North Carolina Wealth Law Counselor : North Carolina Estate Planning Lawyers & Attorneys for Asset Protection & Trust Administration in Greensboro, Raleigh & Winston-Salem NC

Confusion and chaos.  That's what the Florida Supreme Court created in Olmstead v. F.T.C. In Olmstead the Florida Supreme Court, in a 4-2 decision with a scathing dissent, ruled that Florida law allows a court to order a judgment debtor to surrender all right, title, and interest in the debtor's single-member limited liability company (SMLLC) to satisfy an outstanding judgment.  The court went on to note that the charging order provision set forth in Florida Statute Sec. 608.433(4) was, on its face, a nonexclusive remedy and that the statute "does not in any way suggest that the charging order remedy is an exclusive remedy."

Olmstead correctly pointed out that the Florida statute made no distinction between a SMLLC and a multi-member limited liability company.  As the dissent in Olmstead observed, because the statute makes no distinction between SMLLCs and multi-member LLCs, the court's ruling arguably applies with equal force to both SMLLCs and multi-member LLCs, so that a charging order is at best a nonexclusive remedy for multi-member LLCs as well, and "render[s] assets of all LLCs vulnerable."

In its simplest form, a charging order is an order from the court directing an entity to pay over to the judgment creditor any monies or property that the judgment debotor would have received, if and when the judgment debtor becomes entitled to a distribution.  A charging order typically remains in effect until the judgment is satisfied in full.

Charging orders originated in England when Parliament enacted the Partnership Act of 1890.  Prior to that time, a creditor who had a judgment against a partner of a partnership on a claim wholly unrelated to the partnership could seize partnership assets to satisfy the judgment.  This wreaked havoc on partnerships because partners were powerless to prevent judgment creditors from interjecting themselves into the partnership's business. 

Both the Uniform Partnership Act and Uniform Limited Partnership Act in the United States borrowed the charging order concept from England's Partnership Act of 1890.  When states enacted laws permitting limited liability companies, the charging order concept was carried through to LLCs.   With the possible exception of certain Nevada corporations, corporations and their shareholders do not have similar protections.

As the different states enacted legislation allowing for the creation of LLCs, some states, such as Alaska, Nevada, North Carolina (see below), North Dakota, South Dakota, and Texas to name a few, provided that a charging order is the sole remedy of a judgment creditor.  Other states, such as California, Colorado, South Carolina, Utah, and West Virginia, permit a judgment creditor to foreclose on member's interest in a LLC.  Until Olmstead, many Florida practitioners would have said a charging order was the sole remedy under Florida law. 

While the Olmstead decision created much confusion and consternation among the Florida bar, its effects extend well beyond Florida.  Many states' LLC statutes contain language similar to Fla. Stat. 608.433(4). For instance, N.C.G.S. Sec. 57C-5-03 is almost identical to Fla. Stat. Sec. 608.433(4), and makes no distinction between SMLLCs and multi-member LLCs. Although the  North Carolina Court of Appeals in Herring v. Keasler  held that a judgment creditor could not seize and sell the judgment debtor's membership interests in several LLCs, and instead the judgment creditor's "only remedy is to have those interests charged with payment of the judgment under N.C. Gen. Stat. § 57C-5-03," the judgment debtor in Herring only owned a 20% interest in the LLCs at issue.  

Like Florida before Olmstead, North Carolina appellate courts, as well as appellate courts in a number of other states with similar LLC statutes, have yet to address this issue.  While North Carolina's statute seems plain enough on its face - it should apply equally to SMLLCs and multi-member LLCs - Olmstead illustrates the risks of making any such assumption absent legislative or judicial clarification.  Until then, multi-member LLCs provide the safest course of action for charging order protection.

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In a recent decision, the normally unfriendly United States Tax Court ruled in favor of a taxpayer in a family limited partnership ("FLP") case. 

In Estate of Shurtz (.pdf), the Tax Court ruled that despite somewhat lax observations of the corporate formalities, a FLP was nevertheless formed for legitimate non-tax reasons and that the formation was a bona fide sale for full and adequate consideration.  The Tax Court held that asset protection and protection of the family business is a legitimate non-tax purpose. 

While the Shurtz' FLP followed ordinary formation procedures, the FLP:

• failed to open a checking account for at least 4 months
• made disproportionate distributions
• did not keep normal partnership records (accountant's records served as the paper trail to document capital accounts and other transactions). 

Nevertheless, the court ruled there was a bona fide sale for full and adequate consideration.  Reviewing the factors set out in Bongard (.pdf), a 2005 Tax Court case, the Shurtz Court noted:

1. The contributors received interests in the FLP proportionate to the ownership interest each contributed. The Shurtz engaged an accountant to calculate the value of a 1-percent general partnership interest in the FLP based on the value of the total property being contributed. The Shurtz each contributed property equal to the value of a 1-percent general partnership interest and the 98-percent limited partnership interest.
    
2. The respective assets contributed were properly credited to each partner's respective capital account.
    
3. Distributions from the FLP required a negative adjustment in the distributee partner's capital account.
    
4. Asset protection and protection of a family business is a legitimate and significant non-tax business reason for the establishment of the FLP.

For these reasons, the Tax Court was satisfied that the formation of the FLP and the contribution of property to the FLP were carried out in the way that ordinary parties to a business transaction would do business with each other. Consequently, the Tax Court ruled that the transfer of property to the FLP was made for adequate and full consideration.

FLPs, which include family limited liability companies, present a great opportunity to pass family wealth to future generations at discounted values, while at the same time providing significant asset protection features to preserve and protect a family's accumulated wealth.  However, the window of opportunity for passing wealth at discounted values may be closing soon.

The most recent proposal sent over by the White House substantially restricts valuation discounts.  If the legislation is passed in its current form, any entities formed and funded after the effective date of the legislation will lose valuable opportunities for discounting.  Once closed, the window may remain closed forever.

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