Asset protection planning with limited liability companies.

• Author: Ellentuck, Albert B.

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When consulting with a client regarding forming a limited liability company (LLC) for business and tax reasons, it is common to address the issue of asset protection. The basic objective of asset protection engagements is to transfer assets to reduce or eliminate any exposure to liabilities in conjunction with the client's estate plan or other financial concerns. Care must be taken to avoid transfers specifically to avoid creditors, which can be considered fraudulent.

Practitioners often are in an excellent position to identify the need for an asset protection strategy and recommend possible methods of implementation. For example, suggesting the formation of an LLC before a client acquires a parcel of commercial real estate may protect the client from liability exposure. The practitioner may also suggest that the client restructure his or her existing holdings to protect assets.

Caution: Restructuring a client's existing asset holdings for asset protection purposes has many legal implications that must be considered with the assistance of an experienced attorney.

In general, a transfer of assets to an LLC protects the assets from the LLC member's creditors. However, a member's creditors can obtain a charging order against the member's interest and become entitled to receive any profits, losses, and distributions to which the member would otherwise be entitled. The creditor does not, however, have the right to participate in LLC management, including the right to force a distribution. This may put the creditor in a difficult position, since he or she may be allocated the debtor member's share of LLC taxable income but receive no distribution to pay the income taxes due on that income.

Fraudulent Transfers

Any asset protection plan must consider the possible application of fraudulent transfer laws. The purpose of these laws is to prevent debtors from transferring assets for the primary purpose of defrauding creditors. If a court determines an asset transfer to be fraudulent, the transfer will be voided, exposing the asset to a creditor's claim.

Fraudulent transfer laws vary from state to state and are also addressed in the U.S. Bankruptcy Code and the Internal Revenue Code. Three common questions considered by most jurisdictions when applying fraudulent transfer laws are:

1. Did the transferor intend to hinder, delay, or defraud a creditor at the time the transfer was made?

2. Was the transferor solvent at the time of the transfer?

3. Was the transfer made in exchange for reasonably equivalent consideration?

   While formulating asset protection plans that involve the transfer of assets, practitioners must objectively consider a possible challenge from the point of view of the client's creditors. The business purpose for the transfer should be documented in order to prove that the transferor did not intend (actually or constructively)...