We use a variety of special purpose entities (“SPE”) as firewalls to shield your asset from creditors. In this section we will explore the most effective SPEs for asset protection planning. Two of the most effective SPEs for asset protection are:
- the Domestic Asset Protection Limited Liability Company (DAPLLC) and,
- the Domestic Asset Protection Limited Partnership (DAPLP).
We will consider each one in turn.
Domestic Asset Protection Limited Liability Companies
The limited liability company is a relatively new form of business entity that combines the limited liability benefits of a corporation with the ease of operation of a partnership. It’s only been around since the 1970’s, so case law is still evolving. The LLC is referred to as a “Company.” The owners are called “Members” and the LLC is run by a “Manager” who directs its business affairs.” The Manager can be a Member or a non-Member.
In general, neither the Manager nor the Members are liable for the debts of the Company. The Member’s sole risk is their capital investment in the Company. If the Company makes money, they make money. If it loses money, the most they can lose is the capital investment they made in the Company. Profits and losses are usually incurred in proportion to the Member’s ownership interest in the LLC.
Depending on the state in which the LLC is formed, a Member’s ownership interest in the Company can be protected from creditor attack. For example, here in Florida, a creditor of a multi-member LLC is limited to a charging order (hyperlink) against a Member’s interest in the Company as means of collecting on its judgment. In other states, the creditor also has a right of foreclosure, which means the creditor can seize the member’s ownership interest in the Company.
Because Managers and Members have no personal liability for the debts or liabilities of an LLC, it can be an ideal entity to hold high risk assets (such as real estate) or to conduct a business.
The benefits of the limited liability company are similar to the benefits of a limited partnership. Considering their similarities, some lawyers recommend using an LLC for asset protection purposes, while others prefer the limited partnership form of entity.
The difference between an ordinary LLC and a DAPLLC lies in the governing documents drafted and the choice of law selected by the asset protection attorney. There are many different types of LLCs, and their legal structure will reflect the purpose for which it is formed. Most LLCs are formed to operate a business, with no consideration or provisions made for asset protection. The DAPLLC, however, is a highly specialized entity that is formed for one reason and one reason only –asset protection.
The difference between a business LLC and a well-crafted DAPLLC is like night and day. For example, a butterknife and a surgeon’s scalpel are both “knives.” However, no doctor would ever consider using a butterknife to operate on a patient, and no normal person would use a scalpel to butter toast.
The level of asset protection provided by the DAPLLC will depend on its governing document (called an operating agreement). Does the operating agreement contain all the anti-creditor provisions and all the asset protection provisions that are available under the law? Has the correct jurisdiction been selected? Has the operating agreement been customized to meet the specific asset protection needs of the client? Ultimately, the quality and effectiveness of the DAPLLC will turn on the creativity, competency, and attention to detail of the attorney creating the agreement.
Limited Partnerships have been around for more than 100 years and there is a robust body of case law that can be relied upon to design an effective asset protection plan. Limited partnerships have two classes of partners – the General Partners and the Limited Partners. LP’s can be used for investment purposes asset or to conduct a business. General Partners make all the decisions on behalf of the limited partnership. They decide what investments the limited partnership will make, when distributions will occur, and control all other business decisions. An individual can be both a general partner and a limited partner and can hold an ownership interest as one or both.
Limited Partners are silent partners for the most part because they have very little say in the management or control of the partnership. Like Members of an LLC, Limited Partners sole risk is their capital investment in the partnership. Profits and losses are usually incurred in proportion to their ownership interest in the partnership.
General Partners, however, are personally liable for all of the partnership’s debts, liabilities and obligations. For this reason, one should never act as a General Partner in their personal name. Rather, one should set up an LLC to act as the GP. By using a GP/LLC, one can effectively shield themself from personal liability. Another alternative would be to have the limited partnership elect to be treated as a “limited liability limited partnership” (“LLLP”). In an LLLP, the General Partner is not personally liable for the partnership’s debts and obligations. Florida law allows for a limited partnership to elect to be treated as an LLLP.
As with the case of LLCs, the level of asset protection provided by the DAPLP will depend on its governing document (called the limited partnership agreement). Does the limited partnership agreement contain all the anti-creditor and asset protection provisions that are available under the law? Has the correct jurisdiction been selected? Has the operating agreement been customized to meet the specific asset protection needs of the client? Again, the quality and effectiveness of the DAPLP will turn on the creativity, competency, and attention to detail of the attorney creating the agreement.
Using LLCs and Limited Partnerships for Asset Protection
LLCs and limited partnerships are well suited to hold various assets and shield one’s wealth from creditors if formed in charging order protected states. For example, here in Florida one’s ownership interest in an LLC or a limited partnership cannot be taken by a creditor to satisfy their judgment. In Florida, a judgment creditor cannot foreclose your ownership in an LLC or limited partnership, nor go after any assets, bank accounts, real estate, etc. that is titled in the name of the LLC or the limited partnership. Provided the governing documents of the LLC or the limited partnership are properly drafted, a creditor has no right to interfere with the management of the entity, inspect its financial records, or force a distribution of assets.
In Florida and in some other states, a judgment creditor’s rights are limited by statute to what is called a charging order (sometimes referred to as a “charging lien”) against your ownership interest in the LLC or the limited partnership. While a charging lien will allow a creditor to intercept a payment or distribution of assets from the LLC or the limited partnership to the judgment-debtor, the creditor cannot force the entity to make such a distribution. Provided the governing documents are properly drafted, the General Partner or Manager will have the sole and exclusive discretion over whether and when to make distributions and can withhold distributions to frustrate a judgment creditor holding a charging lien against the debtor’s ownership interest in the entity. If no distributions are made, the judgment creditor receives no payments towards its judgment. All the judgment-debtor’s assets and undistributed income remain protected behind the legal walls of the LLC or limited partnership fortress.
Single Member LLCs in Florida
In some states, single-member LLCs enjoy the same charging order protection as multi-member LLCs. Unfortunately, in many states they do not. Further, the national trend seems to favor denying single-member LLCs charging order protection. In 2011, Florida’s legislature amended the law to permit creditors to use foreclosure and other means of collection against a debtor’s interest in a single-member LLC. The change in law also made clear, however, that charging liens are the sole and exclusive remedy against a debtor’s membership interest in a multi-member limited liability company.
Under the 2011 law, if a creditor can establish that its judgment will not be satisfied within a “reasonable time” from a charging lien against a single-member LLC membership interest, the creditor will be allowed to foreclose that ownership interest. Therefore, good practice dictates that one should only use a multi-member LLC for asset protection purposes, or if that is not possible, then to use a multi-layered asset protection structure. How much of the LLC should the second member own? We do not have a court case yet that addresses that question, but most attorneys seem to agree that it should be 5% or more.
Corporations may be a good choice to set up a business, but they are not a good choice for asset protection. The reason is simple. With very few exceptions, state statutes around the country provide that ownership of stock in a corporation will not enjoy charging order protection. That means that stock can be easily seized by creditors to satisfy a judgment. As a result, if one still needs to use a corporation for business or tax reasons a multi-layered asset protection structure should be used to protect those shares from creditor seizure.
The Domestic Asset Protection Trust (“DAPT”) is an irrevocable trust that allows the settlor (YOU – the creator of the trust) to also be both the trustee and a discretionary beneficiary of the trust. It is relatively new type of trust that has been created by statute and has been adopted in a handful of states. Generally speaking, an irrevocable trust is a powerful asset protection tool because once an irrevocable trust is created and the assets are titled into the trustee, you no longer own the assets. They are owned by the trust. If you get sued, your creditors cannot touch the assets in the trust.
Prior to the statutory creation the DAPT, the settlor (YOU) could not be both the trustee and a beneficiary. Therefore, once you transferred your assets into the trust, you no longer had any right to use or enjoy those assets (However, see SPA Trusts (hyperlink) and International Trusts (hyperlink)). They were gone forever. The DAPT was created and adopted by several states to help compete with International Trusts by addressing this problem. The DAPT allows the settlor (or creator) of a trust to also be a discretionary beneficiary.
While this trust sounds good in theory, we do not recommend that it be used for asset protection. This is because most states do not recognize the DAPT as an irrevocable trust, and permit creditors to seize the assets of the trust if you are also a discretionary beneficiary.
Recent litigation around the country has highlighted this problem. Unless you are domiciled in a state that has adopted a DAPT statute, have all your assets in that state, do not engage in business outside of that state, and do not travel outside that state (meaning there is no likelihood you will never be sued outside of that state), you should not use a DAPT for asset protection purposes.
Limited liability companies and limited partnerships are far better suited for asset protection planning.