"The best time to plant a tree was twenty years ago …
The second best time is today. "
For nearly 35 years, I have represented commercial real estate investors, developers and business owners. Most of that time has been spent helping them acquire, finance, expand, develop, manage and grow their assets and businesses. For the past 5 to 6 years, as we have struggled through the Great Recession , a huge amount of my time has been spent helping clients keep their assets.
Growing up, I was steeped in the practical view that it is not so much what you acquire that counts, but, rather, what you keep. My parents and grandparents were not in the real estate business to make others wealthy. They were playing real life Monopoly®. They played to win. It was less about money for money's sake than it was a means of keeping score. Invest. Reinvest. Expand the bottom line. Control your losses. And keep what you acquire.
A key concern was always asset protection. Perhaps this was a byproduct of my grandfather's experiences during the Great Depression . He did well, while others around him lost everything. A theme underpinning virtually all investment strategies was to structure our business affairs into risk remote compartments, so that if bad things happened to one project, or with one business, the damage could be contained. My father would compare it to the structure of his ship in the Navy during World War II. If the hull was damaged, water tight bulkheads could contain the damage to avoid jeopardizing the entire ship.
This brings to light one of the great misconceptions about asset protection. A sizable number of people start with the belief that the objective of asset protection is to prevent all creditors from ever getting any of their assets or income. Realistically, it doesn't work that way. Not even if you use an offshore asset protection trust or other advanced asset protection devices. To even approach making that happen, you would have to create such a tangled weave of trusts and limited liability entities, and give up so much control, that you would never be able to conduct your business or live your life as a functioning human being. It would be immensely expensive, and it still wouldn't protect everything.
Asset protection need not be particularly complicated or expensive. Basic asset protection strategies can be implemented that do not get in the way of your business or everyday life. Although advanced asset protection planning can utilize off-shore trusts and off-shore bank accounts, those tools and techniques are the exception rather than the rule. They are available if the situation warrants, but for most people there is seldom a legitimate reason to go to such extremes.
Sadly, a significant number of commercial real estate investors and business owners, and many of their lawyers and accountants, pay almost no attention to even basic asset protection strategies. This was never more obvious, and unfortunate, than during the Great Recession we have been working through over the past five to six years. Otherwise sophisticated and historically successful commercial real estate investors, developers and business owners have lost virtually everything. What makes this even more tragic is that, with even modest asset protection planning, many of these catastrophic financial disasters could have been averted.
Clients of mine who planned ahead by structuring their affairs for asset protection have survived this recession and are generally well positioned to move forward to take advantage of emerging opportunities as the economy improves. Many who did not are faced with starting over.
Why not think ahead to protect your assets? You are under no legal obligation to structure your financial affairs in a way that makes it easier for banks and other creditors to take virtually everything you own. Your obligation is to your family, and to yourself, to make sure your life's work and life's savings are not lost in the event of financial calamity.
A key point about asset protection is that, to be effective, it must be done well in advance. Once the proverbial fan has been hit, it is likely too late. There may still be some modestly effective strategies to be employed to minimize damage, but real asset protection with powerfully effective results starts when there are no (or, at least, very few) storm clouds on the horizon.
Once you are in financial trouble, it is often too late. Transfers of assets for less than fair value can be set aside as a preference in bankruptcy, or as a fraudulent transfer. The "fraud" in "fraudulent transfer" is not traditional fraud. It is simply the transfer of an asset for less than fair value for the principal purpose of avoiding creditors.
In Illinois, the statute of limitations for fraudulent transfers is four years. This means attempts to transfer assets for less than fair value can be attacked and set aside for four years after the transfer is made. For Medicaid, the look-back period is five years. Early adoption and implementation of even a simple asset protection plan can avoid these attacks.
One of the simplest examples of asset protection: If you are married and own a home with your spouse in Illinois or Indiana, and in most other states, there is virtually no excuse for not owning the home as tenants by the wholeeties to protect your home from claims of creditors of only one spouse. This is particularly true if one spouse is engaged in business or professional activities with a high risk of liability (business owner, investor, developer, doctor, entrepreneur, etc.), while the other is not. Remarkably, I discovered while defending real estate developers and investors in loan workout and loan settlement efforts over the past few years that not even this modest asset protection tool is always in place. It would have cost nothing. Instead, its absence cost some families their homes.
Beyond these fundamental considerations, there are many others. A common mistake made by business owners is that they will sometimes form a corporation or limited liability company with the intent to protect themselves from personal liability, but then place virtually all of their business assets in a single company, or in a subsidiary of a high risk operating company. If a judgment is entered against the company, all of the business assets may be lost.
Whenever practical, business operations posing a risk of liability should be separated from asset ownership. Assets can and should typically be owned by a low-risk (preferably tax-advantaged) entity and leased or licensed to the higher risk operating company. The best, and least expensive, time to implement this structure is when you acquire the asset or business. Ownership of the low-risk company should likewise be held by a low-risk owner – perhaps a spouse, adult child, trust or holding company. The asset protection plan can, and often should, be part of a more comprehensive estate plan.
Similarly, real estate investments and business ownership structures are often not adequately designed to militate against the risk of liability arising from loan and lease guaranties or other sources of liability to individual sponsors or principals.
There is much that can be done to protect your assets. Many techniques present tax advantages as well. Exactly what can be done depends upon your particular circumstances and when you begin. The best time to begin would have been several years ago. The second best time to begin is now. It is foolish to leave your hard earned assets needlessly exposed to creditor claims when even basic asset protection planning can protect them.
War stories abound of commercial real estate investors and business owners who have lost fortunes, large and small, because they did not plan ahead. Perhaps they thought they were smart enough to be able to avoid financial catastrophes like we have experienced over the past several years. Or they thought they had large enough incomes or net worth to withstand economic adversity or unexpected liability. Or they believed they had such great relationships with their banks or other lenders that obtaining loan extensions or new working capital lines of credit would never be a problem. I've head most of the "reasons" – but none of them matter when your assets are being attached by hungry creditors. When you go from being worth millions, to having huge unsatisfied deficiency judgments entered against you, the reasons for not protecting your assets, and your family's future, ring hollow.
The past five to six years, in particular, have been an asset protection laboratory. Theory has been tested. We have seen many examples of even basic asset protection techniques that work, and have seen, unfortunately, what happens when little or no asset protection planning took place.
If your real estate investments and commercial activities are worth your time and energy – particularly if you dedicate most of your adult life away from your family working to make them succeed – then they are worth protecting. It is much more cost effective to develop and implement an asset protection plan "as you go", rather than waiting until you decide your estate is "big enough to protect". At that point, it may be too late, it will certainly be more expensive, and will very likely be less effective. Often, asset protection as you go will cost no more to do right than you spend doing it wrong.
Over the next several years a lot of rebuilding will take place. Literally, in the form of new and redeveloped commercial real estate projects and business enterprises, and figuratively, as previously successful real estate professionals and business owners rebuild their financial lives. Do not make the same mistakes this time around as were made by many in the past. Plan ahead. Build-in basic asset protection strategies in every business structure you devise. Don't wait another twenty years. You may not get a third chance.
Thanks for listening …
R. Kymn Harp