Florida Asset Protection : Asset Protection Law & Planning in Florida - Florida Homestead Exemption

Sometimes there is no alternative to  a single member LLC, or you just can’t find anyone you trust to be a second member in your business. One example is where a husband and wife establish a LLC owned as tenants by entireties which I believe would be considered a single member LLC (although there is no case on the issue). The LLC may have worked well for some time  to protect the LLC interests against the creditors of one spouse, but now the owners unexpectedly confront a joint creditor, and find it difficult to include another member. Is there anything a single member LLC can do to achieve some asset protection.

What about reorganizing the LLC in a state such as Delaware or Wyoming with statutes that protect single member LLCs from creditors because the state law provides the charging lien is the exclusive creditor remedy to attack all LLCs regardless of number of members. I’ve stated previously on this blog that I do not think a Florida court would apply the foreign state’s LLC statute when considering the collection remedies of a Florida creditor against a Florida debtor. I don’t think moving your LLC out of state will work.

Last month I spoke at the Florida Bar’s annual asset protection seminar in Ft. Lauderdale. One of the other speakers, attorney Alan Gassman, suggested a way for a single member LLC to protect itself from its owner’s creditors. Alan said that he writes LLC agreements which appoint the initial manager permanently and state that the members cannot vote to remove and replace the manager. If a creditor or the creditor’s assignee becomes a substitute member he would own an interest in an LLC managed by the initial manager appointed by the debtor. In most cases, the debtor himself would be the permanent  manager.

 

Most agreements give the manager control over the LLC’s assets and its distributions. A creditor that takes over a debtor’s interest in a single member LLC may find itself owning an LLC which it cannot control. This may work. We’ll have to see how it holds up in court. In any event, I think the irrevocable manager is a better solution than moving the LLC to another state.
 

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When you file an LLC in Florida you have to name the person who is serving as manager and indicate if the manager is also an LLC member. I often get asked by clients and blog readers  if there is a benefit to form an LLC in states which do not publish either the owner or managers on the state’s website. You can form an LLC in Delaware, Nevada, Wyoming, and maybe other states without naming the manager or LLC owners. Also, public access to these other  states’ website is more limited than Florida’s website.

 Some people see a “secrecy” advantage in creating LLCs in these states. They believe that their creditors will likely search the public records of Florida and other states to see if the debtor owns or is associated with an LLC formed in these states. If the creditors do not find any business entities associated with the debtor’s name in the public record, the creditors will be less likely to pursue aggressive collection of the debtor-according to the secrecy theory.

In my opinion, this is hogwash. I don’t think creditors search public records in order to decide whether and how aggressively to collect judgment debts. Also, there is no secrecy in debt collection or in asset protection (other than perjury).  Within 45 days after a civil judgment is signed the debtor is usually  required to send the creditor a financial affidavit which lists all of the debtor’s assets. When a creditor takes the debtor’s deposition in aid of execution of the judgment the creditor will ask the debtor to describe his interest in any LLC, partnership, or other business entity. In the course of the creditor’s discovery procedures the debtor’s business  interests will be disclosed and the secrecy advantage of forming the LLC in another state will be lost.

 

With the passage of Florida’s new LLC law in 2011, Florida law provides asset protection benefits to partnerships and multi-member LLCs which is as good as any other state. As in Delaware, Wyoming, and Nevada the creditor charging lien is clearly the creditor’s exclusive remedy of collection against all but single member LLCs. I generally advise Florida residents to form partnerships or  multi-member LLCs in Florida or in another state with good LLC laws where the clients own property or operate a business.
 

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LLCs provide better asset protection of the owners’ interest than do corporations. Many asset protection plans involve changing a clients’ existing Subchapter S corporations to an LLC taxable as an S corp. There are two ways to do this. One way is to create a new LLC and then file articles of conversion which turn the corporation into the new LLC. The corporation turns into an LLC and all corporation assets automatically transfer to the LLC The other way is to merge the corporation into an existing LLC which already has assets. When the corporation has assets with built-in appreciation the there is an income tax issue with this plan. The issue is whether the change to the corporation accelerates income tax.

This past week one of my clients was considering whether he wanted to convert a corporation to a new LLC or merge the same corporation with an existing LLC. He asked me whether the IRS treats the merger and conversion differently with respect to taxation of built in appreciation in corporation assets. As I am not a tax attorney I had to reach out for the answer.

 

I consulted with my asset protection CPA, Lonnie Young of Orlando, Florida. Mr. Young explained that a merger into an LLC or a conversion to an LLC are treated the same for income tax purposes. He said that if the LLC has elected taxation as a sub-S corporation and the ownership of the LLC is  the same as the ownership of the corporation, neither the merger nor the conversion has adverse income tax consequences.

This particular client would have a tax problem with his plan. He owned 100% of his corporation stock, but he wanted a two member LLC for asset protection. Adding the LLC owner would cause a tax issue.
 

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You can file a new LLC yourself at Florida’s business website: www.sunbiz.org. The website has the forms with instructions, and it take just a few minutes. File your own LLC and save legal fees. It appears to be very simple. Yet, my experience is that about half the asset protection clients with a “do-it-yourself” LLC screw it up.

The Sunbiz form requires that you name at least one LLC manger and that you designate that manager as either “mgr” or “mgrm.” You are not required to file with the State the owners of the new LLC. Ownership can be determined as part of the operating agreement which is a private contract. However, when you designate an individual as an “mgrm” you are telling the State and the world that the person has an undivided  ownership interest in the LLC.

Here is an example of the problem. A husband and wife want to start a new business as an LLC to be run and managed by the husband but owned jointly as tenants by entireties. The husband assures his wife: “don’t worry, I can do it myself.” Husband files the new LLC on Sunbiz and puts his own name as “mgrm”. He is the manager and he is also an owner so the “mgrm” designation seems to fit. However, the husband arguably has registered an individual ownership position in the LLC which is inconsistent with his intention to own all the equitable membership interest as tenants by entireties. You cannot tell your creditors you hold all your LLC membership interests by the entireties if you previously have told the State of Florida(or the IRS) that you have an individual interests.

The above hypothetical example is but one of many problems I have seen with LLCs formed by legally  unsophisticated business owner who  find themselves seeking asset protection of their LLC ownership. My advice: do it yourself at Home Depot, but not a Sunbiz.org.
 

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The Florida Supreme Court decision this summer which removed charging lien protection for single member LLCs has caused business owners and their attorneys to search for ways to make sure their LLCs have more than one member. When only one person has invested money in a business it is difficult to turn that same LLC into a multi-member entity. One possibility is for the current owner to sell a portion of his LLC to a third party for reasonable value. The sale would have to withstand creditor challenge of the sale price and whether the sale is really “arms length.” A second possible plan is for the LLC membership interest to be divided into voting interests and non-voting interest, and for the owner to invite a third party to join the LLC as a voting member. The debtor would retain all the financial interest, but important LLC actions would require the consent of the new voting member.

The use of voting and non-voting membership interests raises some interesting issues which may someday be answered in court cases. For instance, does a second member with voting rights, but without a financial interest, make the LLC a multi-member LLC for charging lien purposes? The charging lien remedy is supposed to protect non-debtor member’s LLC interest, but a member with voting rights only has no financial interest to protect from the debtor member’s creditors. Another issue is whether the voting member should give consideration for acquisition of his voting interest in what had been a single member LLC? Is this plan simply another fraudulent transfer to avoid creditors? These are not the only issues.

Even with potential legal challenges, I think that a business owner can increase LLC protection by giving away some voting rights to a trusted associate or employee without relinquishing or selling financial stake in a single owner business.
 

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The Florida Supreme Court’s Ohmstead decision regarding LLC asset protection has caused surge of academic debate about LLC planning. Some of the discussions involved suggestions to form or move LLCs to states other than Florida because the other states’ laws expressly provide that a charging lien is the creditor’s sole remedy against a debtor’s LLC interests. These other state statutes do not distinguish single member and multiple member LLC protection. The academic issue is which state has the best LLC law? I think the question is provides an interesting academic exercise and comparison charts of various state statutes, but it does not address the real question, which is: would a Florida court dealing with a Florida judgment against a Florida debtor apply the LLC law of the state where the debtor formed his LLC (Nevada, Wyoming etc) or would the court apply Florida’s LLC law to the creditor’s collection enforcement?

A discussion of this issue is too involved for a brief blog post, and in any event, I don’t believe anyone knows the answer with certainty. I do have a suggestion, however, if you want to located an LLC outside of Florida for better asset protection. If you are going to form an LLC in another state, or move your Florida LLC elsewhere, your position will be improved if your LLC owns assets in the state where it is formed. The LLC’s bank accounts should be in banks located in the LLC’s home state at banks that have no Florida branches. If the LLC owns securities, transfer the securities to a broker whose offices are located only within the LLC’s home state. Successfully maintaining an LLC in a state other than Florida probably requires more than just registration. The more assets the LLC owns in its home state the more likely a Florida court will apply that state’s laws to a creditor action against your LLC interest.
 

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Over the years I have received many calls from Georgia residents wanting asset protection help. Other than inviting these caller to move to Florida there was not much else I could advise them to do for protection. I felt bad from these Georgia debtors because Georgia has few asset protection tools. For instance, the Georgia homestead exemption is limited to $10,000 equity. Georgia has no wage garnishment exemption and no tenants by entireties exemption. In Georgia, you have to pay your debts.

To appreciate the impact of the Ohmstead decision (discussed fully in prior post) it is interesting to compare the asset protection status of Florida LLCs to how Georgia law treats a debtor’s LLC interest. In Florida, after Ohmstead, a creditor can use all available creditor remedies to attack a debtor’s LLC membership interest, certainly in the case of single member LLC and probably in the case of multi-member LLCs as well. Under Georgia law, a creditor may get a charging lien and other remedies, but the Georgia statute specifically prohibits a creditor from foreclosing a debtor’s membership interest, The law also specifically prohibits a creditor from participating in LLC management which prohibition seems to stop a creditor from forcing the LLC manager to make distributions which could be subject to a charging lien. Georgia law has better LLC protections than does Florida law after the Ohmstead decision.

I never thought Florida’s asset protection laws could be worse than Georgia, but its happened with respect to LLC interests. It appears that our LLC protection has hit bottom.

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Many single member LLCs have been established to own stock in subchapter S corporations as part of asset protection planning. Before the LLC became the most popular business entity attorneys and accountants typically advised clients to operate a business as a sub-S corporation. As the asset protection benefits of the LLC became better known, the sub-s owner wanted to change his business ownership from a corporation to an LLC. The problem was that there are often tax problems, and also legal restrictions in some professional businesses, associated with converting an s-corp to an LLC.

The solution was to set us a single member LLC and transfer the s-corp shares to the single member LLC. This plan provided better asset protection subject to uncertainty about application of asset protection benefits to a single member LLC. Now that the Olmstead decision has undermined the asset protection benefits of multi-member as well as single member Florida LLCs, people with s-corp shares in a single member LLC are looking for asset protection solutions.

A well-known tax attorney from south Florida asked me whether I thought it possible to create a limited partnership which could elect to be taxes as an s-corporation and then transfer s-corporation stock from an existing LLC to the newly formed partnership. IRS rules prohibit S-corp shares from being owned by an entity taxed as a partnership, but a partnership electing taxation as an s-corp could possibly own the s-corp shares that were previously assigned to a single member LLC for asset protection.

The issue with this solution is whether a limited partnership could qualify to be taxed as an s-corp. IRS rules prohibit an s-corp from having more than one class of shareholder (not counting distinctions between voting and non-voting shares). If the general partnership and limited partnership interests are considered different ownership interests then a limited partnership cannot be taxed as an s-corp because it would consist of more than one class of ownership.

The answer is that there is no answer. In January, 2010, the IRS issued a Revenue Procedure bulletin stating in part that the IRS will not answer the question. The IRS said it will not issues rulings as to whether a state law partnership electing to be taxed as a corporation has more than one class of ownership for purposes of qualifying as a sub-s corporation. 26 CFR 601.201. Therefore, converting a single member LLC with s-corp shares to a limited partnership taxed as an s-corp is not a reliable asset protection alternative.

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After the Florida Supreme Court’s Olmstead decision the Florida limited liability has lost its utility as an asset protection tool. Is the LLC is done forever, or could it someday re-emerge as an asset protection entity. The Court’s adverse ruling was based largely on its interpretation of the Florida LLC statute. The court noted that unlike Florida’s limited partnership statute, the LLC statute provides that a creditor may get a charging lien against the debtor’s LLC interest, but that the statute does not say the charging lien is the "exclusive remedy" leaving available more effective collection tools such as levy and sale.

I’ve been monitoring some attorney discussion groups which are discussing asset protection planning in light of the Florida Supreme Court decision. For example, there is a very high level academic discussion through Leimburg Information Services including well-known estate planning and asset protection attorneys such as Alan Gassman, Chris Riser, and Mark Merric.. This discussion group, and some other experienced attorneys I’ve spoken with, seem confident that the Florida legislature will act to fix the LLC statute so that the charging lien remedy is made exclusive as is currently for limited partnership interests. Speculation is that the legislative revision could come in 2011, or if not, soon thereafter.

In the meantime, people with LLC businesses must deal with decreased asset protection against their individual creditors. Speculating on laws being passed by the Florida legislature is not sound asset protection strategy. While it seems logical, if not likely, that the legislature may make LLC’s charging lien provisions consistent with that of the limited partnership attorneys must help asset protection oriented business clients bolster LLC protection either by amending the LLC operating agreements or migrating to other business structures.

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Using a Florida limited liability company as an asset protection tool used to be relatively easy. Attorneys understood that a creditor’s sole remedy against a debtor’s interest in a Florida LLC, especially multi-member LLCs, was a charging lien. The charging lien gave the creditor restrictive and impractical tools to capture money from the debtor’s LLC interest. No more. The Florida Supreme Court’s Olmstead decision last month seems to give creditors the right to use any and all collection tools, not just the charging lien, to go after a debtor’s membership interests.

The next line of asset protection defense is the LLC operating agreement. Contractual provisions in the LLC operating agreement can minimize a creditor’s power to compel LLC distributions or liquidate LLC assets. Effective asset protection language is not in "off the shelf" or standard LLC operating agreements.

Prior to the Olmstead ruling a small business owner might get by with a "do it yourself" LLC. The owner could create an LLC online and buy a standard operating agreement online from any of the many sites that market legal forms. Once you realized the LLC was the preferred asset protection business structure a competent business owner could achieve good asset protection with the "do it yourself" Florida LLC. Not any longer. Do it yourself may work at Home Depot, but it won’t protect your Florida LLC from judgment creditors.

LLC owners concerned about asset protection are going to have to do something. There are many asset protection alternatives to the basic LLC structure. The simplest and cheapest next step - not necessarily the best or the most effective step- is to have an attorney customize your LLC operating agreement with provisions that will weaken and deter your prospective creditors. Yes, it may cost money. But, these things can happen whenever the Florida Supreme Court is in session.

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