Drafting LLC/LP Agreements to Withstand Bankruptcy

I read an interesting and important article in this months Florida Bar Journal about limited partnerships and limited liability companies in bankruptcy. The article was, “Asset protection Proofing Your Limited Partnership or LLC for the Bankruptcy of a Partner or Member”, by Thomas O Wells and Jordi Guso.The LP and LLC have effective asset protection features outside of bankruptcy. If a debtor files bankruptcy, the bankruptcy trustee has greater powers to attack and liquidate the interest of the debtor partner or member, to the detriment of both the bankruptcy debtor and his other business associates. The Bar Journal article cited a bankruptcy decision in the case of In re Ehman and certain sections of the bankruptcy code which provide powers to the trustees to attach partnerships and LLCs which powers are not available to normal judgment creditors.

The authors suggested several provisions be added to LLC and partnership agreements to help protect the debtor’s interests in bankruptcy. The most important changes to the agreements are imposing obligations on members and partners to make future capital calls and to be involved in management. The agreement should state that its intent to be an “executory contract.” As a side note, mandating partners’ involvement in management does not expose limited partners to general liability given changes in Florida’s limited partnership statute.

When drafting an LLC operating agreement of family partnership agreement for asset protection the attorney and client should understand that the asset protection features of these entities are designed to defend against creditors in state court collections as the protective features are provided by Florida statute. The protective features of LLCs and FLPs are not found in federal law and in the bankruptcy code, in particular. As the article points out, special provisions are required to make the LLC and FLP effective in a bankruptcy setting, and even with the suggested provisions  I do not think these tools are nearly as effective once a debtor finds himself in bankruptcy court.

Last updated on May 22, 2020

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