By Kent Phelps, Attorney
DURFEE & PHELPS, PLLC
The Florida Supreme Court just issued it’s long awaited ruling in the case of Olmstead vs. Federal Trade Commission. This decision is significant regardless what state you live in because the Florida Supreme Court is now the highest court to continue the trend of other courts across the country to allow creditors to penetrate a single member LLC (Limited Liability Company). There are many nuances to the case that fall outside the scope of this blog post. For example, the Court’s analysis of Florida’s charging order statute. But the central message from the Court is the same as other courts which have decided similarly: owners of single member LLC’s beware.
THE FIX – LLC’S WITH SOLID BUSINESS PURPOSES, PROTECTED 3RD PARTY PARTNERS, AND WELL-DRAFTED OPERATING AGREEMENTS
Gone are the days (if they ever existed) when we could simply form an LLC and treat it like a vault, doing nothing more than throwing our assets into it and expecting that they would be protected if we ever got sued. What have you got in your LLC? Your business? Real estate? Investment accounts? “Toys” such as airplanes, boats, and vehicles? What is the business purpose of your LLC? If all the LLC does is own your personal boat and nothing more, it probably does not have a legitimate business purpose given current court trends*. But if you rent your boat out, keep books, have a business plan, and file a company tax return, it probably does. Courts always want to see a legitimate business purpose for the LLC.(*However, if the LLC is a subsidiary of a larger company with diverse business activities, such as a limited partnership, and integrated into an advanced estate plan, a multi-member LLC will most likely hold up as the LLC can be justified with multiple business and estate planning objectives.)
Third Party Partners
The logistics of how a court makes available the assets of your LLC to the plaintiff who sues you can vary from case to case but one common approach is for the court to transfer your membership interest to the plaintiff. The plaintiff takes control of the company and liquidates assets to satisfy their judgment against you. The courts conclude that without any other partner interests to consider, there is no compelling reason not to transfer your LLC membership interest to the plaintiff.
So who should your partner be? Adding a spouse may be a slight improvement but, especially in a community property state, probably not sufficient given the overlapping property rights between you and your spouse. Adding your adult children, your friend, or Uncle Harry may improve your position but now you have exposed yourself to the potential headaches of having to deal with their creditors, divorces, and other life crisis events.
We recommend the members (partners) of your LLC not be you, your spouse, your children, or Uncle Harry. We recommend the majority owner be a limited partnership you ultimately control, thus making the LLC a subsidiary of another company. And that the other partner in the LLC be a special kind of trust – an Irrevocable Dynasty Trust – you establish for the benefit of your heirs. This trust is controlled not by you, but by a trustee you choose. The trust is recognized as an “arms length” partner under the law. The trust will also shield your company from the potential crisis events of the trustees and beneficiaries of the trust.
Solid Operating Agreement
An operating agreement is to an LLC what bylaws are to a corporation or a partnership agreement is to a partnership. A protected LLC will have an attorney-drafted operating agreement that reserves certain rights to the manager of the company, such as authority to make or not make distributions of profit. It will also include important restrictions on transfers of membership interest to prevent a court, or a trustee in bankruptcy, from transferring your membership interest; thus preventing the plaintiff who sues you from taking over your company.
The Florida Supreme Court’s decision confirms what we have known for years. Single Member “shell” LLC’s just don’t work. Employing the fixes outlined above will keep your LLC assets safe and secure. These fixes are not cheap. But if you have assets valuable enough to protect, you should make the necessary legal investment with a competent estate and business planning attorney, fortify your LLC, and protect your assets.
Kent Phelps, Attorney
DURFEE & PHELPS, PLLC