The family limited partnership, created in 1916, has many unique attributes that are beneficial for both lawsuit protection and estate planning. With almost a century of case law surrounding it, the FLP has emerged as a tremendously powerful tool to protect real estate, equipment, bank accounts, and other assets against lawsuits. It also prevents lawsuits by making one so unattractive to a plaintiff’s attorney that he/she will choose not to pursue a lawsuit. In some situations (such as multiple rental properties), an LLC or single-member LLC will be used in conjunction with FLPs as part of one’s overall asset protection plan to hold certain assets for lawsuit protection.
FLPs are structured somewhat like a family business, with one or more general partners controlling the partnership. The “limited partners” have no control whatsoever. They receive income, which is determined and distributed by the general partner(s). The FLP is a pass-through entity, so it does not pay taxes.
Not all FLPs are created the same, however. Specialized attorneys have retooled the FLP to include lawsuit protection principles. Once your assets are properly structured in this way, you will have the financial peace of mind that comes from knowing you are protected from losing the assets you have worked a lifetime to secure.
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 all of the person’s property is held within carefully drafted asset-protection FLPs, the law in all fifty states absolutely prohibits any of that property from being seized, sold, or turned over. In fact, the terms of carefully drafted asset protection FLPs give plaintiffs only one remedy to collect on their judgment: the “charging order.” This means that a plaintiff’s only right is to receive distributions from the family limited partnership.
Asset-protection FLPs contain a clause that enables the general partner to distribute income on a non-pro-rata basis, which means they can distribute income to themselves and other limited partners. They also have the ability to exclude 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 an FLP is required to pay taxes on “phantom income,” which is the income of the FLP, 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 FLPs to a prosecuting attorney is a great deterrent to the filing of a lawsuit. Since many lawsuits are taken on a contingency basis, placing your assets into properly drafted legal entities removes the financial incentive for prosecuting attorneys.
Why Does the Charging Order Law Exist?
After teaching people about the family limited partnership and the power of the charging order, we often hear the comment, “This sounds too good to be true.” So why does the charging order law exist?
xWhen two or more people desire to work together for a business purpose, they often form what is called a general partnership. This can be a written or oral agreement between the partners or can be an implied general partnership based on the working relationship. The general partnership is a common form of business because it is the default partnership arrangement and requires no state filings or paperwork.
general partnership is a very dangerous way to conduct business because of the unlimited liability of the partners. For example, if two or more doctors opened a practice together as general partners, each doctor would be personally liable for his own actions and would also be liable for the negligence or malpractice of the other doctors in the partnership. If one doctor were sued and the plaintiff won a $10 million judgment against him or her, the plaintiff creditor could take assets from all of the doctors in the general partnership to satisfy the judgment.
Also, in a general partnership, any one partner can enter into contracts binding on the general partnership, and the other partners are personally liable for the terms of the contract, even if they had no knowledge of the contract and did not authorize the action. For example, Dr. William is one of two doctors in a medical general partnership, and his partner took a million-dollar loan on behalf of the general partnership without Dr. William’s knowledge and without his approval. When Dr. William’s partner was unable to repay the loan, Dr. William was 100% responsible to repay the million-dollar loan.
Under the terms of a general partnership, the assets of the partnership can also be taken to satisfy the non-partnership debts of one of the partners. For example, if one partner were sued for an accident at his home, the judgment creditor could obtain a Writ of Execution to seize the assets of the general partnership to satisfy the judgment, regardless of the fact that the partnership had no involvement or liability in the case.
The results of unlimited liability of all the partners in a general partnership has resulted in businesses being destroyed and significant economic injustice to non-debt partners as their portion of assets were seized to satisfy one partner’s debt. The unlimited liability of the partners on behalf of the general partnership and other partners was detrimental to the formation of partnerships, so every state enacted legislation allowing the formation of a type of partnership known as a limited partnership.
Under the terms of a limited partnership, a creditor with a judgment against a partner, but not against the partnership, cannot seize the partnership assets as he could under the terms of a general partnership. Thus, a limited partnership limits the liability of the partners. Instead of being allowed to seize assets, the law only allows the creditor to obtain a charging order, which affects only the actual distributions made from the partnership to the debtor partner. The business of the partnership is allowed to continue unimpeded, and the assets and distribution of the non-debtor partner(s) is not affected.
The protection of assets in a family limited partnership is not the result of a loophole or a twisting of the law. The laws preventing a creditor from taking assets from a limited partnership are well established and have decades of precedence with the courts upholding these asset-protecting provisions. Having an available alternative to general partnerships is desirable and necessary. It was created for the very purpose of limited liability, so it is very unlikely that laws would ever be changed to eliminate the asset-protection provisions of the charging order.
Do Some States Protect Better Than Others?
The charging order language in the family limited partnership and LLC legal documents is 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 statute 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.
If you have any questions regarding the family limited partnership, please contact the American Society for Asset Protection.