DAVID J. WILLIS ATTORNEY
Copyright © 2013. All rights reserved worldwide.
Equity Stripping for Asset Protection
by David J. Willis, J.D., LL.M.
Equity stripping is the art and science of making a business appear to be worth less than it really is. It has been said that perception is everything, an aphorism that is definitely true in asset protection. If a review of public records indicates that a potential target company is in debt and its assets are encumbered by liens, why would a plaintiff file and pursue an expensive lawsuit in order to wind up with an uncollectable judgment? If the company appears judgment proof, will a contingency-fee attorney take the case?
The core documents of an equity-stripping system are
(1) a secured promissory note in a substantial amount (at least $1 million);
(2) a line-of-credit agreement supplementing the terms of the note;
(3) a deed of trust and security agreement listing real and personal property collateral subject to a lien to secure payment of the note;
(4) a company resolution authorizing the loan; and
(5) a presigned release of note and lien.
Only the deed of trust and security agreement is filed of record, but that is enough. This document states clearly that both a company’s real estate and its furniture, fixtures, and equipment are subject to a lien to secure repayment of a very sizeable amount of money. The other equity-stripping documents are kept with the company record book as documentary support. The most important of these is a presigned release of note and lien which is held in reserve until it is necessary or advantageous to file it. After all, one should never allow the filing of a lien without a reliable means of getting that lien released later.
The note is payable on demand. The borrower should be an investor’s limited liability company. If the borrower is a series LLC, the note should state that all series are jointly and severally liable for payment, not just the company at large. The identity of the lender may vary. This firm favors utilizing a Nevada company (or more specifically a DBA thereof). The Nevada component makes it marginally more difficult for a plaintiff to obtain information or subject the lender to compulsory document production in a Texas court.
The Role of Deterrence
Recall that a key principle of asset protection is deterrence. Deterrence in the form of equity stripping affects the process at two possible points: first, when the plaintiff and his lawyer perform due diligence (as they should) on the available assets of their target before launching an attack; and second, after suit is filed during document production, when the defendant produces copies of the note and the deed of trust and security agreement–documents which, at least on paper, vastly reduce net worth. Given the soaring expense of litigation, most plaintiffs would then pause and carefully evaluate the prospects for a tangible recovery. After all, a lawsuit is just another form of investment, and a rational plaintiff is looking for a return on that investment. Similarly, a plaintiffs’ attorney who has accepted the case on a contingency basis may be wary. The attorney may even go to the client and demand a substantial retainer if the case is to proceed. Result? The lawsuit may end there.
Equity Stripping and the Two-Company Structure
We recommend a two-company structure for most real estate investors: one LLC as a management company and another a stand-alone holding company. Activities are thereby separated from assets, greatly minimizing risk. Since in this system the management company is already a shell, it is the holding company that should be considered as a candidate for equity stripping.
Is equity stripping a form of fraud against creditors?
The answer to this question is absolutely not, so long as it is handled correctly. After all, the note merely authorizes advances of up to $1,000,000. It does not indicate how much money (if any) has actually been advanced. Moreover, all documents relating to the transaction are entirely in order. The deed of trust and security agreement (the only recorded document) merely states the maximum loan amount and reveals nothing further about advancements or other details of the loan agreement.
It would be a different matter if one is queried during the discovery process as to how much of the loan had been advanced. One should never be untruthful in discovery; however, it is a corollary to this rule that one should provide only the minimum information necessary to be adequately responsive. If the plaintiff does not ask, then the defendant is not under an obligation to provide gratuitous information.
The Issue of Existing Lienholders
Unless one’s company is fortunate enough to own its properties outright, then there will be existing lienholders to consider when it comes to equity stripping. First-lien deeds of trust recite that the priority status of their lien must be preserved or the borrower will be in default. Is this a problem? It should not be. The reason is that the deed of trust and security agreement used for equity stripping expressly states that its lien is inferior to earlier liens of record.
It is paradoxical that it may be in your best interest to appear less wealthy than you are, but it is nonetheless true in the world of asset protection.
Information in this article is proved for general informational and educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes and statutes or cases referred to should be checked for updates. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well. This firm does not represent you unless and until it is expressly retained in writing to do so.
THIS DOCUMENT IS NOT INTENDED TO BE USED, NOR CAN IT BE RELIED UPON, BY ANY TAXPAYER FOR THE PURPOSE OF AVOIDING PENALTIES IMPOSED UNDER UNITED STATE FEDERAL TAX LAWS. THIS DOCUMENT DOES NOT CONSTITUTE DOES NOT CONSTITUTE A TAX OPINION OR OTHER ADVICE TO WHICH CIRCULAR 230 IS RELATED.
Copyright © 2013 by David J. Willis. All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, http://www.LoneStarLandLaw.com.