that if you enter into a contract with a third party, that party will have an opportunity to question you about your nonexempt assets, and negotiate suitable security for any amount advanced or credit extended. If a lender, for example, is dissatisfied with a borrower's separate property, and sole and joint management community property, the lender may ask the borrower's spouse to co-sign or guaranty the loan. If the creditor fails or chooses not to obtain the spouse's agreement to pay the loan, the creditor has foregone the opportunity to attach the spouse's separate and sole management community property.

2. Tort Claimants.

   The law provides special protection to tort claimants. The theory for this protection is that unlike a contractual creditor, a tort plaintiff has no choice as to the property ownership attributes of the person by whom he is injured. Accordingly, he is an "innocent" victim who should be provided greater protection. As a result, a tort victim has access to the nonexempt separate property of the debtor, and if the debtor is married, to all nonexempt community property of the debtor and the debtor's spouse.

3. Internal Revenue Service.

   Because of the supremacy clause of the United States Constitution, the protections discussed above provided by Texas law do not always apply to the federal government. In particular, the Internal Revenue Service is not obliged to recognize the exempt property provisions set forth above. However, if a spouse is able to establish the defense of "innocence" with respect to certain Internal Revenue Service claims, that spouse may protect his or her separate property, and can seek reimbursement for his or her share of the homestead levied upon and sold by the IRS.

4. Providers of Necessities.

   In the marital property area, an exception to the general contract rule is provided for persons who provide goods and services considered "necessary for support." The law imposes upon each spouse a legal duty to support the other. Accordingly, all property owned by either spouse is subject to liabilities incurred for health care, food, lodging, and other items necessary for support of either spouse.

3. Form of Ownership.

1. Corporations.

   As a general rule, assets owned by a corporation are subject to the claims of creditors of the corporation without distinction or exemption. In fact, formation of a corporation is often the result of a policy decision by business owners to expose business assets to business risks, in exchange for receiving asset protection for the individual shareholders. As a general rule, the corporation, and not its owners, is liable for debts incurred in the course of its business. This rule has certain exceptions, the most important of which include the following:

1. Personal Negligence. A corporation's employees are responsible for their own actions, including actions undertaken during the course of their employment. Thus, a shareholder-employee may be held personally responsible for his or her own actions. However, in a contract setting, an employee or officer of a corporation may negate personal liability for a contract by clearly identifying the capacity in which he or she signs on the corporation's behalf.

2. "Piercing the Corporate Veil." Under common law, a court may ignore the existence of a corporation and impose liability upon its owners if the corporation is so undercapitalized as to constitute a sham or artifice to defraud creditors, or ignores all corporate formality and operates as nothing more than the "alter ego" of its owners. In the leading Case of Castleberry v. Branscum, 721 SW 2d 270 (Tex. 1986), the Texas Supreme Court held that "piercing the corporate veil" can be allowed on a showing of constructive fraud occurring when inequity or unfairness exists. In response to this court decision, Article 2.21 of the Texas Business Corporation Act ("TBCA") was enacted to protect shareholders from liability under a "piercing" attack. Art. 2.21 provides that a corporation will not be deemed the alter ego of its shareholder(s) unless the shareholder(s) caused the corporation to be used for the purposes of perpetrating, and did perpetrate, an actual fraud.

3. Certain Federal Tax Claims. A corporation holds taxes withheld from its employees' wages in trust for the IRS. If the withheld taxes go unpaid, the IRS may not only sue the corporation, but may also impose a "penalty" equal to 100% of the unpaid taxes against each person responsible for seeing to the payment of taxes. The IRS frequently asserts this 100% penalty personally against each officer, director, check signer and controlling shareholder.

4. Texas Franchise Tax. Corporations are subject to Texas franchise tax. A corporation with annual gross receipts of more than $150,000 must pay a 4.5% income tax to the state, or a capital tax of 0.25% of the net asset value, whichever is greater. This added state tax encourages the use of partnerships in Texas, because under current law partnerships are not required to pay franchise taxes.

2. General Partnerships.

   Under Texas law, each partner in a general partnership is personally liable for the debts of the partnership. This liability extends to partnership loans or other contracts, and to "torts" or injuries committed by any partner in the course of partnership business. A general partnership requires no written agreement. Therefore, creditors occasionally try to establish a "partnership" in contexts unanticipated by the parties. Creditors often argue that a "partnership" has been formed in the context of office-sharing arrangements, loan relationships and other business transactions. Partnerships (whether general or limited) are not currently subject to franchise tax in Texas.

3. Limited Partnerships.

   Partners may agree in writing that certain partners (limited partners) will not face this general liability. This type of partnership is called a limited partnership. A limited partnership may be formed by filing a certificate of limited partnership with the Texas Secretary of State pursuant to the Texas Revised Limited Partnership Act ("TRLPA"). A limited partnership has two (2) classes of partners: (a) one or more "general" partners who have unlimited liability; and (b) one or more "limited" partners who are protected from personal liability for the actions of the partnership. The general partner of a limited partnership can be a corporation or LLC (defined below), so that no individual must assume personal liability. Limited partners must agree to take no active role in the day-to-day management of the business affairs of the partnership. The liability protections afforded to limited partners is similar to, and subject to the similar exceptions as, the protections afforded the shareholders of a corporation.

4. Limited Liability Partnerships.

   A limited liability partnership ("LLP") is a general partnership where the partners file a formal election with the state to be treated as a LLP and pay an annual fee (currently $200 per partner per year) so that each partner will not be personally liable for the negligence of each other partner. The LLP statute also affords protection against joint and several liability for general partnership debts (both tort and contract) if the LLC election is current and the partnership carries at least $100,000 in insurance covering the general liability of the partnership and the errors, omissions and negligence of the partners. See Texas Revised Partnership Act, Art. 6132b-3.08. A limited partnership also may elect to be treated as a "LLP," in which event the partners, including the general partner(s), will receive the further protection of being a LLP under Art. 6132b-3.08, in addition to the liability protection afforded under TRLPA.

5. Limited Liability Companies.

   The Texas Limited Liability Company Act, Art. 1528n, allows a business to be organized as a limited liability company ("LLC"). LLCs are formed in a manner similar to corporations. LLCs are governed by "members" who (like corporate share-holders) are not generally liable for the debts of the LLC. The LLC is generally treated as a partnership for federal income tax purposes (unless there is only one owner, in which case it is taxed as a sole proprietorship), but is subject to the Texas franchise tax.

6. Trusts.

   Trusts are a form of asset ownership whereby the creator or "grantor" of the trust transfers assets to a "trustee," who is charged with handling the assets as instructed by the grantor for the benefit of the trust's beneficiaries. As a general matter, the trust's assets are subject only to liabilities lawfully incurred by the trustee on the trust's behalf, but not the personal liabilities of the grantor or the trustee (unless the trust is "self-settled," as discussed below). If the trust so provides, the creditors of a beneficiary (other than a beneficiary who is also a grantor) are effectively prevented from reaching the assets of the trust for satisfaction of the creditors claims. Such a trust is referred to as a "spendthrift" trust. See Texas Trust Code § 112.035; Nunn v. Titche-Goettinger, 245 SW 421 (Tex. Com. App. 1923); First Bank & Trust v. Gross, 533 SW 2d 93 (Tex. Civ. App. 1976).

3. TRANSFERS OF PROPERTY

   Many asset protection techniques involve an evaluation of the ownership of property available to satisfy claims. In many circumstances, a debtor's assets available to creditors will include not only assets owned by the debtor at the date of the claim, but also assets that have been previously owned by the debtor. The law prohibits transfers in fraud of creditors. Examples of these laws include the following:

1. Bankruptcy.

   If a party declares (or is forced into) bankruptcy, the bankruptcy court may set aside certain preferential transfers made within 90 days of the filing of the bankruptcy (or within 1 year of the filing of the bankruptcy for transfers made to related parties), and "fraudulent" transfers (i.e.. those without adequate consideration) made within 1 year of filing. Thus, a party contemplating a transfer of assets must determine whether bankruptcy is likely in the near future and whether the transfers contemplated might be set aside by a bankruptcy court. In addition to the preferential and fraudulent transfer rules of the Bankruptcy Code, a trustee in bankruptcy has all the rights and powers of a hypothetical state law creditor under the fraudulent transfer laws of the state. Texas has adopted the Uniform Fraudulent Transfer Act, found at Chapter 24 of the Texas Business and Commerce Code ("TBCC"). Under this statute, as explained below, a bankruptcy trustee could look back 4 years (and even further if the transfer is concealed) in an attempt to avoid fraudulent transfers.

2. "Fraudulent" Transfers.

1. Transfers Resulting in Insolvency.

   Under Texas law, transfers made (or obligations incurred) by a debtor can be set aside by a court, for creditors claims arising prior to the transfer, if the debtor was insolvent at the time of or as a result of the transaction. See TBCC § 24.006. "Insolvent" means that the sum of the debtor's debts exceeds the fair market value of the debtor's nonexempt assets. See TBCC § 24.003(a). A debtor who is generally unable to pay his debts as they come due is presumed to be insolvent. See TBCC § 24.003(b). In order to set aside such a transfer, a creditor must show either:

1. The debtor failed to receive a "reasonably equivalent value" for the transfer; or

2. The transfer was to an "insider" of the debtor, made to pay off a pre-existing debt. See TBCC § 24.006.

2. Intent to Defraud Creditors.

   The law also provides that a court can avoid any transfer made (or obligation incurred) by a debtor with "the actual intent to hinder, delay or defraud" any creditor whose claim arose within a reasonable time before or after the transfer. See TBCC § 24.005(a). Thus, even a transfer that does not render a debtor insolvent can be set aside by a creditor whose claim arises a reasonable time before or after the transfer, if the creditor can establish "intent" to defraud. Since a transferor's "intent" is difficult to prove, Texas law has established eleven factors (sometimes called "badges of fraud") which courts may consider in establishing the actual intent of a debtor,

1. The eleven factors set forth by statute [See TBCC § 24.005(b)] are:

1. Whether the transfer is to an "insider" (family member, partner or affiliated business);

2. Whether the debtor retains possession or control of the transferred property;

3. Whether the transfer is concealed;

4. Whether the debtor has been sued or threatened with suit prior to the transfer;

5. Whether the transfer is of substantially all of the debtor's assets;

6. Whether the debtor leaves the jurisdiction of the court;

7. Whether the debtor conceals assets or removes them from the jurisdiction of the court;

8. Whether the value received by the debtor in exchange for transferred assets is reason- ably equivalent to the value of the transferred assets;

9. Whether the debtor is insolvent as a result of, or shortly after, the transfer;

10. Whether the transfer occurs shortly before or shortly after a substantial debt is incurred; and

11. Whether the debtor transfers essential business assets to a creditor, who then re-transfers the assets to an insider of the debtor.

2. The above factors are not exclusive. On the other hand, the existence of one or more factors does not create a presumption that a transfer is fraudulent. Rather, the court must determine the existence of intent based upon all facts and circumstances of a particular case, with the listed factors to be used as guidance.

3. Constructive Fraud.

   Texas law further provides that a transfer of property for which the debtor does not receive "reasonably equivalent value" is deemed to be constructive fraud. See TBCC §24.006. In such a circumstance, a creditor whose claim arises a reasonable time before or after the transfer need not show an actual intent to defraud, if the creditor can establish that:

1. The debtor intended to incur, or believed he would incur, more debts than he would be able to pay after giving effect to the transfer; or

2. The debtor was left with an unreasonably small amount of assets with respect to the risks associated with the transactions or business activities in which the debtor is engaged, or about to become engaged. "Reasonably equivalent value" is defined in TBCC § 24.004(d) as being a value "within the range of values" of an arm's-length transaction.

4. Time Limits for Challenging Transfers.

   In order to set aside a transfer, a creditor must bring an action within the time allowed by statute. TBCC §24.010 provides that the statute of limitations for challenging a transfer of assets is as follows:

1. For transfers with the "intent" to defraud, within 4 years after the transfer or, if later, within one (1) year after the creditor could reasonably have discovered the transfer. Inasmuch as transfers with intent to defraud are often concealed, the "discovery" rule allows a creditor to challenge concealed transfers that were made much longer than 4 years from the date of transfer.

2. For most transfers resulting in insolvency, or "constructive" fraud, within 4 years after the transfer.

3. For transfers to insiders in satisfaction of pre-existing debts, within 1 year after the transfer. Again, however, transfers to insiders often have the earmarks of fraudulent intent. Accordingly, creditors often argue "concealment" in an effort to extend the 1-year period (it can be extended to 4 years if concealment is shown).

4. For transfers to a spouse, minor, or disabled person, within 2 years after the transfer or, if later, within 1 year after the creditor could reasonably have discovered the transfer (but note that time limits do not run against a minor or incapacitated person until adulthood or recovery from incapacity).

4. SPECIFIC PLANNING TECHNIQUES

   The foregoing discussion suggests certain estate planning opportunities which may be utilized to preserve assets. This planning generally involves modifying the form in which assets are held, transferring assets within the limits afforded by law to place them beyond the reach of future creditors, and acquiring new assets in a form exempt from future creditors. Another approach involves restructuring asset holdings to leave them available to future creditors, but to make them unattractive as sources of funds for satisfaction of a successful claim.

1. Modifying the Form of Asset Ownership.

1. Corporations.

1. A corporation acts to contain liabilities arising out of the business within the corporation. Thus, as a general rule, a business creditor of a corporation may reach only the assets placed in the business. Parties contemplating a business undertaking which itself could generate liability, then, would be well-advised to place assets in the corporation, withholding non-business assets to protect them from the claims of business creditors. However, a corporation generally is not as effective as certain other entities (such as limited partnerships and LLCs) in protecting the assets and business of the corporation (or acting as a "shield") against claims arising outside the corporation against the corporation's share-holders. For example, a creditor of a shareholder could execute against the share-holder's stock in the company, become the owner of that stock, and thereby vote the shares and otherwise gain a measure of control over the business. Also, tax planning, including the Texas franchise tax, must be given consideration when choosing the appropriate entity to hold assets or operate a business. As a "rule of thumb," a corporation is a good choice of entity for the operation of a service business, but not to hold substantial assets, such as real estate or investment securities.

2. Professional Associations and Corporations.

   Texas law provides an exception to the general rule that owners of corporations are not liable for its debts. In general, an eligible licensed professional who forms a professional corporation or association cannot interpose the corporation to avoid liability for his or her professional misconduct. Thus, a malpractice claimant can reach the assets of the professional corporation or association, and also reach the non-exempt personal assets of the business owner that committed the malpractice. In the context of a general partnership, the same claimant could reach not only the non-exempt personal assets of the negligent business owner, but also the non-exempt personal assets of his or her partners. Therefore, whenever two or more professionals are engaged in business together, it may be advisable for each such to form a professional association or corporation and for those entities to form a partnership for the conduct of their business, and the partnership may subsequently elect to be treated as a LLP.

3. Limited Liability Companies (LLC).

   A LLC acts much like a corporation in containing or encapsulating the liabilities of the business within the LLC. However, LLCs are superior to corporations as a device to protect the business from creditors of the members of the LLC. A creditor of a member of an LLC could obtain the right to receive the member's share of any distributions made by the LLC to its members; but, unless and until the creditor is expressly admitted as a member (if ever), the member (and not the creditor) retains the right to participate in the management of the LLC. Thus, a creditor of a member of an LLC cannot unilaterally acquire a voting interest in the LLC. LLCs are generally treated as partnerships (or sole proprietorships, if a single-member LLC) for federal income tax purposes, but are potentially subject to Texas franchise tax. Accordingly, LLCs generally are not favored as entities to hold substantial assets such as real estate or investment securities.

4. Limited Partnerships.

   As mentioned earlier, limited partners are afforded protections similar to shareholders in isolating themselves from liability for the conduct of partnership business. However, because the general partner in a limited partnership must accept full liability for the business of the partnership, a limited partnership is not preferable as an entity to operate a business which itself throws off potential liabilities unless a corporation or LLC is used as the general partner. A limited partnership also is an excellent choice of entity for protecting the partnership assets from the creditors of the partners. As a general rule, a creditor of a partner in a limited partnership can obtain only the right to receive that partner's share of partnership distributions, as and when made, but unless and until the creditor is admitted to the limited partnership as a partner (if ever), the creditor would remain a mere assignee of the interest of the partner and could not vote the interest or otherwise participate in the management of the limited partnership. Additionally, since rules relating to the relative rights and duties of limited partners are established by agreement and not by statute, limited partnerships provide considerable flexibility in the manner in which potential obligations of the partnership may be discharged. A limited partnership is not currently subject to Texas franchise tax and thus generally is the "entity of choice" to hold investment assets such as real estate and securities.

5. Summary - Choice of Entity.

   The foregoing liability considerations for the choice of entity are summarized in the following chart:
    

(1) Yes as to limited partners
(2) No as to general partners, unless corp/LLC is used as general partner

2. Transfers of Property.

   One way to protect assets from the reach of creditors is to part with the ownership of the assets. As indicated above, solvency, intent and timing are critical factors that must be evaluated with respect to any transfer of assets. As a general rule, however, subject to the limitations on insolvency and fraudulent conveyances, future creditors cannot reach assets that a debtor has effectively transferred.

1. Investment in Exempt Property.

   Subject to the fraudulent transfer rules discussed above, a debtor may convert nonexempt property into exempt property to avoid reach by future creditors. In particular, highly liquid clients may consider paying off the mortgage on their homestead in order to maximize the value of this exemption. Although courts may look to this sort of payment as an indication of bad faith on the part of the debtor, courts have been reluctant to abrogate the constitutional homestead exemption in favor of creditors. However, conversion of nonexempt personal property into exempt personal property is expressly disallowed by statute in Texas, if done with the intent to defraud, delay, or hinder a creditor, so long as the creditor brings a claim within four years of the transfer. See Tex. Prop. Code § 42.004. Moreover, conversion of non-exempt personal property into exempt real property (i.e., a homestead) could give rise to denial of a discharge under Section 727 of the Bankruptcy Code.

2. Transfers to Trusts.

   Generally, a person may establish a trust to own property, and transfer ownership of the property to a trustee to hold in trust. From a legal standpoint, the trustee (and not the transferor) then owns the property.

1. Revocable and "Self-Settled" Trusts. As a general rule, if the transferor retains a power of appointment over the property or is otherwise able to revoke the trust, the transfer is ineffective as against creditors of the transferor. See Tex. Trust Code § 112.035. In other words, under Texas law, a self-settled trust provides no protection from claims of creditors of the transferor. Certain other states and foreign jurisdictions, however, permit self-settled "spendthrift" trusts, as discussed below.

2. Irrevocable Trusts. A trust may be established, however, for the benefit of persons other than the transferor. The theory here is that the transferor has truly and irrevocably parted with the assets (presumably transferring them to someone that the transferor loves more than his creditors). To be effective, the trust must be irrevocable, must provide for no retained interests by the transferor (although the transferor's spouse and dependents may be beneficiaries) and must not run afoul of the fraudulent transfer rules discussed above. Note that if the spouse is a beneficiary of the trust, and a community property interest is transferred into the trust, that spouse's creditors may reach the trust assets because, with respect to that property, the beneficiary-spouse is a transferor. Accordingly, if this type of transfer is desired, a marital partition, converting the property to the separate property of each spouse, would be necessary prior to one spouse establishing a trust for the other spouse as discussed in Section 3 below.

3. "Foreign" Trusts. Several states (most notably Alaska, Delaware and North Dakota) and many foreign countries (e.g., the Cook Islands, Nevis and others) have enacted laws that enable an individual to transfer assets to a trust for the benefit of himself and his family, and have the assets held in trust and outside the reach of creditors. Some foreign jurisdictions even permit the transferor to retain the right to have the assets returned to him after a fixed period. These laws generally provide that, so long as the transferor is solvent after the transfer, no creditor may attach his interest in the trust. Such trusts typically provide that the trustee (usually a bank or trust company) has the right to extend the trust indefinitely if the grantor is "under attack" at the time that the trust is scheduled to terminate. Texas law, however, provides that such a provision is ineffective against the grantor's creditors, and the transferor may be compelled, under threat of contempt of court, to obtain a return of the assets.

3. Transfers to a Spouse or Another Party.

   The separate property of a debtor's spouse is not liable for claims against the debtor unless that spouse has agreed contractually to assume liability for those debts. Thus, married couples can agree to partition assets so as to establish certain property as the separate property of each spouse. It is incumbent upon the spouse asserting protection to establish the separate property character of the assets to be protected. Accordingly, separate record keeping and segregation of funds is imperative to maintaining the effectiveness of this technique. Alternatively, property may be transferred outright to others (children, parents, etc.), so long as the fraudulent transfer rules described above are not violated. Of course, the reason that future creditors are prevented from reaching these assets is that they are beyond the debtor's reach. If the debtor divorces, the divorce courts are prevented from awarding one spouse's separate property to the other, even if the property was derived as a gift from the former spouse. Additionally, there may be substantial estate tax disadvantages to a partition of community property into separate property.

4. Transfers to Charity.

   Transfers to charity often provide attractive income and estate tax benefits as well as a sense of satisfaction to the transferor. For tax and personal planning purposes, transfers to charities may be made through the use of a trust, with the grantor or his family retaining an interest in the assets of the trust, either before they are given to charity, or after the charity has used them for a specified period [commonly known charitable remainder trusts (CRTs), or charitable lead trusts (CLTs) respectively]. While such transfers are subject to the fraudulent conveyance rules described above, the benefits provided to charity, as well as the tax and estate planning benefits of the transferor, may tend to negate claims of an "intent" to defraud creditors.

5. Inheritance.

   A client who expects a significant inheritance can, depending upon his family situation, request that the inheritance be made to him through the use of a "spendthrift" trust as opposed to transferring property to him directly. He can serve as the trustee of his own trust, deciding when to make distributions to himself and his family. Because he is not the creator of the trust, the creditor protection provisions of the trust should be effective to prevent his creditors from claiming his inheritance. For similar reasons, many clients chose to establish wills that pass property to each other, and ultimately to their children, in lifetime trusts. Children can be allowed to become a co-trustee or sole trustee at an age designated by the parents. Assets inherited in trust are protected from divorce and creditors, and can also afford substantial income and estate tax saving opportunities.

3. Asset Protection Strategies.

   In the foregoing sections we have discussed that, subject to the prohibitions against fraudulent transfers, both parting with ownership of assets and the way in which assets are owned may be used to make a person's particular holdings less attractive to creditors in enforcing any judgment. Below is a discussion of some common asset protection strategies involving various elements of these techniques, usually employed in combinations.

1. Family Limited Partnerships ("FLP").

   A "family limited partnership," i.e., a limited partnership in which all of the partners are family members, is a technique used by estate planners to achieve a variety of objectives. These objective include providing centralized management of family investments; allocating income among family members in an income tax advantaged manner (subject to certain limitations imposed by income tax laws); reducing estate values for estate and gift tax purposes; and simplifying annual gifting and other transfer techniques. As an ancillary benefit, limited partnership interests may deter creditors from attaching property, due to their inability to reach partnership assets or compel distributions. As discussed above, the source of this deterrence is that a creditor who attaches a partner's interest in a partnership is not thereby automatically made a partner. Rather, the creditor becomes an "assignee" of the partnership interest under state law. Under TRLPA, an assignee does not have the right to withdraw from the partnership or terminate the partnership prior to its stated term. An assignee's only right is to receive distributions from the partnership at such times and in such amounts as the general partner may determine. On the other hand, an assignee may be required to pay tax on his share of the partnership's income, regardless of whether such income is distributed to the assignee. As a consequence, a creditor may find itself in a situation where it must pay tax on income that he cannot reach. This exposure often deters creditors from seeking to attach partnership interests. On the other hand, if the partnership distribution policies are changed to reduce or eliminate distributions after the creditor becomes an assignee, the litigation risk increases. An assignee/creditor could argue that the general partner breached a duty to the limited partners in curtailing distributions.

2. Combination of FLP with Other Techniques. The FLP may be combined with other techniques such as marital partitions, spousal gifts, trusts for children and/or grandchildren, foreign trusts, and charitable gifts. One example of how this might work is as follows. A person in a high-risk occupation who could be the target of lawsuits (but currently has no claims pending) could pursue the following plan:

1. Pay off home mortgage debt; maximize contributions to profit sharing, IRA and 401k plans; invest in life insurance.

2. Transfer nonexempt investment assets such as non-homestead real estate and investment securities to a FLP (with a corporation or LLC as a one percent (1%) general partner; and the transferor(s) as 99% limited partners).

3. Depending on strength of marriage and other factors (including estate planning considerations), partition limited partner units into separate property interests of each spouse to protect the "low risk" spouse's interest from claims against the "high risk" spouse. Additionally (or alternatively, if partition is not advisable), some or all of the "high risk" spouse's limited partner units could be transferred by gift to children (depending on gift tax consequences) and/or the other spouse (or to "spendthrift" trusts for their benefit).

4. As an alternative to (or in combination with portions of) the transfers described in c. above, limited partner units (and possibly ownership interests in the corporation or LLC serving as general partner) could be transferred to a trust formed in a jurisdiction which permits self-settled "spendthrift" trusts.

5. THE LAWYER'S ROLE

   The Texas Disciplinary Rules of Professional Conduct provide that an attorney shall not assist a client in conduct the lawyer knows is criminal or fraudulent. See Rule 1.02. The Disciplinary Rules define "fraud" or "fraudulent" as conduct having a purpose to deceive, and not merely negligent misrepresentation or failure to disclose relevant information. If an attorney discovers the client has embarked on a fraudulent scheme, the attorney must withdraw. See Rule 1.15(a)(1).

   While the foregoing material suggests several planning techniques that may be suitable to implement in proper circumstances, it also describes conduct that might, in extreme cases, constitute fraudulent conduct. Also, attorney/client privilege may not exist if the lawyer is involved in aiding or abetting the commission of a crime or fraud by the client. In addition to the Texas Disciplinary Rules, a lawyer could be subject to criminal penalties under the bankruptcy crime provisions of 18 U.S.C. §152 and 157, if the lawyer knowingly and fraudulently conceals or withholds information from the trustee or court, or devises a "scheme" to defraud and "for the purpose of executing" such scheme files a petition, document or makes a false representation in a bankruptcy case. Other laws may apply depending on the facts including money laundering statutes, anti-racketeering laws, and tax crime laws. Accordingly, lawyers have to be cautious when assisting clients who desire to pursue asset protection planning.

6. CONCLUSION

   The foregoing discussion provides a sampling of the factors to consider and the techniques available in planning to preserve assets. The considerations set forth must, of course, be tailored to each individual case to determine which techniques, if any, are appropriate for any given individual. One must weigh the cost and inconvenience associated with engaging in one of these techniques against the likelihood of attack by a future creditor. Many potential debtors choose to defer action until creditors are "knocking on the door." Under those circumstances, there is not much a lawyer can or should do to assist the debtor in "protecting" assets from claims of creditors. As indicated above, however, timing, motive and forethought are critical elements in the effectiveness of any asset preservation planning. Transfers of assets to place them beyond the reach of known creditors with fixed claims are generally ineffective and can create more problems than they solve. On the other hand, there is nothing wrong with arranging one's affairs so as to minimize exposure to future unknown potential creditors. Accordingly, individuals with the most foresight will reap the most benefits from these techniques.