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ASSET SEQUESTRATION

By: Marjorie McMahon Obod, Esquire, Elizabeth L. Bennett, Esquire

I. INTRODUCTION

In the context of a divorce, asset protection can better be referred to as asset sequestration. In the normal business context, asset protection can take both legal and illegal forms. It includes such diverse activities as failing to disclose income, hiding cash, and the formation of off-shore trusts for individuals, such as doctors who may have a large exposure to tort liability, or businessmen who may fear attachment of assets by creditors. In the divorce context, the same activities are accomplished for the purpose of removing assets from the jurisdiction of the court or keeping them out of the marital estate.

This practice is, of course, contrary to one paramount objective of the Pennsylvania Divorce Code of 1980, which is to [e]ffectuate economic justice between parties who are divorced or separated and grant or withhold alimony according to the actual need and ability to pay of the parties and insure a fair and just determination and settlement of their property rights.  23Pa.C.S. '3102(a)(b).

II. ETHICAL CONSIDERATIONS.

The practitioner should be aware that there are serious ethical considerations involved in any asset protection plan. Attorneys and accountants may not participate in any plan to commit tax fraud.

III. ETHICS AND PUBLIC POLICY QUESTIONS FOR LAWYERS

Clients engaging in asset sequestration with the hope of hiding assets from creditors may be unsuccessful both at home and in the offshore jurisdiction. When a client intends to hinder existing creditors, asset sequestration is not only controversial, but may lead to adverse civil and criminal exposure for everyone involved. Even if a foreign jurisdiction prevents the creditor from gaining access to the assets in a foreign trust account, a United States court may hold the settlor in contempt of court for failure to release the assets.

The Restatement (Second) of Trust states that "(a) trust or a provision in the terms of a trust is invalid if the enforcement of the trust or provision would be against public policy, even though its performance does not involve the commission of a criminal or tortious act by the trustee."

It is against public policy to create self-settled spendthrift trusts, which permit a settlor to tie up his own property in order to prevent it from being reached by creditors. Although self-settled spendthrift trusts are valid in foreign jurisdictions, they violate United States public policy.

For purposes of this outline, it has been assumed that the issue of asset sequestration arises in the process of divorce planning, rather than in the discovery context. Many of the asset sequestration devices discussed below are also utilized for tax evasion purposes. Practitioners should not enter into asset sequestration planning unless they are convinced of the legitimacy of or the purpose served by the asset sequestration plan, and they are fully cognizant of the ethical considerations relevant to such a strategy, as well as the validity and justice of such a strategy, especially as it may relate to the future well being of any children. No lawyer or accountant is required to continue representation if a client requests action which violates their sense of conscience and does not, otherwise, conflict, if they are a lawyer, with their obligation to continue representation of a client in the context of a trial. See Appendix "A".

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IV. DOWN AND DIRTY STRATEGIES WHICH VIOLATE THE LAW.

1. Cash Sequestration.

The most obvious and most frequently used method for diverting marital income and assets is hiding cash. Cash can be hidden in safety deposit boxes, tennis ball cans or any type of container. Cash may be obtained from kickbacks, purchases of supplies for a business, over-the-counter transactions which are not recorded, and as payoffs for contracts or other activities.

A. Discovering Cash. The following strategies may be utilized if it is believed cash is being sequestered:

(a) Hire a private detective to observe cash handling and retail practices.

(b) Subpoena banks to identify extraordinary deposits, safety deposit boxes, or additional accounts in the name of the opposing party individually or held jointly with third parties.

(c) Obtain injunctions for the opening and inventory of safety deposit boxes or other possible cash depositories.

(d) Hire an accountant to estimate cash expenditures for the purpose of proving the existence of available cash to fund those activities, i.e.: "income reconstruction".

B. Risk. A court has the right and may even feel obligated to report to the Internal Revenue Service any tax fraud revealed in the context of a divorce case. If joint returns have been filed and the requirement for the innocent spouse exemption are not met, both parties may be liable.

 

2. Transfers to Relatives or Others.

Often stocks, securities, or real estate will be transferred to a relative with an undocumented intent that the asset be returned to the opposing party after the divorce is concluded.

A. Discovering Transfers to Relatives.

(a) Obtain or subpoena all bank and securities records and look for withdrawals and transfers.

(b) Perform title searches in the name of the opposing party, critical relatives, paramours, and associates.

B. Defeating Fraudulent Transfer. The law permits the creation of a constructive trust. The constructive trustee may be joined as a third party, and the relevant asset may be returned to the marital estate if adequate proof of fraudulent intent to defraud the transferor's spouse is established. See Robbins v. Kristofic and Kline, 434 Pa. Super. 392, 643 A.2d 1079 (1994), appeal denied, 539 Pa. 654, 651 A.2d 541 (1994); see also Creeks v. Creeks, 422 Pa. Super. 432, 619 A.2d 754 (1993).

 

V. UNIFORM FRAUDULENT TRANSFER ACT ("UFTA")

Adopted by Pa. legislature on 12/3/93

 

1. Intent is the Defining Factor in Fraudulent Conveyance Analysis:

Factors to consider in determining intent:

 • Was the transfer or obligation to an insider?

 • Did the debtor retain possession or control of the transferred property after the conveyance?

 • Was the transfer or obligation disclosed or concealed?

 • Was the debtor sued or threatened with suit before the conveyance?

 • Was the debtor insolvent at the time of conveyance?

 

2. Constructive Fraud

Absent a showing that a transfer was actually intended to defraud, hinder, or delay his creditors, a creditor may set aside a transaction under the doctrine of "constructive fraud." The UFTA classifies as constructive fraud schemes by which an insolvent transfer or a completed transaction is made "without receiving a reasonably equivalent value in exchange for the transfer."

3. Statute of Limitations

A. The statute of limitations for intentional fraudulent transfers is the later of 4 years from the transfer or 1 year from reasonable discovery, thereof to challenge intentional fraudulent transfers. The statute of limitation for constructive fraud is 4 years from the transfer.

 

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VI. COMMON LEGAL METHODS FOR DIVERTING FUNDS.

1. Swiss Bank Accounts.

The United States has recently proposed a tax treatment agreement with Switzerland, however, it is of little use in discovering money in Swiss Bank Accounts. One must know the name of the bank in order to start tracking down information relating to the account.

A. Advantages

(a) Strong non-disclosure laws, in effect "secrecy" laws, exist in Switzerland and are geared to protect depositors by creating civil and criminal sanctions for disclosure of foreign accounts.

(b) Switzerland is an established financial center which carries no risk of political instability, theft by trustees, etc.

B. Disadvantages

(a) If an account is discovered (bank and account numbers) domestic judgment is often recognized in Switzerland.

(b) Foreign bank accounts are required to be reported on United States Income Tax Returns if they have in excess of $10,000 in an account. Additionally, the depositor must report interest income.

(c) Reporting requirements with the IRS could lead to discovery.

 

C. Discovery

In looking for the existence of foreign bank accounts, one should request or subpoena:

(a) records of bank accounts;

(b) records of wire transfers. Checks must report money brought into the U.S. in excess of    $10,000;

(c) customs records;

(d) passports, which might reveal trips to Switzerland simultaneously with unexplained withdrawals from bank accounts;

(e) credit card records reflecting hotel and restaurant expenses;

(f) A Form 1040, Schedule B might reveal whether the individual:

 

(i) had an interest in or a signature or authority over a financial account in a foreign county (such as a bank account, securities account, or other financial account) at any time during the tax year;

(ii) was the grantor of or transferor to a foreign trust that existed during the current tax year, with or without any direct beneficial interest.

 

If "Yes," the individual must file Form 3520, 3520A or 926.

2. Devaluing the Family Residence.

Many times, either party will use a joint line of credit to withdraw equity from the family residence. The proceeds from the withdrawal may be used for any number of reasons which would not be for the benefit of the other party, usually the party who is likely to receive the residence upon the final disposition of the divorce and equitable distribution.

A. Discovering Devaluation of the Family Residence.

 • Subpoena all bank records including the original note.

 • Perform a title search on all residences.

 • Subpoena opposing party or home equity loan mortgagor for cancelled checks, if any.

 

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VII. FINANCIAL PLANNING STRATEGIES WHICH CAN BE USED FOR ASSET SEQUESTRATION PURPOSES.

There are a number of financial planning strategies which can be utilized for legitimate estate and tax purposes, but which, if entered into by an in-law or a party/spouse when the marriage is rocky, may actually be utilized for asset sequestration and divorce planning purposes.

Whenever representing the dependent spouse in estate or financial planning matters, one should be alert to the possibility that suggested financial planning devices for the family may, in fact, guarantee the distribution of assets to the independent spouse's parents or heirs, remove those assets from the marital estate and the control of the dependent spouse, and/or defer benefits to the independent spouse until after the occurrence of the divorce.

1. Retained Subchapter S Corporate Income.

The owner of a Subchapter S Corporation may receive income from corporate profits, perquisites, expense accounts, release of debt, and salary income. The profits of the corporation do not necessarily have to be distributed to the owner, but may be retained inthe corporation.

2. Corporate Borrowing.

Shareholders can borrow funds from their corporation, dispose of those funds, and then repay those funds to the corporation over time. If the loan has already occurred, the debt to the corporation will be an obligation of the borrower and an asset of the corporation. Thus, depending on the composition of assets and liabilities in the corporation, the asset to the corporation may not actually create the corollary additional value to the marital estate. Moreover, borrowing from a corporation may create future tax liability, if the borrowing is later deemed to be a distribution of dividends to the borrower as opposed to a loan. If the dependent spouse has filed a tax return and received the benefit of the loan, they may incur future tax liability without advance knowledge.

3. UGMA Accounts.

The most frequent advice given to the independent spouse planning a divorce is to put marital assets into Uniform Gifts to Minor Act Accounts, or in trust for the children for payment of their college education costs. This effectively removes those assets from the marital estate and allocates them to payment of expenses which the independent spouse was legally required to make prior to the Blue decision, but is now only morally obligated to make.

4. Trusts.

The creation of inter vivos trusts are a financial and estate planning device which can be used to remove assets effectively from the marital estate. In big money cases, one of the parties or their parents can put money into an irrevocable trust with only a retained income interest in the party beneficiary. Hence, the assets from which the independent spouse may benefit are not available for equitable distribution, and can never be shared with the dependent spouse on a 50/50 basis. This strategy may likely deprive the dependent spouse of significant value, the income stream being considered for alimony only. Alimony is rarely granted in generous amounts or on a permanent basis. It is important to identify the trustees and determine their independence from the opposing party as well as identify the discretion, if any, in the trustee with reference to principal distributions.

5. Non-Qualified Deferred Compensation.

Non-qualified deferred compensation packages need not be disclosed under ERISA. They can be agreed to on the back of a cocktail napkin. This is especially true in a closely held business that is not subject to SEC requirements to disclose compensation packages to shareholders. If the independent spouse fraudulently fails to disclose a non-qualified deferred compensation plan, the information may need to be subpoenaed from the officers and directors of the corporation and the corporate accountant, among others.

VIII. SOPHISTICATED ASSET PROTECTION DEVICES.

1.  Family Limited Partnerships are most likely tobe created by the parents of your client, for the purpose of retaining control of family assets by the previous generation and limiting access to your client's family wealth by your client's spouse. Your client, who may be the limited partner, will be deemed to have an interest in a percentage of the partnership rather than an interest in a percentage of the partnership assets unless it can be shown that the limited partner has a right to force liquidation. Control is generally retained in the general partner. Tax benefits are created by distributing benefits to the heirs of the general partner without necessarily having the appreciation on the principal taxed in the general partner's estate.

 

A. Discovering Limited Partnership Interests.

One should ask for the identity of all family estate planning lawyers, accountants, and financial advisors, production of all partnership documents, production of all bank accounts holding limited partnership assets, and production of all tax returns for those partnerships.

B. Defeating Limited Partnership Interests.

(a) In order to defeat a limited partnership interest, an endeavor for which there is no precedent in the divorce law of Pennsylvania, one should consider attempting to prove that the limited partnership was established for the purpose of depriving the dependent spouse of access to those assets and, further, if possible, that there is insignificant or little tax and estate planning advantage in the creation of the limited partnership. In this context, a constructive trust argument for the purpose of defeating marital rights should be considered. This probably would be very difficult to prove in most big money cases and, thus, the limited partnership interest may be hard to beat.

(b) An alternative strategy would be to obtain an assignment of a percentage of the limited partner's interest in the partnership, or to join the general partner as a party to the divorce.

(c) A charging lien against the limited partners is a collection device for creditors of limited partners which, in different forms, is available in different states; perhaps a charging lien could be utilized to secure a percentage of the benefits of the partnership interests.

 

2. Asset Protection International Trust.

    There are approximately fifteen foreign jurisdictions which are favorable to the creation of Asset Protection International Trusts: Bahamas, Barbados, Belize, Bermuda, Cayman Islands, Cook Islands, Cyprus, Gilbralter, Mauritius, Turks and Caicos, Nevis and Neue. Unlike a limited partnership interest, an Asset Protection International Trust, if created properly, may completely and effectively defeat the claims of a domestic creditor or dependent spouse, since an off shore trustee is not within the jurisdiction of a United States Court, if that trustee has no connection to the domestic jurisdiction. Further, there will not be in rem jurisdiction, since the situs of the corpus of the trust will be located outside of the United States. The transfer of assets into an Asset Protection International Trust will not be taxable if the grantor is treated as the owner of the entire trust. See Revenue Ruling 87-61 and Internal Revenue Code of 1986 '671-679 and '1491.

 

A. Barriers Against Creditors

1.  Offshore jurisdictions will not recognize foreign judgments. To succeed against the trust, the opponent must commence a new action in the foreign court and hire a foreign attorney who may often require estimated attorney fees up front for litigation. The burden of proving a fraudulent conveyance will most likely be higher than in the United States.

     Eg: Cook Islands - Plaintiff must prove actual intent to defraud beyond a reasonable doubt, instead of the "preponderance of evidence" standard adopted in the UFTA. Therefore, as long as the settlor has legitimate grounds for setting up the trust, creditor will likely lose.

     Eg: Belize - No comparable fraudulent conveyance law.

2.  As for statutes of limitations, Cayman Islands are the most accommodating to creditors - six years from date of transfer. Bahamas and Cyprus have a statute precluding a suit brought two years from date of transfer. In the Cook Islands, the statute is for a bar two years after creditor's cause of action accrues. Often, by the time you find where the money is and file your action, the statute of limitations bars the suit.

 

B. Disadvantages

 • Political instability - The remedy is flight/fee clauses.

 • Location of assets - If in foreign situs, one is susceptible to problems in the foreign country. If in the United States, one may be susceptible to creditors.

 • Trustee must be foreign - If domestic, the trustee can be subpoenaed. If foreign and not well known, the trustee can abscond with assets.

 • Expensive to create and maintain - Routine expenses of $15,000 for trust with $1 million assets and 1% maintenance costs can be expected.

 • Reporting Requirements with the IRS can lead to discovery

 

C. Discovery

Subpoenas of relevant forms should include:

a. Department of the Treasury Form TD F 90-22.1 -- Report of Asset Protection International Bank and Financial Accounts

b. Form 56 -- Notice Concerning Fiduciary Relationship

c. Form 709 -- United States Gift (and Generation Skipping Transfer) Tax Return

d. Form 926 -- return by a transferor of Property to an Asset Protection International Corporation, Asset Protection International Estate or Trust, or Asset Protection International Partnership

e. Form 3520 -- Creation of or Transfer to Certain asset Protection International Trusts

f. Form 3520-A -- Annual Return of Asset Protection International Trust with United States Beneficiaries

g. Customs Form 4790 -- Report of International Transportation of Currency or Monetary Instruments

h. Form 1040, Schedule B

 

i.   "At any time during the tax year, did you have an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account or other financial account?"

ii.  "Were you the grantor of or transferor to a foreign trust that existed during the current tax year, whether or not you have any beneficial interest in it?"

 

If "Yes," you may be required to file Form 3520, 3520-A or 926.

In addition, if any of the trustees of trust protections are United States Citizens, they may be subpoenaed and deposed and, if the assets are discovered to be located in the United States and the creditor has a party/spouse judgment in the United States, one may attempt to seize those assets.

D. Important Distinction from Swiss Bank Accounts

Unlike with Swiss bank accounts where once an account is discovered, recovery will be possible, judgments will most likely not be recognized in the offshore trust. Even if discovery of the trust is accomplished, it is often difficult to get to the assets. It may be best after opposing party discovers the trust to negotiate a settlement because of the:

 • non-recognition of U.S. judgments;

 • secrecy;

 • insurmountable roadblocks

 

E. Identifying and Understanding an Asset Protection

International Trust.

This identification process depends on the identification and analysis of the trust administration, and the trust assets, the relevant law under which the trust was created, the location and the identity of the trustee, beneficiaries, and settlor.

In order to identify the benefit to an opposing party in a divorce who is the settlor of an Asset Protection International Trust, it is necessary to research the law of the foreign jurisdiction in which the Asset Protection International Trust is located. Various foreign jurisdictions provide advantageous laws with reference to probate procedures, transferring assets, taxation and confidentiality.

IX. CONCLUSION.

Diligence is a prerequisite to the discovery of hidden assets. Tracing of funds through primary account records, title reports, depositions of accountants, financial advisors and estate attorneys may be required. Diligence is frequently rewarded.

APPENDIX "A"

1. Ethics

A. Rule 1.2(d) of the Model and Pa. Rules of Professional Conduct states that a lawyer "shall not counsel a client to engage, or assist a client in conduct that the lawyer knows or reasonably should know is criminal or fraudulent."

B. Lawyers should determine the financial condition of settlors, specifically:

1. that the settlor is not insolvent;

2. that no lawsuits, divorce actions are pending;

3. that settlor is not attempting to hinder or delay existing creditors.

 

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I conveniently represent clients in the Bucks, Chester, Delaware, Montgomery, and Philadelphia Counties, the towns of Wayne, Radnor, Philadelphia, King of Prussia, Paoli, Devon, Berwyn, Newtown Square, Villanova, Bryn Mawr, Haverford, Ardmore, Lower Merion, Media, Wallingford, and Swarthmore, and throughout Pennsylvania.

 

© 2015 by Elizabeth L. Bennett, Esquire. All rights reserved.

 

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