Better Than A Prenup!

Dealing with clients who have done well in life, two primary goals arise in almost every case. “Protect assets from taxation and lawsuits” and “Keep assets in the family.” Tax strategies and the comparative merits of different protective legal structures are an easy enough conversation. A very delicate question will inevitably come up….. “How happily married is the client?” Oh and by the way….. “Are their kids happily married?”

When sizing up threats to your family business and combined estate, divorce is one of the most critical and obvious. That and it is always uncomfortable to discuss. Divorce in the USA is a $50 billion a year industry, an estimated $30 billion of which goes to legal fees. Roughly 50% of first marriages end in divorce, the rate gets higher for second and third marriages. Even if the client’s marriage is very loving and stable, which I am happy to say is what I see more often than not, what about their children and grandchildren? How do you guard against the son-in-law whom your daughter married after college who turned out to be anything but the man you all believed him to be? Is your estate prepared for the vindictive former daughter-in-law with her aggressive attorney who are determined to get everything out of your son they can? Who on Earth can predict what courtship & marriage challenges one's grandchildren will face in such a constantly changing social environment?

“That's what prenups are for” is what the overwhelming number of people will say. Here is the next critical question….”How strong are prenups in reality?” The truth is that prenups are challenged successfully all the time. How much of an age and wealth gap was there between the parties when the prenup was written and signed? Was the lawyer who drew up the document paid for by one of the parties with the other not having been advised by independent legal counsel? Was one of the spouses born outside the USA and therefore may not have really understood what was being agreed to? A prenup is an odd contract in that the more thoroughly and completely it protects your interests, the better an opponent can argue that it should be thrown out. Yes, judges can easily do this, they have full discretion to do so. Prenups do work well under certain conditions, mainly if there are no kids involved. Be aware that a prenup cannot be used to guarantee your rights to custody or specify child support parameters.

What state is this taking place in? I certainly do not want to rely on the even handedness of a California judge. Remember, District Judges have almost complete discretionary power in family court. All of these are factors which clever and very motivated attorneys have successfully used to challenge prenups. Yes, a prenup can be used to protect one’s anticipated inheritance if declared as separate property. However, if any of these other weaknesses apply, the fact of one spouse is expecting a large inheritance can be used to bolster the opposing spouse’s argument that the prenuptial negotiation was too one sided to be valid or equitable. Speaking of California, you probably already knew that this is the worst state by many metrics to get divorced in (particularly for men). There are also circumstances under which unmarried though cohabiting partners can be held financially liable in the event of separation.

This not only opens one to attacks on assets that they owned prior to marriage, it can impact other family members in cases of large estates or family held businesses. Things can get ugly here in more ways than financially. If the divorcing spouse was privy to any potential tax or business secrets, the family can be faced with their laundry and other drama being aired publicly. Former employees or ex-business partners who have been nursing a grudge may come out of the woodwork and join the party with their own allegations or lawsuits. An unfortunate byproduct of success is that the bitter, the envious and unscrupulous will see you as a higher value target. Then there is the structural inadequacy of a prenup in that it just protects what you had going into the marriage, not the future earnings which may or may not have been a joint effort with both spouses contributing.

So now that I have covered the dangers of divorce in the United States and the weaknesses of prenuptial agreements, let's talk about the solution I propose. Even in the worst case scenario, the ability of the most biased judge or stacked court is limited….by their jurisdiction. The safest route is to have your assets legally held outside the jurisdiction of a US Divorce Court or any US Court for that matter. Time to set your sights overseas!

Currently there are 75 countries that meet the definition of a Tax Haven or Offshore Financial Center (OFC). Obviously these countries offer more than tax advantages as many of them have strong laws in place to insure financial privacy and a plethora of options for legal protection. Since a number of nations have pursued this strategy of using banking and legal protections to attract international investment, they have worked to set themselves apart from one another focusing on specialized niches. Well known financial freedom destinations like Switzerland, Dubai and Singapore have a lot to offer on the banking and tax side. Panama, Seychelles and Belize are great places to establish the most secure corporations available. For protection against US Courts, an Offshore Trust is called for and topping the list of providers for this service is one of the most obscure places in the world.

Welcome to The Cook Islands! This nation of just over 15,000 citizens is self governing and operates in free association with New Zealand. French Polynesia & the island of Tahiti are the Cook Islands closest neighbors, 700 miles to the East, New Zealand lies 2,000 miles to the Southwest and Hawaii is 2,854 miles to the North. Needless to say this is a very out of the way country which does not court a lot of controversy or international attention. The Cook Islanders have hit upon a fantastic strategy to attract successful people from around the world to consider their country’s financial services sector. That strategy lies in their Offshore Trusts which are among the strongest in the world.

How does a Cook Islands Trust work? The mechanics are fairly straight forward as international financial instruments go. The Trust is established very much in the same manner as a domestic US Trust would be, preferably through a Cook Islands Law Firm that specializes in such matters. A local regulated Corporate Trustee will be the Trustee of your new Trust. The assets you wish to protect will be put into a newly established LLC. You are the manager of this LLC and therefore you have full access to and use of the assets therein. The LLC itself can be a Cook Islands LLC or it could also be set up in another jurisdiction which specializes in wealth protection, such as Switzerland, Singapore or the Caribbean Island of Nevis being a very strong example. In the unfortunate event that your assets are under legal peril, the Trustee takes over management of the LLC. Your funds have the added protection of being insured under the Trustee’s bond. The Cook Islands does not recognize foreign court judgements, therefore the local Law Firm acting as Trustee is bound by law not to release your assets as per the demand of the foreign court. Cook Islands case law history demonstrates that this is arguably the strongest asset protection mechanism in the world. Once the legal peril is resolved, the Trustee returns control of the LLC to you and perhaps the best feature is that the Trustee can release funds within the LLC to you while the legal dispute is in progress. Your assets are protected from your legal adversary though not inaccessible to you during the period of legal conflict.

As you likely guessed, this strategy works best for protecting liquid assets held in offshore bank accounts. These are by far the least accessible assets to a US Court. However, a Cook Islands Trust can also be used to protect immobile assets, most notably real estate located in the United States, even in the most litigious States such as my home State of California. This involves the process of “Equity Stripping.” Mortgages against your real estate, payable to the LLC are recorded as part of your Trust. At first glance, this looks like the prelude to a “Scorched Earth” strategy of rendering your real estate unusable to your opponent. In fact it is far more sophisticated. This setup allows a friendly third party to purchase these mortgages from the LLC and the cash generated by this sale placed in a locked account within your Cook Islands Trust. Ergo, you have converted the value of your US Real Estate into a liquid form that is held safely while legally encumbering the property which will make it time consuming and legally expensive for the attacking party to gain a judgment against. Even if successful, your opponent’s victory will be thoroughly Pyrrhic and you are no poorer as a result. Likely you will retain your property, worst case being that your net worth is all but unscathed, with only the balance of your asset categories having been tactically altered.

Now that you have your introduction to Cook Islands Trusts, it is time to provide a little more context as to why you should consider the Cook Islands ahead of other Offshore Financial Centers. Aside from the aforementioned legal protections offered by a Cook Islands Trust, it is worth adding that the Cook Islands are not a signatory to the 1970 Hague Divorce Convention, nor the 1985 Hague Trust Convention. This cannot be said of some other notable Offshore Financial Centers, namely Switzerland, Luxembourg and the United Kingdom. It is important to note that the United Kingdom’s signatory to the Hague Divorce Convention extends to some of her otherwise self-governing territories such as Bermuda, Jersey, Guernsey and the Isle of Man, names that will be familiar to anyone knowledgeable of Offshore Banking. This serves to underscore how important it is to thoroughly research your Offshore Financial Centers to be sure they are the best fit for the threats you seek to guard against. While fiercely guarding the protections afforded by their courts as their best way of attracting business to the local financial sector, this does not apply to money laundering. The Cook Islands are rated as one of the most compliant nations in the world for anti-money laundering measures as rated in 2018 by the Organization for Economic Cooperation and Development and the Financial Action Task Force (OECD and FATF Respectively). While a self-governing nation, the Cook Islands operates in a state of “Free Association” with their bigger neighbor New Zealand with whom they share a lot of historic and cultural ties and with whom most Cook Islanders share dual citizenship. New Zealand is consistently rated one of the least corrupt countries in the world by Transparency International. To say nothing of New Zealand being one of the safest and most crime free nations. This means you are achieving world class legal protection for your wealth by working through countries that are anything but shady or disreputable!

None of us wants to go through a contentious divorce or malicious lawsuit. Lesser still do we want to see our children or other loved ones subjected to such an ordeal. Life can be a battlefield fraught with many perils, the worst of which often start out as your best partnerships or most intimate relations. Sadly, it is these very close relationships which can metastasize into legal nightmares with the ability to imperil everything you have accomplished in life, as well as impact generations of hard work and sacrifice. The best defense is a proactive one and the time to prepare is now so that you may act well before the threat is on your doorstep. The cost of setting up a Cook Islands Trust will generally run from $35,000 to $50,000, a fraction of the cost of a hotly contested legal battle or a bad divorce. In addition to the protections of a Cook Islands Trust, there is also the deterrent value to those who may be tempted to act against you in the courts. The vengeful ex-business partner’s calculus will be influenced by the attorney costs they will incur to seek a judgment against your estate that case history strongly demonstrates will be unenforceable. We all strive to make sure that anyone who marries into our family does so for the right reason and knowing that there is no jackpot divorce settlement if the marriage does not last will certainly deter any prospective spouse or in-law with less than pure motives. In the still more unfortunate situation of a contentious divorce with child custody being used as a bargaining chip, the greater your financial leverage, the more likely you will be able to defuse the conflict before irreparable damage can be done.

Don’t let attorneys tell you that the courts of a particular jurisdiction can back you into a corner…..look at the globe and you’ll see that it doesn’t have any corners!