I’m registering LLCs for our properties for Asset Protection. I have the option to register with either the LLC reserved to the members or vested in a manager. What is the legal affect of this choice? Which is the more commonly used setup for LLCs used to hold real estate for asset protection?
Thanks
V
If you ever repeat what you posted here in a deposition, the LLC won’t matter. You are engaging in illegal activity and the court will not respect the LLC. They are not for asset protection. They are for business continuity, estate planning, or some other legal, business purpose. In those cases, smart people use manager-managed LLCs. Member-managed LLCs create a means around the LLC protections.
OK, that’s all well and good. But what is the difference between a LLC vested in the members vs. managers?
V
If they are not for asset protection then what is the actual point of an LLC for a small investor? Everywhere I read it is mentioned that you will help protect your other assets from problems with properties in the LLC.
Scott
BLL is actually right. There is a lot of precedents in law that show judges completely throwing out LLC protection when the party in court stated that they were using them for ‘Asset Protection’. What isn’t stated clearly here however is that although they might be used for that purpose, you can’t state that it is your intention to do so.
When it comes to the purpose of limiting liability, the devil’s in the details.
But we are digressing completely off the point of my original post. What is the difference between vested in the members and manager-managed LLCs? That’s my simple question. If you want to start a thread on the value of LLCs, please let’s not hijack this one to do it. Its the worst form of forum etiquette out there.
V
Member-managed means the members (owners) of the LLC run the LLC.
Manager-managed means the members (owners) hire managers to run the LLC and do not run it themselves.
Member-managed LLCs put the personal assets of the members at risk for liability associated with the LLC. The LLC is not a real person and cannot engage in any business activity. Real people act on behalf of the LLC and are always responsible for their personal actions, even when they act on behalf of the LLC. When those member-managers do something on behalf of the LLC that creates liability, the LLC is liable and they are personally liable. The LLC assets can be used to satisfy any judgment as well as the personal assets of the member(s) involved.
Manager-managed LLCs avoid this situation. Their fatal flaw is that charging order protection doesn’t really apply. The point of a charging order is to prevent damage to the business by preventing the debtor member’s interest from passing to a creditor who wants cash. He doesn’t care about the business or the other members. He would liquidate the LLC to pay the judgment. Since the debtor member only takes distributions and doesn’t contribute to the operation of the LLC, there is no reason to limit the creditor to a charging order. The creditor can take control of the member interest without any disruption to the LLC. This situation can avoided by a properly drafted operating agreement, but that is an advanced topic that is not found in most operating agreements.
None really. Most small investors have much of their net worth inside the LLC where it sits unprotected. LLCs don’t protect anything they own. They isolate assets inside the LLC from assets outside the LLC. The other problem is that small investors actually run their businesses. That creates personal liability to bypass the LLC protection.
They do when used properly in conjunction with other entities. An LLC by itself doesn’t do much good.
I also thought that one big advantage of Using an LLC or other corporate entity is to build a business credit profile and access that credit to purchase properties thereby separating personal credit out of the picture (for the most part).
Without the use of business credit through a corporate entity one would have to use personal credit to buy, rehab and hold rentals. This would diminsh a personal credit report in no time. So Is this not an advantage to any RE investor???
Have you actually checked the downpayment requirements and interest rates of commercial loans for your LLC? Its not the same as a personal loan, and you’ll still be expected to personally guarantee the loan, from my experience.
V
Their fatal flaw is that charging order protection doesn't really apply.
Since the debtor member only takes distributions and doesn't contribute to the operation of the LLC, there is no reason to limit the creditor to a charging order.
I don’t understand your reasoning BLL. Charging order protection applies because the law says it applies. No reference is made in the LLC act (TX) with regard to charging order protection and whether or not the member is actively managing the entity.
You seem to have the risk reversed. Only in the case where the member is also manager would charging order protection be pointless: both the member and the entity would both be liable.
Charging order protection protects the entity from member personal liabilities arising OUTSIDE of the business.
Any single member cannot liquidate the business (even more complicated if he’s not the manager) unless the operating agreement gives him that power. Whether or not he “cares” about the other members is irrelevant.
Mark,
Let me speak to the concept of a charging order. Charging order protection isn’t a way for people to avoid paying debts. It was created to prevent the personal liability of one partner/member from disrupting the operation of a partnership/LLC where the other partners/members were not involved in the act that caused the liability. It is not a right of the debtor. It is protection for the innocent parties who would be adversely affected if the debtor’s interests were transferred. Charging order protection is in jeopardy when transferring the interest affects no one but the debtor.
Statute law is important, but it’s the case law that actually defines how the law is interpreted and applied. A member can forfeit his interest to a bankruptcy estate per Ehmann. Although this case only applies to bankruptcy, it’s important since a creditor can force a debtor into involuntary bankruptcy relatively easily. The case hinged on the fact the OA was non-executory, meaning the debtor member and LLC had no reciprocal obligations. The result would have been different if the agreement were executory. Another situation where charging order protection may not apply is when all the partners/members have the same creditor. A subset of that scenario is the single member LLC. It is also possible for the debtor’s interest to go to a creditor if all the other partners/members agree.
A properly structured partnership/operating agreement can mitigate these risks.
When the liability arises from the operation of the business, the entity is liable in addition to the person who actually caused the injury. In the case of partnerships, all general partners are personally liable as well. The creditor can seize entity assets because the entity is liable and can seize the personal assets of those individuals who are personally liable. Charging orders aren’t applicable in these cases.
Charging orders only apply to situations where the personal liability of the debtor partner/member has nothing to do with the business (e. g. being responsible for a car accident while on vacation). It is about collecting the personal assets of the debtor to satisfy the judgment. The key point is that charging order protection may not apply if the debtor is the only one who is adversely affected by the transfer of the interest instead of limiting the creditor to a charging order.
The key point is that charging order protection may not apply if the debtor is the only one who is adversely affected by the transfer of the interest instead of limiting the creditor to a charging order.
I think we’re on the same page, just took different paths to get there.
Iron sharpens iron…