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FLP And LLC Rules

By Rob Lambert - Email Editor

Date : 31-May-2007

Dear Subscriber:

Now that I am on a rule kick, I am dusting off some of my old newsletters that many (probably most) of my readers have never seen before. If you remember this, then reread it anyway because the info is good stuff!!!

Any regular reader knows that I don’t think Limited Liability Companies or Family Limited Partnerships are dependable stand alone Asset Protection vehicles. 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. I have also started to have remarkable results using offshore LLCs instead of domestic LLCs. Sometimes I even insert duress provisions into the operating agreement (more on this in a later newsletter).

The problem with domestic LLCs and FLPs is that when the rubber meets the road they are not 100% 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. Judges are getting sick of this abuse 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 prenup was solid. ...

With that said, you still may want to consider setting up a LLC or even a FLP as a first step toward more solid protection in the future. In many prior 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. I often say that one of the main reasons to utilize a FLP is to separate ownership from control and not Asset Protection in and of itself (more on this in a later newsletter).

If you do decide to start with a LLC or FLP please realize its shortcomings and that it is only a first step. Be careful to follow the following two rules and one recommendation.

RULE 1: Make sure you form the entity when the financial seas are calm. I have beat this fraudulent conveyance issue to death in earlier newsletters and will not rehash it here.

RULE 2: Document several solid BUSINESS purposes for the entity. Purposes like ease of management, protection from creditors (yes, Asset Protection is a valid business purpose), integration with my estate plan, and the like 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 to be pillaged by a creditor of a partner. It is simple common sense: Courts are much more likely to allow a business entity like a 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 these rehashed rules are helpful.

I wish you a healthy and protected week.

Rob Lambert

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