Asset Protection for Orthodontists

Although orthodontists represent only 7% of all dentists in the United States,¹ they face a disproportionately large number of malpractice lawsuits. This is true for anyone in the medical field who performs a large number of procedures. Orthodontists are perceived by plaintiffs’ attorneys as desirable litigation targets because they generally earn more than general dentists. Higher earnings lead to greater wealth, and orthodontists find themselves facing numerous malpractice lawsuits. The vast majority of these lawsuits are frivolous (a plaintiff succeeds in only one out of every four medical malpractice lawsuits),² but given the sheer number of lawsuits filed, orthodontists should be concerned about lawsuits that may exceed their malpractice insurance coverage or that may not be covered at all.

Asset protection is a field of law that deals with structuring asset and business ownership to make it either impossible or at least very expensive for a plaintiff to reach a defendant’s assets. If your personal assets are impossible or too difficult to collect against, a plaintiff’s attorney will either not file the lawsuit in the first place, or will be a lot more willing to settle on terms favorable to you.

Jacob Stein, JD

Asset protection does not deal with secrecy or hiding assets, because an intelligent and determined creditor will always be able to unearth hidden assets. A properly structured asset-protection plan employs commonly used structures such as trusts and limited liability companies in a manner that legally, ethically, and effectively shields assets from any lawsuit and any creditor. If you implement an asset-protection plan you will be able to sleep soundly, knowing that whether your are hit with a malpractice claim, pursued by an insurance company for filing erroneous claims, or involved in an automobile accident, your assets will be safe and unreachable.

Asset Protection 101

Once the plaintiff obtains a legal judgment against you in a malpractice lawsuit, the plaintiff becomes your creditor and you become a debtor. The plaintiff can now use the judgment to collect and attach almost any of your personal and business assets. Consequently, the focus of all asset-protection planning is to remove you from legal ownership of your assets, while retaining your control over and enjoyment of the assets.

There is no “magic bullet” asset-protection strategy. Depending on the assets you own, the plaintiff’s aggressiveness, and certain other factors, you should use different structures to protect your assets. The timing of your planning is important as well. While it is always possible to engage in asset-protection planning after a lawsuit has been filed, the planning will be a lot more effective and simpler when implemented before a malpractice claim arises.

Personal Residence

No asset is more important to shield from a creditor’s claims than your personal residence. Personal residences represent the bulk of many people’s fortunes and have great sentimental value.

Creditors pursue not the residence itself but the equity in the residence that can be converted into money through a foreclosure sale of the residence. There are two equity-stripping techniques.

One way to strip out the equity is by obtaining a bank loan. Even if we assume that a bank would lend an amount sufficient to eliminate 100% of the equity, the cost of this asset-protection technique is staggering. A $1 million loan bearing a 7% interest rate costs $70,000 per year. Another way to strip out the equity is to encumber the residence by recording a deed of trust in favor of a friend. This avoids the carrying costs of an actual bank loan. With this technique it is important to know the intelligence and the aggressiveness of the creditor. Some creditors may stop trying to collect when they realize that there is no equity in the residence. Others may dig deeper, and if the debtor cannot substantiate the transaction as an actual loan, the deed of trust will be set aside by a court as a sham.

In addition to stripping out the equity, it is also possible to protect your residence by transferring ownership but retaining control and beneficial enjoyment. This can be done in many ways.

An arm’s-length cash sale is the best way to protect your house (and the equity in it), because it is much easier to protect liquid assets than real estate. While this technique affords you the best possible protection for your home, it is also the most radical and may result in additional income taxes. This technique is usually reserved for orthodontists who are facing very determined plaintiffs or government agencies.

An alternative to an outright sale is the sale and leaseback of your house to a friendly third party on a deferred installment note. This allows you to transfer the ownership of your house without having to move out. This structure works only so long as you can establish the legitimacy and the arm’s-length nature of the sale.

Contributing the residence to a limited liability company (LLC) or a limited partnership may be another way to protect it. The protection afforded by LLCs and limited partnerships is derived from the concept of the charging order protection, addressed in more detail below. While the charging order protection is generally powerful, its usefulness may not extend to personal residences.

Certain state statutes require LLCs or limited partnerships to have a business purpose, and there is no business purpose in holding a personal residence in a legal entity. Other downsides may include the loss of the $500,000 gain exclusion on the sale of the home, the loss of the homestead exemption, and the triggering of the due on sale clause in the mortgage.

The final available way to protect your personal residence is to transfer the ownership to a trust commonly referred to as a personal residence trust (PRT). This is a trust established initially for the benefit of you and your spouse, and later for the benefit of your children or other beneficiaries. Because the trust is irrevocable, it is treated as the owner of the house although you retain full control over your residence by appointing a friendly trustee. The trust allows you to sell the existing home, buy a new home, and refinance. You retain all the mortgage interest deductions and exclusion of $500,000 of gain on the sale of the residence, and the transfer into this trust does not trigger the due on sale clause in the mortgage. In practice, PRTs have proven to be a simple and extremely effective way of protecting a personal residence.

Rental Real Estate and Other Nonliquid Investments

Some of the techniques discussed above may be used to protect rental real estate, businesses, intellectual property, collectibles, or other valuable assets. These assets may be transferred into irrevocable trusts, sold for cash or on installment basis, or encumbered. However, for assets other than a personal residence, there is a much better and simpler way to achieve as much or more protection: an LLC or a limited partnership.

Assets you own through an LLC or a limited partnership are not deemed owned by you because these entities have their own separate legal existence. If you transfer the ownership of your apartment building into an LLC, you will no longer be treated as the owner of the apartment building. Instead, you will now be treated as the owner of a membership interest in the LLC. This means that plaintiffs suing you will no longer be able to reach the apartment building directly—they would now have to pursue your interest in the LLC.

Forcing the plaintiff to pursue an ownership interest in an LLC or a limited partnership is a lot more advantageous for you because interests in LLCs and limited partnerships are not subject to attachment by a plaintiff. This is known as the charging order protection. The charging order protection limits a plaintiff’s remedy to a lien against the distributions from the legal entity, without conferring on the plaintiff any voting or management rights. Because you will remain in control of the entity and can defer distributions, the plaintiff will have no way of enforcing the judgment against your LLC or limited partnership interests or the assets owned by these entities.

Assets that you own through a corporation would not enjoy the same protection. There is no charging order protection for corporate stock. This means that the same apartment building owned by an orthodontist through a corporation can be seized by a creditor by first seizing the corporate stock owned by the orthodontist.

As a practical matter, LLCs and limited partnerships create a formidable obstacle to the creditor’s collection efforts and usually force the creditor to drop his collection efforts or to settle. You should consider these entities for all valuable assets with the exception of your personal residence, and, as discussed below, liquid assets.

Liquid Assets

Liquid assets may be protected through many of the techniques described above, including LLCs, limited partnerships, and irrevocable trusts. Liquid assets may also may be protected by placing them in a foreign trust.

A foreign trust is an irrevocable trust governed by the laws of a foreign jurisdiction. Several foreign countries have enacted trust laws designed to assist debtors with asset protection. The laws of these countries go through a number of steps to make it impossible for a plaintiff to pursue the assets of a foreign trust.

These foreign countries erect the following obstacles in the plaintiff’s path: 1) They will not recognize a legal judgment from any other country, including the United States. This means that a malpractice judgment obtained against an orthodontist in the United States becomes useless to the plaintiff. 2) Because the plaintiff’s attorney is not licensed to practice law in that foreign country, he would have to hire local attorneys to litigate for him, which is a very expensive proposition. 3) The trustee of the foreign trust is a trust company that has no connections to the United States, which means that an American judge will not be able to force the trustee to distribute trust assets to the plaintiff.

The assets transferred to a foreign trust are usually liquid, such as bank accounts or brokerage accounts, but they can also include intellectual property and interests in legal entities, among other things. The assets owned by the trust can be located anywhere in the world, including the United States or Europe. The assets are almost never held in the same country where the trust is set up.

Most of these trust structures are established in a manner that would allow you to be the only one who can know what assets are owned by the trust and to be the only one who can access the trust’s funds. Even the trustees can be effectively prevented from having access to your assets.

Over the years, foreign trusts have become a favorite planning technique for many debtors. These structures are perfectly legal, tax neutral, and extremely effective in protecting assets from lawsuits.

For more advice on the financial side of practice management, search for “” in our online archives.

It should be noted that many debtors believe that simply moving money to an offshore bank account will serve as sufficient protection from creditors. While the plaintiff may have a difficult time enforcing a judgment in a foreign country and levying on a foreign bank account, the debtor will never have a problem withdrawing the money if the account is directly in the debtor’s name. Consequently, the plaintiff may petition the court to direct the debtor to withdraw the money from the foreign account and pay it over to the plaintiff. With a foreign trust, that can never be a problem, because you technically do not own the assets of the trust.

In conclusion, orthodontists will always be targets of lawsuits. The only way to change that is by removing a plaintiff’s financial motivation to pursue litigation. Asset protection is a simple, inexpensive, and effective means of changing the plaintiff’s financial analysis and making you “judgment-proof.” As with any other planning, asset protection is a lot more effective when implemented in advance.

Jacob Stein, JD, is a partner with the Los Angeles law firm of Boldra, Klueger & Stein LLP, which focuses on tax and asset-protection planning for professionals and business owners. A frequent lecturer and writer on tax, estate, and asset-protection planning, he welcomes comments at

References

1. US Department of Labor, Bureau of Labor Statistics. Occupational Outlook Handbook. Available at: [removed]www.bls.gov/ocos072.htm#earnings[/removed]. Accessed February 5, 2007.
2. US Department of Justice, Bureau of Justice Statistics. Medical Malpractice Trials and Verdicts in Large Counties, 2001. Available at: www.ojp.usdoj.gov/bjs/abstract/mmtvlc01.htm. Accessed February 5, 2007.