LLCs in Florida: BEWARE!

LLC

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There are two asset protection tools which have substantial benefits for estate planning as well as asset protection. These are the limited partnership (LP) and the limited liability company (LLC).

A limited partnership is a partnership consisting of two classes of partners, general partners and limited partners. A general partner has general liability for all partnership debts, and he has the responsibility and authority to manage partnership business. The general partner controls the partnership’s investments, distributions, and other business decisions. A limited partner has an investment interest in the partnership, and he plays a passive role in partnership business. An individual can be both a general partner and a limited partner in an LP.

A limited liability company is a business entity created pursuant to Chapter 608 of the Florida Statutes. An LLC is controlled by a manager. The manager directs the LLC’s business affairs and determines the amount and timing of cash distributions. The investment interest in an LLC is held by members. Members invest the initial capital in the limited liability company, and they incur gains or losses from the LLC’s business. An individual can be both a manager and a member of an LLC.

An LP interest and a membership interest in an LLC are both intangible property and both types of interest are assignable and transferrable subject to restrictions of the LP agreement or the LLC operating agreement.

Asset Protection Benefits of a Partnership or Limited Liability Company

A limited partnership and a limited liability company offer the same degree of asset protection. The investment interests in an LP or LLC are not “exempt” from levy by creditors of the limited partner. There is no constitutional or statutory provision in Florida which protects a limited partner’s or an LLC’s member’s investment. Asset protection is available by virtue of the limited procedural remedy given to creditors to levy upon a debtor’s limited partner interest and an LLC membership interest. 

A creditor has no right to seize property within a partnership or an LLC to satisfy the debt of a partner or member. Moreover, in a properly drafted LP agreement or LLC agreement, a creditor has no right to vote or inspect the books and records of the LP or LLC. Under Florida law, a creditor’s rights are limited to receiving distributions of cash or other property made from the LP or LLC to limited partners or LLC members. In most closely held business arrangements where one partner or member has a creditor problem, a cooperative general partner/manager will retain profits inside the LP/LLC and make no distributions which might be taken by a lurking creditor. If the general partner/manager does not order distributions of cash or property, then the creditor gets nothing.

In addition, a creditor with an active charging lien may incur income tax liability. A 1997 Revenue Ruling suggests that where a creditor has a charging lien on an LP or LLC interest and the general partner/manager does not distribute partnership income, the creditor, not the limited partner/member, is responsible for paying the tax on allocated income. The charging lien may become a “poison pill” as long as the creditor receives no money but incurs income tax liability in his effort to collect a judgment debt.

One practical limitation with the limited liability company and partnership charging lien protection is that cash and assets can remain trapped inside the entity by a “patient creditor” holding a charging lien.  Even though the creditor cannot get assets inside the entity, neither can the member or limited partner get these assets because any attempted distribution would be seized by the charging lien.  A member or limited partner may need access to cash from the entity to maintain a normal lifestyle.  One solution is for the LLC/LP to pay the debtor a salary which is exempt from creditors if the debtor is head of household.   Another solution is for the LLC or LP to purchase an annuity naming the debtor as a beneficiary.  Florida courts have held that annuity payments remain protected after distribution and deposit in a bank account so long as the funds are segregated.  Therefore, an LLC or LP should be able to distribute annuity proceeds to the debtor/beneficiary despite the existence of a charging lien.

Some attorneys have questioned whether a single member LLC affords the same asset protection benefits of a multi-member LLC. The policy for limiting a creditor to the charging lien remedy as the exclusive collection remedy against a debtor’s membership interest is preventing the creditor of one member from disturbing the ownership interest of other non-debtor members in LLC assets. In a single member LLC, the debtor’s LLC has no other members, and the creditor would not affect the ownership interest of any innocent members. Creditors have argued that a creditor should be able to seize and liquidate the membership interest of a single member LLC. To date, no Florida court has distinguished creditor remedies based on the number of members in an LLC. However, in May, 2008, a Federal Court of Appeals asked the Florida Supreme Court to consider and issue an opinion of whether Florida’s statutory charging lien remedy applies to a single member LLC.  The Supreme Court of Florida ruled in 2010 that one member LLCs have no such protection.  One member LLCs beware, it may be time to become an S-Chapter corporation.