In Lawsuit Protection Part I, we discussed the advantages of being judgment proof. The main advantage of being judgment proof is that aggressive attorneys will not generally pursue judgment proof people or businesses, because there is no financial upside. That article can be summed up as follows: Judgment proof people have nothing to give, so people (attorneys) suing them have nothing to gain. Being judgment proof is a very effective way to avoid getting sued.
But there is an obvious downside: We all want to have wealth and assets. Most people spend their entire lives creating a “nest egg.” So the question becomes, how can one have significant assets AND be judgment proof at the same time? Before we tackle the concept of taking steps to protect assets, the subject of Lawsuit Protection Part III, it’s important for you to understand the concept of what is and what is not an asset.
What Is An Asset?
In an accounting sense, assets minus liabilities equals equity. (A – L = E). In the realm of asset protection, what we really need to protect is equity. A building valued at $3oo,000 with a $325,000 mortgage is not an asset. It’s a liability. It has no equity actually represents a debt. It does not need to be protected. Cash, stocks, and bonds, however, are liquid assets, pure equity, and in need of protection most of the time.
Let’s look at the example of a 31 year old physician living in Texas. Assume this person has $60,000 of cash in the bank and a home valued at $500,000 (with a $350,000 mortgage). Further assume that she owes $200,000 in student loans. In a strict balance sheet accounting sense, this person owes more than she has (i.e. negative overall equity), but she does have assets. Is she judgment proof (assuming there is no malpractice insurance)? To answer this question, we must first understand the difference between exempt assets (protected from creditor claims) and non-exempt assets (available to satisfy credit claims).
Exempt and Non-Exempt Assets
Certain assets are exempt from creditor claims and from lawsuit judgments. They cannot be touched, and you will not lose them. Some exempt assets include ERISA qualified retirement plans (think 401(k) or pension plans) and homesteaded property. In the example above, the $150,000 of equity in her home represents an asset that would be exempt from the claims of a malpractice plaintiff and almost any other kind of creditor.
The $60,000 in cash, however, is not protected at all. It is a non-exempt asset, and a court could order that it be used to pay off a verdict award. An asset protection attorney could help her convey that money into an exempt asset category, or she could simply use it to pay down her mortgage. Why the mortgage as oppose to the student loans? Well, as we discussed above a homesteaded property is an exempt asset–it’s an asset that doesn’t need protection. By paying down her mortgage, she is essentially protecting the asset AND keeping it available to herself (since she could take out a home equity loan in the future). And just as important, if tragedy struck and she was unable to continue paying her student loan bills, guess what . . . her $60,000 would be safely exempt from the claims of the student loan creditors! Remember, exempt assets are protected assets!
The key to making yourself judgment proof, even if you have significant wealth, is taking practical steps to understand the types of assets you have and protecting them one at a time as part of an overall asset protection plan.