Ownership by Spouses

The first alternative is that H and W (or a single individual) hold all or most of the limited partnership interests. The apparent advantage of this arrangement is that it is attractive and convenient. Control is maintained through the General Partnership and equity is preserved through the ownership of the limited partnership interests. This arrangement is generally consistent with the goals of H and W not to part with assets in any meaningful way. The disadvantages of this format are that the interests retained by H and W are subject to a charging order or may be seized by a successful creditor, eliminating any intended asset protection benefits. This remedy is known as a foreclosure and may be particularly powerful in the hands of a knowledgeable plaintiff.

Foreclosure of FLP Interest
We have previously discussed the fact that a judgment creditor of a partner can obtain a charging order against the debtor’s partnership interest. The charging order gives the debtor a right to any distributions from the partnership to the debtor partner and remains in effect until the creditor has been paid in full or until the time limit for collecting the judgment has expired (usually 20 years)  

In addition to the charging order remedy, most states allow a creditor to foreclose on the debtor partner's interest. (Hellman v. Anderson 233 Cal. App. 3d 840; California Corporations Code 17302 (Foreclosure of LLC interests)). A foreclosure means that the court allows a seizure and sale of the debtor's partnership interest. Although the purchaser of the partnership interest may be restricted in the exercise of any management rights, he would be entitled to the debtor's share of distributions without regard to the amount of the judgment. 

For example, a Husband and Wife form an FLP with property worth $1 million. Some years later there is a judgment against the couple for $200,000. If the creditor's remedy is limited to a charging order, he would be entitled to distributions equal to the amount of the judgment. When and if he is paid this amount (plus interest) the creditor's judgment is satisfied. A creditor who is permitted to foreclose on the partnership interest gets more than that. He is legally entitled to distributions without regard to the amount of the judgment. He could ultimately get paid the full $1 million of value.

The timing and fact of any distributions will be subject to legal maneuvering and tactics, but the possibility of a potentially disastrous result must be carefully considered. Further, the mere existence of the foreclosure remedy dramatically increases the negotiating leverage of the plaintiff in any situation in which the value of FLP assets exceeds the amount of the judgment. The threat of a foreclosure by a knowledgeable plaintiff alters the relative bargaining position of the parties by raising the specter of a loss for the defendant beyond even the amount of the judgment. Pre-litigation and pre-trial negotiations would be impacted by the possibility of a remedy that could cost the defendant more than the amount of a potential judgment. The defendant in this situation would have to liquidate the FLP, if possible (unwinding the asset protection plan) or would be forced to settle on the most unfavorable terms.

In light of these potential problems, we can conclude that ownership of FLP interests (or LLC interests) in an unprotected form by an individual, Husband and Wife, or a living trust, creates significant danger and risk of foreclosure and loss. In some circumstance that amount of the loss may even exceed the amount of a potential judgment. 

The crucial element of asset protection planning is creating the proper strategy to hold interests in an FLP, LLC, corporation or any other entity in the structure.