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Feature

Jay D. Adkisson
Partner
Riser Adkisson LLP

The 2005 Bankruptcy Reform Act: Impact on Directors (Part 2)
Strategies to counter the new bankruptcy legislation’s erosion of a director’s ability to protect his or her personal assets.

By Jay D. Adkisson

Ed. Note: Part 1 of this article, which addressed the thrust of the 2005 Bankruptcy Reform Act on director liability, appeared in the December 2005 e–Briefing.

Stung by criticism in a New York Times article about a ‘loophole for the rich’ in the new bankruptcy act, Congress passed a new section 548(e) that allows a bankruptcy trustee to claw back assets that were transferred to an asset protection trust within 10 years of the filing of the voluntary or involuntary bankruptcy petition, if the transfer was meant to diminish the rights of creditors.

Since the very purpose of an asset protection trust is to diminish the rights of creditors, the import is that assets transferred to such trusts can be easily backed out by the bankruptcy trustee.

The new 548(e) not only applies to asset protection trusts, which are self–settled trusts that one creates for his own benefit, but also applied to ‘like devices.’ Congress did not attempt to define ‘like devices’ but one could reasonably infer that it is anything that has a specific purpose for protecting assets while allowing the person who created the structure to have the beneficial use of those assets.

Not that Congress needed to worry about asset protection trusts. The bankruptcy courts had never respected them anyway and in a series of cases the courts simply treated the assets in such trusts as part of the bankruptcy estate.

In one case, involving former derivatives trader Stephen J. Lawrence, the court ordered him to provide information relating to his offshore trust and when he refused the court cast him into prison for contempt. Lawrence went into jail in August of 2000, and was still in the pokey as of the writing of this article.

No Protection There
The truth is that foreign asset protection trusts have a chance of working if you flee the jurisdiction of the U.S. courts when things get dicey. Of course, doing that may cause your other creditor protections, such as homestead, to dissolve and you may be precluded from defending the claims against you under what is known as the ‘fugitive disentitlement doctrine.’ The new Domestic Asset Protection Trusts that are heavily marketed by trust companies based in Alaska, Delaware and a few other states have no reasonable chance of protecting assets under the new 548(e).

To make doubly sure that corporate officers and directors could not hide their wealth in asset protection trusts, Congress specifically mandated that in interpreting 548(e) “a transfer includes a transfer made in anticipation of any money judgment, settlement, civil penalty, equitable order, or criminal fine incurred by, or which the debtor believed would be incurred by” a violation of the securities fraud and securities registration laws.

While this language seems redundant, it sends a clear message: Persons active in the securities industry should be personally liable for their decisions, and this liability should not be defeated by asset protection subterfuges.

So what does work?

Off the Personal Balance Sheet
The key is to keep assets off of the personal balance sheet, so that if there is a bankruptcy the assets will not show up in either the debtor’s schedules or in any recent history of past transactions. This can be legally accomplished through sophisticated estate and business planning done well in advance of any potential creditor problems.

Estate planning is a legitimate form of personal planning that does not by itself raise unnecessary suspicions of anti-creditor planning. While the new Act makes clear that one cannot create a trust for one’s own benefit and still hope that the assets will be protected from creditors, it did not impact ordinary, non-self-settled trusts at all.

One can still, for instance, create a trust for one’s children or grandchildren and convey valuable assets to that trust. So long as it is done at least several years before problems arise, both the transfer and the trust should be respected and stand–up even in bankruptcy.

The key to making estate planning perform an asset protection function is to avoid utilizing gifts as the method of transferring assets to the trust. Gifts by their very nature are without reasonably equivalent value and, thus, are susceptible to being set aside as fraudulent transfers.

Instead, for-value transfers such as self-canceling installment notes and private annuities should be utilized for transfers. While these transfers are much more complicated from a tax perspective, they are much safer from a debtor-creditor law perspective.

Difficulty Accessing
Business planning can also have the effect of moving assets off of the future debtor’s balance sheet and into an entity where a creditor will have a difficult time accessing them to pay a judgment. By contributing assets to a limited partnership, the assets are effectively transformed from a form that is easy for creditors to collect upon into partnership interests against which a creditor will be limited to a charging order that basically restricts the creditor’s rights to receiving the distributions that the debtor would have normally received.

Of course, if no distributions are made to the debtor’s interests, the creditor gets no distributions either, and the case law has, with only rare exceptions, protected the valuable assets within the limited partnership from creditors’ collection attempts.

Future strategies may involve the creative use of life insurance and annuities in the numerous states that offer substantial levels of protection to those products when properly structured and drafted. Although Congress eviscerated some of the most common forms of debtor planning, it did not seek to change the existing state exemptions for those products, although they will still be potentially subject to the 10–year limitations period for the conversion of non–exempt assets into exempt assets. However, by combining sophisticated forms of insurance with certain forms of ERISA planning, plans could be created that would offer formidable barriers to even the most sophisticated creditors.

Plan Well in Advance
The key to effective asset protection planning has always been to do the planning well in advance of creditors. Prior to the new bankruptcy act, the required amount of time for a debtor to reach a degree of comfort that transfers would not be reversed was sometimes measured in months, or at worst a couple of years. Future asset protection planning will require much greater foresight and passage of time before the same levels of comfort can be achieved.

In other words, if you want protection that will have a chance of standing up, you need to start that planning as soon as possible in the hope that some significant water will pass under the bridge before it is challenged.

A final word of advice is to avoid those asset protection solutions that are heavily marketed. Such solutions will not escape the notice of creditors, who may attempt to lobby Congress for additional changes to the bankruptcy code so as to mitigate the effects of those solutions.

Instead, seek personalized solutions that have substantial purposes not ordinarily related to asset protection, but have the collateral effect of making the attachment of assets difficult for creditors. The best asset protection plan is one that is so subtle that it cannot be readily identified by creditors or by the court as an asset protection plan.

Jay D. Adkisson is a partner in the Atlanta-based law firm of Riser Adkisson LLP (http://www.risad.com) and admitted to practice law in Oklahoma and Texas. He is a co-author of Asset Protection: Concepts and Strategies, published by McGraw-Hill & Co., and numerous articles on debtor-creditor law issues. He has twice been an expert witness to the U.S. Senate Finance Committee regarding abusive tax schemes. He is also the director of Private Client Services of Select Portfolio Management Inc., an investment advisory firm in California. He can be contacted at jay@risad.com.