How Does an LLC Provide Personal Asset Protection?
An LLC can protect assets from personal lawsuit creditors. When a judgment is entered against a member individually, that individual member’s personal creditor generally cannot seize any assets of the LLC. Creditors of an individual member usually only have some rights to distributions from the LLC should any occur. Rights would not typically include any right to manage the WY LLC or to demand that distributions be made from it or to vote the LLC interest. LLC law generally provides a creditor with only one way to collect a judgment; this is what is referred to as a “charging order.”
A charging order allows the creditor to seize LLC distributions actually made. But there is no way for the creditor to force a distribution. The creditor would be forced to wait until a distribution was actually made to the debtor-member.
An LLC agreement generally allows withholding of LLC distributions to members in order to accumulate revenue for the reasonable needs of the LLC. This would increase the members’ capital accounts. Moreover, under IRS rules, even if a creditor didn’t receive distributions, the creditor may be required to pay the income tax associated with the LLC interest that is subject to the charging order. This leaves the creditor in the unenviable position of paying taxes on money not received.
What About Fraudulent Transfers?
Fraudulent transfers (also called fraudulent conveyances) are an issue in asset protection planning because creditors often claim that the property was transferred after the claim arose. The definition of a fraudulent transfer is fairly broad. A fraudulent transfer is usually a transfer that is made before or after the claim arose with the intent to defraud, hinder, or delay a known or likely creditor. Intent is generally presumed, leaving the defendant with the burden of proof that there was no fraudulent intent, and it is extremely difficult to prove a negative such as this. Courts look at “badges of fraud” including the transfer of non-exempt assets, a transfer for less than full and fair consideration, with insolvency as a consequence of the transfer. If the court determines that there was a fraudulent transfer within the applicable statute of limitations it can set aside the transfer.
Avoiding Fraudulent Transfer Problems
The key to avoiding fraudulent transfer problems is the timing of transfers to an LLC or other asset protection entity such as a domestic or offshore asset protection trust. An asset protection system must be in place before a claim arises in order to get the best possible result. This is not to say that estate and asset protection planning cannot be done under threat of a claim. However, if a claim has arisen additional design and planning issues will need to be considered.
What if a Creditor Sues the LLC Itself?
If a creditor has a legitimate complaint against the LLC itself, the LLC is the party sued. The creditor may satisfy its judgment with LLC assets and/or insurance. Remember this rule: A creditor can always get to the owner of an asset, and the creditor can also generally get to other assets owned by the owner. If the LLC owns real estate, a judgment creditor of the LLC can levy on the real estate. If that is all the LLC owns, then there are no other assets for the creditor to get, but if the LLC owns many assets, they would all be at risk. This arrangement will not work in all states, however, so LLC members should consult with counsel to obtain more information before implementing an arrangement of this nature.
To avoid the danger of “all eggs in one basket” an LLC may be structured with subordinate entities to own “risky” assets, i.e. those that create liability. The preferred solution is for the LLC to own one or more subordinate limited liability companies. An asset protection design can involve wholly-owned subordinate LLCs (taxable as disregarded entities) to hold risky assets. Since this is the lawsuit risk faced by the LLC, the LLC contains the risk and protects both the other LLC assets and the General Member. The LLC is the property owner, so only the assets of the LLC would be at risk. This arrangement will not work in all jurisdictions, so LLC members should consult with counsel to obtain more information before implementing an arrangement of this nature.