Asset Protection: An Introduction to Virginia’s “Domestic Asset Protection Trust” Statute

Virginia is one of nineteen states whose laws provide for the creation of “Domestic Asset Protection Trusts”—irrevocable trusts the assets of which are impervious to creditor attack that allow the “settlor” of the trust (the individual who contributes assets to the trust) to also be a “beneficiary” of the trust. The formal term for a Virginia Domestic Asset Protection Trust is “Qualified Self-Settled Spendthrift Trust” (“QSSST”).    

 

The Bottom Line:  Virginia law permits the creation of QSSSTs, irrevocable trusts the assets of which are impervious to creditor attack that allow the “settlor” of the trust to also be a “beneficiary” of the trust.   As a result of certain limitations and exemptions, QSSSTs work best when the “settlor” is a resident of Virginia, the funding of the QSSST does not render the “settlor” insolvent, the assets contributed to the QSSST are located entirely in Virginia and the primary purpose of the QSSST is to protect assets from creditors rather than a trustee in bankruptcy.

 

By way of brief background, Virginia law recognizes two types of trusts: “revocable” and “irrevocable.”  In general terms, a “revocable” trust may be modified by the “settlor” at any time.  Assets placed in a “revocable” trust are subject to claims by the “settlor’s” creditors.[1]  An “irrevocable” trust is much harder to modify, requiring the consent of the “settlor,” the “trustee” and the “beneficiary” or a court order.  Assets placed in an “irrevocable” trust are also subject to claims by a “settlor’s” creditors EXCEPT to the extent provided in § 64.2-745.1 and § 64.2-745.2 of the Virginia Code which relate to QSSSTs.[2]    

 

Pursuant to § 64.2-745.1 and § 64.2-745.2 of the Virginia Code, assets contributed by a “settlor” to an “irrevocable” trust shall be unavailable to the “settlor’s” creditors if the following criteria are met:

 

·      Inter Vivos.  The “irrevocable” trust must be created while the “settlor” is alive and not pursuant to a testamentary document such as a will or revocable living trust.     

 

·   Multiple Beneficiaries.  There must be at least one beneficiary other than the “settlor.”  Typically, the other beneficiary or beneficiaries are family members to whom the “settlor” would like assets to go to upon the “settlor’s” death.   

 

·  “Independent Qualified Trustee”.   The trustee must be an “independent qualified trustee” whose actions are not subject to direction by the “settlor,” either directly or indirectly through family members or business associates.  Typically, an “independent qualified trustee” will be a Virginia-based trust company.[3] 

 

· Governing Law.  The “irrevocable” trust must state that the laws of the Commonwealth of Virginia shall govern the validity, construction and administration of its terms and provisions.   

 

·  “Spendthrift Provision”.  The “irrevocable” trust must contain a “spendthrift provision” that restrains both “voluntary” and “involuntary” transfers of the interests of the beneficiaries.   

 

·     No Disapproval Right.  The “irrevocable” trust must provide that the “settlor” does not have the right to disapprove distributions from the “irrevocable” trust.  

 

Assets transferred to a properly established QSSST shall be exempt from attack by all future creditors of the “settlor.”[4]  However, the “settlor’s” existing creditors shall have a five-year period from the date of transfer of assets to a QSSST to reach such assets.[5]    

 

Although very powerful asset protection tools, QSSSTs do have some limitations of which potential “settlors” need to be aware: 

 

· Unenforceable “Spendthrift Provisions.”  Under Virginia law, “spendthrift” provisions such as those required to be included in a QSSST are unenforceable in the case of child support obligations,[6] when the “spendthrift” provision operates “to the prejudice of the United States, the Commonwealth [of Virginia] or any county, city or town”[7] and where there is an obligation to reimburse public agencies (such as Medicaid) for public assistance.[8]

 

·   Solvency Requirement.  QSSSTs are expressly subject to Virginia’s “fraudulent transfer” laws[9] which provide for the setting aside of transfers made with “intent to delay, hinder or defraud” creditors.[10]  Accordingly, “settlors” need to ensure that the transfer of assets to a QSSST does not render them insolvent immediately following such transfer.

 

·     Bankruptcy Lookback Period.  The federal Bankruptcy Code contains a provision that permits a bankruptcy trustee to set aside any transfer made to a QSSST within the prior ten years,[11] substantially compromising the usefulness of QSSSTs in the bankruptcy context.

 

·   State Law Conflicts.    “Domestic Asset Protections Trusts” and the statutes governing their creation have been the subject of interesting (and complex) litigation involving the rights of states to regulate people, property and transactions in other states.  Based on the decisions in these cases, it is unclear whether Virginia law in general or, specifically, QSSSTs would be enforceable in connection with people, property or transactions in other states.      

 

Given the foregoing limitations, QSSSTs work best when the “settlor” is a resident of Virginia, the funding of the QSSST does not render the “settlor” insolvent, the assets contributed to the QSSST are located entirely in Virginia and the primary purpose of the QSSST is to protect assets from creditors rather than a trustee in bankruptcy.    

 

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Should you have any questions regarding the contents of this Client Note, please contact Steven G. Thompson by e-mail at sthompson@sgthompsonlaw.com or by telephone at (757) 253-5711 (Office) or (917) 817-2720 (Mobile).

 

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[1]  Va. Code § 64.2-747(A)(1)

 

[2]  Va. Code § 64.2-747(A)(2)

 

[3]  Annual fees for the investment management and trust administration services of such a Virginia-based trust company are subject to negotiation but one fee structure with which we are familiar is as follows: (i) 1.25% on the first $1.0 million; (ii) .95% on the next $4.0 million; (iii) .65% on the next $5.0 million; and (iv) a percentage “to be determined” on amounts in excess of $10.0 million.       

 

[4]  Va. Code § 64.2-747(A)(2)

 

[5]  Va. Code § 64.2-745.1(D)

 

[6]  Va. Code § 64.2-744(B)

 

[7]  Va. Code § 64.2-744(C)

 

[8]  Va. Code § 64.2-745

 

[9]   Va. Code § 64.2-745.1(C)

 

[10]   Va. Code § 55.1-400

 

[11]  11 U.S. Code § 548(e)

Asset Protection: Four Simple (But Effective) Strategies for Virginia Business Owners

As frequent targets of lawsuits, business owners should develop and maintain a plan to protect their personal assets and the assets of their businesses from judgment creditors.  Although insurance in its various forms (automobile, homeowner’s, life, malpractice, D & O and umbrella) continues to be the cornerstone of any asset protection plan, prudent Virginia business owners should consider additional strategies to protect their assets in the event that insurance coverage is denied[i] or is inadequate.   

 

Although asset protection plans can be complex and expensive to establish and maintain, much can be achieved with simple, cost-effective asset protection strategies.  Four such strategies are set forth below. 

 

The Bottom Line:  While maintaining adequate insurance continues to be the cornerstone of any asset protection plan, prudent Virginia business owners should consider additional asset protection strategies in case insurance coverage is denied or is inadequate.  Specifically, Virginia business owners should: if married, hold title to significant assets (such as their home) jointly with their spouse as “tenants by the entirety”; establish a retirement savings plan that affords statutory protection from creditors; utilize Virginia limited liability companies rather than corporations to take advantage of the “charging order” protections afforded Virginia limited liability companies; and transfer “hot” assets to distinct legal entities to isolate them from other business assets.  

 

STRATEGY NUMBER 1: “Tenants by the Entirety”

 

Virginia is one of twenty-six states that recognizes the concept of “tenants by the entirety,” a special form of holding title to property available exclusively to married couples.[ii]  Both real property and personal property may be held as “tenants by the entirety.”[iii]

From the perspective of asset protection, the primary advantage of spouses holding property as “tenants by the entirety” is that property so titled is exempt from the claims of creditors of just one spouse.  Property held by spouses as “tenants by the entirety” is only subject to the claims of creditors of both spouses jointly. 

Notable limitations of holding property as “tenants by the entirety” include: (i) the fact that, in the case of real property, one spouse cannot sever his or her interest in the property[iv]; (ii) protection from creditor attack ends upon the death of one spouse; and (iii) protection from creditor attack ends upon dissolution of the marriage.

 

Despite some limitations, married Virginia business owners should consider holding title to important personal assets (such as their home) jointly with their spouse as “tenants by the entirety.”

 

 

STRATEGY NUMBER 2: Statutorily Protected Retirement Savings Plans

 

Retirement savings plans afford different levels of asset protection depending upon whether or not the retirement savings plan is a “qualified” plan for purposes of the federal Employee Retirement Income Security Act (“ERISA”).  In general terms, ERISA “qualified” plans include employer-sponsored plans such as 401(k) plans and defined benefit plans.  IRAs and other plans that do not cover employees are not ERISA “qualified” plans. 

 

ERISA mandates that the documentation for every ERISA “qualified” plan contain an “anti-alienation” provision which prohibits the transfer of fund assets to any person other than the plan participant, except in limited circumstances such as property division in the case of divorce, attachment for child support and federal tax levies.[v]  This provision has been interpreted as prohibiting all other forms of attachment, garnishment, levy, or other legal or equitable process being brought against a plan participant’s fund assets. 

 

ERISA contains a provision expressly superseding all state law.[vi]  As a result, subject to the limited exceptions enumerated in the immediately preceding paragraph, assets in an ERISA “qualified” plan are exempt from creditor attack.  There is no dollar limit on this exemption.   

 

Asset protection for IRAs and all other retirement plans that are not ERISA “qualified” is governed solely by state law.  The Virginia Code provides that an individual’s interest in a retirement savings plan is protected from creditors to the same extent that an individual’s interest in a retirement savings plan is protected from creditors pursuant to the federal Bankruptcy Act.[vii]  This creditor protection does not apply in the case of child or spousal support claims[viii] and the dollar amount of creditor protection for retirement plans that are not ERISA “qualified” is currently capped at $1,360,800.[ix]

 

Although the complete exemption from creditor attack makes an ERISA “qualified” plan a superior choice from an asset protection perspective, ERISA “qualified” plans are costly to establish and maintain, requiring the involvement of consultants, actuaries and specialist lawyers to ensure strict compliance with ERISA’s byzantine rules and regulations.   

 

Whether ERISA “qualified” or not, a statutorily protected retirement savings plan is an asset protection “must” for every Virginia business.  

 

 

STRATEGY NUMBER 3: Limited Liability Company “Charging Order” Protection

 

In Virginia, shares of stock in a corporation owned by a debtor may be seized by a judgment creditor. If a judgment creditor acquires enough shares to have voting control, the judgment creditor can compel the sale of the corporation’s underlying assets and cause the proceeds to be distributed to the shareholders including the judgment creditor.     

 

This is not the case for membership interests in limited liability companies organized pursuant to the Virginia Limited Liability Company Act (the “VLLCA”).  The VLLCA expressly provides that the “exclusive remedy” of a judgment creditor against the membership interests of a debtor is a “charging order”[x] pursuant to which a judgment creditor will only have the right to “receive any distribution or distributions to which the judgment debtor would otherwise have been entitled in respect of” the debtor’s membership interest.[xi]

 

As a result of the “charging order” provisions of the VLLCA, a debtor may frustrate collection by a judgment creditor by limiting distributions from the limited liability company.  A debtor engaging in this strategy should anticipate an attempt by the judgment creditor to “pierce the corporate veil” by arguing that the limited liability company in question is just the “alter ego” of the debtor and should be disregarded, exposing the assets of the limited liability company to the judgment creditor. 

 

To ensure the integrity of the limited liability company, the debtor should take all steps necessary to maintain the separate existence of the limited liability company. Specific steps to be taken include having an Operating Agreement, observing all corporate formalities required by the Operating Agreement and the VLLCA, maintaining a separate bank account and documenting all transactions between the limited liability company and the debtor.

 

The “charging order” provisions of the VLLCA prohibiting the seizure of limited liability company membership interests and limiting a judgment creditor’s recourse to distributions on membership interests makes a properly organized and maintained limited liability company a particularly effective asset protection vehicle.    

 

 

STRATEGY NUMBER 4: “Hot” Asset Isolation

 

Certain assets present a higher risk of lawsuits.  A recent survey by a noted insurance consultant found that “human assets” pose the greatest litigation risk to small businesses in the United States.  Specifically, actions brought by employees alleging “employment discrimination and wrongful termination” and “wage law violations” are, respectively, the number one and number three most common sources of lawsuits faced by small businesses in the United States.[xii]

 

Tort cases, including claims for personal injury brought by employees, customers, suppliers and others and breach of contract actions account for, respectively, the fourth and fifth highest number of lawsuits brought against small businesses in the United States.  Actions initiated by governmental agencies tasked with the enforcement of environmental protection, workplace safety and other laws and regulations also pose a litigation risk.

 

Assets that present an increased risk of legal liability—so-called “hot” assets—should be isolated from a businesses’ other assets and primary sources of revenue.  For example, rather than having a business entity hire employees directly, a business owner may wish to create a new, separate entity to hire employees and then have the new, separate entity “employer” enter into an “Employee Leasing Agreement” with the existing business entity.  In the event of an employment-related dispute, the appropriate defendant would be the new, separate entity with limited assets.

 

Similarly, an owner of a business with a transportation component could establish a new, separate entity to own all vehicles used in the business, leasing them back to the existing business entity.  In the case of real property, a new, separate entity could be established to own all business-related real property, leasing all such property back to the existing business entity. 

 

It can reasonably be expected that plaintiffs in legal actions involving “hot” assets will attempt to “pierce the corporate veil” by arguing that the new. separate entity holding and/or operating the “hot” asset is just the “alter ego” of the existing business entity and should be disregarded. 

 

To ensure the integrity of any structure involving the isolation of “hot” assets, it is critically important that every effort be made to observe and maintain the distinct existence of each separate, new entity holding and/or operating “hot” assets.  Specific steps to be taken include observing all required corporate formalities, maintaining separate bank accounts, and documenting all transactions between entities. 

 

If properly organized and maintained, a structure involving the isolation of “hot” assets can provide significant asset protection benefits to Virginia business owners.    

 

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Should you have any questions regarding the contents of this Client Note, please contact Steven G. Thompson by e-mail at sthompson@sgthompsonlaw.com or by telephone at (757) 253-5711 (Office) or (917) 817-2720 (Mobile).

 

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[i] In the words of Professor Stanley Schiff (deceased), a scholar whose primary research interest was Civil Procedure: “Insurance companies are in the business of NOT paying.” 

 

[ii] Va. Code § 55.1-136

 

[iii] Va. Code § 55.1-136(A)

 

[iv] Va. Code § 55.1-136(B)

 

[v] 29 U.S.C. § 1056(d)(1)

 

[vi] 29 U.S.C. § 514(a)

 

[vii] Va. Code § 34-34(B)

 

[viii] Va. Code § 34-34(C)

 

[ix] 11 U.S.C. § 522(n)

 

[x] Va. Code § 13.1-1041.1(D)

 

[xi] Va. Code § 13.1-1041.1(A)

 

[xii] Bonner, Marianne. “5 Most Common Lawsuits.” The Balance Small Business, May 8, 2019, https://www.thebalancesmb.com/five-most-common-lawsuits-3886658

"Financially Distressed" Virginia Limited Liability Companies: Understanding the Fiduciary Duties of "Managers"

 

In their oversight of the business and affairs of a Virginia limited liability company, “managers” of “manager-managed” Virginia limited liability companies and members of “member-managed” Virginia limited liability companies functioning as “managers”[i] owe the limited liability company a fiduciary Duty of Care which requires that the managers perform their oversight duties in good faith and in a reasonably prudent manner.

 

Although there is some uncertainty as to whether managers owe any fiduciary duties to creditors, the Supreme Court of Virginia has intimated that a fiduciary duty may be owed to creditors in the case of “self-dealing” transactions between a limited liability company and its managers where the limited liability company is rendered “insolvent.”     

                                                         

The Bottom Line:  To fulfill their fiduciary Duty of Care owed to the limited liability company and to fulfill any fiduciary duty that might be owed to creditors, managers of “financially distressed” Virginia limited liability companies should: rely upon “opinions, reports and statements” of employees and “statutorily sanctioned” experts; ensure that any “self-dealing” transactions between the managers and the limited liability company do not render the limited liability company “insolvent;” and maintain all materials provided by experts and ensure that all consents and minutes of managers’ meetings are detailed and accurate.

 

The Duty of Care, a common law construct, requires that managers perform their oversight duties in good faith and in a reasonably prudent manner.  The Virginia Limited Liability Company Act (VLLCA) sets forth a threshold test for the Duty of Care, stating that “a manager shall discharge his or its duties as a manager in accordance with the manager’s good faith business judgment of the best interests of the limited liability company.”[ii] 

 

The VLLCA expressly provides that, in making business judgments, a manager may rely upon “opinions, reports and statements” of employees of the limited liability company, legal counsel and public accountants unless the manager has knowledge or information that makes such reliance unwarranted.[iii]

 

While directors and officers of corporations organized pursuant to the Virginia Stock Corporation Act owe the corporation and its shareholders a Duty of Loyalty which prohibits directors and officers from benefiting personally at the expense of the corporation (through, for example, “self-dealing” transactions between the director or officer and the corporation or the usurpation by a director or officer of “business opportunities” that may have benefited the corporation), it would appear that managers of limited liability companies organized pursuant to the VLLCA do not owe a similar Duty of Loyalty to the limited liability company that they serve.[iv]

 

In response, many attorneys will insert provisions into the Operating Agreement between members of a Virginia limited liability company requiring that all “self-dealing” transactions between a manager and the limited liability company be approved by a majority of the “disinterested members” of the limited liability company and further requiring that all “business opportunities” that might benefit the limited liability company be offered first to the limited liability company and/or be “disclaimed” by a majority of the “disinterested members.”     

 

Proceedings against managers for purported breaches of the Duty of Care may be brought by the members on behalf of, and in the name of, the limited liability company.  The provisions of the VLLCA governing so called “derivative proceedings” explicitly limit the right to initiate such proceedings to “members.”[v] 

 

Although creditors of insolvent Virginia limited liability companies do not have the right to initiate “derivative proceedings,” the Supreme Court of Virginia intimated in its 2009 decision in Luria v. Board of Directors of Westbriar Condominium Owners Association that creditors of Virginia limited liability companies may enjoy a direct right of action against managers for breach of fiduciary duty where the managers have approved distributions of funds from a limited liability company to themselves, rendering the limited liability company “insolvent.”[vi]

 

How should managers of “financially distressed” Virginia limited liability companies proceed to ensure that they fulfill their fiduciary Duty of Care owed to the limited liability company and minimize the risk of creditors bringing an action for breach of any fiduciary duty that may be owed to them?  The first step for such managers should be the engagement of legal counsel.

 

With the assistance of legal counsel, the managers should then undertake a comprehensive review of: the VLLCA; the limited liability company’s Articles of Organization, Operating Agreement and the consents and resolutions of the members; any “stand-alone” Indemnification Agreements; and any applicable “D&O” insurance policies, in each case with the goal of understanding the scope of potential liability for such managers and the circumstances under which such managers may have a right of indemnification and/or expense advancement. If necessary, additional “D&O” insurance coverage should be arranged, provisions of applicable documents pertaining to indemnification and/or expense advancement should be revised and “stand-alone” Indemnification Agreements should be entered into. 

 

Although the precise course of conduct recommended to be taken by the managers of a “financially distressed” Virginia limited liability company will depend upon the specific circumstances of each such limited liability company, as a general matter, such managers should:

 

·        Rely Upon “Statutorily Sanctioned” Experts.  Rely upon “opinions, reports and statements” of employees of the limited liability company, legal counsel, public accountants and other persons specified by the VLLCA.

 

·        Thoroughly Scrutinize “Self-Dealing” Transactions.  Exercise extreme care with, and thoroughly scrutinize, all “self-dealing” transactions with the limited liability company.  Consult with employees of the limited liability company and retain public accountants and/or appraisers to ensure that no distributions from the limited liability company to the managers render the limited liability company “insolvent.”    

 

·        Maintain Detailed Records.  Maintain copies of all “opinions, reports and statements” of employees, legal counsel, public accountants, appraisers and other experts relied upon and, where the limited liability company has more than one manager, maintain detailed consents and minutes of all meetings of the managers including complete and accurate summaries of all matters considered.   

 

Faithful adherence to the foregoing should significantly enhance the position of the managers of “financially distressed” Virginia limited liability companies in arguing that such managers have fulfilled their fiduciary Duty of Care owed to the limited liability company and have fulfilled any fiduciary duty that might be owed to creditors.   

 

 

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Should you have any questions regarding the contents of this Client Note, please contact Steven G. Thompson by e-mail at sthompson@sgthompsonlaw.com or by telephone at (757) 253-5711 (Office) or (917) 817-2720 (Mobile).

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[i] Va. Code § 13.1-1024.1(D)

 

[ii] Va. Code § 13.1-1024.1(A)

 

[iii] Va. Code § 13.1-1024.1(B)

 

[iv] In re Virginia Broadband, LLC, 521 B.R. 539 (Bankr. W.D. Va. 2014)

 

[v] Va. Code § 13.1-1043

 

[vi] 672 S. E. 2d 837 (Va. 2009)