This is a summary of the how the Texas Property Code, the Texas Business Organizations Code, and the Texas Constitution make it possible for individuals and business to shield income and assets (particularly equity in real property). The combination of individual protections and excellent LLC laws makes Texas the best state in the United States for achieving asset protection - bar none.
Asset Protection in the Real World
Bulletproof asset protection is not achievable in the real world - even in Texas - in spite of claims made by internet and seminar “gurus” who have never spent time in a real court of law in front of a real judge. Regardless of how hidden or well-placed your assets are, U.S. courts always have a contempt remedy available to them if you do not reveal or produce them when ordered to do so. Technical arguments about trusts and corporations set up in exotic island nations will not prevent an American judge from holding you in contempt - and that could mean a fine or even jail.
Therefore, asset protection is really about deterrence. You should not be disappointed to learn this. Deterrence has real value considering the number of frivolous and contingency-fee lawsuits that are filed each year in the U.S. If you can make it unacceptably expensive and time-consuming for a plaintiff and his attorney to discover and reach assets and income, then the asset protection plan has done its job. Every dollar of cost that imposed on a potential plaintiff or his percentage attorney makes your assets incrementally more secure and makes it less likely that you will have to endure the living nightmare of a lawsuit.
Preventive Measures
It is vital that an asset protection plan be implemented before trouble arises. Otherwise its usefulness may be limited by rules against “fraudulent transfers” that reach back up to 2 years (these rules apply in many foreign jurisdictions as well). Fraudulent transfers are generally indicated by so-called “badges of fraud,” including:
(1) transfers to a family member;
(2) whether or not suit was threatened before it was filed;
(3) whether the transfer was of substantially all of the person’s assets;
(4) whether assets have been removed, undisclosed, or concealed;
(5) whether there was equivalent consideration for the transfer; and
(6) whether or not, after the transfer, the transferor became insolvent as a result (eg., made his cash disappear).
Asset protection strategies are of limited effectiveness in the case of such fraudulent transfers. Therefore, the investor should be proactive and not reactive in asset protection planning. Consider asset protection to be a form of insurance that one takes out prior to a catastrophic event.
The Role of Insurance
It is often asked if obtaining liability insurance alone is sufficient. The answer is a resounding “No.” All legal experts recommend a sensible mix of insurance and asset protection. The principal reason is that insurance companies are in the business of collecting premiums and denying claims - thus every effort will be made by the company to exclude coverage in your case (particularly if the plaintiff alleges fraud, which is never covered). Also, even if the company concedes coverage, extravagant claims made in lawsuits nowdays may (and often do) exceed available coverage. Moreover, the existence of a sizable policy and umbrella may in and of itself encourage a lawsuit because it will be perceived by the plaintiff’s attorney as a tempting target!
Elements of Basic Asset Protection
(1) creation of an LLC to hold title to properties and establish liability barrier;
(2) anonymity (creation of trust and/or DBA for the title-holding LLC);
(3) separation of management or operating functions into a separate shell LLC;
(4) attorney-client privilege (use of attorney as registered agent or trustee);
(5) review and re-arrangement of personal holdings to insure falling within constitutional and property code protections for individuals.
Creation of an LLC
Texas has excellent LLC laws and is recommended for simplicity of operation. Other popular options include Nevada and Delaware, but forming one of these companies requires designation of a registered agent in that state (who serves for a fee) and expensive filing fees to register your “foreign company” in Texas.
An LLC provides a true liability barrier (so long as the company is maintained by minimal record-keeping, payment of taxes, etc.) along with limited anonymity. Anonymity is limited because information on the organizer, the initial member(s), and the registered agent of an LLC is contained in the Certificate of Formation that is filed with the Secretary of State. It is therefore public record. One can achieve maximum anonymity by having your attorney act as organizer, initial member, and registered agent - and then, afterward, privately transfer the membership interest to you. This way, your name does not become part of the official records at the Texas Secretary of State’s office or at the Texas Comptroller’s office.
It is critical that your attorney draft the LLC’s company agreement so that it discourages creditors from ever attempting to seize your membership interest or the membership interest of a fellow member. A membership interest in an LLC is not a protected asset under the homestead laws (see below) - so provisions should be included in the company agreement to the effect that any creditor succeeding to a membership interest by means of collection or execution on a judgment will not be able to vote that interest; not be able to serve as a manager or officer; not be able to direct that assets of the company be sold; and not be able to alter or reduce the company’s ability to do business. A good asset protection lawyer will know how to do this correctly. The object is to make your membership interest (or the membership interest of any of your partners) worthless to a creditor, so that the creditor passes it by in any attempt at collection. Remember: asset protection is about deterrence.
LLC’s are typically capitalized by a combination of equity (monetary contribution) and debt (loans to the company). Your attorney should help you sort this out.
Our fees (subject to change) are $650 plus costs ($325 filing fee, $80 for the corporate book, $10 shipping), which include pre-formation strategies, extensive documentation, and follow-up legal advice. Optional add-on fees are $250 annually for the attorney to serve as registered agent; and $450 (one time) if the attorney acts as organizer and initial member so that your name does not appear in public records.
Operation of Your LLC
One of the first things you will want to do is transfer the property you wish to protect into the company. In the case of real estate, this is done by means of a general or special warranty deed. Are due-on-sale clauses a problem? Not usually. See our companion article, Due-on-Sale Clauses in Texas.
Tenants and creditors should be instructed that they are doing business with the LLC and making payments to the LLC. There is an old rule of thumb that people tend to sue the person or entity they write checks to . . . so ideally, your personal name, address, or social security number should never appear anywhere on any paperwork or documents executed with third parties.
Once a company is formed, it must be maintained. There are minimum formalities that must be observed in order to order to preserve the LLC’s liability barrier. These include issuing membership shares; holding annual meetings; obtaining a TIN number and filing tax returns; having a company bank account; and the like. Failure to do this sort of routine maintenance is a common mistake. It can be fatal to your asset protection plan.
Use of LegalZoom-Style Internet Services to Form Your LLC
NO serious businessman or investor would do this. Such services allegedly provide “self-help legal services at your specific direction.” What nonsense. Here is what such services do not provide:
NO comprehensive advice on how to structure your business and investments so as to achieve maximum asset protection
NO attorney to serve as organizer, initial member, and/or registered agent in order to maximize your anonymity
NO sophisticated company agreement that deters creditors from taking control of your company
NO advice on how to move property into the LLC after it is formed
NO advice on how to set up and arrange the LLC’s finances, including setting up LLC accounts, injecting capital, and/or loaning money to the LLC
NO advice on how to maintain the LLC liability barrier to prevent a plaintiff from “piercing the corporate veil”
NO free follow-up questions after the LLC is formed
Additionally, the documents provided by such services are barely above the level of junk. This office spends a fair percentage of its time cleaning up the inadequacies in companies formed this way.
Offshore Entities
An additional option is to create an offshore entity (eg., a Panama or Cayman Islands LLC) which will own the Texas LLC. This structure is entirely legal and provides superior asset protection. It also allows flexibility in holding some of your assets in currencies other than the ever-weakening dollar. (Note: use of an offshore entity for asset protection purposes is not designed to achieve tax reduction or avoidance, which is illegal. All U.S. citizens must pay income tax on earned income.)
Role of a Land Trust
Once the LLC is established, it can choose to transfer its properties to a land trust which indicates nothing of record about real underlying ownership. This strategy is effective only if there actually exists a written trust agreement to support the transaction.
Land trusts also provide the capability of closing into a subprime buyer without lender approval and (for brokers) the opportunity to earn a commission. This is possible because beneficial interests in a trust are personal and not real property, and therefore the transaction is not subject to Sec. 5.069 of the Texas Property Code, which now makes conventional lease-options generally unworkable unless written for a term of less than 6 months or the property is paid for.
Note that land trusts do not defeat “due on sale” clauses although they may make a lender’s exercise of such a clause less likely.
A land trust is most effective when used in conjunction with an LLC. This is necessary because a trust alone is not a liability barrier and therefore provides no asset protection. A trust provides anonymity only. The belief that intervivos trusts protect assets is widespread but unfortunately false.
Management or Operating Companies
The investor should consider setting up a management or operating company that is unaffiliated with the asset-holding LLC and which will serve as the front line of defense against tenants, creditors, and plaintiff’s attorneys. This entity should also be an LLC that is basically a shell or a pass-through for funds. It should own no substantial amount of real or personal property - just its office furniture and equipment - and this should be the company that hires and pays employees. Third parties should all do all business with the management company and should never even be made aware of true underlying ownership or the location of real assets.
In addition to its management duties, the role of the management LLC is to serve as a target that is deliberately put out there to draw fire away from the owners and their assets. If anyone obtains a judgment against the management company, it will likely be uncollectible.
Attorney-Client Privilege
Use of an attorney as registered agent for the LLC or as trustee of a land trust adds yet additional layers of protection - first, anonymity, and second, the attorney-client privilege. In the case of a trust, the attorney serves is named as trustee but then appoints the Investor’s LLC as managing agent and attorney-in-fact to conduct day-to-day operations. A drawback to this technique are the fees and costs that must be paid annually to the attorney to compensate him for the risk involved in acting as the investor’s lightening rod.
Family Limited Partnerships
What about family limited partnerships (FLP’s)? As for anonymity, Texas limited partnerships (like LLC’s) must be filed with the state and pertinent ownership information is revealed. An in-state registered agent must be designated to receive service of process if the partnership is sued. Liability protection is best achieved if the limited partner is a corporation or LLC. Nonetheless, an FLP is not the best ownership vehicle for so-called “risky assets” such as investment real estate. They are more suitable for cash, stocks, and bonds. Also, the FLP concept of a “friendly lien” on the homestead is not workable in Texas. FLP’s are not a panacea, at least in Texas, but have some utility as part of an overall asset protection plan. FLP’s are not included among the more basic options for purposes of this article.
Limited Partnerships with an LLC General Partner
These vehicles are more complex and expensive, usually used in larger commercial transactions, and are beyond the scope of these comments.
Texas Homestead Protections for Individuals
Texas Homestead protections for individuals are contained in Art. XVI, Sec. 50 of the Texas Constitution and in Chapters 41 and 42 of the Texas Property Code. These protections apply to both income and assets, and they have long made Texas a haven for debtors. If a lawsuit is anticipated, or if a judgment creditor is expected to attempt collection, then it is wise to review and maximize these protections.
Sec. 28 of the Constitution prohibits garnishment of wages, which protects the income of a person who receives a salary or wages. As to assets, the homestead of a family or single adult is protected from forced sale for purposes of paying debts and judgments except in cases of purchase money, ad valorem taxes, owelty of partition (divorce), home improvement loans, home equity loans, and reverse mortgages. No matter how much the home is worth, an ordinary judgment creditor cannot force its sale. An attempt by such a creditor to place or enforce a lien against the homestead can be defeated using the procedure in Texas Property Code Sec. 53.160. See our companion article, Removal of Wrongful or Invalid Liens.
The Property Code further provides in Sec. 41.001(5)(c) that “The homestead claimant’s proceeds of a sale of a homestead are not subject to seizure for a creditor’s claim for six months after the date of sale.” This expressly permits homestead protections to be rolled over from one homestead to the next, notwithstanding the preference on the part of title companies to collect judgments upon sale of the homestead. Taylor v. Mosty Bros. Nursery, Inc., 777 S.W.2d 568, 570 (Tex.App. - San Antonio 1989, no writ).
The Texas Property Code goes into more detail, specifically listing the amount and types of other exempt property, including a vehicle for each licensed driver in the household; home furnishings; and the debtor’s IRA or 401(k). In keeping with Texas’ frontier spirit, you can even keep two horses if you wish.
The Texas Constitution and the Property Code provide an excellent opportunity for individuals (not corporations, LLC’s, or partnerships) to engage in asset protection. Essentially, this means converting non-exempt assets (cash, for instance, or investment real estate) into exempt assets. As an example, one might consider paying off the homestead or the vehicles. The conversion process can be tricky. It is best accomplished with the guidance of an attorney knowledgeable in this field.
Texas homestead laws are liberally construed by the courts. “Indeed, a court must uphold and enforce the Texas homestead laws even though in so doing the court might unwittingly assist a dishonest debtor in wrongfully defeating his creditor.” Painewebber, Inc. V. Murray, 260 B.R. 815, 822 (E.D.Tex.2001).
Although there is a conceptual overlap, the homestead protection laws should not be confused with the homestead tax exemption as reflected on the rolls of an appraisal district, which is designed to lower ad valorem taxes on homeowner-occupied property.
Articles on the following related topics can be found at our website: Texas Homestead Protections for Individuals; LLC Formation in Texas; and LLC Documents in Texas.
