Asset Protection is a method of arranging and organizing assets for protection against attacks from lawsuits, judgment liens and creditors. Asset protection involves many new concepts for you and your family.
1. Right Business Entity Choice
A professional practice or the business you own can be a magnet for litigation. Every patient, client, and customer can file a lawsuit that will can threaten your savings and assets that you have worked so hard to accumulate.
1.1. Limited Liability Company. Under most state laws, a Limited Liability Company (LLC) is generally a convenient and flexible business format. The LLC avoids many of the tax problems, double taxation and the maintenance expenses associated with corporations. Generally, the law protects the personal assets of the owners of the company from liability produced by the business.
1.2. Use LLC, Corporations and FLP. In most states, physicians and some other licensed professionals cannot shield themselves from liability with either an LLC or a corporation. In order to protect the family home and savings, an alternative route is needed. If you can't limit your personal exposure to claims, use a strategy such as a Family Limited Partnership (FLP), an LLC, or a trust, which will protect the assets themselves. That way, even though you can be sued-it won't be worthwhile for the plaintiff to do so.
1.3. Professional Practices. A professional practice that cannot be formed as an LLC should be incorporated. Although the corporation does not offer protection from malpractice claims, it can protect the owners personal assets from many other types of business risks. Generally, when you use a corporation, you are not responsible for corporate obligations unless you have given your personal guarantee. In addition, you will be shielded from most types of claims from employees, suppliers, and landlords.
1.4. Corporation as a Partner. If you have other partners in your professional practice, you can limit your liability for claims arising from their negligence by separately incorporating your practice. Your corporation would be a partner with each of the other corporations and you would not be responsible for claims against the others.
1.5. S-Corporation. Since a corporation is a taxpaying entity, you will have to plan for eliminating a potential double tax on corporate earnings. This can be accomplished by using an S Corporation or by zeroing out corporate income through salaries to officers. To ensure that the corporation will be respected for legal and tax purposes, the corporate formalities of minutes, bylaws, and stock certificates must be observed. All of your dealings with third parties should be conducted in the corporate name, and a separate corporate bank account must be used.
2. Avoid Business Partnerships and General Partnerships
Never enter into a business partnership with anyone. General partnerships can produce unlimited liabilities for you which are totally unexpected and not your fault. As a co-general partner you are responsible for all partnership debts and any negligent acts of your partners. A business partnership expands the scope of your personal liability when you should limiting your risks.
3. Never Give Personal Guarantee
A personal guarantee places all of your assets at the mercy of a particular business deal and you are undertaking a risk with odds much worse than those offered in most gambling casinos.
If you give a personal guarantee, then you will lose the protections of incorporating. Many of the problems which we see in our practice are caused directly by needless guarantees for corporate loans leases of unsuccessful business ventures.
3.1 Avoid Giving Personal Guarantees on a Lease. Generally, lenders or landlords may not require a personal guarantee if he or she can be persuaded that the business or proposed venture is sound. Today, lenders are anxious to make good loans, and landlords want to lease empty space. If you cannot convince them that your company is going to be successful and that they should rely solely on the business for payment, you should not enter into a deal with them.
4. Use Multiple Entities If You Have More Than One Type of Business
Use different entities to conduct each facet of the business. The goal is to protect each separate business from liabilities produced by the other activities of the other businesses.
Physicians operating more than one clinic should never hold ownership in a single entity. Similarly, if you own several real estate properties, use different entities to hold each one. If there is a lawsuit in connection with one of the properties, the others won’t be endangered. The same logic would be applied if you owned properties and also performed property management services for others. You would want to separate the management business from the ownership of the properties.
As a general principle, the ownership of an asset with a high risk of producing liability, should always be separated from Safe Assets, such as cash or securities. These Safe Assets should not be jeopardized by a liability associated with your business or other Dangerous (high risk) Assets which you own.
For example, a restaurant owner had substantial retirement savings in the bank. If he was sued because of a liability in connection with the restaurant, his retirement savings could be lost. Instead, merely by putting the restaurant in an LLC, we removed the Dangerous Asset from his legal ownership. Then, any lawsuit against the LLC, which owned the business, would not place his other assets at risk.
5. Estate Plan Avoids Probate
Without an estate plan, your assets, business, home, cash and savings can be frozen until the probate procedure has been completed. In many states, the probate procedure can take two or more years. In addition, the cost of probate can be very high.
5.1 Revocable Living Trust
Property in a trust is not subject to probate fees and delays. Trust assets pass instantly to designated family members. A revocable living trust is a popular format for avoiding probate and carrying out basic estate planning strategies.
5.2 Limited Term Trust
Property can be placed in trust for a designated term of years. The support or educational needs of a child or other family member can be satisfied from trust income or principal. Assets can be protected from potential claims during the period of the greatest liability. The property can be returned to you for retirement or other needs at a later period in your life-when you are no longer working and your liability concerns are diminished. One good strategy is to place FLP limited partnership interests in this type of trust.
5.3 Irrevocable Life Insurance Trust
Insurance is used to provide adequate funds for family living expenses; cash to meet business liquidity needs and necessary amounts to pay estate taxes-without a loss of accumulated savings. To avoid estate taxes of up to 55 percent on the insurance proceeds, a Life Insurance Trust must be used to hold the policy. Amounts transferred into this plan have the added advantage of building cash value free of income tax and fully protected from any lawsuits or claims against you.
5.4 Estate Freeze Trust
Investments that are likely to appreciate in value should be moved into the Estate Freeze Trust. Real estate, stocks, and ownership in a new business venture are often used to fund these trusts. Amounts up to the exemption amount can be transferred without gift tax. This amount plus future increases in value-perhaps millions of dollars-can escape taxation with the proper planning.
5.5 Personal Residence Trust
Your largest source of savings may be the equity in your home. A loss would be disastrous from an emotional as well as a financial standpoint. You need to protect your home-but at the same time preserve the tax benefits of the mortgage interest deduction and the ability to avoid gain on the sale. The Personal Residence Trust is an excellent technique for accomplishing asset protection without losing the unique tax advantages of home ownership.
5.6 Privacy Trust
Privacy for what you own may be an important issue to you. When others can easily locate your bank accounts and real estate, dangers are created. Lawsuits and claims against you are encouraged when you hold property in an accessible and unprotected form. A Privacy Trust can be created which will allow you to hold bank and brokerage accounts and real estate without revealing your ownership. You can control the information about yourself which is available to others. The Privacy Trust can be combined with a Family Limited Partnership or LLC to satisfy asset protection as well as privacy concerns.
5.7 Offshore or Asset Protection Trust
The Offshore or Asset Protection Trust (
6. Discourage Lawsuits
A Family Limited Partnership (FLP) will provide you with four significant advantages that cannot be obtained through any other vehicle. The first advantage is that the FLP can discourage lawsuits. Assets that are protected in the Family Limited Partnership cannot be seized by a judgment creditor. It is unlikely that someone will want to sue you if they do not believe that they will be able to collect a judgment.
7. Save Income Taxes
With state and federal combined tax rates of 50 percent, overall family income taxes may be reduced by shifting income to lower bracket family members. This can be accomplished by gifting some limited partnership interests to children or grandchildren who are fourteen years or older. Depending upon the number of beneficiaries and the amounts involved, over a period of years the total savings can be quite substantial.
Aggressive tax planning with the FLP often includes a nonprofit organization as a partner in the FLP. Properly designed, significant tax savings can be generated and overall family wealth can be increased with this structure.
8. Save Estate Taxes
Limited partnership interests that are transferred by gifting to children or other family members, will not be included in your estate for estate tax purposes. A small percentage could be transferred each year which would not be subject to gift tax under the annual exclusion of $12,000 per donee. Greater value, up the exemption amount, could be transferred for additional savings. The amount of the gift plus appreciation of the underlying assets would escape estate taxes. An estate of $2 million can grow to $15 million or $16 million-invested at 7 percent per year, for someone in their early or late 40s. Potential estate taxes of $8 million can be avoided-with no inconvenience or loss of control. Under current law, the value of the interests transferred will be discounted in value to account for the lack of marketability and control. Significant estate tax savings can be generated by taking advantage of this technique.
9. Protect Assets
The most valuable feature of the Family Limited Partnership is the ability to protect and shield assets from potential claims. The law is well-established that a creditor of a partner is not permitted to seize assets of the partnership to satisfy the debt. That means that business interests, savings, and investments may be safely insulated from potential liabilities in this manner. This excellent result will not be accomplished if a creditor is able to obtain a charging order, foreclosure or seizure of your ownership interests in the FLP. Limited Partnership interests should be held by children, or trusts specifically designed for ownership purposes. This technique will preserve and may significantly enhance the available level of asset protection.
LLC & ASSET PROTECTION
(a) If family LLC, then can say no assignability
A Charging order, in English law, is an order obtained from a court or judge by a judgment creditor, by which the property of the judgment debtor in any stocks or funds or land stands charged with the payment of the amount for which judgment shall have been recovered, with interest and cost
§ 708.310 OF THE
If a money judgment is rendered against a partner or member but not against the partnership or limited liability company, the judgment debtor’s interest in the partnership or limited liability company may be applied toward the satisfaction of the judgment by an order charging the judgment debtor’s interest pursuant to § 15673, 16504, 17302 of the California Corporations Code.
Summary: If a money judgment is rendered against a partner but not against the partnership, the judgment debtor’s interest in the partnership may be applied toward the satisfaction of the judgment by an order charging the judgment debtor’s interest pursuant to Section 15029 or 15673 of the Corporations Code
§ 708.320 SERVICE OF NOTICE OF MOTION FOR ORDER CHARGING INTEREST AS CREATING LIEN ON INTEREST – DURATION.
On application to a court of competent jurisdiction by any judgment creditor of a partner, the court may charge the limited partnership interest of the partner with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of the limited partnership interest. This chapter does not deprive any partner of the benefit of any exemption laws applicable to the partner's limited partnership interest.
Summary: On application to a court of competent jurisdiction by any judgment creditor of a partner, the court may charge the limited partnership interest of the partner with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of the limited partnership interest
(a) A limited partnership interest is assignable in whole or in part. An assignment of a limited partnership interest does not dissolve a limited partnership or, other than as set forth in this chapter, entitle the assignee to become or to exercise any rights of a partner. An assignment entitles the assignee to receive, to the extent assigned, the distributions and the allocations of income, gain, loss, deduction, credit, or similar item, to which the assignor would be entitled. Except as otherwise provided in the assignment, an assignee of a limited partnership interest in a limited partnership with over 100 limited partners also shall be entitled to all of the rights granted to a limited partner pursuant to Section 15634. A limited partner remains a partner upon assignment of all or part of the limited partner's limited partnership interest, with the rights that the assignee does not acquire or possess, subject to the assignee becoming a limited partner pursuant to subdivision
(a) of Section 15674.
(b) The pledge of, or granting of a security interest, lien, or
other encumbrance in or against any or all of the partnership
interest of a partner shall not cause the partner to cease to be a
partner or to grant to anyone else the power to exercise any rights
or powers of a partner.
c) A partnership agreement may provide that a general partner may
not assign or encumber a partnership interest in a limited
Summary: An assignment of a limited partnership interest does not dissolve a limited partnership or, other than as set forth in this chapter, entitle the assignee to become or to exercise any rights of a partner. An assignment entitles the assignee to receive, to the extent assigned, the distributions and the allocations of income, gain, loss, deduction, credit, or similar item, to which the assignor would be entitled.
(a) On application by a judgment creditor of a partner or of partner's transferee, a court having jurisdiction may charge the transferable interest of the judgment debtor to satisfy the judgment. The court may appoint a receiver of the share of the distributions due or to become due to the judgment debtor in respect of the partnership and make all other orders, directions, accounts, and inquiries the judgment debtor might have made or that the circumstances of the case may require.
(b) A charging order constitutes a lien on the judgment debtor's
transferable interest in the partnership. The court may order a
foreclosure of the interest subject to the charging order at any
time. The purchaser at the foreclosure sale has the rights of a
(c) At any time before foreclosure, an interest charged may be redeemed in any of the following manners:
(1) By the judgment debtor.
(2) With property other than partnership property, by one or more
of the other partners.
(3) With partnership property, by one or more of the other
partners with the consent of all of the partners whose interests are
not so charged.
(d) This chapter does not deprive a partner of a right under
exemption laws with respect to the partner's interest in the
(e) This section provides the exclusive remedy by which a judgment
creditor of a partner or partner's transferee may satisfy a judgment
out of the judgment debtor's transferable interest in the
(a) On application by a judgment creditor of a member or of a member's assignee, a court having jurisdiction may charge the assignable membership interest of the judgment debtor to satisfy the judgment. The court may appoint a receiver of the share of the distributions due or to become due to the judgment debtor in respect the limited liability company and may make all other orders, directions, accounts, and inquiries that the judgment debtor might
have made or that the circumstances of the case may require.
(b) A charging order constitutes a lien on the judgment debtor's assignable membership interest. The court may order a foreclosure on the membership interest subject to the charging order at any time. The purchaser at the foreclosure sale has the rights of an assignee.
(c) At any time before foreclosure, a membership interest charged may be redeemed in any of the following manners:
(1) By the judgment debtor.
(2) With property other than property of the limited liability company by one or more of the other members.
(3) With property of the limited liability company by one or more of the other members with the consent of all of the members whose membership interests are not so charged.
(d) This section does not deprive any member or assignee of a membership interest of the benefit of any exemption laws applicable to the membership interest in the limited liability company.
(e) This section provides the exclusive remedy by which a judgment creditor of a member or of a member's assignee may satisfy a judgment out of the judgment debtor's membership interest in the limited liability company.
Summary: On application by a judgment creditor of a member or of a member’s assignee, a court having jurisdiction may charge the assignable membership interest of the judgment debtor to satisfy the judgment.
(a) Except as provided in the articles of organization or the operating agreement:
(1) A membership interest or an economic interest is assignable in whole or in part, provided, however, that no membership interest may be assigned without the consent of a majority in interest of the members not transferring their interests, as required pursuant to Section 17303.
(2) An assignment of an economic interest does not of itself dissolve the limited liability company or, other than as set forth in the articles of organization or operating agreement, entitle the assignee to vote or participate in the management and affairs of the limited liability company or to become or exercise any rights of a member.
(3) An assignment of an economic interest merely entitles the assignee to receive, to the extent assigned, the distributions and the allocations of income, gains, losses, deductions, credit, or similar items to which the assignor would be entitled.
(4) Upon the assignment of all or part of an economic interest, the assignor shall provide the manager or member of the limited liability company responsible for maintaining its books and records with the name and address of the assignee, together with details of the interest assigned. Upon receipt of that notice, the limited liability company shall amend the list required by paragraph (1) of subdivision (a) of Section 17058 accordingly. Until the assignee of that interest becomes a member, the assignor continues to be a member and to have the power to exercise any rights and powers of a member, including the right to vote which, in the case of a member who has assigned his or her or its entire economic interest in the limited liability company, shall include the right to vote in proportion to the interest in current profits that the assigning member would have, had the assignment not been made.
(b) Except to the extent assumed by agreement, until an assignee of an economic interest in a limited liability company becomes a member, the assignee shall have no liability to the limited liability Company under Chapter 5 (commencing with Section 17200) and Chapter 6 (commencing with Section 17250) solely as a result of the assignment. The assignor of a membership interest is not released from liability as a member solely as a result of the assignment. (c) The pledge of, or granting of, a security interest, lien, or other encumbrance in or against any or all of the membership interest of a member shall not cause the member to cease to be a member or to grant to anyone else the power to exercise any rights or powers of a member.
(a)(1) A membership interest or an economic interest is assignable in whole or in part, provided, however, that no membership interest may be assigned without the consent of a majority in interest of the members not transferring their interests.
(a)(2) An assignment of an economic interest does not of itself dissolve the limited liability company or, other than as set forth in the articles of organization or operating agreement, entitle the assignee to vote or participate in the management and affairs of the limited liability company or to become or exercise any rights of a member.
(a)(3) An assignment of an economic interest merely entitles the assignee to receive, to the extent assigned, the distributions and the allocations of income, gains, losses, deductions, credit, or similar items to which the assignor would be entitled.
Note: If asset protection is the primarily or sole reason for setting up the limited partnership or the LLC, the partner/member may have nothing to lose by adding, in some form, the non-assignability language.
The author particularly favors granting a third-party manager approval rights over assignability and transferability of all interests, including economic rights. The downside of this practice would cause one to default to the standard charging order rules discussed above. The upside would deprive the creditor even from the right to receive distributions. This strategy will not work in
CHARGING ORDER CASES IN
Charging Order Cases
There are not a great many cases on charging orders, primarily for two reasons. First, many creditors fail to find the charging order to be a useful remedy, and seek to settle with the debtor rather than hoping to get a distribution out of the entity. Second, even when creditors pursue the charging order remedy, the charging order is granted by a trial court and is rarely appealed, so there are few published opinions. Many of the reported cases deal with the creditor’s ability to foreclose; most cases authorize the creditor to foreclose but restrict the buyer of the interest to the economic component of the interest. There are also some interesting outliers, readily demonstrating the degree of judicial imagination involved in statutory interpretation.
The California Supreme Court has affirmed that the charging order has replaced levies of execution as the remedy for reaching partnership interests. The two most interesting charging order cases out of
In Crocker, the court concluded that a partnership interest may be foreclosed upon if the sale of the interest does not violate the partnership agreement and the other partners consent to the sale. In Hellman, the court confirmed that foreclosure of the charged interest is authorized by the charging order statute, but disagreed with Crocker that consent of non-debtor partners is required. The court concluded that consent from other partners is not required because pursuant to the foreclosure sale the buyer receives only the economic interest in the partnership, but not voting or management rights. Consequently, the buyer will never have ability to interfere with the business of the partnership and inconvenience the non-debtor partners. Going even further, the Hellman court remanded the case back to trial court for a determination whether the foreclosure of the economic interest (limited as that interest may be) would unduly interfere with the partnership business.
In the only reported
In Deutsch v. Wolff, a
In Baker v. Dorfman, a
The magistrate’s ability to do anything but collect profits was later affirmed (with minor modifications) by the Second Circuit. By granting the receiver the ability to manage the LLC, the court certainly went far beyond
In a different
MAXIMIZING THE UTILITY OF THE CHARGIN ORDER
Maximizing the Utility of Charging Orders
Most partnership and operating agreements being drafted today provide that only the economic interest in the LLC may be assigned, but not the entire membership interest. This mirrors the uniform acts and the various state statutes.
A carefully drafted partnership or operating agreement can greatly enhance the charging order protection. As discussed above, the statutes allow partners and members to override the default statutory provision of assignability of interests. In most business dealings it would not be possible for practitioners to make LLC interests entirely non-assignable. Clients want to retain flexibility and ability to dispose of their LLC interests. However, in family settings, or for LLCs set up solely for liability protection purposes, it may be possible to either prevent assignability altogether or to limit it in such a manner so as to make the charging order remedy of little value to the creditor.
Because the charging order protection is predicated on the debtor’s continued ability to manage the entity and thus control distributions, the distribution clauses of partnership/LLC agreements become critical. If the agreement provides that all distributions must be made to the partners/members on a pro-rata basis, then distributions have to be made either to all partners/members or none. This means that if one partner/member is pursued by a creditor holding a charging order, protecting that partner/member would mean withholding distributions from all other partners/members of that LLC. Consequently, agreements should be drafted to deal with this potential problem.
One possible solution is to allow the general partner or the manager, in the partnership or operating agreement, to make distributions to all other members, and not the debtor-member. The author’s preferred solution, is to provide that the debtor vests in the distribution (i.e., cash and assets are distributable to the debtor) but instructing the general partner or the manager to withhold the distribution while the charging order is pending. This allows the entity to allocate taxable income to the creditor (following a foreclosure) without distributing cash to the creditor.
Pursuant to the uniform acts and most state statutes that allow foreclosure, prior to the foreclosure, the debtor may redeem its partnership/membership interest. The statute does not specify that the interest must be redeemed for fair market value. This leaves room for drafters to insert various favorable redemption provisions into the operating agreement, such as a poison pill.
A poison pill provision usually allows either the entity itself or the non-debtor partners/members to buy-out the debtor for a nominal amount of money. The poison pill has the effect of substituting the debtor’s interest in the entity with a nominal amount of cash, which limits the assets that a creditor can collect against. If the entity is established well in advance of any creditor challenges, when the partners/members do not know who will benefit from the poison pill and who will find it detrimental, it should be enforceable (although there are no cases on this point). Because the poison pill will kick in automatically, it should not be deemed a fraudulent transfer, although a challenge is likely. Poison pill provisions are usually limited to family-setting LLCs where the family members are on good terms with each other.
PRACTICAL TAKE ON CHARGING ORDERS
A Practical Take on Charging Orders
Charging orders generally allow debtors to retain control over partnerships and LLCs and determine the timing of any distributions. There are some exceptions to that general rule, particularly when the following facts are present: (i) there is a fraudulent transfer, and (ii) in the context of bankruptcy. It may be argued that single-member LLCs should also be deemed an exception to this general rule, based on the Albright case and the historical origin of charging orders. This author believes the Albright case to be an outlier, and in direct conflict with the charging order statutes of all states that have adopted single-member LLC provisions. Historical origin is also of little significance in this area. There is no need to interpret statutes that are very clearly drafted to apply to all LLCs.
Purchasing a foreclosed partnership interest may be foolhardy when the debtor, or a person friendly to the debtor, remains in control of the entity and can hold up the creditor’s share of distributions. This will lead to adverse tax consequences for the creditor.
As a practical matter, creditors rarely choose to pursue charging orders. A charging order is not a very effective debt collection tool. The creditor may find itself holding a charging order, without any ability to determine when the judgment will be paid off. Practitioners should remember that any uncertainty surrounding charging orders is uncertainty for both the debtor and the creditor. This uncertainty forces most creditors to settle the judgment with the debtor, on terms more acceptable to the debtor, rather than pursue the charging order remedy.
America has become the most litigous society in the world! Just read the paper or turn on the television, the our country is living through a litigation explosion with expanding theories of liabilities and outragious jury awards. What can an business persons and professionals do to help minimize one's vulnerability to law suits and judgments. The answer is Asset Protection.
ASSET PROTECTION IS NOT THE FOLLOWING:
ASSET PROTECTION PROVIDES
To achieve this goal, an attorney will combine business, estate, family planning, along with asset protection methods. However, asset protection does not deal with the secrecy of hiding assets, fraudulently transferring property or other fraudulant methods to avoid creditors. These methods, in most cases, can protect assets before liability is incurred, or these methods can make it very expensive for plaintiffs to file a lawsuit. These methods may not work for everyone. Please consult a lawyer if you can benefit from asset protection, and if so, which methods are best for your specific needs.]]>