Three types of Florida business organizations have substantial benefits for asset protection:
- the Florida limited partnership (LP)
- the Florida limited liability limited partnership (LLLP) and,
- the Florida limited liability company (LLC).
A Florida limited partnership is an agreement between two classes of partners, general partners and limited partners, to conduct a business or invest in an asset. The terms and conditions of the partnership are expressed in a written limited partnership agreement. Limited partnerships are separate legal entities created and administered under Florida Statutes, Chapter 620. A general partner controls the partnership’s investments, distributions, and other business decisions. The limited partners have an equity interest in partnership assets, but they have a passive role in the partnership’s business activity. An individual can be both a general partner and a limited partner in a limited partnership. Limited partners are personally liable for partnership obligations and losses only to the extent of the amount of money they invested in the partnership. A general partner is personally liable for all partnership debt and obligations without limit. Florida law provides that a limited partnership may elect to be treated as a “limited liability limited partnership” (“LLLP”) under Florida Statute 620.9001; the LLLP general partner is not personally liable for all partnership obligations.
A limited liability company is a business entity wherein none of the participants, referred to as “members”, are liable for all of the entity’s obligations and debt. Each member’s liability is limited to their investment in the limited liability company. An LLC treats member liability similarly to the above-described Florida LLLP. An LLC is controlled by a manager who directs the LLC’s business affairs. Members invest initial capital in the limited liability company, and they can incur gains or losses from their proportionate share of the LLC’s assets and its business. An individual can be both a manager and a member of an LLC. The manager of the LLC can be a member or non-member.
Florida limited liability companies are created pursuant to Florida Statutes. Florida’s limited liability company laws were rewritten in 2013 creating a new Chapter 605, the Florida Revised Limited Liability Company Act. The new statute does not change the asset protection features and requirements of Florida LLCs. The Act does make it easier to design LLC membership and operating agreements to provide asset protection benefits.
LLC and Partnership Asset Protection
A limited partnership interest and LLC membership interest ( “Ownership Interests”)are not an exempt assets under Florida Statutes, but a creditor’s ability to collect a judgment against your partnership interest is limited by Florida Statutes. Florida law provides that a judgment creditor cannot seize or garnish your Ownership Interests, and the judgment creditor has no ability to attack assets, financial accounts, or real estate owned in the name of the partnership or LLC . In a properly drafted agreement, a creditor is not able to inspect the LLC or partnership’s financial records and is unable to participate in management.
A judgment creditor’s rights are limited by Florida Statutes to a obtaining what is called a “charging lien” against your limited partnership interest. Florida Statute 620.8504 provides that a creditor’s exclusive remedy against a judgment debtor’s partnership interest is a charging lien on the debtor’s transferable interest and distributions. Florida Statute 605.0503 provides that the charging order is the creditor’s exclusive remedy against a judgment debtor’s membership interest in an LLC. The creditor can obtain a charging lien by application to the court that issued the judgment against the debtor The charging order gives the creditor a lien against any distributions of cash or other property, if any, which the partnership or LLC makes or owes the debtor. The general partner or LLC manager, or other persons with discretion over distributions, could withhold distributions in the event a judgment creditor obtains a charging lien against the debtor’s Ownership Interest As long as the LLC or partnership does not distribute income, the judgment creditor would receive no money. All assets and accrued, undistributed income remain protected inside the LLC or partnership.
Single Member LLCs
In 2011, the Florida legislature amended Florida’s LLC statute to state that a charging lien is the exclusive creditor remedy against a debtor’s membership interest in a multi-member limited liability company. The 2011 LLC law permits creditors to use foreclosure and other alternative collection remedies against a debtor’s interest in a single-member LLC. The creditor must demonstrate that its judgment will not be satisfied in a “reasonable time” from a charging lien on the single-member LLC membership interest. LLCs designed for asset protection should include at least two members, and existing LLCs should add at least one member to restrict a creditor to a charging lien.
A common question is whether a second LLC member has to have a minimum percentage interest in order to qualify the entity as a multi-member LLC. The Florida LLC statute does not specify a minimum LLC interest, and Florida courts have not addressed this issue. Most attorneys will advise that a second member have at least a 5 percent membership interest in LLC equity, and many attorneys advise a greater minority interest for asset protection planning.
People with existing single-member LLCs may want to convert their LLC to a multi-member LLC. Adding a second member to an existing single-member LLC often raises fraudulent transfer issues. Simply assigning a small economic interest to a second member without fair consideration is reversible as a fraudulent transfer. The initial member may either sell a small economic interest to a new member for reasonable value and convey the interest by assignment, or the initial member may accept new capital from the second member in exchange for an economic interest issued by the LLC.
In 2013, the Florida legislature passed the Florida Revised Limited Liability Company Act (which was effective in January 2014). The Act revised the definition of an LLC member in Section 605.0401 in a way that makes it easier to add non-equity members to an LLC in order to create a multi-member LLC. The 2013 law defines an LLC member as a person who may, or may not, hold any economic interest in an LLC and who may, or may not, be obligated to contribute money or other capital to the LLC.
Choosing Between Partnership and LLC
Partnerships and LLCs have similar asset protection benefits. There are, however, other differences in the two types of legal entities which affect entity is best suited for a particular business. For example, Florida charges higher annual fees for limited partnerships than for LLCs. Many CPAs believe that LLCs are more flexible entities for income tax planning. In practice, partnerships are more commonly used for real estate investments, whereas, LLCs seem to be chosen to own operating businesses. However, as time goes on, the entities seem to be more interchangeable for business planning. Again, for asset protection the LLC and partnership have similar protection.
Funding Limited Partnerships and LLCs
A limited partnership or limited liability company works for asset protection and/or tax planning only if you transfer assets from your name into the name of the entity. Transfer of assets into a partnership, LLC, or other entity is often referred to as “funding” the entity. LP and LLC creators must decide which of their assets are appropriately held in the name of the LP/LLC. In making this decision about funding, it is important to understand the distinction between “safe assets” and “liability assets.” Limited partnerships and limited liability companies should hold only safe assets.
Safe assets are those which are unlikely to invite their own liability. For example, passive ownership of publicly traded investment securities such as stocks, bonds, or mutual funds is unlikely to result in your being sued. Mere ownership of passive investment assets, without some active involvement in the underlying business, will not expose the owner entity to legal liability and civil judgments.
Liability assets, by their nature, create a substantial risk of liability. These assets general involve active participation and/or direct dealings with third parties. Examples of liability assets are rental real estate, commercial businesses, boats, or motor vehicles, any of which has inherent risks of legal disputes.
Asset protection planning uses partnerships and LLCs to protect valuable assets. If the entity itself incurs liability through ownership and operation of a liability asset, the entity will be the target of a lawsuit. If an entity is named as a defendant in a lawsuit, all of the assets you sought to protect in the entity could be subject to the claims of the judgment creditor. Liability assets should either remain outside of the asset protection entity, or alternatively, these assets should be titled and operated in one or more special purpose entities. Asset protection isolates valuable safe assets from any and all potential liability assets.
How to Form a Limited Partnership or LLC
The first step in creating a Florida limited partnership or limited liability company is the preparation and filing of an application with the Secretary of State. An applicant files a Certificate of Limited Partnership to form a limited partnership or Articles of Organization to form a limited liability company. The applicant has to provide a name for the partnership or LLC. You can search name availability on the Secretary of State’s website. If you submit a filing with a name already in use or if the name is similar to another name on file, your documents will not be accepted. The application for LP/LLC requires naming a registered agent. The registered agent is the person (or company) who is authorized to receive service of process if the LP/LLC is sued. Any person residing in the state of registration can be designated as the registered agent so long as that person/entity has a Florida street address. If you form an LP or LLC in a state other than Florida, you will have to find a company or individual that will, for a fee, serve as registered agent in the state of formation.
In Florida, the Certificate of Limited Partnership includes names and addresses of all general partners of the partnership. The names of the limited partners are not required to be filed with the State. LLC Articles of Organization include the name of the LLC’s manager. The members’ names are not required to be filed with the State. Since these documents are a matter of public record, the names of the general partners of an LP and the manager of an LLC will be publicly available, but the limited partners (LP) and members (LLC) will be private except as disclosed on a federal tax return.
A partnership is legally formed when the Secretary of State’s office receives the properly filed Certificate of Limited Partnership and filing fee. Likewise, an LLC is legally formed with the Secretary of State receives properly completed Articles of Organization and the filing fee. You may need a certified copy of the filed documents to open a bank or brokerage account or for the purchase or sale of real estate in the name of the LLC or LP. You should consult your CPA about obtaining a tax identification number for your new entity.
Where to File
Formation of limited liability companies (LLC) and limited partnerships (LP) outside of Florida, such as in Nevada and Wyoming, is widely promoted on the internet. The promised benefit of forming a partnership in a state other than Florida (a “foreign state”) is that foreign state partnership laws are more protective of a debtor’s interest in a limited partnership or LLC. Promoters of foreign state LPs and LLCs argue that their state’s law will best protect the Florida debtor’s interest.
The supposed advantage of foreign LPs and LLCs assumes that the laws of the foreign state will apply to a creditor’s collection effort in Florida or that a Florida court may not impose a charging lien on your partnership or LLC interest without jurisdiction over the foreign state LLC. The general rule is that the law applicable to a creditor’s execution of a civil judgment is the law of the state where the debtor resides. Florida courts do not need to have jurisdiction over an LLC or LP to impose a charging lien on the partnership or membership interest held by a Florida resident because the LP/LLC is not a party to the charging order request. If you live in Florida, Florida law governs your creditor’s efforts in executing the judgment against your LP/LLC interest regardless of where you filed your entity.
Contrast this rule to what is known as the “internal affairs doctrine” which holds that internal disputes among partners are governed by the law of the state of filing or incorporation. The internal affairs doctrine means that if you create an LP/LLC in Nevada, Wyoming, or other foreign state, disagreements with your fellow partners/members will be governed by the laws of the state of formation. The internal affairs doctrine has nothing to do with defending judgment collection against your investment interest in an LP/LLC. Assertions of asset protection advantages of foreign state LPs/LLCs for Florida residents are “hype” designed to sell you something you do not need. As stated elsewhere, filing a partnership or LLC in a foreign state may reduce your filing fees, but it will not provide a significant asset protection advantage.
Operating Agreements / Partnership Agreements
After the limited partnership or limited liability company is filed and legally created, the partners/members should next prepare a written agreement expressing the provisions which govern their business and legal relationship. That agreement is called a “Limited Partnership Agreement” (for an LP) or “Operating Agreement” (for an LLC). The agreements contain similar provisions and serve the same purpose in both types of legal entities. In both, the agreement expresses the financial and legal agreements among the participants such as the general partner or manager’s duties, matters on which the vote of the partners/members is required, each person’s initial capital contribution and obligation to contribute additional capital over time, each person’s share of the LP/LLC capital and profits, and all other matters affecting the relationships between the parties.
The partnership or operating agreement should also contain certain key provisions designed to accomplish your estate planning or asset protection goals. For example, the agreement should include legal restrictions on the transfer of investment interests to third parties, including your creditors. The agreement should deny any individual’s creditors the right to participate in internal entity affairs. A well written agreement is flexible and may provide different investors with varying amounts and priority of distributions, preferences and values on liquidation, voting rights, duties to contribute services and money to the entity, and other contract provisions governing the operation and management of a financial arrangement among the parties.