Donald Hess, a wealthy Swiss businessman, was not happy when his wife of 20-plus years sued him for divorce. He was even less pleased when she went after his $200 million estate.
Fortunately, so he thought, he had the foresight to have her sign a marital agreement providing that, in the event of a breakup, she would receive only a few million dollars. But she was not happy with that. Hess was concerned in spite of the marital agreement that the courts often find a way to favor the “poorer” spouse and therefore, shortly after the divorce was filed, he established an offshore trust to which he contributed the bulk of his $200 million estate, including the interests of his business.
His concerns about a runaway court order were not unfounded. One U.K. court ordered billionaire hedge fund manager Chris Hohn to pay his estranged U.S. wife more than $500 million. Bernie Ecclestone, the CEO of the Formula One Group, had to pay his ex-wife over $1 billion. And actor Mel Gibson was nearly wiped out when ordered to pay wife Robyn over $400 million.
In fact, there is a long list of wealthy, successful businessmen who have paid billions to their ex-wives in divorce. (The only woman on the Top 25 list of huge divorce settlements is Madonna, who reportedly paid ex-husband Guy Ritchie about $90 million to say goodbye.)
And what about Donald Hess? How much was his ex-wife able to recover from the $200 million Hess placed in the offshore trust when she filed suit in the foreign jurisdiction?
Not a dime. In fact, her argument was barely heard by the court because she was unable to show that Hess’s transfer of funds to the trust rendered him insolvent, as required by the law of that jurisdiction. (Hess retained more than enough outside the trust to pay her the specified amount under the marital agreement.)
How is it that all these brilliant, successful businessmen (and one woman) on the Top 25 list did little or nothing to protect their billions? There is no question that many of them must have had a family office. If so, there can only be one of two answers to that question. One, that the advice from their family office on how to protect their funds was not taken, or two, that the office gave them faulty advice or no advice at all. In my experience, the latter is the more likely answer. Despite the increasing popularity and use of family offices, the advice of most family office manuals deals with everything except asset protection for the family members. Such a lack of specific planning not only leads to huge financial losses but, in some cases, to the loss of control over family businesses.
A Case Study
Consider the following hypothetical case: Decades ago, Damien Crump took over Crump Corp., a family business, from his father and continued to grow it into a hugely successful company. Having bought out his siblings along the way, Damien’s intentions were to transfer the business to his son and daughter, Christopher and Christine, and their children. Over the years, Damien transferred some of the Crump Corp. shares to Christopher and Christine, and also to trusts for the grandchildren. But Damien was the type who insisted on maintaining control. At last count, Christopher and Christine each owned 20% of Crump Corp., and the grandchildren’s trust owned 9%. Of course, there were the usual restrictions on ownership and transfer of the shares. Meanwhile, Damien, with the help and recommendation of his advisors, established the Crump Family Office, which advised the family on all aspects of management and operations of the family empire, as most family offices do.
While driving to the office one day, Damien was in deep thought about constructing a space station bearing his name that could be seen from Earth. Visualizing the idea, Damien drifted into another lane, causing a van carrying a couple and their four young children to run off the road and crash into an abutment. The couple and one of their children were killed, the other three children were left handicapped for life. Of course lawsuits followed, resulting in a huge judgment against Damien that was far in excess of his insurance coverage, his available cash and his available non-company assets. The only other assets were his shares of Crump Corp., which were held in his name. In such a case, to Damien’s astonishment, he found that his new creditors could reach his shares. That is because a judgment creditor whose judgment is unsatisfied can recover specific assets belonging to the judgment debtor. In this case, Damien’s shares represented a controlling interest in the company.
Disaster Can Strike (Goliath Can Fall)
What would that do to the company? The creditors could take control, drain the company of cash and assets, or even sell it outright to recover their judgment. Even if it didn’t go that far, unwanted shareholders could interfere in the company if their shares matched Christopher’s or Christine’s. Where the satisfaction of a judgment is involved, depending on the circumstances, the restriction on transfers of shares could be overridden, particularly if a forced bankruptcy resulted, and non-debtor family shareholders could find themselves with new partners.
This is not to say that family offices offer no advice on asset protection issues. The problem sometimes is that the key party or parties often want to keep direct control in their own names without even the hint of interference they’d face by entering a limited liability company, partnership or even a trust. Nevertheless, many managers press for these structures.
Would An LLC Or FLP Offer Protection?
Speaking of LLCs and partnerships, many advisors believe that a family limited partnership (FLP) or LLC could prevent the disastrous fate that befell the Crumps, and as a result such entities are often recommended by family office advisors. But even though a limited partnership and especially an LLC would certainly be far better than outright ownership of a company by an individual, these entities generally only postpone a reckoning with creditors and definitely won’t allow you to avoid claims (it depends to some extent on the jurisdiction where the partnerships are formed and the nature of their assets). At most, such partnerships help persuade creditors to settle, but they also leave debtors in compromising positions: When a member of the partnership or LLC becomes a judgment debtor, a “charging order” may be imposed on the member’s interest. This has the effect of blocking any payment to the member until the creditor’s judgment is paid. Furthermore, some states allow the creditor to foreclose on the debtor’s interest, causing the debtor to lose his or her entire interest in the LLC.
Building A Protective Plan
A more complete family office manual could reveal ways for a business owner to retain control over his or her company without exposing the company to creditors. It also offers ways of protecting the children’s and grandchildren’s assets and company interests from creditors, as well as ways of passing the baton without passing the exposure.
But that requires a careful and expert structuring of the underlying entities. The authors of the family office manual must have in mind the family’s immediate, intermediate and long-term objectives, but also make the language flexible. Even the best plan can later be handicapped or rendered vulnerable to creditors by unforeseen changes in the family, such as a divorce or disability, or a change in the law, or a change in the nature of a major asset. So flexibility must be built into the plan, and there should be specific provisions for its periodic monitoring to consider any family changes that could affect it.
Taking Advantage Of Legal Trends
One such change is that self-settled asset protection trusts are now allowed in 17 states. These are trusts a person establishes for his own benefit and which, after a certain period of time, become impenetrable to creditors. The creator may retain the right to direct investments and vote shares of his closely held business when these are placed in these trusts, but the assets are protected from creditors. As a beneficiary of the trust, the creator would also be able to enjoy any profits the company paid out.
A creator can enjoy even greater protection—for instance, to divorce claims such as those in the Hess case—when offshore trusts or other entities are employed. U.S. courts have no jurisdiction over such trusts or other entities, so once again, the assets are protected.
Tailor The Plan To The Family
The key, however, is that the asset protection plan must be designed for a particular family and its particular assets. A family with large holdings of real estate, for example, would undoubtedly have a different plan than the Crumps, whose assets are largely intangibles such as the family business.
Furthermore, such planning details should extend to the activities and interests of each of the family members, whether or not they are engaged in the family business. That would require an asset protection analysis for each member. If Christine Crump were a pediatric brain surgeon, for example, her individual plan might include an offshore trust to hold her share of the family’s assets, and an estate plan to provide for her family as a whole.
Given the asset protection planning options available to family offices, and the threat to assets from outsiders, it is hard to understand why family office manuals don’t address these issues more. Unfortunately, it appears they may be missing a chapter—and an opportunity.
Alexander A. Bove Jr., Esq., is senior partner at the law firm of Bove & Langa PC in Boston.
