Limited Partnerships

A large number of you demanded; yes, demanded reassurances that your "trusty dusty" limited partnerships would withstand any attack by creditors. Evidently there is a feeling that since LPs have been around for a century or so, they have withstood the test of time. However, before you go putting every dime you have in your family limited partnership, you may want to call up and talk with your local bankruptcy trustee or look at the various websites that sell assets taken over by the trustees. Invariably, there are some new LP interests coming up for sale each and every week. Here's a link to a sale of a 50% LP interest by a bankruptcy trustee, by the way, Arizona, the state of this LP and the bankruptcy proceedings is a charging order sole remedy state.

How can that possibly be? A couple of reasons: The first is that your Partnership Agreement is not worth the paper it was written on. Sure you saved a few hundred bucks by buying the internet special but as the old Valvoline commercials went, you can pay me now, or you can pay me later. By skimping on a customized partnership agreement there is a good chance, the bankruptcy trustee or predatory creditors are going to be able to take over ownership in your Limited Partnership. If you just have a "stock" Partnership Agreement, drop everything and get your agreement updated right now.

The other way you are going to lose ownership in your LP is that the field of law is vast. It is impossible to expect an attorney to be good at personal injury, family law, estate planning, and asset protection all at the same time. If you work with an attorney who is not a specialist, you may not get the full benefits of the law. This is especially true in the asset protection and bankruptcy field. Right now the market for bankruptcy attorneys is booming, which in turn is attracting a lot of attorneys who haven't worked in the bankruptcy realm before. Since the newcomers don't know all the nuances about the subject, they may not be aware of what your legal rights are and, as a result, the unintended consequence is that you could end up with no rights at all.

Case in point, even as I type this I've got a case on my desk where a couple has over $500,000 inside a spendthrift trust. Even though they only have debts of about $100K, for some reason they filed bankruptcy, and the bankruptcy trustee is now taking over their interest in the trust. How is the trustee taking over the spendthrift trust? It’s pretty simple, their attorney, who cuts quite the dashing figure in TV commercials, is a Johnny come lately to the bankruptcy field and evidently has given some bad advice. His lack of knowledge in this arena is now going to cost the couple a few hundred thousand.

Let's talk about another asset protection misnomer: If somebody slips and falls on a piece of property owned by an LLC or LP, the injured party is not able to sue the owners of the LP or LLC. What’s that old saying? I wish I had a nickel for every time someone said…

The problem

Any attorney worth their salt is going to name the manager of the LLC or the general partner of the LP in some sort of negligence action. (If you’ve got an entity as the General Partner, don't act so smug. A living breathing human has to be making decisions, and that living breathing human is going to get named in the suit.) Welcome to America!

Let's look at another common pitfall. How many of you have had real estate that is upside down inside your LLCs? Have you taken money out of the LLC? Remember, if you want creditors to treat your LLC as a separate entity from yourself, you need to treat it the same way. Think about it, what was the legal basis for you to take money out of an LLC which is upside down? Loan? Advance? Distribution of profits?

Here is another case that ended up on my desk: The client’s LLC never earned a profit and yet the members took out hundreds of thousands in "draws". The LLC is now in bankruptcy which means the trustee owns any "causes of action" the LLC had, including fraudulent conveyances. It's pretty much a slam dunk that draws, that is to say distributions of future profits that didn't materialize are going to be considered transfers without value. The end result is, when the trustee sells off the LLC to the highest bidder for a measly $500 bucks or so, the high bidder will have claims against the debtors, claims that are in the hundreds of thousands, claims that survive bankruptcy.

How about retirement plans, do I even need to talk about them? Most of you who have read my articles know that I don't believe IRAs have asset protection due to the stringent IRS rules that no one follows. And yet, I would guess that the bulk of people's liquid assets are inside IRAs. There is going to be a very rude awakening very shortly.

To paraphrase Dr. Pangloss, in a perfect world everything would work perfectly. Unfortunately, we don't live in a perfect world and thus there is no black and white solution to your asset protection problems.

Bottom line

There is a healthy dose of fiction regarding what is and what is not a viable asset protection plan. The reality is asset protection is not a cookie cutter approach. It is a constantly changing field. The imposition of the new Uniform Trust Code amongst a number of jurisdictions is a great example. A bunch of the powers that be decided to change the laws regarding trusts and a number of state legislatures have blindly agreed. The end result is the wishes of the people who created the trusts are now being reinterpreted by this new law and in many cases causing results directly opposite from what the trust creators wanted. Just because one strategy happened to work for your neighbor doesn't mean that it is going to work for you. The best asset protection strategy is to associate yourself with a knowledgeable practitioner in the field and work with them to develop a strategy to custom fit your needs.