Pre-Divorce Planning for Asset Protection
Naturally, nobody wants to think that their marriage will end in divorce. Unfortunately, this is a reality for many people. Pre-divorce planning for asset protection can reduce a lot of stress in the event of divorce. For wealthy individuals, having a well-crafted asset protection strategy which includes protection in the event of divorce is absolutely essential. Fortunately, there are many legal vehicles available for asset protection in the event of divorce.
Common Law Property VS. Community Property
The first step in protecting assets in pre-divorce planning is determining how state law allocates property between spouses. This is because property law has a significant impact on the way that courts divide assets in a divorce case. As a result, a basic understanding of how property law works is essential in knowing how to protect assets if a divorce is on the horizon. States are defined as being either common law property states or community property states.
The majority of states in the United States are considered common law property states. In common law property states, the law considers property one spouse acquired spouse during marriage as the sole property of that spouse. It is only that property the married couple purchased jointly and titled in both their names, that the law considers joint property. In this case, each spouse owns one half of the joint property.
Common Law Property
In common law property states, the courts determine the division of property. Courts attempt to distribute common law property equitably rather than equally. The legislatures in these states have done this to ensure that the law fairly compensates both spouses for what they put into the marriage.
Community Property States
Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin are community property states. Community property states have three different forms of property under the law. They are separate property, community property, and quasi community property.
Separate property consists of property which that one individual spouse acquired before the marriage. The law also considers property one spouse received as a gift or inheritance during marriage as community property. Courts also consider property which the couple has agreed to treat as separate property during marriage as separate property. The creditors of one spouse may not make claims against the separate property of the other spouse during. The law considers separate property as separate for all purposes in community property states, including in divorce. So, that is why it is important to know how the law treats property when putting together your pre-divorce planning strategy.
Community property is property which both spouses own jointly. A person must be married in order to acquire community property. They must also be domiciled in a community property state. This property may be real estate, jewelry, stocks, bonds, and other types of personal property. One may locate community property anywhere in the world. Either or both spouses may manage, control or direct it.
Both spouses have co-extensive interest in community property. This means that the creditor of one spouse has the ability to reach all of the community property owned by the couple. This applies to debts and obligations which either spouse incurred prior to or during the marriage. Creditors can reach community property regardless of which spouse has control of said property. If a judgment is against one spouse the creditor can also enforce it against the community property of both spouses.
The law can also considers property as quasi-community property. This is the case if the law could have classified the property as community if someone had acquired it in a community property state. The law may consider personal and real property as quasi-community property. Quasi-community property is considered community property in states which observe community property law with regards to liability.
Various states use four different criterion to determine whether or not he law considers property as separate property, community property, or quasi-community property. First, it considers the timing of when the property was acquired. Property acquired before marriage is generally separate property. Property acquired following marriage is usually community property.
Source of Funds
Another important consideration when formulating a pre-divorce planning strategy is the source of the funds used to acquire the property. Property which is acquired using funds which are the sole property of one spouse is usually considered separate property. Property acquired using joint funds tends to be considered community property. Transmutation agreements also affect the way that the law classified the property. The couple may use transmutation agreements to turn separate property into community property. They may also turn community property into separate property or transfer the separate property of one spouse to the other spouse.
Once one determines the type of property, that person can can seek the appropriate legal vehicles to protect one’s assets.
Pre-Divorce Planning Tools for Asset Protection
There are many legal vehicles which can be used for protecting assets from a spouse in the event of divorce. The following three tools are among the most popular:
Prenuptial and Postnuptial Agreements
Prenuptial agreements are pre-divorce legal agreements which people make before they get married. Postnuptial agreements are agreements made between spouses after they are married. Prenuptial and postnuptial agreements can be used by couples to assist in the division of assets if they divorce.
In order for prenuptial and postnuptial agreements to be valid in most states, they must be made in writing. Both parties must also be entering into the agreement voluntarily in order for it to be considered valid. In some states, such as California, each party needs independent legal counsel.
The downside to prenuptial and postnuptial agreements is that they may not provide adequate asset protection in divorce. This is because they are usually entered into while the relationship between the couple is happy. An overly rosy outlook can cause individuals to enter into agreements which may be too generous or not represent their legal best interest.
During divorce proceedings, it is very common for former spouses to challenge prenuptial and postnuptial agreements. Usually, a former spouse must prove that the agreement was made as the result of undue influence and/or misrepresentation in order to have it overturned. The courts will consider several factors with regards to overturning a prenuptial or postnuptial agreement. These considerations include extreme disparities between the parties in age or knowledge. They also include lack of adequate counsel and vulnerabilities created by specific circumstances such as poverty, pregnancy, or illness. Prenuptial and postnuptial agreements can be useful tools for asset protection planning. However, they certainly are not bulletproof.
Domestic Asset Protection Trusts
A domestic asset protection trust is another popular legal vehicle which one can use for pre-divorce planning. Domestic asset protection trusts allow for settlors of trusts to also act as the beneficiary and a co-trustee. These trusts are irrevocable. They are often referred to as self-settled asset protection trusts. By acting as a co-trustee, the settlor may maintain control of the trust. However, another co-trustee must be appointed in order to protect assets from the claims of a former spouse. The co-trustee must have discretion over the distribution of assets held in the trust. This is essential in order for the trust to protect the assets.
Asset protection trusts can be effective in cases of divorce since the settlor does not have control over trust distributions. As a result, the assets are protected from the claims of a former spouse. The co-trustee is also banned from making distributions if they can reasonably assume that they would be seized by a former spouse. The beneficiary, who in this case may also be the settlor and trustee, does not control distributions.
It is important to note that many domestic asset protection states allow former spouses to act as exception creditors. This means that domestic asset protection trusts will not be effective in protecting assets from divorce in the majority of states where they are offered. However, there are states which do not have exception creditors, such as Nevada. These states offer trusts which will protect assets in the event of divorce. A person looking to use a domestic asset protection trust as a pre-divorce planning tool must pick the right jurisdiction.
The problem is the US trusts have are under the jurisdiction of US courts. Results-oriented judges often rule on their own desired outcomes rather than the theoretical protection purported by the statutes. Moreover, let’s say someone resides in California, New York or Florida that does not have asset protection trust law. They set up a trust in Nevada or Delaware, that does. The judge may set aside the trust and apply the laws of the local courts. We have seen this outcome repeatedly with domestic trusts.
Offshore trusts offer some of the best pre-divorce planning strategies for asset protection. The offshore trusts work in a very similar way as the domestic asset protection trusts. The main advantage of offshore trusts over domestic asset protection trust is this. First, the US courts do not have jurisdiction over foreign trustees. For example, our Cook Islands law firm/trustee can step in to protect assets in the event of divorce. The courts force domestic trustees, however, to comply with US court orders.
The second advantage has to do with fraudulent transfer claims. Fraudulent transfer occurs when assets are transferred with the expressed intent of defrauding creditors. On important note is the fraudulent transfer is a by-and-large a civil matter and not a criminal one. These creditors can include former spouses during and after In divorce cases, fraudulent transfer occurs when one spouse transfers assets immediately before divorce is filed. It can also occur if assets are transferred when divorce is reasonably imminent. An example of this would be after a spouse has been caught cheating.
The burden of proof for fraudulent transfer claims in most domestic asset protection trust jurisdictions is clear and convincing evidence. If one former spouse is able to show intent on behalf of the other spouse, the burden of proof will transferred to the spouse with the trust. The accused spouse will have to prove that they did not intend to make a fraudulent transfer of assets. The burden of proof in offshore jurisdiction lies completely with the spouse trying to make a claim on trust assets. Some offshore jurisdictions, including the Cook Islands and Nevis, have a burden of proof which is beyond a reasonable doubt. This means that a former spouse making an accusation of fraudulent transfer in these jurisdictions must meet the same standard of proof necessary for a murder case.
Additionally, many offshore jurisdictions do not recognize foreign judgements. In order for a former spouse to make a claim of fraudulent transfer, they must have their case re-adjudicated in the jurisdiction where the trust is held. The time and cost associated with this alone may be enough to discourage a former spouse from pursuing the assets held in the trust. As a result, offshore trusts have shown themselves tremendously advantageous over domestic asset protection trusts in the pre-divorce planning.