Case Example #1

Mrs. Drake was a seventy-five-year-old widow. She sold a duplex she had owned in California for many years for $200,000 and used the money-her life savings-to move to Arizona and buy a condominium. Her only income was Social Security payments of $1,200 per month, which she used to pay her living expenses.

Three years after the sale, the real estate market in California collapsed and the value of the duplex dropped by half. That shouldn’t have mattered to Mrs. Drake since she had sold the property three years earlier. The new buyer was just unlucky when he lost his equity in the property.

But that’s not how it works anymore. The buyer sued Mrs. Drake in California claiming that she had failed to disclose defects in the property. None of these allegations were true. The reality was that the buyer had lost money when the market declined and he wanted it back. So he asked the court to rescind the sale contract-meaning that he wanted his $200,000 back plus interest.

The lawsuit placed Mrs. Drake in a terrible position. To defend the case she would have to hire an attorney-and these types of cases are very expensive. She was told that legal fees to defend her would run from $25,000-$50,000-money she clearly could not afford. The buyer’s attorney, on the other hand, was handling the case on a contingency-so the buyer really had no cost and nothing to lose by pursuing the lawsuit.

Rather than risk losing her home and the rest of her savings and knowing that the litigation costs alone could wipe her out, Mrs. Drake settled the case for $70,000. She borrowed the money against the equity in her condominium and she now uses most of her Social Security check to make the monthly mortgage payment. Instead of a comfortable retirement enjoying her life, she lives a spartan existence, barely surviving each month.

What did she do wrong? She sold her property at the top of the market. She should be rewarded for her good business sense. Instead, because she was an easy and a vulnerable target, the buyer and his lawyer managed to extort most of her life savings.

What should she have done? The outcome of the case would likely have been different if she had used an LLC with protected membership interests (or a Personal Residence Trust) to hold her Arizona condominium. The lawyer for the buyer would have determined that her assets (the condominium) were unreachable, and without funds to pay a judgment, Mrs. Drake would not have been an attractive defendant. Additionally, with the proper advance planning, even if Mrs. Drake had been sued by the buyer—and if she had lost—her home would have been shielded from the judgment. Legal protection for assets is a plan that usually defeats these types of extortion attempts.