Asset Protection? Back to the BasicsBack to the Basicscrlaw.com/news/wp-content/uploads/2012/01/SKT_Asset...– See Firmani v. Firmani, 332 N.J. Supper. 118 (App. Div. 2000)(fraudulent

Asset Protection? Back to the BasicsBack to the Basics

P d bPresented by:Scott K. Tippett

Carruthers & Roth, P.A.(336) 478-1130(336) 478 [email protected]

Overview of the Collection PProcess__________________________

1. Lawsuit.2. Judgment.3 Notice of Right to Exempt Property3. Notice of Right to Exempt Property.4. Debtor designates exemptions.5. Hearing?6. Execution.7. Levy & Sale

When Does A Judgment Lien Arise?♦ N.C.G.S. § 1-313(1), a judgment is not a lien

upon personal property until the sheriff has d l h lmade a levy on the personal property.

♦ Before the sheriff can levy, the clerk must issue a writ of executiona writ of execution.

♦ The clerk cannot issue a writ of execution unless:

1. The judgment debtor’s exemptions have been designated.

2 The j dgment debtor has ai ed his e emptions2. The judgment debtor has waived his exemptions.3. The Clerk determines exemptions are inapplicable.

When Does a Judgment Lien Arise?When Does a Judgment Lien Arise?

♦ Under Rule 62(a) of N.C.R.Civ. Pro., no execution ( ) ,shall issue upon a judgment nor shall proceedings be taken for its enforcement until the time for filing a notice of appeal has r nfiling a notice of appeal has run.

♦ Typically this is 30 days from the date of the entry of judgmentof judgment.

♦ Under N.C.G.S. § 1C-1603(a)(4) a clerk may not issue an execution unless the judgment debtor has been served with a notice from the court advising him of his rights to designate exempt property.

♦ U d N C G S § 1C 1603( )(2) j d t♦ Under N.C.G.S. § 1C-1603(e)(2) a judgment debtor has twenty (20) days from the date of service of the Notice of Exemptions.

Judgment Liens – Personal PropertyLet’s Do The Math.

Date Judgment Docketed: January 2, 2008

Add 30 days for FilingNotice of Appeal: February 1 2008Notice of Appeal: February 1, 2008

Add 20 days for judgmentd b ddebtor to respond to Notice of Exemptions: February 21, 2008

Hearing Date: ???

Actual Levy: ???Actual Levy: ???

Judgment Liens – Real PropertyJudgment Liens Real Property

♦ A judgment is a lien immediately upon docketing, j g y p g,which typically happens with a day of the judgment being filed.

The Math

Date Judgment Docketed: January 2, 2008

Lien Against RP in CountyWhere Judgment Docketed: January 2, 2008

Overview of Laws Involved.Overview of Laws Involved.

♦North Carolina Statutory Constitutional♦North Carolina Statutory, Constitutional and Case Law

♦North Carolina Fraudulent Conveyance♦North Carolina Fraudulent Conveyance LawF d l B k C d d h♦Federal Bankruptcy Code and the Bankruptcy Abuse Protection and C A f 2005Consumer Act of 2005

♦Other states’ laws (exemptions; conflicts)

Fraudulent Conveyance Law.

♦Uniform Fraudulent Transfer Act ♦Actual Fraud (intent to hinder...)

– See Firmani v. Firmani, 332 N.J. Super. 118 , p(App. Div. 2000)(fraudulent conveyance of property upon transfer of property to FLP owned by defendant).

♦Constructive Fraud (insolvency)♦ 4 Year Time Limit

The Basics

1 Choice of Entity1. Choice of Entity.2 Compensation Structure.2. Compensation Structure.3. Retirement.4. Insurance.

Choice of EntityDo It First and Do It RightDo It First and Do It Right.

________________________________

1. Sole Proprietorships.2 G l P t hi2. General Partnerships.3. Limited Partnerships.

Li i d Li bili P hi4. Limited Liability Partnerships.5. Corporations.

a. Professional Corporations.b.Other Corporations.

6. Limited Liability Companies.

General PartnershipsSt t l t f d l t l ifi ti t l b t♦ State law, not federal tax classification, controls, but….- The filing of a partnership tax return is significant evidence of a

partnership (Wilder v. Hobson)(In re Vannoy).

N.C.G.S. § 59-36(a):- A partnership is an association of two or more personsA partnership is an association of two or more persons

to carry on as co-owners for profit.

A t hi i i f l d b f d b l♦ A partnership is informal and may be formed by oral agreement (Campbell v. Miller).

ALL j i l d ll li bl f h♦ ALL partners are jointly and severally liable for the acts and obligations of the partnership.

♦ No formal filing necessary.

♦ A partnership interest is personal property.

Limited Partnerships♦ Formation only upon filing an executed certificate of

limited partnership with the North Carolina Secretary of St tState.

♦ A partnership interest is personal property.p p p p p y

♦ Limited Liability:

- N.C.G.S. § 59-303 - Liability to Third Parties

A limited partner is not liable for the obligations of a limited partnership by reason of being a limited partner and does not become liable by participating inpartner and does not become liable by participating in the management or control of the business of the limited partnership.

Limited PartnershipsLimited PartnershipsLimited Liabilityy

- N.C.G.S. § 59-703 – Rights of CreditorO li ti f j d t dit tOn application of a judgment creditor, a court may charge the partnership interest of the partner with payment of the unsatisfied amount of the judgment l iplus interest.

To the extent charged, a judgment creditor only hasTo the extent charged, a judgment creditor only has rights of an assignee.

Limited PartnershipsLimited Partnerships♦Limited Liability cont’d♦Limited Liability cont d

N C G S § 59-702 – Assignment of Limited- N.C.G.S. § 59-702 Assignment of Limited Partnership Interest

Except as provided in the partnership agreement, a partnership interest is assignable i h l i tin whole or in part.Assignment only entitles assignee to receive distributions and allocations to which assignordistributions and allocations to which assignor would be entitled.

Limited PartnershipsLimited Partnerships♦ Limited Liability?y

♦ What is missing?g

♦ Unlike LLCs, there is no North Carolina case that limits a creditor’s remedy solely to obtaining a charging order. Cf. Herring v. Keasler, 150 N.C. App 598 563 S E 2d 614 (2002)App. 598, 563 S.E.2d 614 (2002).

♦ Absent such a limitation judicial foreclosure is a♦ Absent such a limitation, judicial foreclosure is a potential remedy.

Limited Liability PartnershipsLimited Liability Partnerships♦ Statutory Authorityy y

- N.C.G.S. § 59-84.2 through § 59-84.4.

♦ Statutes provide procedure by which a LLP is created, but no substantive guidance.

♦ Because North Carolina does not limit a creditor’s d l l t bt i i h i d iremedy solely to obtaining a charging and given

the lack of legislative or judicial guidance, other forms may give more reliable protection.y g p

CorporationsCorporations

♦Professional Corporations♦Professional Corporations

Professional Corporations Provide Very Little Protection!!!

Why?Why?

Corporations-Professional Corporations

♦ Historically professionals viewed as public service♦ Historically professionals viewed as public service providers.

♦ Historic Fear: If professionals re allowed to pincorporate, they will emphasize the business aspect of their practice, to the detriment of the service aspect.

♦ The result was the formation of “associations” with other professionals, hence the Professional Association or PA.


♦ The Service treated PAs as partnerships for federal income p ptax purposes, therefore could not obtain any of the employee fringe benefits.

♦ Morrisey v. Commissioner, 296 U.S. 344(1935)The Morrisey Test – unincorporated businesses can be taxed as

ti if th b i hibit d f tcorporations if the business exhibits a preponderance of corporate characteristics.

-Limited liabilityC li d-Centralized Management

-Transferability of Ownership-Continuity of Life


♦ United States v. Kitner, 216 F.2d 418 (9th Cir. 1954).-The Kitner Regulations

The corporate characteristics under Morrisey are to be determined under state law BUT….because common law prohibited professionals from incorporating, it was highly unlikely that a PA could fulfill a majority of the corporate characteristics under Morrisey.

In response to Kitner, professionals lobbied for legislatures to enact professional corporation statutes.p p

Service issued Rev. Rul. 70-101, which said that professional corporations organized under state professional corporation statutescorporations organized under state professional corporation statutes would be treated as corporations for federal income tax purposes.


♦ North Carolina’s Professional Corporation Act♦ North Carolina s Professional Corporation Act♦ Chp. 55B

N C G S § 55B-9: Professional Relationship and LiabilityN.C.G.S. § 55B-9: Professional Relationship and Liability.(a) Relationship.—Nothing in this Chapter shall be interpreted to

abolish, modify, restrict, limit or alter the law in this State applicable to h f i l l i hi d li bili i b h lithe professional relationship and liabilities between the licensee

furnishing services and the person receiving such professional services.

(b) Liability.—A shareholder, director, or officer of a professional corporation is not individually liable…for the debts obligations, and liabilities of or chargeable to the professional

i h i f i i li l icorporation that arise from errors, omissions, negligence, malpractice, incompetence, or malfeasance committed by another shareholder, director, officer, or by a representative of the professional corporation.


♦ This looks great right?♦ This looks great right?

♦ Nelson v. Patrick, 73 N.C. App. 1, 326 S.E.2d 45 (1985).♦ Nelson v. Patrick, 73 N.C. App. 1, 326 S.E.2d 45 (1985).-Medical malpractice action arising out of radiation treatment for cervical cancer.Pl i tiff t t d b l b f th PA-Plaintiff was treated by only one member of the PA.

-Plaintiff sued both members of the PA.HELD:

A professional corporation is liable to the same extent as if it were a partnership.A t d f d t ld b h ld j i tl d llAs a partner, defendant could be held jointly and severally liable for any negligence of his partner which occurred during the course of the corporation’s business.

Corporations-All OthersCorporations-All Others♦ N.C.G.S. § 55-6-22-Liability of Shareholders§ y

Shareholder not liable to corporation or it creditors except to pay the agreed upon

id i hi hconsideration for his shares.

N C G S § 1 324 3N.C.G.S. § 1-324.3Any share…belonging to the defendant in execution may be taken and sold by virtue ofexecution may be taken and sold by virtue of execution in the same manner as goods and chattels.

Limited Liability CompaniesLimited Liability Companies

♦Nature of Membership Interest♦Nature of Membership Interest

N C G S § 57C 5 01– N.C.G.S. § 57C-5-01A membership interest is personal property.

--Even if the sole asset is real property, the b ’ i i lmember’s interest remains personal property.

Limited Liability CompaniesLimited Liability

N.C.G.S. § 57C-3-30A person who is a member, manager,

director,executive or any combination thereof of a limited liability company is not liable for thelimited liability company is not liable for the obligations of the limited liability company solelyby reason of being a member, manager, officer, director, or executive and does not become so by participating in whatever capacity in the management or control of the businessmanagement or control of the business.

Cf. Nelson v. Patrick (As a partner defendant could be heldCf. Nelson v. Patrick (As a partner, defendant could be held jointly and severally liable for any negligence of his partner which occurred during the course of the corporation’s business).

Limited Liability Companies♦ Important North Carolina Cases:

1. Spaulding v. Honeywell International et al., 184 N.C.App. 317, 646 S.E.2d 645 (2007).-LLC’s operating agreement, which allocated certain liabilities to non-member manager, could not be used as basis for claims gby employees because the were not parties to the operating agreement.

2. Hamby v. Profile Products, LLC et al., 361 N.C.App. 630, 652 S.E.2d 231 (2007).-Absent agreement to the contrary, member-managersAbsent agreement to the contrary, member managers are specifically shielded from liability when acting as LLC managers. When member-manager acts in its managerial capacity, it acts for the LLC, and obligations incurred in that capacity are those of the LLC.

Limited Liability CompaniesLimited Liability Companies♦ Babb v. Bynum & Murphrey, PLLC, et al.,182 y p y, , ,

N.C.App. 750, 643 S.E.2d 55 (2007).-where partner had no direct knowledge of his

b l li blpartner’s embezzlement, partner not liable for partner’s embezzlement of client funds.LLC Act did not require partner to investigate-LLC Act did not require partner to investigate

acts of fellow partner absent some actual knowledge of fellow partner’s wrongdoing.-Operating agreement did not create a duty of inquiry on part of non-malfeasing partner.

Limited Liability CompaniesLimited Liability Companies♦ Limitation of Remedies♦ Limitation of Remedies

-Herring v. Keasler, 150 N.C.App. 598, 563 S.E.2d 614 (2002).( )“Despite Plaintiff’s attempts to have Defendant’s membership interests in the LLC seized and sold, his only remedy is to have those interests charged with payment ofremedy is to have those interests charged with payment of the judgment under N.C.G.S. § 57C-5-03.”

Limited Liability CompaniesLimited Liability Companies

♦ Important Limitations♦ Important Limitations-Do Not Rely on Rev. Rul. 77-137

An assignee acquiring substantially all of the dominion and control over the interest of a limited partner is treated as a substitute limited partner for federal incomeis treated as a substitute limited partner for federal income tax purposes.

-Review GCM 36960 (upon which Rev. Rul. 77-137 is based).

Asset Protection Through Compensation Planning

♦ The Myth:yIn North Carolina you can only garnish wages for taxes or child support.

♦ The Law:N.C.G.S. § 1-362

Th t j d d t h thThe court or judge may order any property, whether subject or not to be sold under execution ….except that the earnings of the debtor for his personal services, t ti ithi 60 d t di th dat any time within 60 days next preceding the order,

cannot be so applied when it appears, by the debtor's affidavit or otherwise, that these earnings are necessary f th f f il d h ll l bfor the use of a family supported wholly or partly by his labor. (Emphasis supplied).


♦ Relevant North Carolina Cases:Shearin v. Beaman, 323 B.R. 917 (USDC, EDNC 2004), aff’d, 126 Fed. Appx. 640 (4th. Cir. 2005); In re Shearin, 224 F.3d 346 (4th. Cir. 2000)Two Important Points:

1. Bonus based on work more than 60 days prior to filing of bankruptcy petition was not exempt.

2. Capital accounts of a professional service entity (in this case a limited liability partnership) are not exempt.

In re John C. Connelly, 276 B.R. 421 (USBR, WDNC 2002)Important Point:

1. Unmarried debtor could not exempt bank account under N th C li t t t th i i d bt t tNorth Carolina statute authorizing debtor to exempt earnings from his personal services, provided these earnings were necessary “for support of a family.”


Harris v. Hinson, 87 N.C. App. 148, 360 S.E.2d 118 , pp ,(N.C. App. 1987)Important Points:

1. Court held N.C.G.S. § 1-362 precludes the execution on any future earnings to satisfy a judgment.

2 A j d t d bt i hi l d di2. A judgment debtor can receive his salary and dispose of it in any manner he chooses, regardless of whether it contains an amount of funds in excess of what is required to satisfy his and his family’s reasonable living expenses, even if he squanders his excess funds with the express intent of avoiding paying a judgmentwith the express intent of avoiding paying a judgment that by all laws of principle and fairness he should be made to satisfy.


Important Lessons Learned:Important Lessons Learned:1. The state of incorporation/organization

does matterdoes matter.2. The type of entity does matter and can

k diffmake a difference.3. When possible, use semi-annual or

quarterly bonuses instead of annual bonuses, thereby leaving less cash available beyond the 60 day exemption period.

Asset Protection PlanningProtecting Your Retirement

♦ The Myth:y– A creditor cannot reach my IRA(right?!)

♦ The Law:– N.C.G.S. 1C-1601. What property exempt; waiver;

exceptionsexceptions.(a) Exempt property. - Each individual, resident of this

State, who is a debtor is entitled to retain free of the enforcement of the claims of creditors:enforcement of the claims of creditors:

(9) Individual retirement plans as defined in the Internal Revenue Code and any plan treated in the same manner as an eve ue Code d y p e ed e s e e sindividual retirement plan under the Internal Revenue Code. For purposes of this subdivision, “Internal Revenue Code” means Code as defined in G.S. 105-228.90.


♦ The Problem♦ The Problem1. Exemptions Have No Extraterritorial Effect

a Laws regarding remedies are controlled not bya. Laws regarding remedies are controlled not by the state in which the case was tried, but by the law of the state in which the remedy is sought.

b. This means that a state’s exemption laws typically have no application or effect beyond the borders of that statethe borders of that state.

c. While North Carolina has very liberal exemption for IRAs, some states are more stingy, with substantially lower limits or none at all.


♦ The Result?

Aggressive creditors are domesticating judgments in gg g j gother states, typically where the home office of the IRA custodian is based, and are enforcing the judgment directly against the debtor’s IRA assets in that state.against the debtor s IRA assets in that state.

Mahl v. Aaron, 809 N.E.2d 953 (Ind. App. 2004)., ( pp )In re Marriage of Hamood, 506 N.W.2d 803 (Iowa App.1993).Jakubik v. Jakubik, 208 Ill.App.3d 119, 566 N.E.2d 808 (1991).


♦The Solution?♦The Solution?

ERISA Qualified Plans Are AlwaysERISA Qualified Plans Are Always Exempt Under the Federal Pre-Emption

Doctrine!Doctrine!Guidry v. Sheet Metal Workers Pension Fund, 493 U.S. 365 (1990), the United States Supreme ( ), pCourt made it clear that outside of bankruptcy a creditor could not reach “ERISA qualified” plan assets based on the anti alienation provisionsassets based on the anti-alienation provisions under ERISA § 206(d)(1).


Patterson v. Shumate, 504 U.S. 753 (1992), the United States Supreme Court held thatthe United States Supreme Court held that “ERISA qualified” plans are also excluded from a debtor’s bankruptcy estate pursuantfrom a debtor s bankruptcy estate pursuant to § 542(c)(2) of the Bankruptcy Code.

Okay, what is an “ERISA qualified plan?”


♦ Neither the Internal Revenue Code of 1986, as ,amended, nor the Employment Retirement Income Security Act (ERISA) define an “ERISA q alified” planqualified” plan.

♦ Two schools of thought♦ Two schools of thought.

A. The Restrictive View

(1) The plan must be subject to ERISA;(2) The plan must be qualified under § 401 if the IRC;( ) e p us be qu ed u de § e C;(3) The plan must contain the anti-alienation provisions which

are required under both the Internal Revenue Code (IRC §401(a)(13)) and ERISA § 206(d)(1).

Asset Protection PlanningProtecting Your RetirementB. Patterson (less restrictive)B. Patterson (less restrictive)

A plan should only need be subject to Title I of ERISA and contain the required anti-alienation provision under §206(d)(1).

But, Patterson excluded certain types of plans:a pension plans established by governmental entities;a. pension plans established by governmental entities;b. certain church plans;c. unfunded excess benefit plans; andd any other plan that need not comply with subchapter I ofd. any other plan that need not comply with subchapter I of

ERISA, including the anti-alienation provision of §206(d)(1)…

Anybody care to guess what other types of plans were excluded by Patterson?


IRA !!!IRAs!!!Patterson also held that retirement plans that qualify for preferential treat under IRC § 408 are specifically excepted from ERISA’s anti-li ti i i d th f talienation provisions and are therefore not

“ERISA qualified” plans. This means IRAs!!!


♦ A Possible Solution1. Have the business establish a profit sharing plan, p g p

which is an “ERISA qualified” plan.2. Make sure the PSP does not require a rollover of

assets upon separation from serviceassets upon separation from service. 3. Make sure the PSP is structured to accept rollover

contributions from an IRA.4 If h b i l d h PSP d h l4. If the business already has PSP, amend the plan to

allow a participant to leave his or her portion in the PSP and to accept rollover contributions.

5. Rollover any IRAs into the PSP.


♦ Drawbacks/Limitationsa. A plan can be amended to provide more

liberal benefits, i.e. the ability to accept ll t ib ti t llrollover contributions or to allow

persons separated from service to leave their plan balances in the plan, but it

t b d d t b t i ticannot be amended to be more restrictive.

Once the plan is created or amended to contain pthese provisions, these provisions will be there until the plan is terminated.

b. The provisions must be available for all plan participants.

Asset Protection ThroughCaptive Insurance Companies

♦ Is A Captive Right for You?p gCaptives - What Are They?

A captive is an insurance company that belongs to a corporation or group and underwrites or reinsures primarily or exclusively the risks of firms that belong to p y y gthat group.

The captive insures certain risks of its sister companiesThe captive insures certain risks of its sister companies, which pay insurance premiums to the captive and take a current-year deduction for the insurance premium expense.

Underwriting profits are retained by the captive, and not lost to a third-party insurance company.


A property and casualty insurance company with netA property and casualty insurance company with net premium income of less than $1.2 million may elect under Code Section 831(b) to be taxed only on its investment i Thi it i t t d it iincome. This means it is not taxed on its insurance underwriting income.

If structured and run properly, premium payments to a captive are deductible under IRC § 162.captive are deductible under IRC § 162.

A captive may underwrite unrelated business.p y


♦ Helvering v. Le Gierse, 312 U.S. 531 (1941) defined “insurance” for federal income tax purposes. To be insurance, three things must exist:

(1): an insurance contract; (2) risk-shifting; and (3) risk-distribution.

The IRS’ Position on Captives1. Prior to June 2001

Rev. Rul. 77-136; No transactions that occur with an “economic family” are considered to be insurance

2. Changes in the LandscapeRev. Rul. 2001-31; IRS announced it will no longer

i h “ i f il h ” f h i R R lraise the “economic family theory” set forth in Rev. Rul. 77-136. Instead, Service will address captives on a case-by-case basis.


♦ Areas of inquiry/concern1. Thin capitalization.p2. Presence of “parental guarantees” and “hold harmless”

agreements.

The Trinity of Revenue Rulings for Captives

1. Rev. Rul. 2002-89 - Unrelated Risksa. 10% unrelated risk is not adequate for risk shifting or

risk distribution; parent risk not insurance.

b. 50% or more unrelated risks is adequate risk shifting and risk distribution; parent risk is insurance.


Rev. Rul. 2002-90 - Brother-Sister Risks

1. At least 12 insured subsidiaries.1. At least 12 insured subsidiaries.2. No one sub has more than 15% or less than 5% of risks.3. Risks homogeneous.4 N l b k4. No loanbacks.

Rev. Rul. 2002-91 - Group Captivesp p

-At least seven (7) member insureds.


Rev. Rul. 2005-40 - Service examined 4 Scenarios1. Single unrelated insurance was not sufficient

i k di t ib tirisk distribution.2. Two (2) unrelated insureds (90/10

concentration) was not sufficient risk distributiondistribution.

3. 12 LLCs (all disregarded entities) was a single insured, therefore no risk distribution.

4. 12 LLCs, all of which elected to be treated as ,associations were multiple insureds, therefore adequate risk distribution.

Rev Proc 2002-75Rev. Proc. 2002-75Service announced it will entertain rulings on captive insurance company status.


Benefits1. Reduced Operating Costs.

♦ 2. Investment Income.♦ 3. Broader Insurance Coverage.♦ 4. Available/Stable Coverage.♦ 5. Direct Access to Re-Insurance Market.♦ 6. Potential Immediate reward for

Controlling Losses.♦ 7. Fewer Regulatory Restrictions Than

Traditional Insurance CompanyTraditional Insurance Company.♦ 8. Tax Savings - Potential for Advanced

Tax Deduction for Loss Reserves.


♦ Domicile1. Domestic

a. Choices:VermotHawaiiSouth CarolinaSout Ca o aNew YorkArizonaColoradoColorado

b. Benefits:1. Low Premium Tax2 No Offshore Taint2. No Offshore Taint


c. Drawbacks:1. Higher Capitalization Rate vs.1. Higher Capitalization Rate vs.

Offshore-typically 1:3 for domestic captives vs. 1:5 for offshore.

2. More highly regulated than offshore captivesoffshore captives.


♦ Offshorea. Choices

BermudaCayman IslandsGuernseyGue seyThe Bahamas

b Benefitsb. Benefits

1. Lower Capitalization Requirements, typically 1:5 for coverage written.

2 L t i ti l ti th U S2. Less restrictive regulation than U.S. jurisdictions.

3. No premium tax.


c. Drawbacks

1. Offshore Taint (?)1. Offshore Taint (?)

2. Foreign Excise Tax (IRC § 4371 through 4374)4374).But can negate with a 953(d) election.


C i i i♦Beware - Captives Most Likely Will Not Work for Small Professional Practices or

S l P i iSolo Practitioners.

Documents

Asset Protection? Back to the BasicsBack to the Basicscrlaw.com/news/wp-content/uploads/2012/01/SKT_Asset...– See Firmani v. Firmani, 332 N.J. Supper. 118 (App. Div. 2000)(fraudulent