One of the most important, yet least understood, aspects of asset protection is that it is a means of psychologically intimidating creditors, or would-be creditors. This intimidation has a two-fold effect:
- It often prevents litigation or aggressive collection against debts.
- If litigation ensues, an effective asset protection program will lead the plaintiff to settle with the defendant on terms that are very favorable to the defendant.
Firstly, asset protection often discourages litigation because a would-be litigant will either not find assets to collect (due to financial privacy measures), or he will see that these assets are effectively shielded. If a debtor appears to have little or no assets, then he will not appear to be a “fat cat” that the creditor can collect from if he sues and wins.
Thus, the debtor will likely be deemed “uncollectible” and not worth going after. If however the creditor locates the debtor’s assets, but sees that they’re held in an effective asset protection structure, then although the creditor may still be able to attach these assets, attempting to pierce the structure will be a very expensive and lengthy legal process. Even worse, the creditor will be very uncertain as to whether such efforts will be successful, which means the creditor will end up significantly poorer and worse-off in the likely event his collection attempts fail.
If litigation nonetheless commences, the plaintiff is likely to settle the case (prior post-judgment) for pennies on the dollar relative to the claimed debt. This is because, as mentioned previously, an attempt to forcefully collect the assets of a protected debtor will require a great deal of time, money, and effort, and even then the plaintiff may be unlikely to succeed. These factors will strongly influence the plaintiff towards taking an easy, albeit much smaller, settlement as opposed to fighting a long, costly, and potentially unsuccessful battle.
It is in this light that the value of liability insurance becomes clear: instead of fighting an uphill battle to get the debtor’s assets, the plaintiff will most likely just settle for the debtor’s insurance payout, thus allowing the debtor to escape the crisis relatively unscathed.
Interestingly enough, asset protection often works in a similar manner, but for different reasons, when the hostile creditor happens to be the IRS. Not only has this been the author’s experience, but this fact is confirmed by Maureen O’Dwyer, a grade 13 international examiner for the IRS, when she testified before the well-known Senate Committee Hearings on alleged IRS abuse on April 30th, 1998. The assertion that asset protection discourages IRS collection activity becomes abundantly clear from reading excerpts of her testimony, as follows:
“A[n IRS] manager who has an aging [tax collection or audit] case in his group will not receive an evaluation that will merit him a monetary award and help him carve out a career path within the Service … the technically weaker managers consistently ordered cases closed, no change, if they begin to age …
In large case CEP it is standard practice to drop an issue that will delay the closing of a case. Large dollar amounts on major taxpayers are routinely zeroed out in this manner. It matters not that there appears to be an egregious tax abuse, nor that the complexity of the issue requires time to develop. What matters is the manager receives a performance award for having met the case closing deadline timely…
… The cases that begin to age ordinarily have outstanding issues which have gone unresolved due to the complexity of the issues involved and the difficulty of their development, or due to the deliberate procrastination and lack of cooperation on the part of the taxpayer. Therefore it can be seen that the cases which are closed, no change, under this statistically driven cosmetic deadline are usually large and wealthy taxpayers who have the means to consistently contend and dispute with the IRS.” [Emphasis is mine.]
Keep in mind that, due to fraudulent transfer law, one must be extremely careful in implementing an asset protection program (and oftentimes such an attempt should not be made at all) once a tax debt has been assessed, or a creditor’s claim arises. However, asset protection done in advance of incurring a tax liability or debt is an effective psychological deterrent.