Asset Protection in Texas – With the Texas Series LLC at Its Core
Keys to Asset Protection
Principles of Asset Protection
advance, preemptive planning to deter lawsuits and creditor action
creating legal barriers to personal liability
separating assets from activities (contracts, leases, etc.)
maximizing anonymity in the public records
utilizing homestead and income protections afforded by the Texas Constitution and Property Code
asset spreading/compartmentalization
exhausting your opponent’s resolve and depleting his resources
Recommended Tools of Asset Protection for Texas
LLC to hold assets (Texas Series LLC or Nevada Series LLC)
shell management company (a separate, pass-through Texas entity)
anonymous land trust
assumed name certificates (DBA’s)
attorney-client privilege
more exotic devices, including offshore entities, are seldom necessary
Introduction
Texas has an established history of protecting debtors. This is a summary of the how the Texas Property Code, the Texas Business Organizations Code, and the Texas Constitution make it possible for individuals and businesses to shield income and assets (particularly equity in real property). Together, these are among the most favorable asset protection laws in the United States. Our core recommended structure involves two LLCs – one to hold assets and the other to manage them. The “holding company” may either be a Texas Series LLC or a Nevada Series LLC. When properly structured, an asset protection strategy will deter the filing and pursuit of lawsuits and also make it difficult for a creditor to collect on a judgment.
Homestead Protections for Individuals in Texas
Texas offers unique homestead protections for individuals that should be integrated into any asset protection plan. These protections are contained in Art. XVI, Sec. 50 of the Texas Constitution and in Chapters 41 and 42 of the Texas Property Code. They apply to both income and assets, and they have long made Texas a haven for debtors. In other states, a judgment can be put you on the street, but not in Texas. If a lawsuit is anticipated, or if a judgment creditor is expected to attempt collection, then it is wise to review and maximize these protections.
Sec. 28 of the Constitution prohibits garnishment of wages, which protects the income of a person who receives a salary or wages. As to assets, the homestead of a family or single adult is protected from forced sale for purposes of paying debts and judgments except in cases of purchase money, ad valorem taxes, owelty of partition (divorce), home improvement loans, home equity loans, and reverse mortgages. No matter how much the home is worth, an ordinary judgment creditor cannot force its sale. An attempt by such a creditor to place or enforce a lien against the homestead can be defeated using the procedure in Texas Property Code Sec. 53.160. See our companion article, Lien Removal in Texas.
The Texas Property Code goes into more detail, specifically listing the amount and types of other exempt property, including a vehicle for each licensed driver in the household; home furnishings; and the debtor’s IRA or 401(k). In keeping with Texas’ frontier spirit, you can even keep two horses if you wish.
The Property Code further provides in Sec. 41.001(5)(c) that “The homestead claimant’s proceeds of a sale of a homestead are not subject to seizure for a creditor’s claim for six months after the date of sale.” This expressly permits homestead protections to be rolled over from one homestead to the next, notwithstanding the preference on the part of title companies to collect judgments upon sale of the homestead. Taylor v. Mosty Bros. Nursery, Inc., 777 S.W.2d 568, 570 (Tex.App. – San Antonio 1989, no writ).
The Texas Constitution and the Property Code provide an excellent opportunity for individuals (not corporations, LLC’s, or partnerships) to engage in asset protection. Essentially, this means converting non-exempt assets (cash, for instance, or investment real estate) into exempt assets. As an example, one might consider paying off the homestead or the primary vehicles. The conversion process can be tricky. It is best accomplished with the guidance of an attorney knowledgeable in this field. Our companion article, Homestead Protections in Texas, offers more detail on this subject.
Going Beyond the Statutory Homestead Protections: Forming an LLC
Clearly, if one owns more than one’s home or has investment property, the statutory protections are not enough. The next level of protection is achieved by forming a Texas Series LLC which accomplishes two critical goals: it creates a liability shield for the protection of member-owners; and it creates individual “series” or compartments which, when properly implemented, insulate each series from the liabilities associated with the other series (details below). The benefits? Simplicity and economy.
All LLC documents – beginning with the Certificate of Formation (Texas) or Articles of Organization (Nevada) and continuing with the company agreement – should be drafted with an eye toward asset protection. It is critical that company documents discourage creditors from attempting to seek control of any member’s interest. Remember: part of asset protection is deterrence. For instance, the company agreement should provide that any creditor succeeding to a membership interest by means of assignment, collection action, or execution on a judgment will not be able to vote that interest; not be able to serve as a manager or officer; not be able to direct that assets of the company be sold; and not be able to alter or reduce the company’s ability to do business. Who would want to spend time and money suing a company when they know in advance that even victory would be worthless? For more detail, read our companion article The Texas Series LLC.
Doing Business as an LLC
One of the first goals is transfer investment property into the company. In the case of real estate, this is done by means of a general or special warranty deed. Are deed of trust due-on-sale clauses a problem? Almost never, in spite of what your lender may tell you. Lenders have their plates full with monetary defaults and generally do not accelerate a performing a loan if the property is transferred to the borrower’s personal company. In fact, this author has never seen that happen. See our companion article, Due-on-Sale Clauses in Texas.
Tenants, creditors, vendors, and the public should be instructed that they are doing business with the LLC. They should invoice the LLC and make payments to the LLC. When a W-9 is required, it should contain the LLC’s tax identification number. There is an old rule of thumb that people tend to sue the person or entity they write checks to… so ideally, your personal name, address, or social security number should never appear anywhere on any paperwork or documents executed with third parties.
Once a company is formed, it must be maintained. There are minimum actions and formalities that must be observed in order to order to preserve the LLC’s liability barrier. These include proper organizational documents; issuing membership shares; holding annual meetings; obtaining a TIN number and filing tax returns; having a company bank account; and the like. Failure to do this sort of routine maintenance is a common mistake. It can make your company vulnerable to a “piercing the veil” suit and therefore be fatal to your asset protection plan.
Pre-Suit Asset Protection Strategies
Asset protection strategies fall into two groups – strategies implemented in advance of collection action and suit by a creditor; and strategies that can be put into effect afterward. It is by far preferable to plan ahead and be prepared, since the range of pre-suit alternatives is much greater. After suit is filed, depending on the circumstances, options are reduced by laws relating to “fraudulent transfers” – moving assets around to defeat the legitimate claims of creditors – and courts are on the lookout for these. After suit is filed, the Texas defendant may be limited to converting assets to homestead-exempt items (one’s primary residence, cars, etc.), moving depository accounts into cash and money orders (USPS money orders are recommended), and pre-paying certain key items (taxes, attorney’s fees, and the like which are very unlikely to be questioned as fraudulent).
Post-Suit Strategies
Once litigation is commenced, your actions will be subject to close scrutiny by the plaintiff and his attorney. Obvious attempts to maneuver and manipulate your assets will likely be detected. This is so because the discovery process (including interrogatories and requests for production of documents) is available to creditors to inquire into your transactions, and the scope of this process can be wide indeed. Failure to fully respond is grounds for contempt – although “fully respond” should never be interpreted as supplying more information than is absolutely necessary. Creditors may do research on you – particularly if the debt is very substantial – but most of the time they have only the information that you give them in pre and post-judgment discovery.
The most pernicious discovery occurs post-judgment, since creditors can then go beyond the facts of the case and compel disclosure of sources of income and the location of assets – even assets that are legally exempt and cannot be touched. This can be a headache since creditors may nonetheless attempt to go after the exempt assets, forcing a debtor to seek protection from the court. You can see why it is important that your attorney make a creditor fight vigorously for every bit of information that is provided in responses to discovery.
The usefulness of post-collection asset protection strategies are also limited by fraudulent transfer rules that allow courts to reach back up to two years (these rules apply in many foreign jurisdictions as well). Fraudulent transfers are generally indicated by so-called “badges of fraud,” including transfers to a family member; whether or not suit was threatened before it was filed; whether the transfer was of substantially all of the person’s assets; whether assets have been removed, undisclosed, or concealed; whether there was equivalent consideration for the transfer; and whether or not, after the transfer, the transferor became insolvent as a result (e.g., made his cash disappear all at once).
Recommended Two-Company Structure
An investor should consider setting up a management or operating company that is unaffiliated with the asset-holding LLC and which will serve as the front line of defense against tenants, creditors, and plaintiff’s attorneys. This entity should be an LLC (a traditional LLC or a corporation will serve the purpose) that is basically a shell or pass-through entity without assets. Many people already have an LLC or corporation and wonder what to do with it now that we have a series LLC available in Texas. The management company is an excellent option.
The management company should own no substantial amount of real or personal property – it should lease everything, including vehicles. It should also hire and pay employees. The public should do business with the management company and never even be aware of true underlying ownership or the location of assets – which are of course held in the series LLC.
Why this structure? In addition to its management duties, the role of the management company is to serve as a target that is deliberately put “out there” to draw fire away from the owners and their assets. If anyone sues and obtains a judgment against the management company, it will be uncollectible.
What is to keep the plaintiff from suing the holding company? The legal doctrine of “privity.” Since the holding company (the Texas Series LLC) has signed no leases or contracts or done any direct business with anyone, no legal action can be successfully maintained against it.
Levels of Asset Protection
LEVEL 1:Basic Asset Protection for Investors (the Texas Series LLC)
(1) form a Texas Series LLC to own and manage investment properties and businesses in separate “series” or compartments, establishing a barrier against personal liability in the event of lawsuits;
(2) file an assumed name certificate (DBA) for this Texas company and utilize the DBA in business dealings;
(3) establish a checking account for the company under its DBA’s and have
(4) checks, letterhead, cards, etc. printed that way;
(5) transfer properties held in personal names into individual series of the holding company (Series A, Series B, etc.) using properly-worded general warranty deeds;
(6) separate homestead and other creditor-exempt items from investments; reduce debt on these items in order to maximize protections afforded by the Property Code and Texas Constitution;
(7) form a living trust for the homestead to avoid probate, transfer the home into it, and then execute a “pour over” will to transfer other assets to the trust upon your death, thereby eliminating legal hassles for your heirs.
LEVEL 2: Two-Company Structure (the “Texas Two Step”)
(1) establish a Texas Series LLC to own and hold (but not manage) investment properties and businesses (the “holding company”);
(2) form a separate Texas LLC to act as a “shell” management company (which owns no significant assets) for dealings with tenants, vendors, contractors, and the public – income passes through to the holding company as consulting fees;
(3) file assumed name certificates (DBA’s) for the holding company and for the management company and utilize these names;
(4) establish checking accounts for the each company under their respective DBA’s and have checks, letterhead, cards, etc. printed that way;
(5) transfer properties held in personal names into individual series of the holding company (Series A, Series B, etc.) using properly-worded general warranty deeds;
(6) separate homestead and other creditor-exempt items from investments; reduce debt on these items in order to maximize protections afforded by the Property Code and Texas Constitution;
(7) form a living trust for the homestead to avoid probate, transfer the home into it, and then execute a “pour over” will to transfer other assets to the trust upon your death, thereby eliminating legal hassles for your heirs.
LEVEL 3: Texas-Nevada Combination (the “Two-State Solution”)
(1) establish a Nevada Series LLC to own and hold (but not manage) investment properties and businesses (the “holding company”) achieving a measure of distance and anonymity from Texas plaintiffs;
(2) form a separate Texas LLC to act as a “shell” management company (owning no significant assets) for dealings in Texas with tenants, vendors, contractors, and the public – income passes through to the Nevada holding company as consulting fees;
(3) file assumed name certificates (DBA’s) for the holding company and for the management company and utilize these names;
(4) establish checking accounts for the each company under their respective DBA’s and have checks, letterhead, cards, etc. printed that way;
(5) transfer properties held in personal names into individual series of the Nevada holding company (Series A, Series B, etc.) using properly-worded general warranty deeds;
(6) separate homestead and other creditor-exempt items from investments; reduce debt on these items in order to maximize protections afforded by the Property Code and Texas Constitution;
(7) form a living trust for the homestead to avoid probate, transfer the home into it, and then execute a “pour over” will to transfer other assets to the trust upon your death, thereby eliminating legal hassles for your heirs.
Role of Trusts
Trusts come in all shapes and sizes – do not be fooled, there is no “standard form” that is good for all purposes in all states.
An appropriately drafted trust can be useful because it can provide:
(1) anonymity, since underlying ownership need not be revealed in the deed of property into the trust;
(2) ease of transferability, since beneficial interests can be privately assigned without necessity for recording a deed or other instrument; and
(3) probate avoidance, since the beneficiaries acquire their interest automatically without probate proceedings or the intervention of a court.
Note, however, that a trust does not have a liability barrier as does an LLC – so trusts standing alone are insufficient for asset protection. Trusts are merely one tool in the toolbox.
How do an LLC and trust work together? Once the LLC is established, it can choose to transfer its investment properties to an “anonymity trust” which indicates nothing of record about real underlying ownership. Example: title to property is held in the name of “Main Street Trust.” It is a myth that one must even name the trustee in the deed, since county clerks gladly record such deeds. Anyone seeking to know who the principals are and what assets they may have has their work cut out for them.
Note that under Texas law one must actually create a written trust agreement for this strategy to work. Also, a title company will want to see a copy of the trust before transferring title out of the trust to a new buyer. Additionally, courts are likely to ignore the existence of an alleged trust that has no written agreement behind it.
Apart from investments trusts, there are also living trusts (or inter vivos trusts) which are a valuable probate-avoidance device for the homestead and should be considered by everyone as part of the overall asset protection/probate avoidance structure. Anyone who has probated an estate is familiar with the procedural nightmare that occurs when dealing with attorneys and judges who will happily reduce the estate “castle” to rubble.
Do not be deceived into purchasing so-called standard trusts off the internet. Texas has very particular trust laws – the Texas Trust Act is part of the Property Code. Consult a Texas attorney experienced in trusts to be certain that your trust will not only be valid in Texas but will accomplish what you want it to do.
Anonymity
Anonymity is an important aspect of asset protection. An LLC can provide a certain measure of anonymity depending on the amount of information that is furnished to the Secretary of State when the initial documents (the “Certificate of Formation”) is filed and when the annual public information report is filed. Additional anonymity tools include use of land trusts, which should not disclose any personal names in the public records (and that includes the name of the trustee); use of assumed name certificates or “DBA’s;” and use of an attorney as registered agent or trustee who has the power to invoke the attorney-client privilege. The goal should be to achieve maximum anonymity combined with the liability barrier created by the series LLC. All of this creates legal, practical, and psychological obstacles to a potential plaintiff.
A word about the company’s registered address: some people go to the trouble of forming an LLC but then list their home as the registered address. This hardly enhances anonymity, nor does it prevent a constable from knocking at your door at 5:30 a.m. to serve a lawsuit. A physical address (not a box) is required, since the constable cannot serve a PO Box. Either use your office address, if you have a physical office; use your attorney as registered agent of the company ($250 annual charge); or go to a UPS store and obtain a box with a real street address and suite number (which cannot contain the words PMB, POB, Box, or a double suite number, which is an obvious indication of a box). Tenants, vendors, contractors, and the public at large should never have your homestead address.
The Role of Insurance
It is often asked if obtaining liability insurance alone is sufficient. The answer is a resounding “No.” Insurance is a passive measure. It is possible to be far more proactive. All legal experts recommend a sensible mix of insurance and asset protection. The principal reason is that insurance companies are in the business of collecting premiums and denying claims – thus every effort will be made by the company to exclude or avoid coverage in your case (particularly if the plaintiff alleges fraud, which is never covered). It may then become necessary to sue the insurance company.
Also, even if the insurer concedes coverage, extravagant claims made in lawsuits may (and often do) exceed available limits. Moreover, the existence of a sizable policy and umbrella may in and of itself encourage a lawsuit because it will be perceived by the plaintiff’s attorney as a tempting target! Nonetheless, having adequate insurance is a necessary evil.
Bankruptcy
Bankruptcy – Chapter 7 in particular – is the “nuclear” option in asset protection. Even so, rules against fraudulent transfers (called “preferences” in the Bankruptcy Code) apply in this area as well. The court can reach back up to a year. Also, false information in a bankruptcy petition may be investigated by the FBI; and of course bankruptcy does not discharge taxes (although the IRS may be more likely to work with you on a payment plan), child support obligations, student loans, and any items that a debtor fails to list on the petition.
The Bankruptcy Code allows a debtor to choose between the federal exemptions (i.e., list of exempt assets) or the state ones – and in Texas we always choose the state exemptions since they are so favorable. These are summarized later in this article.
By and large, filing bankruptcy is an admission that your previous asset protection strategies have failed. The bankruptcy trustee and the court assume control of your life. It is a last resort. This office does not handle bankruptcy – we recommend obtaining a board-certified lawyer in the field.
Lifestyle Considerations
Your lifestyle should be consistent with maintaining an effective asset protection strategy. In addition to all the other suggestions contained in this article relating to anonymity, creating a liability shield, maximizing protections under the Texas homestead laws, and the like, you should:
(1) avoid conspicuous consumption – living a notch below your means (at least outwardly) makes a less appealing target for plaintiffs and their attorneys;
(2) avoid personally guaranteeing any business debt or co-signing on others’ notes;
(3) carry health and term life insurance on yourself as well as “key man” term life insurance on your business partners;
(4) avoid all forms of debt that do not result in an income stream – this includes nearly all consumer debt which, after the thrill of that new Porsche dissipates, merely serves to keep you up at night;
(5) reduce all business arrangements – including those with family and friends (especially those with family and friends) – to a written agreement that contains an “exit strategy,” specifically including buy-sell provisions;
(6) diversify assets and investments;
(7) put approximately 10-15% of your assets into gold, cash, and other “doomsday” assets – the worst case scenario could actually happen. Honor the second amendment.
Other Asset Protection Devices
There are many other asset protection devices and entities that are beyond the scope of this introductory article. Included among them are:
Family Limited Partnerships There is much discussion about family limited partnerships (FLP’s) in states other than Texas. For Texas asset protection, this author prefers LLC’s and/or trusts. Texas FLP’s (like LLC’s) must be filed with the state and pertinent ownership information is revealed; also an in-state registered agent must be designated to receive service of process if the partnership is sued. So why not just form an LLC (especially a series LLC if assets are in real estate) and then move title to assets into a land trust? The result is superior liability protection and anonymity. Another drawback of the FLP is its concept of a “friendly lien” on the homestead, which is not workable in Texas.
Limited Partnerships with an LLC General Partner. These vehicles are more complex and expensive, usually used in larger commercial transactions, and are beyond the scope of these comments.
LegalZoom-Style Internet Services
Internet services allegedly provide “self-help legal services at your specific direction.” This is internet huckstering. All LLC’s are not created equal. Your goal should not be to merely “set up an LLC.” Your goal should be to establish a Texas Series LLC that includes sophisticated asset protection provisions beginning with the very first document that is filed. At best, internet services provide a “plain vanilla” company with no bells or whistles; there is no focused effort to maximize asset protection.
Here is what such services do not provide:
NO comprehensive advice on how to structure your business and investments so as to achieve an overall asset protection plan
NO attorney to serve as organizer, initial member, and/or registered agent in order to maximize your anonymity
NO sophisticated company agreement that deters creditors from taking control of your company
NO advice on how to move property into the LLC after it is formed
NO advice on how to use the LLC in conjunction with a land trust
NO advice on how to set up and arrange the LLC’s finances, including setting up LLC accounts, injecting capital, and/or loaning money to the LLC
NO advice on how to maintain the LLC liability barrier to prevent a plaintiff from “piercing the corporate veil”
NO free follow-up questions after the LLC is formed
Additionally, the documents provided by such services are simplistic and barely above the level of junk. This office spends a fair percentage of its time cleaning up the inadequacies in companies formed this way.
Conclusion: Asset Protection in the Real World
Absolute, true “bulletproof” asset protection is probably not achievable in the real world – even in Texas – in spite of claims made by internet and seminar “gurus” who have never spent time in a real court of law in front of a real judge. However, one can come close this ideal by using the correct structure. Asset protection is ultimately about preparation and advance planning that have the effect of deterring lawsuits and exhausting your opponent’s determination and resources. Deterrence has real value considering the number of frivolous and contingency-fee lawsuits that are filed each year in the U.S. If you can make it difficult to find your assets and make it unacceptably expensive and time-consuming for a plaintiff and his attorney to reach them, then your asset protection plan has done its job. Every dollar of cost that is imposed on a potential plaintiff or his attorney makes your income and assets incrementally more secure and makes it less likely that you will have to endure the living nightmare of a lawsuit and execution on a judgment.