Asset Protection Loopholes: Revisiting Fraudulent Transfers

In a recent conversation with a potential client, something became apparent: Many people think they can “game” the asset protection system.  In some cases, that might be true.  But when your hard-earned assets are on the line, do you really want to risk it?  If you gamble on being able to beat the system and lose that bet, you’re assets will be seized.  Are you prepared for that?

Avoiding Fraudulent Transfer

The conversation mentioned above hinged on the concept of fraudulent transfer laws.  The question asked by our potential client was fairly straightforward: Can fraudulent transfer laws be avoided if an individual debtor transfers her or his cash into a limited partnership (‘LP”) or limited liability company (“LLC”) in exchange for an interest in the entity?  That way, the transfer is for something that can at least reasonably be perceived as fair value.

This is a good question, and it highlights the important of asset protection planning.  First, assuming the strategy would work, why would someone want to follow the course described above?  It’s because some jurisdictions would limit the recover from an LP or LLC owned in part by a debtor to the actual distribution of income from those entities.  This type of legal protection is known as charging order protection.  In theory, this would be an elegant solution, but it should only be considered as a last resort–it should only be considered by people who failed to adequately plan in advance, because it’s not likely to withstand scrutiny by the courts.

The Problem with Post Hoc Planning

Fraudulent transfer laws do not just prohibit transfers that are for less than fair value.  They also prohibit transfers that are intended to defraud creditors or otherwise unreasonably hinder a lawful recovery.  Consider the case of In re Kelly (2007 WL 2492732) where a debtor used money to repay a loan taken against a life insurance policy.  Even though the transfer was clearly “for fair value,” the court ruled it a fraudulent transfer and cited a number of cases in support of that conclusion.

While each case is fact-specific, it’s certainly not wise to depend on being able to get around fraudulent transfer laws.  What you can rely upon is an asset protection strategy implemented in advance of trouble arising.  Contact Lodmell & Lodmell today if you have questions or if you would like to discuss your options.  We are totally dedicated to helping you implement an effective, well-thought-out asset protection strategy.