| A couple months ago we introduced you to Adam and Andrea, the hapless couple who suffered the consequences of their failure to establish an effective asset protection plan.
After Adam and Andrea were faced with a run of unfortunate events, they sought to protect their assets by turning to their friend Jack who advised the couple to follow his patented four-step plan. Last month we discussed the pitfalls of his first step; this month we tackle his second step, which was to simply walk away from the pending lawsuits and their mortgages. Unfortunately, Jack failed to advise Adam and Andrea about default judgments and deficiency judgments. A far better strategy, if Adam and Andrea had planned far enough ahead would have been asset protection via corporate protection.
In North Carolina, when a defendant is properly served with a complaint, the defendant has 30 days to respond to that complaint. If Adam and Andrea had followed Jack’s advice and “walked away” from any lawsuits filed against them, they would make the plaintiff’s job easy. First, without having received a timely response to the complaint, the plaintiff would have sought an entry of default from the clerk of the court and scheduled a hearing with the court for a default judgment. In all likelihood, at the hearing the plaintiff would obtain that default judgment.
Depending on the circumstances, the law allows Adam and Andrea to attempt to undo any step along this path, including even after a judgment has been entered. However, the likelihood of success is tied to both the reason why Adam and Andrea did not participate in the judicial process and the length of time they waited before seeking such relief. The bottom line is the sooner Adam and Andrea participate, the better their chances.
If Adam and Andrea did have a judgment entered against them (default or otherwise), the plaintiff, or now, judgment creditor, after waiting 30 days could begin collection efforts. Collection efforts can include obtaining a lien against Adam and Andrea’s home or investment properties or having the sheriff seize bank accounts, automobiles and household furnishings. Put simply, by ignoring the lawsuits, Adam and Andrea risk losing almost everything they own.
Jack’s advice to Adam and Andrea to walk away from their mortgages was similarly foolish. A deficiency judgment arises when the security for the loan is insufficient to pay off the loan. For example, if Adam and Andrea owed $100,000 on their beach house when it was foreclosed upon and sold for $60,000, there would be a deficiency judgment of $40,000.
While North Carolina has an anti-deficiency judgment statute which limits certain lenders to the value of the security (e.g. the beach house), it only protects borrowers who utilized purchase money mortgages or deeds of trust. Essentially, it limits the lender from recovering more than the security when the lender was also the seller, which is not common.
For the rest of North Carolinians, likely including Adam and Andrea, the bank who loaned them the money to purchase their beach house could, after having foreclosed upon the beach house, obtain a judgment for the deficiency in the amount owed and come after Adam and Andrea for that amount with the collection efforts explained above.
What could Adam and Andrea have done? One of the more effective asset protection devices is the formation of corporate entities to hold assets. If assets are owned by corporate entities, they are isolated from one another. This kind of asset protection planning, like most asset protection planning, must be done prior to problems arising so as to avoid claims of fraudulent transfer as discussed last month.
There are a number of corporate entities individuals can form—corporations, partnerships, limited liability partnerships, limited liability companies, the list goes on. They each have formation requirements and have differing tax consequences and impacts as to liability protections for the individuals within them. However, if properly formed and properly maintained, an individual can enjoy the benefits of owning an asset and lessen the risk of liability from that asset.
As an example, Adam and Andrea owned two rental properties. If instead of owning them in their individual names, one property was owned by Adam, LLC and the other by Andrea, LLC, if someone tripped over a fish sculpture in the foyer of the property owned by Adam, LLC they likely could not collect on assets owned by Andrea, LLC or by Adam and Andrea individually. Further, if the uninsured Adam was sued for hitting Al with his Hummer, the assets in Adam, LLC and Andrea, LLC would likely be out of the reach of Al.
Join us next month when we discuss why Adam and Andrea should not listen to Jack’s advice to avoid reporting incidents to their insurance company and how bankruptcy might not be the cure-all Jack led Adam and Andrea to believe.
Bob Wishart is a founding partner and head of litigation of Wishart, Norris, Henninger & Pittman, P.A., a law firm which focuses on helping business owners define and achieve their business and personal objectives. Contact him at 704-364-0010 or visit www.wnhplaw.com.