Estate planning is about more than where your farm passes at your death. It is also about making sure you have an estate to live on and to pass on!

After the U.S., Japan is the second largest economy in the world. I recently heard there are more lawyers in West Los Angeles County than in all of Japan. Some might say we have a sue-happy society and too many “frivolous” lawsuits are filed. Others say it is trial lawyers who protect the little guy. But one thing I know: if you are on the wrong end of a lawsuit, and a court awards a large judgment against you, you can literally lose the farm over one simple mistake, and it doesn’t even have to be your fault.

The classic example of a lawsuit that wipes out your farm is personal injury. Some third party is hurt by the activities of you or your employees. The injured person sues you to recover compensation for their medical bills, lost income (if the injury kept them from working) and pain and suffering. We’ll call this a claim and the injured party is a claimant.

It is important to note that you cannot put asset protection planning into place after a claim arises. Doing so is considered fraudulent, and can be worse than doing nothing at all. So, like death and tax planning, protecting your estate from claims means doing legal planning before something goes wrong.

Two types of asset protection

There are two primary types of protection.  One is using legal entities to confine risks so a claim won’t reach you or your assets. Think of this as “corking” the liability bottle. This applies to situations where you do not personally cause the injuries, but are somehow legally responsible. The second involves creating barriers between claims and your valuable assets. This is like building a “moat” around your castle.

Say you hire Tom to work for you during harvest. Tom is driving the combine down the road and fails to see a car that has the right of way. He runs into that car, causing serious injuries to its driver. The law allows the injured driver to sue the person who hurt them—Tom, who was driving the combine—and whoever Tom was working for at the time he caused the injury. Therefore, the claimant sues you.

Tom has very few assets of his own, so he files bankruptcy and his life goes on largely unchanged. But you? You turn the claim in to your insurance carrier. If you’re lucky, the insurance company settles it for less than your coverage limits. Otherwise, the claimant gets a judgment against you for an amount exceeding your limits, and forecloses on your farm to pay the claim.

Bottle it up and cork the bottle

Incorporating your business (or forming a limited liability company) is one way to create some claim protection. But the protection created is limited, and probably not as effective as you think.

Imagine that before the accident described above occurred, you incorporated your operation and your corporation hired Tom. Now the claim would be filed against Tom and the corporation (his employer). You would not personally be sued. You have “corked” the bottle, trapping the claim inside the corporation. If a judgment is awarded, the claimant would take the assets of your corporation. Assuming you hold few assets inside the corporation, you might not lose much at all. Assets that you own personally, that is, outside of the corporation, would generally be safe.

For this reason, some farmers operate as a corporation—holding machinery in the corporation perhaps, along with operating debt—but keep their farmland, home and savings outside of the corporation. The liability is “corked” within the corporate bottle, away from your personal assets.

But, what if you were the one driving the combine? Even if you are working for your corporation, who gets sued? You were driving, so you get sued. The judgment is awarded against you and your corporation. Now the claim reaches all of your assets, whether they are inside or outside of the corporation. The corporation did not protect anything. The claim against you personally, for your own driving accident, cannot be corked.

How to build a moat

For claims against you personally, you must build advance protections around assets, like a moat around a castle.

If a claimant files suit and gets a judgment against you, they are then permitted to enforce the judgment against anything you own (with a few exceptions, like retirement accounts and life insurance). To enforce the judgment, they foreclose on real estate or obtain a garnishment order against other assets.

You think, “OK then, I’ll put everything in my son’s name so I won’t own anything!” Or, “I’ll wait, and if I get sued then I’ll give everything to my son.” Neither will work unless you enjoy imprisonment, for reasons I don’t have space to completely explain. Just rest assured that simplistic solutions don’t exist.

The moat of choice for many is a limited liability company (LLC). An LLC can be formed under Illinois law, or under another state, like Wyoming or South Dakota with somewhat stronger liability protection statutes.

Laws concerning LLCs say if the members (owners) agree in their LLC operating agreement to restrictions on how and to whom they can transfer their shares (ownership), then the shares cannot be taken by a claimant, either. Your claimant would have a right to take the income you receive as a member, but not take the shares you own.

So, before any accident you formed an LLC and deeded your land to it. You are the member of the LLC, along with your spouse and perhaps a small percentage to each child. You own the LLC, the LLC owns the land. The claimant will find it much more difficult to seize your LLC shares than they would have to take land. You are in a better position to get them to settle the lawsuit. The LLC forms a barrier—a moat—between your farmland and the claimant.

A wider barrier can be created by a combination of two entities. You transfer your LLC shares into a special asset protection trust that can be established in other jurisdictions, such as Delaware, Alaska, Missouri, Nevada or certain foreign countries. Your LLC owns the land. The asset protection trust would own your LLC shares. When a claimant sees this, they get very discouraged and are much more likely to settle for your liability insurance.

Without question, using an LLC and an asset protection trust will seem complicated, and you may wonder if it is worth the hassle. If a claim arises, you will have your answer!

Wait and see planning

In recent years, a type of “wait and see” asset protection technique has developed using what are called “powers of appointment.” Using powers of appointment still requires advance attention, so you cannot wait until a claim arises and then rush to your attorney to implement it. However, it can be included in fairly simple estate planning, such as living trusts.

To use powers of appointment, you must have someone in your life who you trust unreservedly. We’ll call them “Protector.”  In your planning documents, you give Protector broad power over the assets involved. The Protector will have power to give your assets away without asking or notifying you. In their discretion, Protector could give the assets to your children, your spouse, or to trusts for them. The Protector could create an asset protection trust for you, and put your assets in the trust. Actions the Protector takes would have tax and estate planning implications, not to mention they might leave you destitute!

But the point? If you got sued, your Protector could, after considering all the pros and cons of doing so, remove your assets from the reach of the claimant. If you personally did the same thing, it would be considered defrauding your creditors, but a Protector could do it for you, legally. For the right people, Protector planning might be the best of all worlds

 

Compiled from articles originally published in the June and July (2010) Prairie Farmer® magazine