Question: Is there a way for my spouse and I to protect our joint securities portfolio from creditors?
Answer: There are various available techniques for shielding personal assets from creditors. One commonly-used technique involves creating a limited liability company (“LLC”) for asset protection purposes. LLCs owned by two or more persons are usually treated as partnerships for tax purposes and are not subject to Federal income tax. A properly-drafted LLC operating agreement which sets forth the rules by which the company is operated, managed and governed coupled with selecting the proper state of formation of the company can pose challenges to creditors endeavoring to seize assets of a company owner.
A key feature of an LLC is the flexibility the members or owners have in receiving distributions from the company. The persons operating the company, the company managers, can be authorized to make or refrain from making distributions to members as the managers determine. Furthermore, the company operating agreement need not require that distributions be made to all members on a proportionate basis. Where an LLC member has potential problems with creditors, distributions need not be made to that member. In the case of an LLC owned by a husband and wife where one of the spouses has creditor problems, distributions can be made to the other spouse and the spouse not receiving a distribution can indirectly benefit from the distribution of company assets to his or her spouse.
Other protections for the membership interest of the creditor-plagued member can be included in an operating agreement. The operating agreement can permit the company to redeem the interest of a member against whom a creditor is seeking to attach assets. A right of first refusal can be included in the operating agreement to permit one or more of the other members to acquire the membership interest of the member threatened by creditors. In either case, the purchasing party can have the right to purchase the interest of a member at a discounted price so the creditor has less of an opportunity to seize funds from the indebted member.
LLC statutes throughout the country give creditors a so-called charging order remedy which entitles a creditor to receive distributions otherwise payable to a member against whom the charging order is obtained. The right to alter distribution rights as noted above is one means of thwarting the creditor holding the charging order as the absence of distributions means the charging order will have little if any impact. Since some state LLC statutes provide that a charging order is the sole remedy a creditor has against an LLC member, significant asset protection can be achieved by forming the company in one of the debtor-friendly states. Differing consequences may result where an LLC member is under the jurisdiction of a bankruptcy court. This can result in challenges to the viability of an LLC as an asset protection strategy. Nevertheless, forming the LLC in a state where the charging order is the sole remedy may, in some cases, also provide a valid defense against a bankruptcy trustee.
As with most asset protection strategies, the objective is not to seek the elusive iron-clad defense against creditors as courts continue to whittle away at the asset protection strategies pursued by debtors. Rather, the objective is to implement a plan imposing challenges on a creditor seeking recovery against a debtor. With a properly-crafted LLC operating agreement for a company formed in a debtor-friendly jurisdiction, you and your spouse may have the opportunity to thwart the claims of your creditors.
The Tax Corner addresses various tax, estate, asset protection and other business matters. Should you have any questions regarding the subject matter or if you have questions you want to be answered, you may contact Bruce at (312) 648-2300 or send an e-mail to firstname.lastname@example.org.