01st July 2007
Author: Zetland
This guide has been prepared by the Zetland Financial Group Limited and is intended for the information of clients or prospective clients. As such, it is designed to provide general information about Asset Protection. The information set out is not, nor is it intended to be, exhaustive. Such information does not purport to be and is not legal, tax or other professional advice. Our aim has been to provide a broad overview. We will be pleased to offer more comprehensive and specific professional advice to individual clients depending on the situation.
Introduction
Asset protection may be defined as the implementation of a plan to shield assets from the claims of future or potential creditors, for example from frivolous lawsuits. It is a form of wealth insurance using a series of lawful techniques to make it difficult or practically impossible for future creditors to get hold of assets. The use of a number of offshore jurisdictions is usually an essential element of asset protection planning.
Why is Asset Protection Necessary?
The last few decades have seen an explosion in litigation and increasingly a change in attitudes in a number of countries towards seeking recompense for perceived losses. The culture of blame has become prevalent and ingrained – to cite a few examples:
Investors increasingly will sue companies and their executives for failure to deliver profits or share price growth. Despite the fact that all businesses must struggle in a chaotic and unpredictable world, investors will claim to have been misled when something goes wrong.
The consequences of product liability claims can be catastrophic for companies and their directors and key officers especially where issues of public health are involved.
The continual growth of good-intentioned but draconian legislation in many countries has opened a steady flow of potential lawsuits ranging from claims for sexual harassment to liability for building safety or environmental problems that a property owner might never have been aware of.
The consequences of an accidental event can be tremendous. For example a burglar who fell through the roof of a factory building in the course of a robbery and was injured successfully sued the building owners for their omission of warning signs!
The perception of what constitutes negligence is continually being stretched. Although some professions have traditionally been seen as high-risk such as obstetricians and surgeons, increasingly any professional or expert is at risk. Accountants, lawyers, investment advisers, beauty salon operators and fitness trainers to name but a few are being sued for failures to achieve the expectations of their clients.
The incidence of divorce continues to grow in most countries and also the ability of an aggrieved spouse (or sometimes merely a defacto partner) to gain excessive compensation through the courts has been increasing. Divorce settlements imposed by courts often appear to be punitive rather than compensatory in nature.
While some of the above risks are insurable most are not. Also the cost of insurance premiums can be high and the cover provided very limited. Many professionals today would probably agree that their professional indemnity cover is inadequate but that it is economically impossible to extend coverage to a comfortable level.
The reasons for the deteriorating state of affairs are often debated – lawyers on contingency fees, the ability of US juries to invoke punitive damages or the tendency for juries to be influenced by emotion, but the simple fact is that in current times someone who is perceived to have deep pockets is an obvious target, given the right opportunity.
Indeed many lawsuits are started purely for their nuisance value on the basis that settlement is the easy way out for a plaintiff and that a simple calculation of costs and time spent will show that it is better to settle quickly rather than to fight.
However when faced with a significant exposure the individual who has implemented an effective asset protection plan is obviously in a strong position to face down threats. When it is realised by the attacker that getting any material assets is going to be a complex, expensive, long-drawn out process and possibly fruitless in the end, the incentive to reach a reasonable settlement quickly becomes very strong.
What is the Essence of Asset Protection?
The essential element of asset protection lies in isolating ownership and (where possible) control from the settlor’s home jurisdiction, out of reach of the courts and therefore the creditors of that jurisdiction. In Zetland’s view the multi layering of jurisdictions in a structure for a potential attacker to face is an important secondary element. The attacker should have to pursue a variety of asset holding structures in a number of jurisdictions with different legal systems that at all times makes it harder and more expensive to achieve his end goal. Another powerful factor is that many offshore jurisdictions have strict confidentiality laws and hence little leakage of information. An attacker may simply not be able to find out where or how assets are held.
To achieve the most basic level of protection an asset owner may decide to place assets in an offshore company which is beneficially owned by him but controlled by nominees. The problem is that beneficial ownership remains unchanged and therefore vulnerable to future attack although the offshore company may give considerable advantages in terms of secrecy of operations. A much better solution is to ensure that ownership is firmly placed in the hands of an independent party who will strongly resist any attempts to seize the assets. The best way of doing this is to establish an offshore asset protection trust – this is discussed below. At all times however the settlor should understand what is being done with his or her assets. That is, complex structures are not necessarily the best means to pursuing asset protection goals.
What are the Timing Issues?
Asset protection planning ideally needs to be thought about and implemented in advance of a problem occurring. Asset protection plans cannot be used to defraud creditors since this would be a criminal act. Often there is considerable forewarning of potential problems and litigation may take time to reach a conclusion so that asset protection work may be usefully undertaken at a relatively late stage. Sound professional advice is essential. Equally individuals who already have offshore operations or existing asset protection schemes are advised to review their plans regularly in the light of threats that they may face.
What are the Tax Issues?
Asset protection planning generally seeks to ensure the safety of assets which have already been acquired from taxed income. There may be issues with some classes of assets upon a formal change of ownership, for example unrealised investment gains may crystallise and attract capital gains tax. Proper tax advice should always be taken in one’s jurisdiction of residence and citizenship.
Having set up an offshore asset protection structure there can be considerable future tax benefits since income or capital gains flowing from the assets may not be taxed. Significant savings on inheritance taxes are also possible but again proper professional advice needs to be taken. There is also a view among many professionals that trusts which are set up with a view to other objectives such as legitimate avoidance of tax or for inheritance planning purposes may be more robust than those established purely for asset protection if attacked in court.
What is a Trust?
A trust is a relationship whereby a legal person (the trustee) holds property donated by a settler (grantor in USA) for the benefit of third parties (the beneficiaries). Trusts are highly flexible arrangements and are well established vehicles in common law jurisdictions and are gaining increasing acceptance in civil law countries. (For further details please consult the Zetland Guide to Trusts.)
An asset protection trust is merely a trust settled under the laws of a jurisdiction which is favourable to asset protection. There are two premier jurisdictions – the Cook Islands and Belize which are discussed in greater detail below. Both jurisdictions have enacted specific legislation which serves to make attacks on trusts settled under their laws extremely difficult as compared with a “regular” common law country. Zetland operates a government licensed trustee company in each place.
A trust can be structured to suit the purposes of the settlor. The settlor may be a beneficiary; he may exercise a considerable degree of control over the assets; he may put in numerous safeguards to ensure that the assets are properly managed. There does need to be a clear separation of ownership of the assets which become the property of the trustee. In turn the trustee has a strong fiduciary duty to look after the trust assets and to ensure that the settlor’s wishes and intentions are being met.
Trusts are excellent vehicles for inter-generational transfers of wealth and a considerable side benefit of setting up an asset protection trust may be that these issues are also addressed. Particularly for individuals domiciled in countries which have forced heirship provisions in their law, an offshore trust can be a powerful means of ensuring that the settlor’s wishes are carried out.
In most cases Zetland recommends putting assets into an offshore company owned and managed by the trustees pursuant to the terms of the trust deed. To create complexity in locating assets it is generally desirable for this company to be in a different jurisdiction from the trustee. The company may then manage the assets and transact business. It is Zetland’s practice to operate such companies from Hong Kong, using the business efficiencies and excellent infrastructure found in the territory.
Often settlors may continue to assist in the management of the offshore company. A popular structure in the USA is for a Limited Liability Company (holding all the assets) to be 99% owned by the offshore trust with the settlor holding a 1% management interest. Under this structure there is a flow-through of income for tax purposes.
Cook Islands or Belize?
The following table highlights some of the key features of the Cook Islands and Belize as the leading jurisdictions for the settlement of asset protection trusts. Further details may be found in the Zetland Guides to Belize/Cook Islands Companies and Trusts. Both jurisdictions have fairly similar provisions – the Cook Islands was a pioneer in the field; Belize was a later entrant and arguably offers a somewhat easier protection against attacks on the grounds of fraud. However there is relatively little case law regarding Belize trusts whereas the Cook Islands has a good track record. Costs are fairly similar in each jurisdiction.
How to Establish an Asset Protection Plan?
There are two phases to establishing an asset protection plan involving a trust – consultation and structuring followed by implementation. During the consultation phase advice needs to be taken from legal and tax advisers and the structure fine tuned to suit the situation. The trustee will need to fully understand the wishes of the settlor and will also require evidence that the trust is not being set up to defraud creditors. If substantial assets are involved investment strategy or guidelines need to be established. Generally in this phase professional advisers will charge fees according to time spent on a client’s matters.
During the implementation phase the trust deed is executed and the transfer of property into the hands of the trustee is made. Operating company and banking and investment arrangements are also put into place. Annual fees for acting as trustee are payable in advance and have a fixed component covering routine matters plus a variable charge if additional time has to be spent. The extent to which the trustee will report on activities of the trust must also be agreed and lines of communication put into place.
The Zetland Financial Group, established in 1987 and headquartered in Hong Kong, has considerable expertise in the setting up and operation of asset protection schemes. Zetland believes in working closely with a client’s professional advisers and works with a network of lawyers, accountants and investment professionals around the world. Zetland’s trust companies in Belize and the Cook Islands are licensed by local governmental authorities and staffed by qualified professionals.
