You're making money again. Let's protect some of it this time. During the recent recession, some of the best operators in the business could not sustain their operations through the economic upheaval that engulfed our entire nation. Just as bad are the many instances of builders who worked for decades to earn their reputations for integrity and paid their bills promptly during good times, only to be bullied by the Goliaths, be they bankers, creditors, or partners who turned on them.
In light of this situation, I am working with business partners to address the inherent risks that are embedded in the home building industry that affect basic wealth protection for you, your business, your family, and even your aging parents. A member of our legal team, Barry Engel, of Engel and Reiman, PC in Denver, is the author of the "Asset Protection Planning Guide," and specializes in asset protection advisory work. Many of the points mentioned in this article are based on our direct experiences with clients managing and developing effective legal strategies for asset protection and risk mitigation.
To start, you need the right professional team. If you do not have asset protection practices in place, then your current professionals are not the right team. This effort is confidential in nature, so your company's primary team can help compile data and information, but they should not be the ones executing your asset protection plan. Why? This type of information matters to you, your confidential advisers, and no one else. Keep it that way.
The asset protection team should consist of seasoned and proven professionals with legal, insurance, advanced business, and CPA credentials. A team leader is essential—especially if you do not have time to manage this effort with the urgency it warrants. Also understand that this process can be misconstrued by others, so the fewer details you share beyond your confidential advisers, the better. If your bankers ask you about this matter, simply respond, "I have a family estate plan in place."
Risk mitigation involves all aspects of running your company and personal life in such a way that if something unfortunate occurs, you have already taken steps to protect your wealth and business. As your wealth grows, you will need to adjust insurance and business practices to accurately reflect the new and growing risk. For instance, building 50 homes a year in five locations is much less risky than building 250 homes in two locations.
The concepts of risk mitigation and asset protection intersect but they are not the same. Risk mitigation involves decisions that must be made by home building executives on a daily basis. Some examples include the company's risk insurance—what does it cover and what are the limits? How thorough is the employee manual, and does it adequately protect the company from dishonest employees and other human resource related claims? These decisions affect the level of risk that your company may be exposed to. A mistake here could escalate to the point where it would test the viability and robustness of your asset protection plan.
The goals of asset protection are pretty straightforward. You want to protect assets for the benefit of your family from lawsuits that potentially could evolve from equity and debt partnerships, contract disputes, labor disputes, environmental claims, and the sale of assets. The assumption here is that you are acting in good faith in all your transactions and that these preparations are part of an estate planning process that a rational business person would normally pursue given the wealth they have created.
Asset protection is sometimes hard to understand, so let's clarify what it is by defining what it is not. It is not based on hiding assets and evading taxes. Asset protection planning is legal, but transferring assets to your wife or children the day before you declare bankruptcy is not. This move is known as a fraudulent conveyance.
Definition from Black's Law Dictionary
Fraudulent conveyance: A transfer of property for little or no consideration, made for the purpose of hindering or delaying a creditor by putting the property beyond the creditor's reach; a transaction by which the owner of real or personal property seeks to place the property beyond the reach of creditors.
Your asset protection should be done well in advance of any overt threat or action against you and when the waters are still and your company is profitable. Just like fire insurance, it is too late to purchase a policy after your house burns down. Each state is unique, but in most instances you must have your asset protection plan in place two to four years before you can benefit from its protections. Given this fact, many of you should have started this effort last year since the housing market's growth cycle is expected to last until 2017.
There are two key elements of asset protection. The first element is that how an asset is entitled determines its vulnerability to lawsuits. In our business, the use of an LLC (limited liability company) to hold land positions and the existence of a housing entity that operates as a builder is important relative to this discussion. In some instances, clients have put all land holdings in one entity. Consequently, an unrelated land holding can be directly harmed by an event with another land position. Second, a creditor or plaintiff can only access what you currently own, not what you've owned in the past. Having a sophisticated and complicated ownership structure is a great way to protect your assets. Keep in mind that simple may be too simple, and you can put your entire company and wealth at risk.
The right of ownership and protection of personal property are among the principal tenets of our society. Asset protection is a systematic, disciplined, and proactive commitment to that right, so everything discussed here is legal. Sadly these practices are not followed by the majority of high risk-takers. Why? Perhaps high risk-takers don't like to admit that economic conditions can get so upside down that the metrics of business success occasionally don't work. Whatever the reason, just chuck the idea that you don't need to take action now; that is not the case.
In one gruesome display of a partnership gone wrong, we watched an equity partner acquire recourse debt from various banks. He then became the owner of some of his own debt and that of his operating partner. Then he sued the operating partner for collection on the note. In this case, the operating partner had signed a personal guarantee and had to sell other assets to make good on a note he shared with the capital partner. In that case, Goliath crushed David.
Asset Protection Tactics
Tactical aspects of asset protection include gifting, insurance, foreign insurance policies, joint ownership, FLP (family limited partnership), domestic trusts, and foreign trusts. Brevity is required in this article, but all of the above are relevant to a robust asset protection plan and should be a part of it. We typically spend a day or two with clients going over such plans in depth.
Gifting is not a favored form of asset protection because you lose control of the asset. You can, however, gift your Rolex watch to your son and say, "I plan to wear it but when I head out, it's all yours." This is a great way to give before you are deceased, because you are doing the giving in person, both parties are aware of the agreement, and it's in writing. Go ahead and bequeath items of emotional attachment, but you cannot and should not gift everything, and you must document all gifts. Gifts can be given over time, and you should have a plan for doing so. Also, large items can be gifted to a trust, and the trust is then in charge of the asset.
Joint ownership has many ramifications and protections and you should leverage the structures as best you can. The joint ownership approach provides a low level of asset protection, but it makes the property unavailable to the creditor so gaining a judgment against it is difficult. This approach is where your asset protection team can provide sound strategic and tactical advice.
Life insurance is another great way to protect wealth. If you establish an ILIT (irrevocable life insurance trust) the proceeds are exempt from creditors and usually non-taxable. Be aware that states have varying laws on the availability of insurance funds to creditors.
Another easy-to-implement recommendation is purchasing umbrella workers' compensation insurance for all the folks that work on your personal property and home. At an estimated cost of about $250 a year, this insurance provides great protection. All your directors and officers should have D&O (directors and officers) liability insurance to protect against litigation. Another suggestion is to consider buying insurance in another country, and make sure the insurance company has no subsidiaries or operations in the United States. If you buy a policy from a carrier in Sweden, for example, the policy payments will be made in Sweden's national currency and such funds (in most cases) are not subject to any encumbrances from the United States.
Perhaps the most simple, yet highly effective, entity to create is a family limited partnership (FLP) and domestic trust. This planning tool transfers assets into the trust, making the assets part of a partnership interest in the FLP. This maneuver would force a creditor to satisfy claims from partnership assets after an exchange, and in most states the sole remedy for that is a charging order.
Definition from Black's Law Dictionary
Charging order: Partnership. A statutory procedure whereby an individual partner's creditor can satisfy its claim from the partner's interest in the partnership.
The creditor must then wait to satisfy claims from the partnership assets. This environment precludes quick access to the assets and in most cases the lack of timing and accessibility will dissuade creditor action. This is a sweet solution and deserves more space than we have available. I'll just note that FLPs are best used for real estate and other non-movable tangible assets. FLPs should not be used for personal valuable property.
A good example and effective use of an FLP would be a family farm or property that is shared by adult siblings. In many instances, this condition is a shared title with many forms of deed structures. If the property is expected to stay in the family as a traditional and historic landholding for generations to come, it would make sense to have it placed inside an FLP, which would protect the next generation and their activities. Otherwise these properties, which typically don't carry a mortgage, are exposed to creditors if one of the partners has financial difficulties.
A foreign trust is a highly sophisticated and complicated form of asset protection. It is important to establish a foreign trust in nations that do not recognize directives from U.S. Courts and are proud of it. The trust has its duties to the beneficiaries who are normally family members. You cannot and should not act as the trustee and run the trust as you are the protector of the trust. Your role is choosing the trustee. This is one area where you must have experienced professionals provide advice and guidance.
The Action Plan
Secure a leader or be the leader and assemble a new team of professionals who can work efficiently and collaboratively to get this protection plan in place immediately. Find professionals who respect your confidentiality and if you want to feel more comfortable, hire advisers from out of town. The leader and team will assemble, create, and do research so that the following tasks are completed and implemented:
1. Appraisal and review of all personal assets and liabilities. This involves what you have and how the property is titled.
2. Assemble the team and documents as you proceed through the process.
3. Implement and create various legal entities and structures based on strategy and tactics.
4. Implement and complete.
5. Just getting to the one-yard line is not OK. You must do all the work, record it legally, and make the transfers. Until you complete all the transfers, you are still exposed.
One of the best outcomes of an asset protection plan is it prevents bankers and others from suing you because they see the difficulties in time, effort, and money that will get in the way of being successful at securing assets to cover their liability. A great asset protection plan will force a banker to analyze the cost benefit of suing versus walking away or settling on a financial dispute. David can stymie Goliath. A well-executed plan will allow you, your family, and your company to live and prosper another day. This is a worthy effort. Sleep comes easier when you have this topic nailed. And yes, the pun is intended.
Noelle Tarabulski is CEO of Builder Consulting Group of Lakewood, Colo., a management consulting firm dedicated to builders and developers since 1991. She can be reached at [email protected].