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How to Legally Protect Your Money From a Lawsuit

In these litigious times, protecting your money from a lawsuit is not as cut-and-dried as locking them up in a bank vault, such as what you might do when your assets consist of instruments like paper securities, coupon bonds, or even cash. Simply insuring them against theft, damage, or what insurance companies refer to as an “act of God,” may not be enough to keep them secure either – especially not from a determined and cunning creditor.

This is especially true in the US, 4.4% of the world’s population, 80% of the world’s lawyers and 96% of the world’s lawsuits. So, to protect your assets from a lawsuit when your assets are at risk of seizure becomes more of a necessity than a luxury.  You can protect your money, income, cash and home from creditors, divorce or other financial perils before or after you are sued. This article will tell you how.

How can you make sure the assets you worked hard for do not end up lining the pockets of a disgruntled ex-employee or an unsatisfied client with an axe to grind? The best way (perhaps one of the only ways) to truly protect yourself is not to hide your assets. It is to divest yourself of them. When you don’t own anything, it is likely your creditors will be entitled to nothing, even if they manage to legally wrangle a judgement in their favor. But when you divest yourself of your assets, do you then end up with nothing as well? Does that not defeat the purpose of enjoying the benefits your assets can provide? Not necessarily.

Establishing a trust or a Limited Liability Company (LLC) has proven to be an effective means of separating yourself from your assets and building a wall around them that will protect them from predatory claims. Although these tools are quite different from one another, both can provide a significant degree of security for your assets. An asset protection trust or an LLC can be established domestically or within an international jurisdiction. Once again, both options come with unique advantages. Only a careful study of each instrument as well as of your specific goals and intentions will help you decide with option will work best for you.

Asset Protection Trust

A trust is aptly named. It is essentially a relationship or arrangement that is made possible by mutual trust among the parties involved. The creator of the trust, the settlor, cedes ownership of and control over his or her assets and turns them over to a trustee. The trustee can be one person, a group of people, or even a corporation. They hold the assets in trust for the beneficiaries named by the settlor at the establishment of the trust, but do not derive any benefits directly from the assets. Professional trustees of course, are paid for their services in accordance to the terms of the trust.

If you question the thought of giving up control in exchange for protection, keep in mind you only do this if the money would be taken by the courts. We place an LLC inside of the trust. You are the manager of the LLC and signature on the bank accounts until doing so would leave you subject to a court order to bring back the money. At that point, the trust company steps in to do what you have them to do: To protect your money.

Don’t get caught like the monkey who gets captured because he won’t pull his fist out of the jar. Sometimes you need to let go of the peanut and escape danger so you can enjoy your freedom. The trust lets you do just that. You put your assets it in a vehicle that lets you enjoy them but your legal enemy cannot freeze and seize.

How Asset Protection Trusts Work

It is the beneficiary or beneficiaries, such as you and your family, who enjoy the benefits of the trust assets. By distancing yourself from your assets, you place them beyond the reach of creditors who may win a judgement against you, without depriving your dependents of the benefits of the assets. Certain types of trusts, to some degree, permit a settlor to be a beneficiary as well, according to the terms of a carefully-worded trust deed.

For a trust to be truly effective, that is, for it to be able safeguard the assets that were funded into it, it must be an irrevocable trust. This means the judge cannot force you to change the wording of the trust to make your legal enemies the beneficiaries. Settlors can also include a spendthrift clause, which prevents a creditor from claiming an interest on any undistributed income from the trust, should he or she win a judgement against the settlor or beneficiary. At the same time, the trustee can legally continue to make third-party distributions on behalf of the beneficiary as long as this does not violate the terms of the trust.

The best time to set up an asset protection trust is, of course, before a creditor files a lawsuit against you. US courts are often skeptical about any assets transferred into a trust after a cause of action has occurred (such as divorce or the dissolution of a business), but before a case is actually filed against a debtor in court. A sympathetic judge may look at such an asset transfer as a fraudulent conveyance and disallow the protection of the trust assets, thereby rendering them within reach of creditors.

Limited Liability Company

An LLC is a corporate entity that combines the limited liability protection of a corporation with the favorable tax benefits of a partnership. An LLC has a unique legal identity that is completely separate from the people that own it, who are called members. (They are not called shareholders because an LLC does not issue shares.) An LLC offers asset protection just like a trust, but it is also a legitimate business entity that can engage in commercial or trading activities as set forth in the articles of organization. Members can enjoy the benefits that an LLC generates, including salaries, perks, and bonuses. However, since members do not own any of the assets, creditors cannot claim them to satisfy a judgement against any member of the LLC.

You have to be especially careful when setting up an LLC, since the protection if provides for your assets largely depends on the LLC being viewed as a legitimate company. If a creditor can prove that the LLC is nothing but a sham company that was set up only to hide a member’s assets from creditors, then a court can rule that the assets are indeed owned by the debtor-member and not by the LLC (which is a sham). This means the assets can be used to satisfy a judgment against a debtor-member. LLC members must file the required documents, pay the prescribed fees, observe the legal formalities of an LLC, and engage in the activity as described and stipulated in their articles of organization.

Domestic Asset Protection

Alaska, the penultimate state to join the United States (January 1959), just happens to be the first US jurisdiction to formulate and enact laws regarding Domestic Asset Protection Trusts (DAPT). Other states soon followed including Nevada, South Dakota and Tennessee, which are currently the three top-ranking states with highly effective asset protection legislation. As domestic asset protection options become more popular in the United States, US jurisdictions will be forced to ‘step up their game’ by offering better protection laws, more comprehensive services, and more cost-effective alternatives.

One of the major drawbacks of domestic asset protection trust is the relatively longer statute of limitations it gives creditors to bring a lawsuit against the settlor or beneficiaries. Domestic LLCs allow for a more constricted window of opportunity, but still does not quite match the limitations imposed by most offshore asset protection instruments. Additionally, even as more and more states consider enacting their own asset protection laws, there is currently little uniformity in this field and the legal landscape continues to be in a state of flux. Thus, you may find your assets safe from an attack emanating from within the state of incorporation, but not from a federal administrative agency or a federal court.

In general, the IRS tends to scrutinize offshore trusts and LLCs more closely than domestic trusts and LLCs. The common perception is that individuals who turn to these international asset protection instruments have something to hide from Uncle Sam. The fact that these offshore jurisdictions almost always do not tax the trusts and LLCs established on their shores only serve to bolster this perception. Setting up a domestic LLC or trust therefore, may just put you under Uncle Sam’s radar and spare you a grueling audit.

Offshore Asset Protection Trust and LLCs

A closer scrutiny from the IRS may be a small price to pay to enjoy the expansive benefits that comes with establishing an offshore trust or LLC to protect your assets from a lawsuit. Most offshore jurisdictions that specialize in asset protection do not recognize foreign judgements against a trust or LLC established under their laws. As sovereign countries, they insist that a creditor starts all over again files a new lawsuit with the foreign court against a debtor-member or a trust settlor or beneficiary, and plead their case in their local court. Courts in these countries are not creditor friendly. The laws are written to side with the debtor.

Moreover, this can be a surprisingly expensive undertaking for the person who obtained a judgment against you which, by itself, may be enough to deter none but the most determined creditor. Nevis for example, requires a creditor to deposit the sum of $100,000 with the Ministry of Finance before any legal procedure can even begin.

In addition to the expense, many offshore jurisdictions limit the scope and effectivity of common creditor remediation such as the Mareva injunction (a freeze order) or a fraudulent conveyance ruling. Belize trust law does not recognize either for common debts when funds are held in a Belize trust. Other countries attempt to mitigate the effectiveness of these tactics by imposing a strict time limit on their legal validity. Some settlors and LLC founders may balk at the thought of entrusting their assets to one of these small nations rather than to the imaginary fortress that is the United States of America. However, these offshore locations (such as Belize or the Cook Islands) permit you to hold your assets elsewhere (such as in Swiss banks) without giving up the protection and benefits that an offshore trust or LLC provides.

Protecting Your Assets from Judgements

Protecting your assets from judgements may mean giving up a certain amount of control over them in exchange for insulating them against frivolous claims. Establishing an asset protection trust or an LLC (or sometimes both) is an excellent option because these distance you, as the owner of the assets, from the assets themselves. This makes it more difficult for a creditor to gain access to your assets since, technically, you no longer own them.

There are benefits and limitations to using domestic and international trusts and LLCs to secure your assets from lawsuits. No matter what asset protection instrument you choose, it’s important to make this decision before any lawsuit is filed against you. To borrow the essential meaning of Benjamin Franklin’s adage, an ounce of prevention is indeed worth a pound of cure. In this case, securing your assets as early as possible will not only protect them, but also spare you and your intended beneficiaries from what may be a costly and protracted court battle against a determined creditor.