Equity Stripping

“Equity stripping” is a relatively new term in asset protection law describing an old asset protection planning technique.  Equity stripping refers to pledging a non-exempt asset as security for a money loan.  In most cases, the debtor obtains a loan from a commercial bank and secures the loan with a mortgage or lien on the non-exempt assets he wants to protect.  The bank records the security instruments which gives the bank’s security interest priority over judgments subsequently obtained by other creditors.  In order for these other creditors to attack the encumbered asset, they would first have to pay off the amount of the lender’s secured loan.  Pledging a valuable non-exempt asset to secure a new loan essentially drains the equity from a non-exempt asset and permits the debtor to move the equity beyond the reach of creditors.  Exempt assets, such as Florida homestead or retirement plan, should not be pledged to borrow new money because these assets are already protected from creditors, and cash obtained from a loan secured by an exempt asset may become unprotected.

Equity stripping is a useful asset protection tool in different types of situations.  Business owners or professionals often have large accounts receivable or valuable equipment which cannot be assigned or titled in other names.  Banks which give lines of credit almost always ask for a first secured position on a business’s receiveables and equipment because these are the most liquid and valuable business assets.  The bank’s security interest is established and recorded when the line of credit is established even though no money is lent to the debtor.  The business can borrow money on the line of credit if and when it perceives a legal problem.  Money borrowed through a line of credit is not protected from creditors, and the business must find other means to protect the borrowed fiunds such as distributing money borrowed to the business owners to pay principal on their homestead mortgage.

Individual debtors also find that encumbering non-exempt assets is a useful tool. For example, a person who moves to Florida to take advantage of Florida’s liberal exemptions can bring with him personal property, but he cannot transport real property owned in the original state.  Many new Florida residents will mortgage their existing home in another state and use the mortgage proceeds to purchase a Florida homestead.  Another example is a real estate investor who owns multiple properties with equity.  Changing title to multiple properties involves expenses of setting up new legal entities and substantial transfer taxation.  An alternative is to buy new properties with loans cross-collateralized by presently owned properties which are otherwise unprotected.

A general advantage of equity stripping is its defense against claims of fraudulent conveyance.  Pledging assets for newly borrowed funds provided by unrelated third parties, many of whom are commercial institutions, is a common business practice which can be justified many ways other than as an intentional asset protection device.

Jon Alper

About Jon Alper

Jon is an attorney focusing on bankruptcy and asset protection in Orlando, Florida.