Heideman: Protecting assets from creditors

Q: What can my family do to protect our assets from creditors? Will creating a trust help protect our assets?

A: Creating a revocable trust will generally not help to protect the assets held in the trust from creditors. This is because, although the assets will be held in your names as Trustees, you still have the right to withdraw the assets at any time. In order to protect assets from creditors by means of a trust, the trust must be irrevocable; you must give up control of the assets for good and, in most cases, not retain a beneficial interest in the trust.

There are a number of other traditional ways, however, in which people and businesses attempt to protect their assets. The more common, with which many of you will be familiar, are:

1. Insurance. Everyone is familiar with liability insurance. It protects you against what is commonly referred to as tort liability. You have automobile insurance to protect you from claims arising from your negligent driving. You have homeowners insurance to protect you from claims for injuries to third persons arising out of defects on your premises. Many persons also carry excess liability insurance which gives protection over and above the coverage provided by the other policies (often referred to as an umbrella policy). We lawyers, like other professionals, carry professional liability insurance, more commonly referred to as malpractice insurance.

2. Incorporation. A person going into business can do so as a sole proprietor, partnership, corporation, or as a limited liability company. If you operate as a sole proprietor, you are subject to all the debts and claims against the business, however those debts and claims may arise. The same applies if you are a general partner in a partnership. Operating a business through a corporation provides protection for the owner or owners of a business for claims made against the corporation. The general rule is that the property of an owner (a shareholder) of a corporation is not subject to the debts of the corporation; a creditor can only reach the assets owned by the business. Limited liability companies offer similar protection to their members. Everyone starting a business should consider forming an entity such as a limited liability company. However, simply forming an entity is not enough to protect you. You must not mingle your personal assets with those of the business; the entity must be separate in substance as well as in form.

3. Limited Partnerships. A limited partnership is a way of investing in a venture without incurring any financial risk in excess of the amount invested. As mentioned above, general partners of a limited partnership are fully liable to creditors of the limited partnership. The limited partners may lose their investment, but should not be subject to any claims against the limited partnership in excess thereof. Unfortunately, sometimes the line becomes blurred between the limited partners and the general partners, in which case a limited partner may become fully liable as a general partner. With the rise in popularity of limited liability companies, and the low cost involved in creating such entities, fewer people are using partnerships to run businesses.

4. Segregation Of Separate Property. By keeping their separate property segregated, husbands and wives may insulate it against the claims of creditors of the other spouse. Generally speaking, a liability incurred by one spouse may be satisfied out of the community property belonging to the husband and wife. The separate property of the spouse incurring the liability will also be subject to its satisfaction; the separate property of the other spouse will not be. In Arizona, separate property includes property which the spouse owned prior to the marriage as well as property received after the marriage by gift or bequest. A spouse can protect his or her separate property from the creditors of the other spouse if that separate property is kept clearly segregated from the parties’ community property or the separate property of the debtor spouse. If separate property is commingled with community property or the separate property of the other spouse, one may not be able to protect it from creditors of the debtor spouse. Note that the presumption in Arizona is that all property is community property.

When it comes to asset protection, most of what I have said here is pretty familiar stuff. However, these measures still work. For most people, they will continue to be the most economic and available means of protecting their assets from creditors.

Andrew Heideman’s column appears as a public service. It is not intended as legal advice and addresses only general propositions. If you have a question about a matter that affects you, contact an attorney. If you have a question to ask Heideman for this column, call his Green Valley office at 625-4405 or you may e-mail questions to aheideman@duffieldlaw.com.