Charging Order Protection
As you know, charging order protection is touted by many so-called asset protection experts as NIRVANA. This characteristic of Limited Partnerships and LLC’s is created by statute. In a nutshell: A creditor of a partner in a partnership is supposed to be limited to getting a charging order against the interest of the partner. As a result, the creditor cannot acquire the partnership (or LLC) interest of the debtor and therefore cannot acquire the assets of the partnership (or LLC). As a result, the creditor traditionally has to wait until the manager or general partner makes a distribution in order to get paid. Of course, in most cases, the manager or general partner has the authority to delay distributions. In the meanwhile, the creditor has to pay the tax which would normally fall on the debtor.
In short, if charging order protection works it is bad for creditors and good for debtors. It is also the justification that many asset protection experts use to charge thousands of dollars for what they call a “Family Limited Partnership” which is, in reality, nothing more than a plain old limited partnership with an extra word in its title and a big bill attached to it!
As regular readers of my newsletter know, I do not think charging order protection alone is solid asset protection. Early last year I wrote in a newsletter: Don’t count on Family Limited Partnerships alone to offer any asset protection. They used to be touted for their “charging order” protection; however, these days are long past. Charging order protection has been abused by every Tom, Dick, and Harry in the USA and now the courts are wise to the ploy. It simply doesn’t work reliably IF the partnership is set up after the bad act is done. In many cases, the courts are allowing the partnership interest to be foreclosed upon. The bottom line is that the system can only be abused so long and finally, it is payback time for every plastic surgeon who has bought the FLP ploy that his soon to be ex-wife won’t get to the dough IF he is “smart” enough to rely on an FLP. Remember, anything that sounds too good to be true probably is. If somebody tells you that your assets are protected by putting them into a partnership – DON’T BUY IT. You are being sold a bill of very stale goods.
Well, we have confirmation from a Federal Bankruptcy Court in Colorado. In a recent case, the Judge refused to limit a creditor’s remedy to that of a charging order. Instead, the court allowed the creditor to seize the debtor’s interest and then sell the assets of the LLC (the analysis is the same for a partnership) to pay the debts of the former member. The Judge wrote “The charging order, as set forth in …the Colorado Limited Liability Company Act, exists to protect other members of an LLC from having involuntarily to share governance responsibilities with someone they did not choose, or from having to accept a creditor of another member as a co-manager. A charging order protects the autonomy of the original members, and their ability to manage their own enterprise. In a single-member entity, there are no non-debtor members to protect. The charging order limitation serves no purpose in a single-member limited liability company because there are no other parties’ interests affected.”
The bottom line: SINGLE Member LLC’s don’t offer any asset protection.
That’s the bad news. The good news is that the Judge did note that the charging order protection would have applied if the case had involved “a passive “member with minimal interest.” So, it is now CLEAR that single-member LLCs don’t offer any protection and MULTIPLE member LLC’s MAY offer to charge order protection. Don’t count your chickens yet though. There are many cases where MULTIPLE member LLC’s and partnerships have been found to not offer to charge order protection. This is normally in cases where the entities were clearly formed to deter a known creditor. The second bottom line: DON’T COUNT ON CHARGING ORDER PROTECTION ALONE. It is nice if it works; however, it doesn’t always work. This is the reason that I normally have partnerships or LLC’s pour into a solid asset protection trust if serious attack looms. Don’t count on LLC’s or partnerships ALONE to protect your assets.
If you would like more information regarding asset protection, trusts, family limited partnerships or the subject of this article please call or email our office.