Part Five | Asset Protection Planning from A-Z: 26 Things to Think About Before Jumping In

Prepared by Jeffrey Zaluda and Shannon B. Miloch

Kitchen Sink

Does one throw the kitchen sink into the asset protection mix? We generally counsel no.

For a client who is the perfect candidate for significant asset protection planning: the integrity of a plan is going to be called into question if the client is placing personal use assets such as a primary residence, cars, day-to-day bank accounts and the like into the entities created. The plan will be further questioned if the client is pulling funds out of the plan on a regular basis, particularly if there are few limits on the client’s ability to do so. A court may view the plan as a sham and take whatever steps it can to disregard the intended protections (much as the IRS views a donor’s ongoing use of a family LLC’s assets with a jaundiced eye for discount purposes).

Rather, the client should view the plan as a nest egg with a long view. The client should only place an amount of assets into the plan that, all things being equal, the client will not need for a period of years in order to support his lifestyle. Whether the nest egg should constitute 25%, 33%, 50% or more of a client’s net worth is largely dependent on the particular facts and circumstances, but it would typically not be advisable to place much more than 50% of the net worth into the plan unless other resources, such as a willing spouse or family trusts, are available to support the client’s needs.

The large majority of clients neither require nor desire complex structures. For most, a combination of tenancy by the entireties, retirement plans, transfers between spouses, and property and casualty insurance is appropriate and sufficient. Even in situations in which a more complex structure is appropriate, perhaps involving LLCs and various types of trusts, the client needs to understand how the plan works and his own responsibilities in making it work.

Remember: if a lawsuit arises, the client is going to be deposed and asked to provide documents with respect to the plan. It is essential that the client be comfortable answering any inquiries.

If a client does choose to place substantive assets into an asset protection plan, one way to prepare for ongoing management of risks and rewards of asset protection is to think of the client’s overall asset protection plan as a cargo ship. The ship is divided into many holds such that if a leak forms in one hold, the cargo in another will stay dry. It takes a pretty big crack to sink the whole ship. Likewise, one should not place all of their assets into a single vehicle, or hold. If a series of LLCs are utilized, and an uninsured loss occurs with respect to the assets held in one LLC, the assets held in another should not necessarily be at risk. Accordingly, the use of multiple planning vehicles is often recommended and effective.

Limited Liability Entities

Corporations? LPs? LLCs? Given a choice, we almost always prefer an LLC because (a) unlike a corporation, it provides protection to the entity from the owner’s creditors, and not just protection to the owner from the entity’s creditors (like a corporation), and (b) unlike a limited partnership, a member can actively participate without putting his liability protection at risk. Nonetheless, all are useful and essential tools in asset protection planning, to be counted among the basic building blocks.

• Corporations.

1. If corporate formalities are followed, a shareholder should only have personal liability for corporate level obligations up to the amount of his investment, plus any distributions received during a period of corporate insolvency. Corporate formalities include, at a minimum, maintaining proper books and records, segregating business assets from personal assets, and maintaining appropriate capitalization of the entity.
2. Professional corporations, however, may not shield a shareholder from liability for his own negligence or, in some circumstances, the negligence of another shareholder. Most states have statutes that provide that a shareholder of a professional service corporation or member of a professional LLC shall be personally and fully liable for any negligent or wrongful act/omission if committed by him or any person under his direct supervision and control while rendering professional services on behalf of the entity. In Illinois, the courts have consistently held that the Medical Corporation Act and the Professional Service Corporation Act protect a shareholder from personal liability for acts of another shareholder who was not working under his direct supervision and control. The Illinois Supreme Court has extended this protection to attorneys who are owners of a law firm that is registered as a limited liability entity with the state and that has met minimum insurance requirements defined in Illinois Supreme Court Rule 722.

• Limited Partnerships.

1. Limited partnerships have an advantage over corporations because there is protection in both directions. That is, the limited partner (someone who does not participate in the management of the entity), is protected against partnership level liabilities. Additionally, the limited partner should be protected against a creditor who attempts to seize the limited partnership interest.
2. The primary value of the partnership as an asset protection device is the limitation placed on the ability of a creditor of an individual partner to attach partnership assets to satisfy a debt. For partner obligations, a creditor can generally only obtain a “charging order” against the partner’s economic interest in the partnership, but cannot obtain any other rights of a partner, including the right to force a liquidation. Under the Uniform Limited Partnership Act (ULPA) section 22 and the Revised Uniform Limited Partnership Act (RULPA) section 703, a charging order charges the indebted partner's partnership interest with payment of the unsatisfied debt. It does not give the creditor title to the limited partner's interest in the business, but merely gives him the limited partner's right to receive limited partnership income and, upon dissolution, that partner's share of limited partnership assets. Moreover, the charging order holder's right to receive partnership income may place him in the position of receiving phantom income as a result of his lien on the debtor partner's interest, without the ability to force a cash distribution.
3. Several bankruptcy courts have held that a bankruptcy trustee can force a sale of a limited partnership interest. As to the debtor partner, this may have little practical impact since the partnership interest would be attached with a charging order in any event. To the partnership itself and to the other partners, however, a forced sale could have a significant impact.

• Limited Liability Companies. The LLC provides all the creditor protection aspects of both limited partnerships and corporations.

1. One primary attraction of LLCs is that all members can actively participate in management without compromising their limited liability, and there is no general partner who is personally responsible for the entity’s debts. If there is a judgment or claim against a member, the creditor is generally limited to the charging order remedy.
2. LLC members may become personally liable if the LLC veil is pierced. The Uniform Limited Liability Company Act (ULLCA) contemplates that the LLC veil may be pierced in a manner similar to the corporate veil.
3. While LLC Acts ought to shield assets held by the LLC from creditors of an individual member, recent judicial decisions have raised the question as to whether a single-member LLC will provide any asset protection when the member is a debtor in bankruptcy court.
4. Successful challenges to single-member LLCs have been made in Colorado, Idaho, Maryland, and Florida, in which bankruptcy courts found that the charging order was not the creditors’ exclusive remedy and that all of the LLCs’ assets were available to satisfy the claims of the single members’ creditors.
5. In In re Albright, 291 B.R. 538, a Colorado bankruptcy court held that the assets of a single-member LLC could be used to satisfy creditors of the bankrupt member. Albright, the sole member of an LLC, filed a bankruptcy petition. Because the LLC did not go into bankruptcy, Albright argued that the trustee in bankruptcy was only entitled to a charging order remedy. The court disagreed with Albright and held that when the sole member of an LLC goes into bankruptcy, the trustee in bankruptcy may control the LLC in order to sell its assets and distribute the proceeds to the bankruptcy estate. The court noted that the charging order remedy serves to protect the non-debtor members of an LLC from judgments against a debtor member. Therefore, with respect to the single-member LLC, the court determined that the charging order served no purpose because there were no other parties’ interests affected.
6. The reasoning set forth in In re Albright was later followed by bankruptcy courts in Maryland and Idaho. For instance, in In re Modanlo, 412 B.R. 715, the court held that a trustee in bankruptcy appointed for the LLC’s sole member had the right to control and manage the LLC (“upon a debtor's bankruptcy filing, the trustee stands in the debtor's shoes and receives the rights and authority that the debtor possessed with respect to the LLC.”. Further, in In re A-Z Electronics, LLC, 350 B.R. 886, an Idaho bankruptcy court ruled that when the debtor is the sole member of the LLC, the trustee in bankruptcy is entitled to manage and control the LLC to the same extent that the member could. In re Penn, 2010 WL 9445533, citing all three of Albright, Modanlo, and In re A-Z Electronics, confirmed that the underlying LLC assets do not become part of the bankruptcy; rather, it’s the debtor’s membership interest that the trustee succeeds to.
7. Finally, in Olmstead v. Federal Trade Commission, 44 So.3d 76, the Florida Supreme Court held that the charging order was not the creditors’ exclusive remedy against the single-member LLC. The court determined that the charging order remedy serves no purpose when there are no other LLC members to protect. The result of this case was the creation of the “Olmstead Patch” in state law, which states “a charging order is the sole and exclusive remedy by which a judgment creditor of a member or member's transferee may satisfy a judgment from the judgment debtor's interest in a limited liability company or rights to distributions from the limited liability company” for multiple-member LLCs.
8. In re Mulder, 307 B.R. 637 - This bankruptcy case out of the eastern division of the Northern District of IL is focused on another issue but the claimant raised analogous defenses to LLC ownership, so the court addressed the logic of Albright in the footnotes. Citing Albright, the footnotes state that if a debtor owned an interest in the LLC, the interest held by the debtor would be property of the bankruptcy estate, not the property belonging to the LLC itself. Further, the footnotes cites to 805 ILCS 180/30-1(a)(2002): “A member is not a co-owner of, and has no transferable interest in, property of a limited liability company.”

Motives

Since a fraudulent transfer by definition requires fraudulent intent, a client’s motives are critical. The perfect client is one who says that he has no existing creditors, he has no history of creditors, he has all required licenses for his occupation, he doesn’t drink and drive, and he has estate planning, investment, business, or other personal or family goals in mind, but if he could gain some asset protection benefit out of the planning, as well, all the better. And most clients do, in fact, fit within that narrative. But, not all. Your job is to help determine what is motivating the client. Avoid assisting the client who is seeking to escape liability for an existing judgment or potential judgment from an existing lawsuit.

On the other hand, feel good about assisting the client who is clean but losing sleep at the prospect, albeit remote or random, of losing his wealth to a future unknown creditor. That client is simply engaging in the three steps of legitimate asset protection: 1. identifying risk (assets or situations); 2. then, segregating good clean assets from those risks; 3. in order to obtain added leverage in a negotiation with future unknown creditors (while all the while avoiding fraudulent transfers). No court in the U.S. would deny a client that right.

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