Avoiding Challenges to Asset Transfers

April 13, 2006

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It is often possible to use carefully planned transfers to place your assets out of the reach of potential creditors. This can done in two ways: asset exemption planning and strategic funding practices within your business entity.

Effective exemption planning can take many forms: using any of your available cash to purchase exempt assets; paying down mortgages on homes if your state provides an unlimited homestead exemption, or if the amount of the homestead exemption exceeds the value of your home; adding a mortgage to a home when the value of the home equity exceeds the amount of the homestead exemption; or converting secured debt into unsecured debt by, for example, using a credit card to make a mortgage payment. A change of residence to a more debtor-friendly state is a more dramatic way to facilitate asset exemption planning.

Strategically funding your business entity means minimizing the amount of vulnerable capital within the business. You can accomplish this by making leases and loans of assets to the business entity; by making a practice of regularly withdrawing funds from the entity as salary, lease and loan payments to yourself; and by encumbering the entity's assets with liens that run in favor of yourself, and that result from extensions of credit from you to the business.

In each situation, it's still possible for creditors to challenge your asset transfers. Through proper planning, these challenges usually can be blocked effectively. This discussion will focus on the primary theories and strategies your creditors may use to challenge transfers under the Uniform Fraudulent Transfers Act (UFTA), as well as the steps you can take to minimize the risks of such challenges.

In addition, we'll examine how transfers can have an impact on your Medicaid status later in life, and how to preserve assets when planning for the medical issues that affect old age.

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Besides the Uniform Fraudulent Transfer Act (UFTA) and bankruptcy code rules that restrict asset transfers, special provisions in state limited liability company (LLC) and corporation statutes also restrict distributions from the business entity to an owner. If your business takes LLC or corporate form, you'll need to consider the impact the laws may have on you.

While the UFTA and bankruptcy code apply to all types of transfers, the reach of these other statutes is limited to distributions made on account of the ownership interest. These distributions include dividends or other distributions of earnings, and ownership buy-outs such as stock redemptions. Ordinarily, these statutes will not apply to payments of salary, or for leases and loans, to the owner, because these distributions are not made to the owner simply because of ownership (i.e., they are made to you in your capacity as an employee, lessor or lender). This fundamental tenet of asset protection is addressed in our discussion of withdrawing funds from the business.

Note that when distributions of earnings and ownership redemptions are planned, the business owner must be aware of the separate rules (including the separate solvency tests) that will apply under these statutes.