Recent Developments #1

Recent Developments – Asset Protection Issues

Family Limited Partnerships and Limited Liability Companies

Since 1986 we have written about and discussed the asset protection benefits of the Family Limited Partnership (FLP) and, the then new, Limited Liability Company (LLC). By now we’ve had considerable experience with these plans and have seen these structures produce consistent success. But, if the FLP is not correctly designed or administered, or if ownership of the interests is not properly protected, asset protection goals will be jeopardized.

In some states, the law still limits a creditor of a partner or member to a “charging order” which will not be a useful remedy for most plaintiffs. However, in many states, a creditor is permitted to “foreclose” on a partnership or LLC interest. A “foreclosure” is a seizure of the debtor’s interest and that is a very powerful weapon for the plaintiff.  (See e.g. Hellman v. Anderson, 233 Cal. App. 3d 840; California Corporations Code Section 17302 (Foreclosure of LLC interest))  An FLP and/or LLC can be useful within the context of a larger plan. But, every plan which involves an FLP or LLC must protect ownership interests with a trust designed for that purpose.

A recent case in the U.S. Bankruptcy Court affirmed that a creditor of a single member LLC would have rights beyond the charging order remedy, Since there was no other member to protect, there was no reason to limit the ability of a creditor to reach the assets of the LLC. In Re: Ashley Albright, U.S. Bankruptcy Court for the District of Colorado (Decided April 4, 2003)

As a result, to protect the assets of a particular LLC against outside liabilities, there must be more than one legal owner of a membership interest in an LLC. For those who need single member status for income tax purposes, a Grantor Trust may be designated as the second member.

Stated again for emphasis, the FLP or LLC interests should not be held directly by the individual client. For those in high liability businesses or who have significant wealth, the interests should be owned by a trust to protect against a potential charging order or foreclosure or even from an argument that the entity is the “alter ego” of the founder. We cannot gamble with the effectiveness of an asset protection plan. The only viable  strategy is a specially designed trust arrangement to provide sufficient “distance” between the client and the FLP or LLC assets. We must insure that the plan is able to withstand whatever degree of scrutiny is ultimately applied.