Published 3/1/2008
Howard B. Yeon, MD, JD; James H. Herndon, MD, MBA

Protecting your assets

Common asset protection techniques

Part I of this series (AAOS Now, January 2008) described problems with the medical malpractice tort system that make sole reliance on malpractice insurance an imperfect solution to protecting a physician’s assets. “Asset protection” techniques are used to limit the risk of involuntary loss of property from adverse judgments or other unforeseen events. This article describes common asset protection strategies that may be useful to many orthopaedic surgeons in making their financial plans.

Note: The information contained in this article is intended for general information purposes only and is not legal advice. Individuals who need legal services should contact a duly licensed professional.

Protecting your home
The largest asset most Americans have is the family home. For this reason, many states have a statutory “homestead exemption” that protects a family’s primary residence by limiting a creditor’s ability to seize it. The amount of the exemption varies by state. For example, Florida and Texas have an unlimited exemption; in Massachusetts the exemption is $500,000, and New Jersey has no homestead protection. A homestead exemption protection can be automatic, but in some states (such as Massachusetts), the property owner is required to register for the exemption in the county where the property is located. Registration generally is not difficult and involves little time or cost.

Another method for protecting real estate and other property is known as “Tenancy by the Entirety.” This option is available only to married individuals who live with their spouses and is quite different than “joint tenancy.”

Property held in a Tenancy by the Entirety is owned by a husband and wife as a marital unit rather than as individuals. This means that the property cannot be seized by creditors of the husband or wife individually. In joint tenancy, however, the property interest of each joint tenant is subject to seizure by creditors.

Although property held in a Tenancy by the Entirety could not be claimed as part of a medical liability judgment solely against the physician spouse, this strategy has its limits. Because Tenancy by the Entirety requires a couple to be married, it ends with divorce or the death of a spouse.

Protecting your businesses assets
Orthopaedic surgeons frequently own significant assets including rental property, equipment, and ancillary businesses. In some states, a Tenancy by the Entirety can be used to protect these assets. Gifting significant assets to a spouse may also be a useful asset protection measure in some states. This strategy, however, has significant drawbacks and may result in unintended consequences.

Gifting requires that the physician relinquish complete control over the asset, which means the recipient has sole discretion on how the gift is used, regardless of the physician’s wishes. With today’s high divorce rates, gifting may put the asset in greater jeopardy and significantly affect the distribution of assets in a divorce proceeding.

Another strategy is to put the asset in trust. Although a detailed discussion of trusts and their uses is beyond the scope of this article, physicians should remember this simple principle: a trust must function as an irrevocable gift to be valid for asset protection purposes.

To avoid the risk of a court’s invalidating a gift or trust, physicians must avoid eleventh-hour gifts and any transactions that may be considered fraudulent. If a court finds that the transfer was intended solely to avoid legitimate creditors or impending litigation, it could invalidate the transfer and possibly assess additional penalties.

Incorporating to protect assets
Another technique physicians may use is to incorporate the practice as a limited liability corporation (LLC). An LLC is a corporate structure that provides its members protection from risk arising from the businesses and property held by the LLC. An LLC may also offer some tax benefits.

Property held in an LLC has significant protection from liabilities arising outside of the LLC. Properly drafted articles of organization can limit an outside creditor of an LLC member to only those payments made by the LLC to the member, without turning over any management control to the creditor.

Properly structuring an LLC requires state-specific legal expertise; physicians considering this option should consult an attorney who will organize the necessary forms, ensure their proper filing, and provide an operating agreement tailored to a client’s individual needs. Attorney fees for these services typically range from $2,500 to $5,000.

Insurance and annuity options
Another form of asset protection is annuities and cash value life insurance, which have traditionally been used to provide financial security to spouses or dependents by guaranteeing a large lump sum payment or a reliable income stream. In many states, these investments have some protection from creditors. Where state statutes provide substantial protections, physicians can place significant cash or other liquid assets in these investment vehicles.

Which asset protective measures are most applicable to an individual physician depends on several factors, including age, level of income, inherited wealth, and the types of assets requiring protection. This article has focused on basic strategies that can be implemented with low transactional costs and professional fees, but group practices and larger physician-run businesses (generally with revenues greater than $10 million per year) may take advantage of other strategies.

The value of protecting your assets
Using basic asset protection strategies is no guarantee that assets are fully protected—a disquieting fact—but not a reason for physicians to abandon or overlook them. Asset protection strategies can be effective in a medical liability environment dominated by contingency fee attorneys. These techniques may help discourage frivolous lawsuits by making assets less vulnerable, increasing the cost of litigation, and raising the uncertainty of collecting on assets. The real-world effectiveness of asset protection measures is evident in a state such as Florida, where many physicians cannot afford to carry medical liability insurance due to high premiums.

Asset protection strategies are both useful and underutilized methods of managing the financial risks of medical liability litigation for frivolous or excessive claims. Medical liability insurance provides physicians with certain benefits—such as access to defense attorneys who specialize in this field—and gives insurance companies an incentive to oppose unmeritorious claims, thus minimizing disruptions to a physician’s time and practice.

Political efforts toward medical liability tort reform continue to face stiff challenges from the plaintiffs’ bar; advocating for improved statutory asset protections may be a way for physicians to achieve similar goals.

Howard B. Yeon, MD, JD, is a graduate of Harvard Medical School, Harvard Law School, and the Harvard Combined Orthopaedic Residency Program. James H. Herndon, MD, MBA, is past president of the AAOS and current program director of the Harvard Combined Orthopaedic Residency Program. For a glossary of key terms, see below.

Comments from members on this article are welcome; e-mail them to aaoscomm@aaos.org

Four steps to protecting your assets
Regardless of the asset protection strategies you use, the following guidelines will help ensure that the steps you take will not be undone or overturned by the courts.

Plan ahead
The most effective way to defeat fraudulent-conveyance challenges is to begin or complete transfers to asset-protected entities long before a creditor appears or the risk of a specific lawsuit becomes apparent. Fraudulent-transfer challenges generally fail when the debt or claim is not reasonably foreseeable at the time of the conveyance.

Even if a lawsuit has already been filed, the pretrial period routinely lasts 2 to 3 years, which may provide the physician with the time and opportunity to take advantage of statutory protections such as homestead, life insurance, and annuity exemptions.

Respect formalities
A key consideration in asset protection planning should be that asset protection is a by-product of other legitimate goals encouraged by government, such as protecting spouses and dependents or stimulating business. The primary goal should never be simply to protect assets. For this reason, asset protection entities, especially limited liability corporations and partnerships, are frequently subject to heightened scrutiny. Physicians who employ these techniques should be sure to keep the appropriate records and pay state fees on a timely basis. Additionally, the partnership or corporation should function as an independent entity rather than an alter ego of the physician.

Segregate assets and risks
Significant assets should be separated into individual protective entities for two reasons. First, legal segregation of dangerous assets limits the spread of risks arising from those assets to other properties. An asset is “dangerous” if ownership of it may itself create liability. For example, rental property is a dangerous asset because someone may be injured on the premises; a car is another dangerous asset because an accident may create liability for personal injury and property damages. In contrast, an investment account is a safe asset that should be segregated from dangerous assets.

Second, because most asset protection devices will likely be challenged in court by a determined creditor, the failure of one device should not expose all of the physician’s assets to seizure. Group practices should be structured to prevent the professional liability of one member from reaching other physicians, through a series of professional or limited liability corporations, for example. In the absence of a specified group structure, courts have assumed a general partnership structure—thereby making all members of the group practice jointly and severally liable for the liabilities of any individual partner.

Involve an attorney
Consulting with an attorney who is familiar with state laws and an accountant who has experience with relevant federal and state tax codes is essential. Remember that communications with an attorney, unlike those with an accountant or financial planner, are protected by attorney-client privilege, which could be important if the physician’s motives in establishing an asset protection portfolio are questioned during subsequent litigation.

Note: The information contained in this article is intended for general information purposes only and is not legal advice. Individuals who need legal services should contact a duly licensed professional.

Asset Protection: Definitions of key terms
An obligation to pay a stated sum, usually monthly or annually, to a stated recipient. These payments terminate upon the death of the designated beneficiary.

Community Property: Assets owned in common by husband and wife as a result of its having been acquired during the marriage by means other than an inheritance or a gift to one spouse, each spouse holding a one-half interest in the property.

Corporation: An entity, usually a business, having authority under law to act as a single person; a group of persons established in accordance with legal rules into a legal “person” that has a legal personality distinct from the natural persons who make it up with the purpose of attracting investments and applying invested capital toward a legitimate business or charitable purpose.

Creditor: One to whom a debt is owed; one who gives credit for money or goods.

Debtor: One who owes an obligation to another, especially an obligation to pay money.

Fraudulent conveyance: A transfer of property for little or no consideration, made for the purpose of hindering or delaying a creditor by putting the property beyond the creditor’s reach.

Joint Tenancy: A tenancy with two or more co-owners who take identical interests and where remaining tenants have the right to the whole estate upon the death of one of the joint tenants.

Judgment Creditor: A person having a legal right to enforce execution of a judgment for a specific sum of money.

Judgment Debtor: A person against whom a money judgment has been entered but not yet satisfied.

Lien: A legal right or interest that a creditor has in another’s property. Typically, the creditor does not take possession of the property on which the lien has been obtained.

Partnership: A voluntary association of two or more persons who jointly own and carry on a business for profit.

Secured Creditor: A creditor who has the right, on the debtor’s default, to proceed against collateral and apply it to the payment of the debt.

Tenancy: An interest in real estate.

Tenancy by the Entirety: A common-law estate in which each spouse has an interest in the whole of the property. Tenancy by the entirety is based on the legal fiction that a husband and wife are a single unit.

Trust: The right to the beneficial enjoyment of property to which another person holds the legal title. A property interest held by one person (the trustee) at the request of another (the settler) for the benefit of a third party (the beneficiary).

Unsecured Creditor: A creditor who, upon giving credit, takes no rights against specific property of the debtor. Judgment creditors are generally unsecured creditors.

Source: Black’s Law Dictionary (8th ed. 2004)