The Importance of Considering State Law "Charging Orders" in an Asset Protection Plan
Unlike other business entities, LLCs, LPs and Family LPs can require a creditor to get a "charging order" in order to pursue their debtor's ownership interest in the business entity. The charging order allows the creditor the right to intercept distributions or income paid by the LLC or LP to the debtor until the debt is satisfied. Corporations offer no such protection, absent careful contract creation. Note, also, that a single-member LLC generally does not offer such protection either, which is why asset protection attorneys recommend against using a single-member LLC. Each state is different in the conditions required for them to grant a charging order, and also different in the value of a charging order to the creditor seeking one. Asset protection attorneys can weigh the alternatives and work with you to make the best alternative part of your asset protection plan.
Charging Orders—Advanced LLC and LP Concepts
In the event that a creditor gets a charging order, either an LLC or an LP can frustrate the creditor's dreams of taking the member's income from the business entity. Here's how:
- The charging order provides the creditor with the power to intercept distributions and income only to satisfy the debt owed. (The charging order itself is a provisional remedy, and only authorizes this interception, nothing more.)
- Therefore, before the creditor seeks the charging order, either
- Set the LLC or LP to provide the income or all distributions from the entity to another business entity, and have that entity provide distributions; or
- Set the LLC or LP to provide no distributions or income to partners in the event of bankruptcy (included by default usually; see #4 at the top); then
- If the creditor becomes frustrated by the lack of distributions and forecloses on the charging order to assume the debtor's ownership interest of the LLC or LP, then the creditor-owner is liable for the tax liabilities of the LLC or LP and falls into the trap:
- The creditor-owner cannot compel dissolution (see #2 at the top);
- The LLC or LP can then change its Governing Agreement to make all of the tax liability be distributed to the creditor-owner (see #5 at the top), meaning that the creditor-owner is forced to pay the taxes due on the income from your assets in the LLC or LP as the creditor-owner's own personal or business income; and
- Despite paying the taxes on your assets, the creditor-owner is unable to get any income out of the foreclosed ownership interest because of the Governing Agreement change (see #4 at the top).