Issues about Asset Protection

Much has been written about the asset protection benefits of the Family Limited Partnership (FLP) and the Limited Liability Company (LLC). It has been seen that these structures produce consistent success. However, if the FLP is not correctly designed or administered, or if ownership of the interests is not properly protected, asset protection goals would be in jeopardy.

In some states, there are laws that limit a creditor of a partner or member to a “charging order” which isn’t a very useful remedy for most plaintiffs. However, in many states, a creditor is allowed to “foreclose” on a partnership or LLC interest. This “foreclosure” is a seizure of the debtor’s interest, and that could be a powerful weapon for the plaintiff. An FLP and/or LLC can be useful within the context of a larger plan. But, every plan involving an FLP or an LLC has to protect ownership interests with a trust designed for that purpose.

In a recent case, 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 wasn’t any reason in limiting the ability of a creditor to reach the assets of the LLC.

As a result, in order 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 needing single-member status for tax purposes, a Grantor Trust may be designated as the second member.

Once again, the FLP or LLC interests should not be held directly by the individual client. For those in a high liability business or having great wealth, the interests should be owned by a trust to protect against potential charging orders, foreclosure or even from an argument that the entity is the other half of the founder. You can’t gamble with the effectiveness of an asset protection plan. The only viable strategy is a specially designed trust arrangement in providing sufficient “distance” between the client and the FLP or LLC assets. You have to ensure that the plan is able to withstand whatever degree of scrutiny that is applied.

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Family Limited Partnerships

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