Consider Converting an S Corporation to an LLC

Both corporations and LLCs provide asset protection in that the owner will generally not be responsible for debts of the entity.  But when it comes to protecting an owner’s personal assets from his or her personal creditors, an LLC generally offers better protection than a corporation.  A creditor who controls the stock of a corporation essentially controls the whole corporation.  A creditor attempting to gain control of an owner’s LLC interest has a much more difficult task. The creditor can generally obtain only a charging order against distributions from the LLC.

Given the advantages of an LLC for certain asset protection purposes, a number of our clients have recently been converting S corporations to limited liability companies.  There can be serious tax and other consequences to this kind of conversion so it should only be done with the assistance of a qualified professional. 

The conversion can be a liquidation for federal income tax purposes.  This may not be the case, however, if you elect to have the LLC taxed like an S corporation.  Again, there are a number of very technical tax implications that have to be addressed in connection with any such conversion.  But in a number of situations there will be clear advantages to converting an S Corporation to an LLC to provide better asset protection.  

New Nevada Law Increases Protection of Single Owners of Corporations and LLCs

On June 16, 2011, Nevada's governor signed a new law specifically making a charging order the exclusive remedy of a judgment creditor against owners of both LLCs and corporations in Nevada.  The legislation specifically includes a sole member of an LLC and a sole shareholder of a corporation.

Nevada is clearly working to provide better asset protection for owners of closely held businesses.  The new law, which was signed by the governor a few days ago, passed the Nevada senate by a vote of 21-0 and the Nevada Assembly by a vote of 42-0.

Earlier this year, the Florida Supreme Court ruled that under Florida law, creditors of a sole member of an LLC were not limited to pursuing a charging order, but could also pursue other remedies against that debtor.  Since that time, a lot of attention has been focused on single member LLCs.

Since the new Nevada statute is only a few days old, commentators are just beginning to offer insights into the new legislation.  But the new Nevada statute is a clear reminder that some states provide better protection than others for business owners (particularly single owners).  Nevada, like Delaware, is currently a good choice for forming a corporation or a limited liability company from an asset protection standpoint.

Florida is Still a Debtor Friendly State for Asset Protection

The Florida Supreme Court recently ruled that a charging order is not the only remedy for creditors of LLC owners. My blog post of August 2, 2010 outlines the Florida Supreme Court decision. While the decision applied to a single member LLC, it could apply to multi-member Florida LLC’s as well. For the time being, Florida LLC owners – particularly single member LLC owners – must consider alternatives for protecting assets (such as a Florida limited liability partnership or reorganizing the LLC in another state such as Delaware).

It is important to keep in mind, however, that Florida is still a very debtor-friendly state. Florida has a virtually unlimited homestead exemption, and its statutes and case law are generally favorable to debtors from an asset protection standpoint.

For example, a Florida appellate court recently ruled that certain trust assets were beyond the reach of a beneficiary’s creditor, even though the trustee had improperly allowed the beneficiary to manage the trust assets. The court in Miller v. Kresser noted that the trustee had clearly abdicated his responsibilities, but nevertheless upheld the so-called spendthrift provisions of the trust. 

So despite the recent decision of the Florida Supreme Court in Olmstead v. FTC, Florida is still generally a very good jurisdiction with respect to asset protection.

LLC Better than a Corporation for Asset Protection Purposes

A limited liability company (LLC) will generally provide better asset protection to its owner than a corporation.

A limited liability company (“LLC”) is a hybrid type of legal entity that has some characteristics of a corporation and some characteristics of a partnership. Owners of an LLC are called members; they can elect to receive pass through tax treatment like a partnership or an S corporation, or to have the LLC taxed like a C corporation; they have limited liability like in a corporation; and they have a great deal of flexibility in management structure. Thus, many business owners now prefer to form an LLC instead of a corporation when the need for an additional entity arises.

LLCs provide significant asset protection advantages. A creditor of an owner of a corporation (that is, a creditor of a stockholder) often can gain control of a corporation by getting control of the owner’s stock. Shares of stock in a corporation are assets that can be “attached” or otherwise taken by a creditor to satisfy a judgment against the owner of the shares. Once the creditor has control of the shares, it can generally vote the shares and possibly gain control of the business entity. Thus, if you own all the stock of ABC Corporation and one of your creditors is able to take that stock, the creditor will control (and own) ABC Corporation. A membership interest in an LLC, however, is treated differently. A creditor of the owner of an LLC, generally cannot gain control of the member’s interest, because LLCs have what is called “charging order protection." If and when the LLC makes a distribution to you, the creditor can take it. However, the creditor generally cannot force a distribution or gain voting control of the LLC. The bottom line is that a creditor of the owner of an LLC membership interest has much less leverage than a creditor of an owner of stock in a corporation.