Charging Order Protection

Asset Protection LLC

A properly-drafted and -worded LLC can provide the same charging order protection that exists in a family limited partnership. If a lawsuit is filed against an individual who owns assets in his/her name and the plaintiff wins, the judge would issue a “turnover order,” in which non-exempt property, including the person’s home, cars, stocks, bonds, bank accounts, etc., could be turned over to the plaintiff to satisfy the judgment. However, if a person’s property is held within carefully-drafted asset-protection LLCs, the law prohibits any of that property from being seized, sold, or turned over. In fact, the terms of carefully-drafted asset protection LLCs give plaintiffs only one remedy to collect on their judgment: the “charging order.” This means that a plaintiff’s only right is to receive income distributions from the LLC.

Asset-protection LLCs contain a clause that enables distribution of income on a non-pro-rata basis, which means they can distribute income to themselves and other limited partners while excluding distributions to the judgment creditor. As a result, the judgment creditor would receive no assets and no income; and because of the IRS Revenue Ruling 77-137, the judgment creditor who obtains a charging order against a LLC is required to pay taxes on “phantom income,” which is the income of the LLC, even if the plaintiff does not receive the income. The result is that the plaintiff does not obtain any assets or income, but is liable for taxes on the income they will never receive. Therefore, the disclosure of properly-drafted LLCs to a prosecuting attorney is a great deterrent to the filing of a lawsuit. Since many of the lawsuits today are taken on a contingency basis, an asset search is one of the first things an attorney does before accepting a case. Placing your assets into properly-drafted legal entities removes the financial incentive for prosecuting attorneys.

Are Some States Better Than Others?

The charging order language in the family limited partnership and LLC document are the same for each state, and the charging order does provide protection in every state. However, the language of the state statute regarding charging orders is better in some states than others. For this reason we suggest Alaska FLPs and LLCs. Alaska’s state statue says the charging order is the sole remedy, and then proceeds to explicitly preclude any other actions, such as foreclosure, receiver accounting, etc. As a result, Alaska’s charging order limits creditors more than any other. In addition, Alaska has case law to back up the drafting. Other states with solid statutes include South Dakota, Florida (FLP only), Texas, Maine (LLC only), Wyoming (LLC only), and the recently revised Nevada FLP and LLC statutes.

Next Topic: "Tax Reduction Overview"