Covering Your Assets: Florida Case Highlights LLC Dangers

In a surprise move, the Florida Supreme Court recently overturned key features of the state’s Limited Liability Company (LLC) law, leaving legal experts scrambling to figure out how the decision might impact particular asset protection strategies.

Robert J. Mintz, JD

An LLC is designed to provide liability protection without the formalities and tax issues that often make corporations difficult and expensive to operate and maintain. An LLC can be a convenient and efficient vehicle for operating a business or holding investment real estate. It protects you from legal liability for any debts or obligations associated with the particular venture or property held by the LLC— if you operate a business in an LLC and the business goes broke, you’re not personally responsible for paying the outstanding bills. The same is true when you put an investment property into an LLC if a tenant gets hurt on the property, you cannot be held personally legally responsible. The risks that arise out of the operation of a business are known as “inside liabilities,” and the law is quite specific that you cannot be sued for any liability of your LLC. You may lose the business or the property in the LLC, but your personal loss is limited to the amount of your investment. Your other assets are not at risk for the debts of the company (unless you personally guarantee the obligation). Physicians cannot shield themselves from malpractice claims by operating as an LLC, but for related business activities, the LLC works very well.

Charging orders and LLC shields

In addition to protection from inside liabilities, LLCs have been used to shield personal assets from other types of claims (“outside liabilities”) not associated with the particular business activity. For example, let’s say you own an investment property that represents a substantial portion of your savings and you would like to shield it from any future claims against you associated with your other business activities. To accomplish this sensible goal, you could transfer the property to a newly formed LLC, after which you would own a membership interest in the LLC rather than the property itself.

LLCs are effective asset protection solutions in situations like this because membership interests are protected by a “charging order” in the same manner as partnership interests. The membership interests are protected from foreclosure by a creditor—a judgment creditor is not legally permitted to seize LLC interests as he or she could with shares of stock or other property. Creditors have no right to vote or control the LLC. The most a creditor is permitted to do is wait for any distribution of income or sales proceeds to come out of the LLC.

Olmstead v. FTC and future planning with LLCs

In June 2010, the Florida Supreme Court ruled that an LLC membership interest is subject to seizure by a creditor in the same manner as corporate stock (http://hcp.lv/ dB6sxU). As a result, a creditor of a member of an LLC is permitted to seize a membership interest under Florida law. Although this decision is consistent with recent court cases and the law in California and several other states, the Florida ruling was a surprise to observers in the so-called “asset protection—friendly” states such as Florida, Nevada, Delaware, and New Mexico, where it was believed that the charging order protection in state law formed a solid foundation for asset protection planning.

The Florida Court’s decision did not impact the usefulness of LLCs as strong protectors against inside liability business risks and claims. If you are operating a business or holding risky assets such as investment property, the LLC will often be the most effective choice of business entity. If you create an LLC to hold assets, the Florida decision, as well as existing law in California and other states, means that your membership interests are vulnerable to seizure by a judgment creditor. This rule applies whether your LLC is a single-member or a multi-member company. Although Florida may now amend its LLC law to counter the impact of Olmstead, owning LLC membership interests in your name is unlikely to provide any significant asset protection for you.

In order to avoid a potential foreclosure of the LLC interests and an outcome similar to the Olmstead case, many lawyers have been recommending that clients put their membership interests into a protective trust (http:// hcp.lv/abuBjy). My firm has been using a Family Savings Trust (http://hcp.lv/csD3xg) for this purpose for many years. Your lawyer should be able to help you with choosing the structure that most efficiently accomplishes your asset protection planning.