An expert shows you how to protect your hard-earned assets against being seized in a malpractice lawsuit
According to the US Department of Justice, approximately one half of all medical malpractice lawsuits are filed against surgeons,1 even though surgeons represent only 14.5% of practicing physicians.2 Surgeons, particularly plastic surgeons, are perceived by plaintiffs’ attorneys as desirable litigation targets because they earn on a nationwide average double what general practitioners earn.2
Higher earnings lead to greater wealth, and plastic surgeons find themselves facing numerous malpractice lawsuits. The vast majority of these lawsuits are frivolous—a plaintiff succeeds in only one out of every four medical malpractice lawsuits.1 However, given the sheer number of lawsuits filed, surgeons are justifiably worried about those that may exceed their insurance coverage or that may not be covered by malpractice insurance.
Asset protection is a field of law that deals with structuring asset and business ownership to make it either impossible or at least very expensive for a plaintiff to reach the defendant’s assets. If a surgeon’s personal assets are impossible or too difficult to collect against, a plaintiff’s attorney will either not file the lawsuit in the first place, or will be a lot more willing to settle on terms favorable to the surgeon.
Asset protection does not deal with secrecy or hiding assets, because an intelligent and determined creditor will always be able to unearth hidden assets. A properly structured asset-protection plan would use commonly used structures such as trusts and limited liability companies in a manner that would legally, ethically, and effectively shield a surgeon’s assets from any lawsuit and any creditor. Surgeons who implement asset-protection plans will be able to sleep soundly, knowing that whether they are hit with a malpractice claim or are involved in an traffic accident their assets will be safe and unreachable.
Once the plaintiff obtains a legal judgment against the surgeon in a malpractice lawsuit, the plaintiff becomes a creditor of the surgeon and the surgeon becomes a debtor. The plaintiff can now use the judgment to collect and attach almost any and every one of the surgeon’s personal and business assets. Consequently, the focus of all asset-protection planning is to remove the debtor-surgeon from legal ownership of his assets while retaining the surgeon’s control over and beneficial enjoyment of the assets.
There is no “magic bullet” asset-protection strategy. Depending on the assets owned by the surgeon, the plaintiff’s aggressiveness, and certain other factors, different structures will be used to protect the surgeon’s assets. The timing of the planning is important as well. While it is always possible to engage in asset-protection planning—even after a lawsuit has been filed—the planning will be a lot more effective and simpler when it is implemented before a malpractice claim arises.
No asset is more important to shield from creditor claims than a personal residence. Personal residences represent the bulk of many people’s fortunes and have great sentimental value.
Creditors pursue not the residence itself, but rather the equity in the residence that can be converted into money through a foreclosure sale of the residence. There are two equity-stripping techniques.
One way to strip out the equity is by obtaining a bank loan. Even if we assume that a bank would lend an amount sufficient to eliminate 100% of the equity, the cost of this asset-protection technique is staggering. A $1 million loan bearing a 7% interest rate costs $70,000 per year.
Another way to strip out the equity is to encumber the residence by recording a deed of trust in favor of a friend. This avoids the carrying costs of an actual bank loan. With this technique it is important to know the creditor’s intelligence and aggressiveness.
Some creditors may stop trying to collect when they realize that there is no equity in the residence. Others may dig deeper, and if the debtor cannot substantiate the transaction as an actual loan, the deed of trust will be set aside by a court as a sham.
In addition to stripping out the equity, it is also possible to protect the residence by transferring ownership but retaining control and beneficial enjoyment. This can be done in several ways.
An arm’s-length cash sale is the best way to protect the residence (and the equity in the residence), because it is much easier to protect liquid assets (see discussion below) than real estate. Whereas this technique affords the surgeon the best possible protection for his home, it is also the most radical and may result in additional income taxes. This technique is usually reserved for surgeons facing very determined plaintiffs, or for surgeons facing government agencies.
An alternative to an outright sale is the sale and leaseback of the residence to a friendly third party on a deferred installment note. This allows the surgeon to transfer the ownership of the residence without having to move out. This structure works only so long as the surgeon can establish the sale’s legitimacy and arm’s-length nature.
The contribution of the surgeon’s residence to a limited liability company (LLC) or a limited partnership may be another way to protect it. The protection afforded by LLCs and limited partnerships is derived from the concept of the charging order protection, which is addressed in more detail below. Whereas the charging order protection is generally powerful, its usefulness may not extend to personal residences.
Certain state statutes require LLCs or limited partnerships to have a business purpose, and there is no business purpose in holding a personal residence in a legal entity. Other downsides may include the loss of the $500,000 gain exclusion on the sale of the home, the loss of the homestead exemption, and the triggering of the “due on sale” clause in the mortgage.
The final available alternative to protect a personal residence is to transfer the ownership of the residence to a trust commonly referred to as a personal residence trust (PRT). This is a trust established initially for the benefit of the surgeon and the surgeon’s spouse and later for the benefit of the surgeon’s children or other beneficiaries. Because the trust is irrevocable, it is treated as the owner of the residence, although the surgeon retains full control over his residence by appointing a friendly trustee.
The trust allows the surgeon to sell the existing home, buy a new home, and refinance. The surgeon retains all the mortgage interest deductions and the exclusion of $500,000 of gain on the sale of the residence. Also, the transfer into this trust does not trigger the “due on sale” clause in the mortgage. In practice, PRTs have proven to be a simple and an extremely effective way of protecting a personal residence.
Other Nonliquid Investments
Some of the techniques discussed above may be used to protect rental real estate, businesses, intellectual property, collectibles, or other valuable assets. These assets may be transferred into irrevocable trusts, sold for cash or on an installment basis, or encumbered. However, for assets other than a personal residence, there is a much better and simpler way to achieve as much or more protection: an LLC or a limited partnership.
Assets owned by a surgeon through an LLC or a limited partnership are not deemed owned by the surgeon because these entities have their own separate legal existence. If a surgeon transfers the ownership of his apartment building into an LLC, the surgeon will no longer be treated as the owner of the apartment building. He or she will now be treated as the owner of a membership interest in the LLC. This means that a plaintiff suing the surgeon will no longer be able to reach the apartment building directly; he would now have to pursue the surgeon’s interest in the LLC.
Forcing the plaintiff to pursue an ownership interest in an LLC or in a limited partnership is much more advantageous for the surgeon, because interests in LLCs and limited partnerships are not subject to attachment by a plaintiff. This is known as the charging order protection.
The charging order protection limits a plaintiff’s remedy to a lien against the distributions from the legal entity, without conferring on the plaintiff any voting or management rights. Because the surgeon will remain in control of the entity and can defer distributions, the plaintiff will have no way of enforcing the judgment against the surgeon’s LLC or limited partnership interests, or the assets owned by these entities.
Assets owned by a surgeon through a corporation would not enjoy the same protection. There is no charging order protection for corporate stock. This means that the same apartment building owned by a surgeon through a corporation can be seized by a creditor by first seizing the corporate stock owned by the surgeon.
As a practical matter, LLCs and limited partnerships create a formidable obstacle to the creditor’s collection efforts and usually force the creditor to drop his collection efforts or to settle. These entities should be considered by surgeons for all valuable assets with the exception of their personal residence, and, as discussed below, liquid assets.
Liquid assets may be protected through many of the techniques described above, including LLCs, limited partnerships, and irrevocable trusts. In addition to these techniques, liquid assets may also be protected with a foreign trust.
The term “foreign trust” means an irrevocable trust governed by the laws of a foreign jurisdiction. Several foreign countries have enacted trust laws designed to assist debtors with asset protection. The laws of these countries go through every step possible to make it impossible for a plaintiff to pursue the assets of a foreign trust.
These foreign countries erect the following obstacles in the plaintiff’s path:
• They will not recognize a legal judgment from any other country, including the United States. This means that a malpractice judgment obtained against a surgeon in the United States becomes useless to the plaintiff.
• Because the plaintiff’s attorney is not licensed to practice law in that foreign country, he would have to hire local attorneys to litigate for him—which is a very expensive proposition.
• The trustee of the foreign trust is a trust company that has no connections to the United States, which means that a US judge will not be able to force the trustee to distribute trust assets to the plaintiff.
The assets transferred to a foreign trust—such as bank accounts or brokerage accounts—are usually liquid, but they can also include intellectual property, interests in legal entities, and other assets. The assets owned by the trust can be located anywhere in the world, including the United States or Europe. The assets are almost never held in the same country where the trust is set up.
Most of these trust structures are established in a manner that would allow the surgeon to be the only one who can know what assets are owned by the trust and to be the only one who can access the funds of the trust. Even the trustee of the trust can be effectively prevented from having access to the surgeon’s assets.
Over the years, foreign trusts have become a favorite planning technique for many surgeons and other debtors. These structures are perfectly legal, tax neutral, and extremely effective in protecting assets from lawsuits.
It should be noted that many debtors believe that simply moving money to an offshore bank account will serve as sufficient protection from creditors. While the plaintiff may have a difficult time enforcing his judgment in a foreign country and levying on a foreign bank account, the surgeon-debtor will never have a problem withdrawing the money if the account is directly in the surgeon’s name. Consequently, the plaintiff may petition the court to direct the debtor to withdraw the money from the foreign account and pay it over to the plaintiff. With a foreign trust that can never be a problem, because the surgeon technically does not own the assets of the trust.
Surgeons will always be targets of lawsuits. The only way to change that is by removing a plaintiff’s financial motivation for pursuing the surgeon. Asset protection is a simple, inexpensive, and effective means of changing the plaintiff’s financial analysis and making the surgeon “judgment proof.” As with any other planning, asset protection is a lot more effective when implemented in advance.
Jacob Stein, JD, is a partner with the Los Angeles law firm of Boldra, Klueger & Stein, LLP, which focuses on tax and asset-protection planning for US professionals and business owners. A frequent lecturer and writer on tax, estate, and asset-protection planning, he welcomes comments at (818) 598-2252 or [email protected].
1. US Department of Justice, Bureau of Justice Statistics, Medical malpractice trials and verdicts in large counties, 2001. Available at: www.ojp.usdoj.gov/bjs/abstract/mmtvlc01.htm Accessed January 4, 2007.
2. US Department of Labor, Bureau of Labor Statistics. Available at: [removed]www.bls.gov/oco/ocos074.htm#earnings[/removed] Accessed January 4, 2007.