Dear Clients, Colleagues, and Friends,
Mike’s lifelong dream of building his own house is about to come true.
After years of searching, Mike finally found the perfect tear-down on an amazing lot with views to die for. He worked for over two years with an architect to design a show-stopping, LEED-certified house that will boast everything from a wine cellar to a sauna in the master bath… and it even has the perfect reading spot for his favorite old hammock.
Now, it’s time for construction. What started as a modest house with killer views has transformed into a spa-style estate, and construction bids are triple Mike’s original budget. Luckily, his newly formed LLC qualifies for a large construction loan, and Mike has the personal assets to support the personal guarantee the lender requires to get the loan. Although the project has tripled in size and cost, Mike is happy, his bank is happy, and his wife and kids, who benefit from a dream house complete with game-room and infinity pool, are really happy.
Several years later, his house is almost done and Mike starts paying off that huge construction loan, at the same time his longtime estateplanning attorney wants him to update his estate and implement some asset protection planning.
“Firewall planning,” or asset protection planning, can protect a person’s or business’s assets from unforeseen lawsuits, legal entanglements or future creditors, when good times turn “not so good.” One only need be reminded of the Great Recession of 2008 and 2009 to recall how good times can turn bad on a “dime.” But such planning must typically be done before any legal claims arise. Mike’s estate planning attorney advises transferring a huge chunk of his liquid assets – which appeared on Mike’s personal financial statement when his LLC applied for the construction loan and the bank asked for his personal guarantee – to an asset protection trust for the benefit of his wife and children.
Can he? Should he?
Because Mike gave a personal guarantee on the loan, any assets he transfers as part of his estate and asset protection plan could impact the bank’s ability to collect on the loan if the borrower/LLC defaults. If Mike fails to notify the bank of the asset transfers and later the borrower defaults, the bank would be right to claim that he made a fraudulent transfer.
A fraudulent transfer is an attempt to avoid a valid debt by transferring money to another person or entity such as a trust without receiving anything of reasonably equivalent value in return. Creditors see fraudulent transfers as attempts to swindle them out of their money, and if a creditor can prove that a fraudulent transfer occurred, it can ask a court to set aside the transfer or to obtain any other type relief, even though the bank going after his assets are the least of Mike and his lawyer’s worries.
Mike imagines having to tell his wife and kids that the safety net he set up for them is being “repossessed” by the bank! He doesn’t want that.
While fraudulent transfer laws preclude “firewall planning” after the worst case scenario actually happens, in this case, that worst case scenario (Mike defaulting on the construction loan) hasn’thappened. And maybe it never will. But, over 50 million lawsuits were filed in the U.S. in 2013, and Mike remembers his college professor once proclaim: Chance favors the prepared mind…
Mike explains to his attorney that his intent is not to swindle the bank, but simply to protect his assets from the future creditors of his kids, such as divorcing spouses, bankruptcy, civil liability, and the like. His attorney informs him that still might result in a fraudulent transfer under the law.
“However,” his attorney says, “if the bank decides to claim that you made a fraudulent transfer, it has a time limit in which to bring the claim. It depends on the jurisdiction and circumstances, but the fraudulent transfer statute of limitations is generally 4 years, and the clock usually starts ticking after the transfer was made or the obligation was incurred, or less time if the prospective creditor knew or should have known of the transfer.”
Mike asks his attorney to explain further, and he learns of a recent case from Delaware (TrustCo Bank v. Mathews, 2015 WL 295373 (Del.Ch., Jan. 22, 2015)) which decided that a lender bank had received substantial inquiry notice regarding its borrower’s transfer of assets. Inquiry notice is the legal notice presumed to exist when sufficient facts would cause a reasonable person to make inquiries about the status of the transfer. In this case, the bank failed to file suit within the statute of limitations of four years once it had inquiry notice, and the bank’s fraudulent transfer claim failed. Had the statute of limitations not run, the defendant debtor would have had to satisfy her obligations to the bank.
While Mike’s personal guarantee on the outstanding bank loan might cause some problems if he transfers assets and then defaults, Mike can mitigate that risk by notifying the bank of his desire to do estate planning so the bank is kept informed. This notice should start the statute of limitations clock, and Mike’s exposure on a potential fraudulent transfer claim can be limited by the simple passage of time.Keeping the bank informed of Mike’s legitimate planning needs willlessen the risk of the bank reaching back and claiming Mike’s assets in his estate planning structures.
If you have made a personal guarantee on a loan and want to discuss “firewalling” your estate with a comprehensive estate and asset protection plan, call us for a consultation to discuss your options. Transparency with your lender now may save you the pain of a bank “repossession” of assets because of a fraudulent transfer claim in the future.