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Sometimes Two Is Better Than One, Especially When LLCs Are Concerned

By Rob Lambert - Email Editor

Date: March 02, 2006

Again, another tidbit for regular folks. Lawyers and financial planners--read no further, as you already know this stuff. However, I promise to say something fancy next week, so make sure you come back!

Any regular reader knows that I don’t think Limited Liability Companies and Family Limited Partnerships are dependable as stand alone Asset Protection entities. Yes, these are great entities and offer some protection. I often use them as part of plans, and they are a great first step for somebody on a budget, aiming to assemble a solid Asset Protection structure in the long run.

The problem with both LLCs and FLPs is that when the rubber meets the road, they are not dependable. LLCs and FLPs are constantly being pierced or disregarded by local judges (most often in unreported trial court decisions). The much touted “charging order” protection is highly overrated, and gradually crumbling, as more and more people are abusing LLCs and FLPs. Courts are getting sick of this and are often inclined to allow a creditor to get to assets held in LLCs or FLPs.

You should NOT fall for the line that an LLC or FLP will give you iron clad creditor protection (a virtual “financial fortress”). This is BULL, and I don’t care if Donald Trump is saying it! This is NOT true. He also probably thought his pre-nup was solid. ...

With that said, you still may want to consider setting up an LLC or even an FLP as a first step toward more solid protection in the future. In the last several newsletters, I have discussed why these vehicles are useful, and how they can be used. In the long run, they only offer dependable Asset Protection when combined with other entities, usually a solid Kinetic Asset Protection Trust.

If you do decide to start with an LLC or FLP, please realize its shortcomings, following these two rules and one recommendation.

RULE 1: Make sure you do the entity when the “financial seas” are calm. I have beat this fraudulent conveyance issue to death in earlier newsletters, so I won’t rehash it here.

RULE 2: Document a solid NON-TAX BUSINESS purpose for the entity. Purposes like, ease of management, protection from creditors, integration with my estate plan, and the like do work. Purposes like “I want to keep the assets out of my wife’s hands and available for my scrub nurse” do not.

The above two rules are iron clad and not negotiable. The following recommendation is just common sense and is often a good idea.

RECOMMENDATION: Assuming you have somebody other than your spouse that you can trust (and many people do not have such a relationship…even with their spouse!), it is often good to have this person as a member or partner in the LLC or FLP. Why? The answer is simple. In the last several years, there have been a number of judges who have actually followed the statute and applied charging order protection to LLCs and FLPs to frustrate a creditor’s effort to reach the assets in the LLC or FLP. In many of these pro-debtor cases, a key factor often was the existence of a second or third “innocent” person, who would be harmed if the business was pillaged by the creditor of a partner. It is simple common sense; courts are much more likely to allow a business entity, like an FLP or LLC, to be pillaged if there is only one person (the “bad guy debtor”) who will be harmed.

With that said, I do not like partners, in many cases, as they can lead to heartache and disputes. So, choose your partners carefully. In my mind, when it comes to your hard earned savings, it is often better to forego a partner and simply combine the FLP or LLC with an Asset Protection Trust. This allows you to have the best of all worlds.

I hope this tidbit has been helpful.

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