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AssetProtection Articles and Resources

Do Land Trusts Provide Asset Protection?

Have you heard that land trusts provide asset protection? Do you believe it?

Applicable Law

Two cases from Illinois concluded that, in a land trust, although the legal and equitable title lies with the trustee, most of the usual attributes of real property ownership are retained by the beneficiary under the trust agreement: (1) Just Pants v. Bank of Ravenswood, 136 Ill.App.3d 543, 483 N.E.2d 331, 335-36 (Ill.App. 1985); and (2) People v. Chicago Title and Trust Co., 75 Ill. 479, 389 N.E.2d 540 (Ill. 1979).

Just Pants v. Bank of Ravenswood

In Just Pants v. Bank of Ravenswood, 136 Ill.App.3d 543, 483 N.E.2d 331, 335-36 (Ill.App 1985), the lessee of property which was subsequently sold under a land trust sued the trustee of the land trust for conversion and breach of contract. Following judgment in favor of the trust, the trial court granted the lessee’s motion to amend the complaint and judgment to include the beneficiaries, and entered judgment against only the beneficiaries. The beneficiaries appealed, and the Illinois Court of Appeals held that reversal was required where the reviewing court had no way of knowing the respective responsibilities of the trustee and the beneficiaries. 483 N.E.2d at 333-34. The Court noted that, in an action involving a land trust, the question of whether the beneficiary or the trustee is the proper party depended upon the nature of the action in light of the rights and duties established by the trust agreement. The Court pointed out that the beneficiary in a land trust is the proper party to litigation involving his rights and liabilities of management, control, use and possession of the property; and, moreover, that beneficiaries in land trusts oftentimes retain managerial rights in the property, and in exercising these rights, enter into a variety of contractual arrangements resulting in the accrual of causes of action against then that do not involve the trustee. The Court observed that actions sounding in tort involving land trust property usually arise from the operation and maintenance of the property; that such causes are based on negligence, and accrue against only the beneficiary, and not the trustee; and that the trustee is insulated from these responsibilities if he has no rights of possession, operation, control, or maintenance. Thus, the Court concluded that trustees who hold legal title to realty through a trust agreement are not liable for damages resulting from defects in the trust premises when the agreement gives the beneficiaries, and not the trustees, the power to make the needed repairs; and furthermore, that beneficiaries can also be held responsible for the torts or frauds of the trustee where they participate in or authorize the commission of the wrongs. 483 N.E.2d at 335. The Court remanded the case to the trial court to determine the respective responsibilities of the trustee and the beneficiary under the trust agreement. 483 N.E.2d at 336.

People v. Chicago Title and Trust Co.

In People v. Chicago Title and Trust Co., 75 Ill. 479, 389 N.E.2d 540, 542-43, 546 (Ill. 1979), a consolidation of six separate actions brought in the name of the People of the State of Illinois to recover unpaid real estate taxes on land held in land trusts, the State sought to impose personal liability for the real estate taxes on the following three entities: (1) the banks or trust companies in their individual corporate capacities; (2) the banks or trust companies in their capacities as land trustees of land trust property; and (3) the beneficiaries of the land trust, all as “owners” of the tracts of land trust property. The trial court found the trustees in their individual corporate capacities liable, and dismissed the cases as to the banks and trust companies as trustees, and as to the beneficiaries. 389 N.E.2d at 542. The Illinois Supreme Court granted motions for direct appeal, and held that, since the beneficiaries of a land trust controlled the purchase, sale, rental, management, and all other aspects of land ownership and title; and since the trustees could act only upon the beneficiaries’ written direction, the beneficiaries were “owners,” within the meaning and intendment of the statute providing that “owners” of realty shall be liable for taxes. As such, the beneficiaries were personally liable for the unpaid real estate taxes. The Court stated that the realities of land ownership clearly indicated that land trust beneficiaries were “owners”; and that, as “owners,” they were personally liable for the unpaid real estate taxes. 389 N.E.2d at 546.

In so concluding, the Court reviewed the history of the Illinois land trust. The Court noted that the Illinois land trust was a unique creation of the Illinois bar, although its acceptance elsewhere had received a great deal of attention. The Court pointed out that its origin was rooted in case law rather than in statute; and that, over the years, the land trust had served as a useful vehicle in real estate transactions for maintaining the secrecy of ownership and allowing for the ease of transfer. The Court noted that, despite recent disclosure statutes, the Illinois land trust remained a widely utilized and useful device. 389 N.E.2d at 543. The Court emphasized that, in land trusts, the legal and equitable title lies with the trustee, and the beneficiary retains what is referred to as a personal property interest; however, most of the usual attributes of real property ownership are retained by the beneficiary under the trust agreement. In fact, the Court observed that the only attribute of ownership ascribed to the trustee is that relating to title, upon which third parties may rely in in transactions where title to the real estate is of primary importance. 389 N.E.2d at 543.

Conclusion

The prevailing belief, that land trusts protect property owners from all liability, is not even true in Illinois, which originated land trusts.

Does Asset Protection Trump the US Constitution?

An Alaska Supreme Court Rules on Alaska Domestic Asset Protection Trusts Created to Protect Assets from a Montana Lawsuit

Court Case: Toni 1 Trust, by Tangwall v. Wacker 2018 WL 1125033

For fraudulent conveyances,

Can one state assert exclusive jurisdiction over another?
Does asset protection trump the U.S. Constitution?

Several years ago Alaska put forth a legislatively strong asset protection statute. It was modeled after the popular asset protection trusts found in the Cook Islands and similarly small Caribbean island nations. These offshore trusts allowed you to both be the grantor (the person setting up the trust) and the beneficiary (the one benefitting from the trust.) Self settled trusts weren’t allowed in old England, the birthplace of common law. They were bad form. You can’t set up your own trust to protect your own assets was the guiding rationale. A ‘self-settled trust’ was akin to cheating. But Britain’s island dependencies needed an industry besides tourism. And the rich needed an island to park their money.

The foreign asset protection trusts became so popular that a number of U.S. states considered them. Alaska was first. Delaware, Nevada and 13 other states followed with their own domestic asset protection trusts (DAPT.) After a holding period where transfers into a DAPT could be challenged (Nevada’s is two years) the trust can’t be breeched or pierced.

Or can it?

In the Toni 1 case (decided on March 2, 2018) the Alaska Supreme Court had to take a hard look at their asset protection scheme. During a Montana lawsuit the Tangwalls transferred Montana real estate to an Alaska DAPT. A Montana court found the transfer was fraudulent under Montana law. (You can’t put assets out of reach once you have been sued or even threatened with litigation.)

Tangwall sought relief in the Alaska court arguing that only Alaska courts had jurisdiction over an Alaska DAPT. But when the transfer of Montana property was involved the Alaska Supreme Court under the full faith and credit clause of the U.S. Constitution could not limit Montana’s jurisdiction.

A full discussion of the case is below. The takeaway, however, is that asset protection-as we’ve noted before-is an ever changing area of the law.

Issue

What are the potential impacts of the recent Alaska Supreme Court decision in Toni 1 Trust, by Tangwall v. Wacker 2018 WL 1125033 (Alaska, March 2, 2018), on asset protection trusts?

Applicable Law

Alaska Statue 34.40.110(k) (the “Alaska statue”), which purports to grant Alaska courts exclusive jurisdiction over fraudulent transfer claims against Alaska self-settled spendthrift trusts, cannot unilaterally deprive other state and federal courts of jurisdiction.

The Facts of Toni

After a Montana state court issued a series of judgments against Donald Tangwall and his family, the family members transferred two pieces of property to the “Toni 1 Trust,” a trust allegedly created under Alaska law. A Montana state court and an Alaska bankruptcy court found that the transfers were made to avoid the judgments and were, therefore, fraudulent. Tangwall, the trustee of the Trust, then filed suit in the Alaska state court, arguing that Alaska state courts have exclusive jurisdiction over such fraudulent transfer actions under the Alaska statute. However, the Alaska Supreme Court concluded that this statute could not unilaterally deprive other state and federal courts of jurisdiction, and the Court affirmed the Alaska state court’s judgment dismissing Tangwall’s complaint.

More specifically, in 2007 Donald Tangwall sued William and Barbara Wacker in Montana state court. The Wackers counterclaimed against Tangwall; his wife, Barbara Tangwall; his mother-in-law, Margaret “Toni” Bertran; and several trusts and businesses owned or run by the family. In the ensuring years, several default judgments were entered against Tangwall and his family. In 2010, before the last of these judgments was issued, Bertran and Barbara Tangwall transferred parcels of real property to an Alaska trust called the “Toni 1 Trust” (the Trust). The Wackers filed a fraudulent transfer action under Montana law in Montana state court, alleging that the transfers were made to avoid the judgments. Default judgments in the fraudulent transfer action were entered against Barbara Tangwall, the Toni 1 Trust, and Bertran. After the fraudulent transfer judgments were issued, the Wackers purchased Barbara Tangwall’s interest in one of the parcels at a sheriff’s sale, as part satisfaction of their judgment against Tangwall and family. But before they could purchase the remaining half interest, Bertran filed for Chapter 7 bankruptcy in Alaska. Her interest in the trust property was therefore subject to the jurisdiction of a federal bankruptcy court. In December 2012, Donald Tangwall, as trustee of the Trust, filed a complaint in the bankruptcy court against the Wackers and bankruptcy trustee Larry Compton. Among other things, Tangwall alleged that service on the Trust in the Montana fraudulent transfer action was defective, rendering the judgment against the Trust void. Rather than litigate whether service in Montana was proper, Compton elected to bring a fraudulent transfer claim against Tangwall under the federal bankruptcy fraudulent transfer statute. A default judgment in Compton’s action was entered against Tangwall, who appealed from this judgment of dismissed.

Tangwall next sought relief in Alaska state court, where he filed the complaint that led to his later appeal. The crux of his argument was that the Alaska statute granted courts exclusive jurisdiction over any fraudulent transfer actions against the Trust. Specifically, he argued that the Trust contained a provision restricting the transfer of the beneficiary’s interest, and that the Alaska statute granted Alaska courts “exclusive jurisdiction over an action brought under a cause of action or claim for relief that is based on a transfer of property to a trust” containing such transfer restrictions. On this basis, Tangwall sought a declaratory judgment stating that all judgments against the Trust from other jurisdictions were void and that no future actions could be maintained against the Trust because the statute of limitations had run. The superior court dismissed the complaint, and Tangwall appealed. Most of Tangwall’s arguments on appeal were supported by little or no citation to relevant legal authority and were, therefore, waived. However, he preserved his argument that the state and federal judgments against the Trust were void for lack of subject matter jurisdiction under the Alaska statute.

The Decision in Toni

A. Under the Full Faith and Credit Clause, an Alaska statute cannot prevent Montana courts from applying Montana fraudulent transfer law.

The Alaska Supreme Court concluded that the Alaska statute, AS.40.110(k), which purported to grant Alaska courts exclusive jurisdiction over fraudulent transfer claims against Alaska self-settled spendthrift trusts, could not limit the scope of a Montana court’s jurisdiction over a fraudulent transfer action against a trust allegedly created under Alaska law, and thus, a fraudulent transfer judgment entered against a trust in a Montana court was not void for lack of subject matter jurisdiction. The Alaska Supreme Court noted that fraudulent transfer actions were transitory actions, and the Full Faith and Credit Clause did not compel states to follow another state’s statute claiming exclusive jurisdiction over actions and purporting to deprive other states of jurisdiction over all fraudulent transfer actions concerning Alaska trusts, even if the actions arose under other states’ laws.

B. The Bankruptcy Court’s judgment was based upon a cause of action arising under federal law, and states cannot restrict federal jurisdiction; furthermore, a federal statute specifically grants federal courts jurisdiction over fraudulent transfer claims. 

Likewise, the Alaska Supreme Court concluded that the Alaska statue could not limit the scope of a federal bankruptcy court’s jurisdiction over fraudulent transfer claims against the trustee of a trust allegedly created under Alaska law, and this a fraudulent transfer judgment entered against a trustee in bankruptcy court was not void for lack of subject matter jurisdiction. In addition, the Court noted that the Alaska statue was preempted by the Federal fraudulent conveyance statute, 11 U.S.C. § 548(a)(1)(A), which permits trustees to avoid fraudulent transfers.

The Rationale of Toni

A. The Alaska statute, AK 34.40.110(k), cannot limit the scope of other states’ jurisdiction.

Initially, the Alaska Supreme Court recognized that the Alaska statute, AK 34.40.110(k), purported to grant Alaska courts exclusive jurisdiction over fraudulent transfer claims against Alaska self-settled spendthrift trusts. The Alaska Supreme Court stated that, “having reviewed the legislative history of AS 34.4.0110(k), we have no doubt the Alaska legislature’s purpose in enacting that statute was to prevent other state and federal courts from exercising subject matter jurisdiction over fraudulent transfer actions against such trusts.”

The Alaska Supreme Court noted that, more than 100 years ago, the United States Supreme Court held in St. Louis, Iron Mountain & S. Ry. Co. v. Taylor, 210 U.S. 281, 285, 28 S. Ct. 616, 52 L.Ed. 1061 (1908), that each state may, subject to the restrictions of the Federal Constitution, determine the limits of the jurisdiction of its courts, the character of the controversies which shall be heard in them, and, specifically, how far it will, having jurisdiction of the parties, entertain in its courts transitory actions where the cause of action has arisen outside its borders. The Alaska Supreme Court further noted that, just a few years later, the United States Supreme Court held in Tenn. Coal, Iron, & R.R. Co. v. George, 233 U.S. 354, 360, 34 S.Ct.587, 58 L.Ed.997(1914), that states are not constitutionally compelled to acquiesce to sister states’ attempts to circumscribe their jurisdiction over such actions.

In Tennessee Coal, an employee sued his employer in a Georgia court, relying on an Alabama statutory cause of action. His employer countered that Alabama state courts retained exclusive jurisdiction over the suit under the Alabama Code, and that the Full Faith and Credit Clause compelled Georgia courts to respect Alabama’s assertion of exclusive jurisdiction. The United States Supreme Court found the “Full Faith and Credit” does not require states to go quite so far. Instead, jurisdiction is to be determined by the law of the court’s creation, and cannot be defeated by the extraterritorial operation of a statute of another state, even though it created the right of action.

After discussing the facts of Tennessee Coal, the Alaska Supreme Court concluded that the Alaska statute crossed the limit recognized by Tennessee Coal by purporting to grant Alaska courts exclusive jurisdiction over a type of transitory action against Alaska trusts. Acknowledging that the analogy was imperfect, the Alaska Supreme Court held, nevertheless, that Tennessee Coal controlled. The Alaska Supreme Court pointed out that the Tennessee Coal court held that the Full Faith and Credit Clause did not compel states to follow another state’s statute claiming exclusive jurisdiction over suits based on a cause of action even though the other state created the right of action. The Alaska Supreme Court stated that the clear implication was that the constitutional argument rejected in Tennessee Coal would be even less compelling were a state to assert exclusive jurisdiction over suits based on a cause of action it did not create. Applying this rationale to the facts of Toni, the Alaska Supreme Court observed that, in seeking to void the Montana court’s judgment for lack of jurisdiction, Tangwall effectively was arguing that the Alaska statute could deprive Montana courts of jurisdiction over cases arising under Montana law. The Alaska Supreme Court rejected Tangwall’s argument and stated that it was a more extreme interpretation of the “full faith and credit” principle than the interpretation considered and rejected by the United States Supreme Court in Tennessee Coal.

Finally, the Alaska Supreme Court noted that the basic principle articulated in Tennessee Coal had not changed in the last century, and concluded, therefore, that the Alaska statue’s assertion of exclusive jurisdiction did not render a fraudulent transfer judgment against an Alaska trust from a Montana court void for lack of subject matter jurisdiction.

B. The Alaska statue, AK 34.40.110(k), cannot limit the scope of a federal court’s jurisdiction.

Similarly, the Alaska Supreme Court denied Tangwall relief from the federal judgment. The Alaska Supreme Court noted that, while Tennessee Coal addressed only a state’s ability to restrict the jurisdiction of its sister states, the more recent United States Supreme Court decision in Marshall v. Marshall, 547 U.S. 293, 314, 126 S.Ct. 1735, 164 L.Ed 480 (2006), had confirmed that the Tennessee Coal rule also applied to claims of exclusive jurisdiction asserted against federal courts.

In Marshall, the United States Supreme Court considered whether Texas probate courts could retain exclusive jurisdiction over a transitory tort arising under Texas law. Relying on Tennessee Coal, the court concluded that they could not, and that state efforts to limit federal jurisdiction were invalid, even though the state created the right of action giving rise to the suit.

Acknowledging that the analogy was imperfect, the Alaska Supreme Court held, nevertheless, that just as Tennessee Coal should control whether the Alaska statute could restrict state court jurisdiction, Marshall should control whether the Alaska statute could restrict federal court jurisdiction. The Alaska Supreme Court concluded that, just as a state could restrict federal jurisdiction, even though the state created the right of action, a state also could not restrict federal jurisdiction over suits based on a cause of action it did not create. In addition, the Alaska Supreme Court pointed out that, if the Alaska statute were interpreted to deny parties access to the federal courts without those courts’ consent, then the statute might well run afoul of the Supremacy Clause, which ultimately precludes state courts from limiting federal jurisdiction.

Observations by the Alaska Supreme Court in Toni

A. Observations on related state court decisions.

In reaching its decision in Toni, the Alaska Supreme Court acknowledged that the Alaska legislature’s attempt to grant Alaska courts exclusive jurisdiction over a class of claims in some circumstances was hardly unique, and that several other sister states had concluded that similar statutes do, in fact, restrict their jurisdiction. See, e.g., Carbone v. Nxegen Holdings, Inc., 2013 WL 5781103, at *4-5 (Conn. Super,. Oct. 3, 2013); Wilson v. Celestial Greetings, Inc., 896 S.W.2d 759, 761-62 (Mo.App.1995); State ex rel. U.S. Fid. & Guar. Co v. Mehan, 581 S.2d 897, 840 (Mo.App. 1979); Foti v. W. Sizzlin Corp., 2004 WL 2848398, at *1-2 (Va.Cir., Feb. 6, 2004).

The Alaska Supreme Court noted that those courts relied on reasoning that was not applicable to the Alaska statute. For example, the Alaska Supreme Court pointed out that some state courts had applied state-law distinctions between local and transitory action to make discretionary decisions whether to stay or dismiss an action in favor of another forum. However, the Alaska Supreme Court observed that Tennessee Coal had established that a state cannot create a transitory cause of action and at the same time destroy the right to sue on that transitory cause of action in any court having jurisdiction, which suggested that states are not barred from asserting exclusive jurisdiction when the cause of action is local rather than transitory; that the Alaska statute granted Alaska courts exclusive jurisdiction over fraudulent transfer actions against Alaska trusts; and that fraudulent transfer actions were transitory actions.

In addition, the Alaska Supreme Court pointed out that other state courts had declined to hear cases on the basis of an exclusive jurisdiction provision without addressing the Tennessee Coal rule. For example, in Foti, supra, a Virginia Circuit Court elected to respect an assertion of exclusive jurisdiction because “comity suggests that limitations one state’s legislature places on its own laws be universally acknowledged.” However, the Alaska Supreme Court noted that comity is not a legal rule; rather it is a principle under which the courts of one state give effect to the laws of another state out of deference or respect. In other words, while courts may elect to follow a statute like the Alaska statute out of comity, they are not compelled to do so. Furthermore, the Alaska Supreme Court pointed out that the Alaska statute is more than a limitation Alaska’s legislature placed on its own laws; instead, it purports to deprive other states of jurisdiction over all fraudulent transfer actions concerning Alaska trusts, even those based on causes of action arising under that state’s own law.

Finally, the Alaska Supreme Court noted that in IMO Daniel Kloiber Dynasty Trust, 98 A.3d. 924 (Del.Ch.2014), the Delaware Court of Chancery had concluded that Delaware could not unilaterally preclude a sister state from hearing claims under that state’s law, citing Tennessee Coal.

B. Observations on similar related court decisions.

In reaching its decision in Toni, the Alaska Supreme Court noted that several federal courts had concluded that state law “exclusive jurisdiction” provisions did, in fact, deprive them of jurisdiction. See, e.g., Lynch v. Basinger, 2012 WL 6213781, at *5(D.N.J.,Dec. 12, 2012); Yale S. Corp v. Eclipse Servs., Inc., 2010 WL 2854687, at *3-4 (ND.Okla., July 19, 2010); Reserve Sols., Inc. v. Vernaglia, 438 F.Supp.2d 280, 288-89 (S.D.N.Y 2006). However, the Alaska Supreme Court pointed out that only one of these cases was reported, and that none of them addressed either Marshall or Tennessee Coal. Furthermore, the Alaska Supreme Court pointed out that other federal courts had reached the opposite conclusion. See, e.g., Superior Beverage Co. v. Schieffelin & Co., 448 F. 3d 910, 917 (6th Cir. 2006)(“a state may not deprive a federal court of jurisdiction merely by declaring in a statute that it holds exclusive jurisdiction”); Begay v. Kerr-McGee Corp., 682 F.2d 1311, 1315 (9th Cir. 1982) (states “have no power to enlarge or contract the federal jurisdiction”), quoting, Markham v. City of Newport News, 292 F.2d 711, 716 (4th Cir.1961); Duchek v. Jacobi, 646 F.2d 415, 419 (9th Cir. 1981)(same). The Alaska Supreme Court state that the reasoning in these latter cases was both persuasive and consistent with the approach set out in Marshall.

Brief Discussion

The following observations apply to the Alaska Supreme Court’s decision in Toni:

1. To date, sixteen (16) states have enacted asset protection trust legislation, and thirty-four (34) states have not. As such, conflict of law questions may arise concerning the ability of an asset protection trust to protect trust assets from the claims of a trust settlor’s creditors.

2. Toni involved a blatant fraudulent transfer of property to an asset protection trust. The transfers in Toni were made only after most of the default judgments were already entered by the Montana state court.

3. All fifty (50) states, including Alaska, interdict the fraudulent transfer of property. Indeed, Alaska statute AK 34.40.110(b) specifically provides that, “[i]f a trust contains a transfer restriction allowed under (a) of this section [asset protection trusts], the transfer restriction prevents a creditor existing when the trust is created or a person who subsequently becomes a creditor from satisfying a claim out of the beneficiary’s interest in the trust unless the creditor is a creditor of the settlor and…the settlor’s transfer of property in trust was made with the intent to defraud that creditor…”

4. It may be advisable to use a foreign asset protection trust rather than a domestic asset protection trust.

5. Asset protection trust works better when the settlor is a resident in the state with asset protection legislation.

6. Asset protection trust work better when the action is outside of bankruptcy.

7. Asset protection trusts work better when the settlor can avoid personal jurisdiction in a state without asset protection legislation.

8. Asset protection trusts work better when the asset transfer occurs more than ten (10) year limitation period set forth in 11 U.S.C. § 548(e).

9. The federal bankruptcy courts may not always recognize the asset protection features of a state with asset protection legislation, because these assets generally are regarded as property of the bankruptcy estate under 11 U.S.C. § 541.

10. The bankruptcy trustee always is free to commence a fraudulent transfer action under 11 U.S.C. § 548, assuming that the transfer to the asset protection trust occurred within ten (10) years prior to the commencement of the bankruptcy case.

Conclusion

Although states with asset protection legislation may purport to hold exclusive jurisdiction over asset protection trusts, this may not always be true when another state has personal jurisdiction over the debtor. However, as long as the funding of an asset protection trust is not voidable, it does not appear that the decision in Toni damages the usefulness of asset protection planning; rather, the decision in Toni stresses the importance of asset protection planning well before the need for an asset protection trust arises.

Five Steps for Real Estate Asset Protection

When purchasing real estate, it’s critical to protect ourselves and our possessions from lawsuits. We live in the most sue-happy society, in one of the most litigious times, and you need to protect yourself. One way to help prevent people from obtaining all your assets is to take precautions and think ahead, in order to ensure all your life treasures are secure. When a lawsuit is filed against you or your business, all your personal assets like you car, house, equity in your house, and bank accounts are at risk to be taken away. Here are a few ways to help ensure your real estate and personal possessions will be protected and secure.

1. Set Up Your LLC to Hold Your Real Estate

Let’s imagine you are purchasing 4-plex for an investment and will be renting it out for profit. When setting up your entity, make sure it is structured properly to hold the title of the real estate. An excellent entity for real estate is a Limited Liability Company (LLC). When you set up your LLC be sure that is it holding the title of your 4-plex. This structure also helps protect all your personal assets. For example, if a tenant of that 4-plex sues for falling on the property and wins the court case, they are not able to acquire all your personal assets like your bank account, the equity in your home, and all your other assets because the 4-plex is owned by the LLC. They are only able to access the assets in the LLC.

However, if you personally owned the 4-plex and did not set up an LLC to keep your assets separate, you could be vulnerable to unlimited personal liability, and you could be personally responsible for paying back whatever the court awards to the tenant for compensation. For some, that could mean bankruptcy. This is why it’s valuable to set up LLCs for protection.

2. Properly Maintain Your LLC

In order for your LLC to protect you from claims, you must maintain it much like taking care of a garden. Taking care of your garden by watering and feeding it properly is the best way for it to survive and keep it producing food for you. In order for your LLC to survive and keep protecting you, you must pay the annual fee to the state, ensure that minutes are being kept at meetings, and there needs to be a resident agent to accept service of process, or notice of a lawsuit. If you do not follow these easy steps, your business entity will lose its good standing, it will not be able to protect you as you could be vulnerable to piercing the corporate veil, and all your business and personal assets could be taken if a legal decision is decided against you. However, if you follow these steps you will be properly protected.

3. Segregate Your Assets

When creating your LLC, it is important to keep in mind that people are still capable of obtaining all your assets within that LLC. So why put all eggs in one basket? Instead separate your assets into different LLCs to act as a safety net, and ensure they aren’t able to obtain all of your real estate investments or company assets.

4. Get a Wyoming LLC to Hold Your Other LLCs

Certain states have different regulations on LLCs that can offer more protection, so why not take advantage of that? Wyoming is special in that it has great asset protection, great charging order protection, and it doesn’t list your name on the internet. Wyoming LLCs can own other LLCs established in other states. Not only does it have these great benefits, but it also has one of the most affordable state fees. Corporate Direct has also identified a way to ensure that the more preferable protections of Wyoming’s state laws take precedence over other state laws. This is a service we offer through our copyrighted legal language that is not available from any other company or law firm. We call it Armor8® . Learn more about our ultimate Wyoming LLC protection.

5. Use Equity Stripping

Another method of protecting assets is ‘equity stripping,’ sometimes called equity transfer.  With equity stripping you protect your equity by encumbering the property itself. Debt is a form of asset protection. The more debt, the less equity, the lesser chance of litigation. Since debt is asset protection, why not create the debt yourself? This can be done several ways such as spousal transfers, using your property as collateral, obtaining a secured line of credit, and a technique called cross-collateralization. Cross-collateralization is a term used when the collateral for one loan is also used as collateral for another loan. If a person has borrowed from the same bank a home loan secured by the house, a car loan secured by the car, and so on, these assets can be used as cross-collaterals for all the loans.

The Top 12 LLC Advantages and Disadvantages

When looking to start a business or protect investments you have several options in the type of entity you can form. As with anything, there are advantages and disadvantages to limited liability companies.

Advantages

  • It limits liability for managers and members.
  • Superior protection via the charging order.
  • Flexible management.
  • Flow-through taxation: profits are distributed to the members, who are taxed on profits at their personal tax level. This avoids double taxation.
  • Good privacy protection, especially in Wyoming.
  • This is a premier vehicle for holding appreciating assets, such as real estate, stock portfolios, and intellectual property.
  • Extraordinary flexibility in the ability to allocate profits and losses to members in varying amounts.

Disadvantages

LLCs and the Charging Order

One of the great asset protection advantages of the LLC is the charging order.

Charging order protection arises from each state’s law and is a key strategy for shielding your assets from attack. As with anything in the law, the charging order is subject to change and interpretation by the courts. Some states view the statute differently than others, which is why it is important to choose the right state when forming a limited partnership (LP) or limited liability company (LLC). It is also important to keep up on the new court cases and trends in this area to keep yourself better protected. Remember, the LLC has only been widely used in the USA in the last 25 years or so. We are just now starting to see court cases defining their scope and use.

Going back to the original statute (the rule passed by each state’s legislature) we consider section 703 of the Uniform Limited Partnership Act. It states that if a partner of an LP owes money to a judgement creditor (one who has gone to court and prevailed) the court may order a ‘charge’ against the partner’s interest to pay the judgement creditor. Thus the term ‘charging order’. This rule also applies to LLCs.

For example, if John owns a 50% membership interest in XYZ, LLC and John owes money to Mary after losing to her in court, Mary can seek a charging order to receive John’s 50% share in the distributions from XYZ, LLC. Of course, John’s other partner Carlos is not as keen to this, but any disruption is minimized with the charging order. Mary does not step into John’s shoes as a substituted partner. She can’t vote and tell Carlos how to run the business. Instead, she is only assigned the distributions that would have been made to John.

Again, the charging order is a court order providing a judgement creditor (someone who has already won in court and is now trying to collect) a lien on distributions. A chart helps to illustrate our example:

illustration of charging order

In our example, John was in a car wreck which injured Mary, the other driver. Mary does not have a claim against XYZ, LLC itself. The wreck had nothing to do with the duplex. Instead, Mary wants to collect against John’s main asset, which is a 50% interest in XYZ, LLC. Courts have said it is not fair to Carlos, the other 50% owner of XYZ, to let Mary come crashing into the LLC as a new partner. Instead, the courts give Mary a charging order, meaning if any distributions (think profits) flow from XYZ, LLC to John then Mary is charged with receiving them.

Mary is not a partner, can’t make decisions or demands and has to wait until John gets paid. If John never gets paid, neither does Mary. The charging order not only protects Mary, but it is a useful deterrent to frivolous litigation brought against John. Attorneys don’t like to wait around to get paid.

This short video also explains the charging order:

But what if there is only a single owner?

The Difficulties of Single Member LLCs

In a Single Member LLC, there is no Carlos to protect. It’s just John. Is it fair to Mary to only offer the charging order remedy? Or should other remedies be allowed?

llc advantages and disadvantages charging order single member llc

A key issue is whether the charging order applies to a single member (one owner) LLCs. There is a nationwide trend against protecting single member LLCs with the charging order. Courts are starting to deny single owner LLCs the same protection as multiple member LLCs. The reason has to do with the unique nature of the charging order.

In June of 2010, the Florida Supreme Court decided the Olmstead vs. FTC on these grounds. In a single owner LLC there are no other members to protect. The court allowed the FTC to seize Mr. Olmstead’s membership interests in order to collect. Other states have followed the trend.

How Corporate Structure Can Increase Protection

Say you have a property in Oregon. That property is entitled to an Oregon LLC, which is owned by a Wyoming LLC. You then invest in a property in North Carolina, so you set up a North Carolina LLC owned by the Wyoming LLC.

If a tenant of your Oregon property sues over something that happened on the property, they have a claim against the Oregon LLC, not against you personally. They can’t get at your North Carolina LLC, and they can’t get at equity held on your personal property.

As you can see it’s beneficial to spread your properties across multiple LLCs. If you have 10 properties all in one LLC, it becomes a target-rich LLC. Often, we recommend only having one property per LLC. You may wish to have two or three properties in an LLC, but it really depends on how much equity you have in each property. The structure of your business really comes in to play during an inside attack, which is where the lawsuit is against an LLC, not the owner.

In the case of an outside attack, where the owner of the LLC is the target of a lawsuit, the charging order comes into play. In our example above where Mary is trying to get at John’s property, let’s assume John is the owner of a Wyoming LLC, and he has LLCs in North Carolina and Oregon. The car wreck has nothing to do with John’s Wyoming LLC, the holding in Oregon or the holding in North Carolina, so Mary can only go after John. And since John has a Wyoming LLC, even if he is the sole owner of the Wyoming LLC, Mary’s only option is the charging order. If the Wyoming LLC makes no distributions, Mary gets nothing. If the Oregon LLC and the North Carolina LLC make no distributions to Wyoming, Mary gets nothing.

This is not a great situation for attorneys who are on a contingency fee. They get a percentage of what is collected and it’s not a really good way to operate if they have to sit around get a charging order against the Wyoming LLC and then sit around and wait to get paid. Attorneys, being rational, economic animals are going to take the next case that has insurance instead of waiting for John to pay Mary.

You want to use the strategic positioning of the Wyoming LLC, which will own all your other out-of-state LLCs. States like Oregon and North Carolina may not protect the single member LLC, so you really need a Wyoming entity for protection in a case like the car wreck example. The Wyoming LLC creates a firewall against attorneys and frivolous lawsuits.

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