Excerpted from The Biggest Legal Mistakes Physicians Make: And How to Avoid Them
Edited by Steven Babitsky, Esq. and James J. Mangraviti, Esq. (©2005 SEAK, Inc.)
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Executive Summary
All signs indicate that the prevalence of litigation against physicians is in a continuing upward spiral across the United States. Although some claims are meritorious, far too many are not. In such an atmosphere, every physician with even a modicum of wealth is subject to an unacceptable level of risk. Aggravating this problem is the fact that even in instances in which liability might, unfortunately, be clear, the extent of the injury and, by extension, the dollar amount of the damages, often remains subjective and can therefore be grossly inflated by an overzealous judge or jury. Timely and professional “asset protection” planning, free of the most common mistakes physicians often make, can help a physician to weather this litigation storm.
Mistake 1 Consulting Counsel Too Late
Once a claim has arisen, it is generally too late for a physician to protect his or her assets. This is because a transfer made with the intent to hinder, delay, or defraud a creditor will be held to be a “fraudulent transfer” and will be undone by a court. Moreover, the law of some states, such as New York, holds that a transfer made after a lawsuit has been brought is automatically deemed to have been made with the intent to hinder, delay, or defraud creditors. However, even transfers made prior to a lawsuit are at risk of being undone if the alleged act of malpractice has already occurred.
Action Step Physicians should consult with counsel to assess their asset protection options before those options are foreclosed by the existence of a claim.
Mistake 2 Hiring Inexperienced Counsel
For the same reasons that one should not rely on one’s internist for medical issues that require a specialist’s expertise, physicians should not expect every attorney to have the same level of asset protection planning skill. Asset protection planning, in particular, requires an in-depth understanding of the law that spans a number of legal disciplines, including trust law, real and personal property law, family law, bankruptcy law, and debtor-creditor law, as well as state and federal income, gift, estate, and generation-skipping transfer tax laws. Moreover, since asset protection often attempts to “cherry pick” the most favorable laws of domestic and even offshore jurisdictions, asset protection planning counsel should have a breadth of knowledge that goes beyond any one state or country.
Action Step Physicians should do their own due diligence before engaging counsel for asset protection planning advice. The attorney who assisted in establishing the physician’s business practice is likely not the right choice to assist in establishing an asset protection plan. Physicians with asset protection plans already in place should consider obtaining a second opinion of the plan from independent counsel.
Mistake 3 Attempting to Protect Too Much
Courts will undo transfers made with the intent to “hinder, delay, or defraud creditors.” Since few, if any, defendants will admit to such intent in creating a trust, transferring property to a spouse, or taking some other action that might protect assets from creditors, courts are forced to look for extrinsic evidence of such intent. To the extent that a physician has attempted to protect all of his or her assets, the courts will almost certainly find a fraudulent intent.
Action Step Physicians should remember the old adage, “Pigs get fat while hogs get slaughtered,” and be satisfied with having obtained a reasonable level of asset protection. This concept is termed “nest egg” planning.
Mistake 4 Failing to Consider Life Insurance and Annuities
Although the issue is one of state law and therefore depends on a physician’s residence, life insurance and annuities are two of a very limited class of investments that are generally protected against creditor claims. The public policy underlying such protection is grounded in the understanding that life insurance and annuities are essential for the debtor and his or her family to maintain at least a minimum level of financial well-being and thereby avoid becoming a burden to the state. The manner in which most state law is written, however, does not limit these protections to subsistence levels and even large dollar amounts can potentially be exempted from creditor claims.
Action Step Physicians should assess their asset holdings and determine whether life insurance and/or annuities should be integrated into their portfolios. Physicians are cautioned, however, to consult with planners who have experience in asset protection planning to ensure that the investment is properly structured to maximize its potential asset protection benefit.
Mistake 5 Failing to Update the Plan and/or to Get a Second Opinion
Asset protection is a moving target. Every year new statutes are enacted and new cases are decided that affect the planning environment in some manner. In addition, a physician’s personal circumstances change over time in myriad ways that will affect the planning environment. To remain protected, it is incumbent upon the physician to remain abreast of changes that affect his or her asset protection plan.
Action Step Physicians should review their asset protection plan with counsel on a regular basis. Physician’s counsel should endeavor to keep the physician informed as to legal developments, and the physician should endeavor to keep counsel informed as to personal developments.
Mistake 6 Retaining Too Much Control
It is simple human nature to desire to control one’s wealth, even after that wealth is “given away” for asset protection purposes. In asset protection planning, however, there exists an inverse relationship between the amount of control retained and the level of protection afforded. For example, a revocable living trust provides no asset protection because it is revocable by the settlor. Even irrevocable trusts can be successfully attacked, however, if excessive control is retained. A physician who establishes irrevocable trusts for asset protection purposes should strongly consider naming independent trustees and protectors, and should forego the option of funding the trust with any limited partnership, limited liability company, or corporation controlled by the physician. This is particularly true for “self-settled” asset protection trusts in which the settlor is also a trust beneficiary.
Action Step With regard to any self-settled asset protection trusts that the physician has created, the physician should resign as trustee and protector and should liquidate into the trust any underlying entity that the physician controls. Moreover, to the extent that a close friend or family member has been named in any of these capacities, he or she should be asked to resign in favor of an independent third party.
Mistake 7 Relying Too Much on the “Charging Order” Remedy
Family limited partnerships and family limited liability companies are often touted as sufficient to protect a physician’s assets from creditors. The legal basis for such assertions is the “charging order” remedy, which provides that an owner’s creditors cannot take the owner’s interest in the entity, but instead are relegated to accepting distributions from the entity if and when distributions are made. To the extent that a family member or close friend is running the company, distributions are likely to cease until the claim is settled on terms favorable to the debtor.
Few state statutes provide that the charging order is an exclusive remedy, however, thereby making foreclosure of the physician’s interest in the entity a real possibility. Moreover, even where the charging order is an exclusive remedy, most state laws require a “business purpose” for a valid limited partnership or limited liability company to exist, and pure “asset protection” might not be deemed a valid business purpose.
Action Step Physicians who have family limited partnerships or limited liability companies should review them to determine the state law under which they were established. If established under the law of the physician’s residence, the physician should question whether his or her state coincidentally happens to have the best legislation in this regard or whether the physician obtained inadequate legal advice. In the latter case, the physician should consider relocating the entity to a more favorable jurisdiction.
Mistake 8 Owning Real Estate Improperly
Residential real estate is exempted from the claims of most types of creditors if owned by a husband and wife in a form of joint tenancy called a “tenancy by the entireties.” The basis for the protection is that one spouse’s interest in the property should not be subject to creditor claims attributable solely to the acts of the other spouse. This protection can, however, be lost in the event of the death of the nondebtor spouse or in the event of a divorce, or where the creditor is a joint creditor of the husband and of the wife.
Commercial real estate should be owned within a limited liability company (an LLC). Like a corporation, an LLC insulates the owners of the company from liabilities arising out of the company’s business (i.e., the rental of real estate), but is better than a corporation for several reasons. First, unlike a corporation, an ownership interest in an LLC is arguably subject to charging order protection and, therefore, an owner’s creditor are not automatically entitled to control or liquidate the company. Second, unlike a corporation, there are few administrative formalities required of an LLC. Finally, unlike certain types of corporations, LLCs pass through all incidents of taxation to their owners, thereby avoiding significant tax complexity and the potential for a second level of taxation.
Action Step Married physicians should review the deed to any residential real estate to ensure that the deed reflects ownership by the physician and the physician’s spouse as tenants by the entirety. Physicians should ensure that any commercial real estate that they own be transferred to a properly structured LLC; where the commercial real estate is currently owned by a corporation or a partnership, the physician should consider converting the entity to an LLC.
Mistake 9 Underfunding Pension Plans and Individual Retirement Accounts
Pension plans that are “qualified” plans under the Employee Retirement Income Security Act of 1979 (ERISA) have been held by the U.S. Supreme Court to be protected from creditor claims. Individual retirement accounts (IRAs) are protected from creditor claims under the laws of some, but by no means all, states. Moreover, even those states that exempt IRAs from creditor claims may not exempt Roth IRAs, since Roth IRAs are created under a different section of the Internal Revenue Code. Physicians should, therefore, be careful when deciding whether to “roll out” a pension plan into an IRA, since doing so may negate the asset’s innate protection.
Action Step Physicians should ensure that they are fully funding their pension plans, as well as their IRAs, since such assets likely provide protection from creditor claims (as well as a significant financial benefit due to the ability to obtain tax-deferred growth).
Mistake 10 Relying on “I Love You” Wills
When a person dies survived by a spouse, no estate tax will be due. This is because an unlimited deduction exists for property that is left to a surviving spouse whether outright or in trust. Due to the perceived complexity of trusts, an individual who is ill advised will often choose an outright disposition of his or her estate to the spouse, and vice versa. Individuals who are well advised will always choose to use a trust; not for any tax benefit, but because creditors are barred from satisfying their claims against monies left in trust. This is true even though the surviving spouse might have broad access to the trust fund.
This planning is especially important for physicians, since they often employ “poor man’s asset protection planning” by titling assets in the name of their spouse. In such a case, if the spouse should die first, that type of planning is undone, since the assets will come back to the physician unless a trust is used.
Action Step Physicians should review their last will and testament and that of their spouse. If it provides that any portion of the estate passes to the surviving spouse outright, it should be redrafted to include a qualified terminable interest property (QTIP) trust.
Conclusion
Physicians need not remain at risk to the possibility of a devastating malpractice claim. Timely asset protection planning, with the assistance of competent counsel and which is regularly reviewed, can reduce a physician’s risk to a manageable level.
Written by:
Daniel S. Rubin, Esq.
Peer reviewed by:
Ira W. Zlotnick, Esq.