The line between participating in a fraudulent transfer and engaging in asset protection planning will be determined by a “facts and circumstances” test: “As a general proposition, attorneys who assist clients with transfers of property in good faith and without actual or deemed knowledge that the transfers are fraudulent conveyances should not be liable to the clients’ creditors or in violation of any ethical obligations that the attorneys may have under state law.” Culp and Perrin, The Case for Caution: Fraudulent Conveyance Risks in Estate Planning, 24 Real Prop. Prob. & Tr. J. 41, 44 (Jan./Feb. 2010).
Accordingly, it is essential that the practitioner document that the plan was not designed to prejudice known or reasonably anticipated creditors:
“Under what circumstances will transfers to APTs [asset protection trusts] be deemed fraudulent under the fraudulent transfer laws? More particularly, if a settlor transfers assets to an APT not with a specific creditor in mind, but rather with the general goal of shielding assets from potential future creditors, will the transfer be deemed fraudulent and thus voidable under the UFTA or similar laws? Although the answer to this question is not without doubt, it appears that most courts are unwilling to void transfers whose purpose and effect is to shelter assets from creditors that were unknown at the time of the transfer. Furthermore, the more remote in time the claim of a future creditor, the less likely a court will be to find that an earlier transfer was fraudulent with respect to that creditor. Thus, as long as a person creating an APT does so well in advance of a creditor’s claim, and especially if the creditor was unknown and unforeseeable at the time of the transfer to the trust, it is likely that the transfer will not be deemed fraudulent.
In an action brought under UFTA section 4(a)(1) — in which the creditor must prove “actual intent to … defraud” — a future creditor must typically establish that, as of the time of the transfer, the creditor held ‘contingent, unliquidated, or unmatured claims,’ or that the creditor held ‘a claim that [could] reasonable [be] foreseen by the transferor.’ Professor Peter A. Alces states that, in an action based on actual intent to defraud, a future creditor must ‘establish a causal link between the fraudulent disposition and the injury suffered.’ Regarding this same question Professor Alces further states that ‘[the] focus on causality provides a means to distinguish between the actions that operate directly to prejudice a particular creditor and those actions that in some remote, not foreseeable way, have after the passage of considerable time or the occurrence of an intervening cause, compromised a creditor’s financial interest.’
Concerning a similar issue, in an often-cited passage the court in Oberst v. Oberst stated: ‘While the Court finds it very difficult to locate the exact line between bankruptcy planning and hindering creditors, Congress has decided that the key is the intent of the debtor. If the debtor has a particular creditor or series of creditors in mind and is trying to remove his assets from their reach, this could be grounds to deny the discharge. If the debtor is merely looking to his future wellbeing, the discharge will be granted. This is an uncomfortable test and does not seem equitable; but it is the law. Thus, the concept of ‘reasonable foreseeability,’ the requirement that future creditors establish a ‘causal link’ between the transfer and their claims, and the notion that one may permissibly plan for one’s general ‘future wellbeing’ all serve to limit those future creditors who can successfully claim that a transfer was intended to defraud them.”
Danforth, Rethinking the Law of Creditors’ Rights in Trusts, 53 Hastings L.J. 287, 330 (2002).
Practitioners should be careful to document: (i) the reasons for any asset protection plan, (ii) the extent of the client’s debt (including foreseeable creditors), and (iii) that, at the time of the plan, the client has sufficient other assets to meet his or her obligations as those obligations come due. A careful solvency analysis will identify those assets that are not available to creditors under state law, identify assets available for a client’s known and anticipated creditors, and then focus the asset protection planning on the remaining assets. This process should be documented in the file. This process has been called a “creditor protection plan.” Osborne and Terrill, Fundamental of Asset Protection Planning, 31 ACTEC J. 319, 324 (Spring 2006):
“The proper approach to effective, careful asset protection planning begins with a solvency analysis of the client.
In an accurate solvency analysis, the lawyer should make a complete list of all of the client’s assets and then make three subtractions from the total value. The first subtraction should be the value of all current debts. Reserves must be established to satisfy these obligations. This action protects present creditors.
The second subtraction should include all liabilities, claims, contingent liabilities, threats, guarantees, contingent claims, pending lawsuits, and potential claims faced by the client. The lawyer should aggressively identify, document and quantify all of these liabilities. To assist in this exercise, it may be appropriate to conduct independent internet database research of the client’s financial/legal situation. In some cases, an audited financial statement is very helpful and should be secured. Furthermore, the attorney should inquire about the client’s business and professional reputation. For example, does the physician client have a history of malpractice claims? Does the business client have a history of disputes with creditors, associates, etc.? After all liabilities are evaluated and summed, reserves must be set aside to satisfy them. This action protects potential subsequent creditors.
The third subtraction in the solvency analysis involves all client assets already protected from creditors under the law (e.g., homestead, insurance, and retirement plans). Such exemptions and protections vary tremendously from state to state, of course. In some cases, it may be advisable to join an attorney from another state (if that is where some assets are located) and/or join an attorney with creditor’s rights expertise (if there are pending claims against the client) as co-counsel.
Finally, at the end of the solvency analysis, the lawyer must devise a methodology to protect creditors. Indeed, that ‘creditor protection plan’ is the entire purpose of the solvency analysis and is, in fact, the linchpin of prudent, careful asset protection planning.”