Three months ago we introduced you to Adam and Andrea, a desperate couple who, after failing to adequately establish an effective asset protection plan, sought out the advice of their friend Jack. Jack advised them to follow his patented four-step plan. We have discussed the pitfalls of his first two steps. Here, we tackle his final two steps, which were to keep their insurance company in the dark about potential lawsuits and to declare bankruptcy if all else failed.
Unfortunately, Jack’s advice would put in jeopardy the one asset protection plan Adam and Andrea had gotten right (insurance) and send them through a process (bankruptcy) that has undergone radical changes recently—mostly to the benefit of creditors and not debtors.
Insurance is an effective asset protection tool. There are many different types of insurance—far too many to discuss here. However, there are two aspects of an insured’s contractual relationship with its insurer that warrant discussion—the duty of cooperation and the insurance company’s duty to defend versus its duty to indemnify.
Virtually every insurance policy requires the insured to cooperate with the insurer. Cooperation requires communication. Adam and Andrea, as early as possible, need to inform their insurance company about any claim or potential claim that may be covered by insurance. In fact, as will be discussed below, it is a good idea to submit a claim to insurance even if there is only a remote chance it is covered by the policy. If Adam and Andrea settle the claim on their own or fail to inform the insurance company of the claim, there is a high likelihood that the insurance for that claim will be void. Thus, Adam and Andrea, and any of their exposed assets, would be the target for collection on that settlement or judgment.
The reason that any claim or potential claim—even if it is unlikely to be covered—should be sent to an insurance company is that an insurance company has both the duty to defend and the duty to indemnify its insured. The duty to defend is the duty the insurance company has to pay for a lawyer to defend Adam and Andrea against any lawsuit. The duty to indemnify is the duty to pay for any judgment that arises out of a claim.
Upon receiving notice of a claim, the insurance company would have three basic options. One, it could acknowledge that the claim is covered and would be responsible for defending and paying any judgment. Two, it could issue a reservation of rights letter, which communicates that it will begin to defend Adam and Andrea, but it is not convinced the claim is covered so it may stop at some point or it may refuse to pay a judgment. Three, it could deny the claim in its entirety leaving Adam and Andrea to both defend the claim and pay any damages, which is what would occur if they never told the insurance company about the claim anyway. If the claim should have been covered by insurance, Adam and Andrea would have a cause of action against the insurance company directly for not defending and agreeing to indemnify them. Accordingly, it is almost always more advantageous to communicate with the insurance company even if the possible claim might not be covered.
Bankruptcy is complicated and was made more complicated by the new bankruptcy laws that went into effect in 2005. Adam and Andrea’s plan to leave their debt behind by declaring bankruptcy likely would run smack into one of the changes that was enacted in 2005. In the past, debtors facing serious financial problems could file Chapter 7 bankruptcy, which in essence requires the debtors to liquidate non-exempt assets and they get to start over debt-free. However, under the new laws, debtors who file for Chapter 7 bankruptcy may have to undergo a “means test” based on their state’s median income. If the debtor has assets above that median income and can pay at least $100 per month for five years, that debtor must proceed as a Chapter 13 bankruptcy rather than a Chapter 7 liquidation.
Under Chapter 13, the debtor engages in a repayment plan in which that debtor repays unsecured creditors with regular payments over five years. If the debtor fails to comply with the repayment plan, the court will dismiss the bankruptcy and the debtor would lose all protections that forced the debtor to file in the first place.
Thus, Adam and Andrea cannot rely on a backstop of bankruptcy as an asset protection tool as it may be an option that ties them up for five years. Rather, Adam and Andrea, as early as possible, should have explored trust and estate protection, corporate protection, and asset diversification that would effectively protect their assets in most circumstances, including the ones they ultimately faced.
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.