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Delaware Bank Accounts for Asset Protection Not a Silver Bullet

Apr 17 2015

Article Written for : bizjournals.com
As the story goes, John D. Rockefeller was getting his shoes shined when the shoeshine boy, not knowing whose shoes he was shining, started offering stock tips.

That was Rockefeller’s cue to turn bearish on the stock market. "Secret" tips lose their efficacy when no longer secret.

While speaking at a recent seminar, we received several questions from CPAs and financial professionals about the use of Delaware bank accounts to protect cash. The questions reflect a national trend to use Delaware accounts for "asset protection."

Delaware law exempts banks and other financial institutions in Delaware from attachment and garnishment. Attempts by creditors to circumvent the law have been met with resistance in Delaware.

In a 1986 case (Delaware Trust Co. v. Partial), a judgment creditor who apparently understood that garnishment was prohibited against banks, tried to freeze a debtor's Delaware account by seeking a temporary restraining order prohibiting the bank from releasing funds. The court considered the order the functional equivalent of a garnishment and denied the request. The court explained that any order restricting the bank from releasing funds would violate Delaware’s "clear legislative policy exempting banks from garnishment."

For desperate debtors subject to a collection action, keeping cash in a Delaware account may offer some added protection; however, it should not be considered a substitute for well­conceived personal planning. Although Delaware banks are exempt from garnishment, nothing prevents a motivated and well­funded judgment creditor from issuing a subpoena to discover information regarding a debtor’s deposits (even knowing they can't be garnished).

A judge outside of Delaware, but with the debtor sitting in his court and intending to see a judgment enforced, may enter an order directed toward the debtor that practically eviscerates the effectiveness of the Delaware restriction. This is precisely what happened in one recent case in the Federal District Court in Orlando, Fla., last year.

In Travelers Casualty and Surety Company of America v Design Build Engineers & Contractors Corp. et al., a judge ordered a defendant with a well-­funded Delaware bank account (but, presumably, little other exposed assets) to post a cash bond with the court as collateral while a lawsuit was pending over certain indemnity agreements.

The facts of the case were the type likely to draw ire from the judge. Travelers sold a surety bond to Design Build Engineers and Contractors Corp., which subsequently got into a dispute over performance of two construction contracts insured by the bond. Travelers ultimately paid nearly $1.5 million to settle the two claims. Under certain indemnity agreements executed in connection with the bond, Design Build’s principals, Mr. and Mrs. Thompson, were required to deposit collateral with Travelers to cover the losses. When they failed to do so, Travelers sued. Then it got interesting.

Facing the lawsuit, the Thompsons formed several LLCs into which they transferred certain properties. Transfers of this type are the reason fraudulent transfer laws exist. Once transferred, two of the properties were sold for about $1 million and the proceeds were used to pay down the Thompsons’ Florida home mortgage. The Thompsons kept all the leftover cash in a Delaware bank account. Travelers sought an injunction requiring the Thompsons to post collateral as required by the indemnity agreements.

The Thompsons’ attorney made the right arguments. First, injunction is an extraordinary remedy intended to prevent irreparable harm that cannot be repaired with money damages. Though unpleasant, the mere loss of money can be remedied by a money judgment and is not recognized, in the legal context, as irreparable harm. Indeed, requiring a party to deposit money with the court would appear to be precisely the type of relief not permitted by an injunction. Additionally, the U.S. Supreme Court stated, in the 1999 case of Grupo Mexicana d Desarrollo S.A. v. Alliance Bond Fund, Inc., that unsecured creditors generally may not freeze assets prior to entry of a judgment. The Thompsons may also have argued that the court had no jurisdiction over the Delaware accounts and could not enter an order with respect to those accounts.

In any event, the court was not persuaded and ordered the Thompsons to post a collateral bond with the court amounting to nearly $1.5 million. In doing so, the court said, “While posting bond may be unpleasant to the Defendants, they will not be harmed by the requirement that they abide by the terms of their agreement.” The ruling stretches the boundaries of applicable law. Although Travelers was entitled to demand collateral under the contract, once the Thompsons failed to comply, the contract remained, on its face, an unsecured contract for money damages. A prejudgment injunction should not be used to magically transform an unsecured contract into one that is collateralized based solely on a claimed breach; otherwise, every contract for money damages may potentially be transformed into one where the posting of cash security is deemed to be fair and equitable relief.

The practical effect of the order places the Thompsons in a precarious position. They can rely on Delaware’s unique garnishment restriction (coupled with Florida’s constitutional homestead protection) to protect their home and cash from being taken directly; however, if they fail to voluntarily make those assets available as collateral, they risk being held in contempt of court. With contempt can come all sorts of horrible effects such as fines and incarceration.

The moral of this story is that reactionary transfers intended to desperately protect assets provide a platform for a court to order extreme remedies. As the Travelers court explained last year, the basis for the order was “supported by Defendant’s efforts to shield assets from Travelers’ lien claims by transferring assets to LLCs controlled by the Defendants.” Clearly, the court was not impressed with the Thompsons’ twelfth-­hour transfers.

Would the result have been different had the Thompsons engaged in the same protective transfers two years before the start of the lawsuit, instead of two weeks after? We think so. The effectiveness of asset protection planning is highly dependent upon timing. And, as the Travelers case shows, gambits such as reliance upon Delaware’s now ­popular banking statutes or Florida’s ultra ­protective homestead laws pale in protective comparison to well­ conceived protective planning.

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Forster & Boughman

Co Authors 
Gary Forster & Eric C. Boughman

Gary is the author of two books. In 2013, he wrote Asset Protection for Professionals, Entrepreneurs and Investors, a guide to asset protection strategies for clients and their financial advisors, now in its second edition. This year Gary finished the first edition of The U.S. Estate and Gift Tax and the Non-Citizen. This new book explains how resident and non-resident foreign nationals are impacted by the U.S. Estate and Gift Tax.

Eric also volunteers as a Guardian ad Litem with the Orange County Legal Aid Society. He is rated AV – Preeminent by Martindale-Hubbell and regularly publishes articles and makes presentations in the areas of asset protection and real estate law.

We cater to the professional, entrepreneur and investor seeking customized domestic and international asset protection strategies.

Our firm also analyzes potential exposure to individuals and businesses and provides strategies to insulate vulnerable assets.

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