When Is An "Offshore" Asset Protection Plan Not Really Offshore?
Introduction In their youth, my children used to love playing "hide and seek" with me. My youngest daughter would make me count to 10 and dash under a nearby piece of furniture or a blanket. Despite her best efforts at hiding, it was always amusing to see a hand or a foot emerging from underneath or behind her hiding spot. She was absolutely convinced that she was hidden from view... but what did she know? She was a child, and what was logical to her was that I could not possibly see her if she could not see me. Occasionally, when I am asked to review a client's existing offshore asset protection plan, I am reminded of the games of hide and seek I played with my daughter. The client may be absolutely convinced that their existing offshore asset protection plan is solid and doesn't need to be amended or updated because it was put together by "a high-priced lawyer." The plan documents, however, tell a different story. While appearing to be an offshore structure with assets tucked under a foreign asset protection blanket, there is, unfortunately, a hand or foot sticking out that can be seen (and seized) by a U.S. judgment creditor. While it might be reasonable for a client to assume that an offshore asset protection plan set up by a lawyer is actually offshore, there are many way in which the structure can become domesticated. This can happen intentionally (by design) or by mistake. For example, there are times when a client may choose to have their offshore structure hold liquid assets in U.S. banks or brokerage accounts. This may done for convenience and ease of management, or for psychological comfort where a client new to international banking is skittish about moving large sums of money overseas. There is nothing wrong with this approach, provided standby arrangements and proper offshore solutions are also put in place. We see cases, however, in which the client (and sometimes their lawyer) has no idea that the structure was never properly established or funded offshore. The consequence of these mistakes is that the intended benefits of offshore protection planning may be illusory, and the client's assets may remain exposed to unanticipated creditor attack back home. In effect, the client's "offshore" asset protection plan may not be offshore at all. A profound challenge with many "offshore" asset protection plans is that they really are not offshore at all. This often comes at a surprise to the client, and – more alarmingly – to the lawyer who drafted the plan as well.-Stephen E. Speiser, Esq. Framing the Concern: What Is An "Offshore" Asset Protection Plan? There are three basic elements to an "offshore" asset protection plan: (i) the legal structure (trust or business entity) must be formed outside the U.S. in a safe jurisdiction; (ii) the assets must be successfully migrated to the offshore legal structure; and (iii) legal control of the structure must be vested in persons or trustees who are not subject to U.S. jurisdiction. That is the theory. Whether this is accomplished in actual practice will depend on the structure used and the type of assets in need of protection. 1. An Offshore Legal Structure Establishing an offshore legal structure for an asset protection plan should be a relatively straightforward task. Typically, the plan will utilize a foreign trust or foreign limited liability entity (such as a foreign LLC) to hold assets outside the U.S. For example, a California resident may want to use a Belize trust to hold assets beyond the reach of U.S. federal and California state courts. Setting up a Belize trust is a relatively straightforward process: The client enters into a trust agreement with a licensed Belize trust company, and the trust is then registered with the Belize authorities. Yet we sometimes find that the client or their attorney has done something that undermines or eviscerates the "offshore" benefits of the asset protection plan. For example, we frequently encounter "offshore" trust structures in which the client or another U.S. resident is the controlling trustee and/or where the client is unaware that their assets are actually being held in the United States. Such a structure is not really "offshore." Rather, it is a domestic asset protection plan that has the potential to perhaps one day be moved offshore. Whether the structure can be effectively migrated offshore after a legal attack occurs here in the U.S., however, will depend upon the facts and circumstances that exist at that time. We know from experience that once a legal claim arises or litigation formally commences, a client's planning options become materially constrained. 2. Migrating Assets Offshore In the above example, the California client has an offshore trust... a trust registered in Belize. However, to properly evaluate the trust structure, we must ask two questions: - What are the assets of the trust? - Where are those trust assets located? Fundamentally, an asset protection structure can only protect those assets that are transferred into the structure. All too often, we are surprised to learn that the law firm that set up an offshore trust never advised or assisted the client in funding the trust. If the trust is not funded, the client has accomplished nothing. Assuming the trust has been properly funded, we must then look to the location of the trust assets. Ideally, an "offshore" asset protection trust will hold assets outside the U.S. In our example of the California resident who sets up a Belize trust, the foreign trustee might open an offshore bank account to hold cash. How much cash should be transferred offshore? That will vary based upon the circumstances and needs of each client. For example, one client may want to fund the offshore trust with most of their liquid assets, while another may want to just have sufficient funds on hand to pay for lawyers in the event a creditor brings a claim in the offshore jurisdiction. Each type of asset has its own planning nuances that should be carefully considered in the asset protection process. For purposes of this discussion, we can assign assets into several broad categories: - Highly Liquid Moveable Assets: This category would include cash and publicly traded securities (stocks and bonds). These are normally easy to migrate offshore. - Moderately Liquid Moveable Assets: Investments in certain mutual funds, hedge funds, and similar structures can be shifted offshore, but they are subject to restrictions that require additional consideration. - Illiquid Moveable Assets: Ownership interests in closely held domestic business enterprises, such as a family-owned business, can be moved offshore, but they require very careful evaluation and may sometimes need to be further protected with some complimentary domestic asset protection planning. - Immoveable Assets: Real estate and other immoveable assets cannot be migrated offshore. Instead, we must rely on domestic asset protection strategies to protect such assets. While the solution may be domestic, these solutions must be designed to work in conjunction with your offshore asset protection plan. We refer to these broad categories in asset protection planning because it helps us to set our expectations. When we consider whether an asset protection plan is effectively "offshore," we expect to see that Category 1 assets (Highly Liquid Moveable Assets) have been migrated into an offshore holding arrangement, such as a trust bank account or an investment account held by a foreign business entity (and owned by the trust). We have different strategies for asset categories 2, 3 and 4. For example, if we are protecting a Category 4 asset such as real estate, the foreign trust or LLC should not take direct title to the real estate. Instead, we expect that a different planning technique will be used to help protect the real estate, such as a loan secured by the real estate and used to fund an offshore trust. The planning techniques and solutions available are myriad and varied. Are the Assets Really Offshore? In the previous section of this article, we said that an "offshore" asset protection plan requires: (i) a foreign legal structure and (ii) assets that have been migrated offshore in one form or another. We further observed that, while the foreign legal structure should be a straightforward proposition, migrating assets offshore may require the use of different planning techniques for different categories of assets. Let us now return to our example, a California resident who has established an offshore asset protection trust in Belize. Suppose further that the trustee has opened an offshore bank account in a reputable offshore banking jurisdiction. Let's further assume that the trustee also moved the California resident's stock and other portfolio investments into a reputable international brokerage firm in a foreign jurisdiction as well. Are the client's funds and investment portfolio now fully protected "offshore"? Maybe. Let us consider the offshore bank: Many international banks and brokerage firms have branches and offices here in the U.S. This could be a serious problem since those branches and offices may subject the offshore bank (and the client's accounts) to U.S. jurisdiction. If the foreign bank holds the client's funds in United States Dollars, can we safely say that the dollars are being held offshore? Well, unless an armored car delivers paper currency to hold in a foreign bank's vault for the client, those United States Dollars may remain in the custody of a correspondent bank here in the United States. Let us also consider the securities held in the client's investment portfolio. Even if that investment portfolio is nominally held by a foreign bank, most publicly-traded U.S. securities remain with custodians back in the United States. Stock certificates, even if delivered to an overseas custodian, may still be vulnerable if a sophisticated creditor convinces a U.S. judge to order the certificates retitled in favor of the creditor.
3. Offshore Control
Assuming one has (i) established an offshore legal structure and (ii) implemented offshore custody of assets, one more element must be analyzed to determine just how "offshore" the asset protection structure is: (iii) Whether legal control of the structure is vested in persons who are not subject to the jurisdiction of courts here in the United States. The theory here is that, in the event of creditor attack, a judge may order the person who controls the asset protection structure to repatriate the assets to the United States under threat of being jailed for contempt of court should they refuse to do so. A number of lawyers and law firms market canned asset protection trust arrangements in which the client or a designee controls the trust from here in the United States. The theory is that, if a creditor attack emerges, the client or the designee could promptly liquidate the trust and send the funds offshore. This strategy, however, relies heavily on timing – hoping that the client acts promptly to move assets on the eve of litigation – and on finding a bank in a foreign country that is willing to receive funds that may subject it to litigation and/or having to respond to court proceedings. In our experience, a potential customer who wants to open a bank account on the eve of litigation is usually considered radioactive. So, in practice, this strategy often fails and has produced a number of particularly disastrous outcomes. A more common strategy is one in which the client oversees a portfolio of assets through a domestic business entity, such as a limited partnership or LLC, that is under the client's managerial control. Ownership of the domestic business entity is often titled in the name of an offshore trust. The theory here is that, if a litigation threat arises, the quick-acting client can direct the distribution of assets from the domestic business entity over to the offshore trust. This also assumes that the offshore trustee has opened a bank or brokerage account that is capable of receiving the assets on short notice. The use of a domestic business entity resembles the use of a domestic trust in several ways. First, the client effectively controls the domestic business entity just as he or she would a trust. Second, both the domestic business entity and the domestic trust rely on the client being able to quickly move assets offshore in advance of a controversy. Yet, there are some important distinctions, which exceed the scope of this article, that make the domestic business entity superior to the domestic trust. Another popular planning technique involves the use of a foreign business entity. Just like the domestic business entity, the foreign business entity is managed by the client, however, ownership is held by the offshore trust. The benefit of this arrangement is that the client does not need to move any assets because the assets are already offshore. In the event a legal threat should arise, all that is required is for the client resign as the manager of the foreign business entity thereby giving up control of the structure. Should that occur, the offshore trustee will step in to manage the foreign business entity until the legal threat subsides. In all three examples – the domestic trust, the domestic business entity, and the foreign business entity – a client may opt to control the assets and keep them onshore when the asset protection plan is first implemented. This planning solution is viable provided the client remains vigilant to the risks discussed in each of these examples, and implements the planning required to mitigate those risks should a litigation event arise.
Conclusion
As discussed in this article, we have seen instances in which people engage well-known law firms to implement offshore asset protection trusts, only to discover through litigation that their assets were never truly "offshore" and that their structure was incapable of protecting them. The good news is that funding an offshore legal structure with assets that are resilient to a creditor attack does not need to be a complex endeavor. It does, however, require legal knowledge, experience, and attention to detail. The Speiser Law Firm is the only firm of its kind to have on its staff the former managing director of the largest international asset protection trust company. We understand how foreign custodians function and the problems and pitfalls of how clients can best migrate their assets offshore. The bottom line is that offshore asset protection can offer unparalleled safety and security, but it does require that you make sure all those little fingers and toes are safely tucked under your offshore asset protection blanket. Read the full article
