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 Laws In Ohio Offer Much Better Asset Protection Alternatives

The Ohio Legacy Trust Act (part of Ohio House Bill 479) becomes effective on March 27, 2013.  Ohio will become one of approximately 15 states with what is commonly called a Domestic Asset Protection Trust Statute.

Ohio House Bill 479 also increases the Ohio homestead exemption and makes other changes that offer better asset protection alternatives in Ohio.  This new law - - coupled with changes to Ohio’s LLC statute that were made last year - - make Ohio a much better asset protection jurisdiction than it was a year ago.

Ohio LLC Statute Now Provides Better Protection from Creditors

Following up on my post of April 13, 2012 --

Ohio House Bill 48 (which becomes effective on May 4, 2012) makes important changes to Sections 1705.18 and 1705.19 of the Ohio Revised Code.  A new Section 1705.19(C) provides:

No creditor of a member of a limited liability company or any member's assignee shall have any right to obtain possession, or otherwise exercise legal or equitable remedies with respect to, the property of the limited liability company.

Section 1705.19(B) strengthened Ohio's charging order protection.  The new subsection (C) makes it even clearer that a creditor of a member simply cannot exercise legal or equitable remedies against the property of the limited liability company.

As I noted in my earlier post, these new provisions make Ohio LLCs much more appealing from an asset protection standpoint.

 

 

Important Changes to Ohio LLC Statute Take Effect on May 4, 2012

Ohio House Bill 48 (signed by Governer Kasich on February 2, 2012) makes some significant changes to Ohio's LLC law.  The new legislation (which becomes effective on May 4, 2012) affects Sections 1705.18 and 1705.19 of the Ohio Revised Code.

The new legislation clarifies that a charging order is the sole and exclusive remedy for satifsying a judgment against a membership interest of a debtor-member.  Other legal and equitable remedies are barred.

There had been some uncertainty about this area of Ohio law, and new legislation clears up that uncertainty.

Ohio law still does not specifically state that single member LLCs and multi-member LLCs will be treated the same.

At any rate, the new Ohio legislation makes Ohio LLCs much more appealing from an asset protection standpoint.

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.

Delaware is a Good Choice for an LLC

As I mentioned in a post last month, limited liability company laws vary significantly from state to state.  Depending on your particular circumstances, one state could have significant advantages over another.

Here are a few reasons why Delaware is one of the best states to form a limited liability company from an asset protection standpoint:

  • Formation is relatively convenient and inexpensive compared to many other states.
  • The applicable Delaware statute clearly makes a charging order the exclusive remedy of a creditor.
  • Certain other creditor remedies are expressly barred.
  • Delaware law allows various provisions in the LLC Operating Agreement that could be favorable from an asset protection standpoint.
  • Delaware has a more developed body of case law than many other states; and the Delaware Chancery Court is a very sophisticated court from a business standpoint. 

If you form your LLC in Delaware but it does business in another state, you will have to file additional papers in that other state to qualify to do business.

Ohio LLCs may provide significant protection; but they are currently not as solid as the protection offered by Delaware law.  I am now generally forming Delaware LLCs even when one of my clients will be doing business in Ohio.

Each situation should always be examined on an individual basis.  As I have mentioned many times before, there is no magic asset protection formula that will be appropriate in all situations.  But in situations where a limited liability company is appropriate, Delaware is currently a very reasonable choice.

Picking the Right State for Your LLC

Limited liability company laws vary significantly from state to state.  Depending on your particular circumstances, one state could have significant advantages or disadvantages over another.

First of all, states have specific requirements when you form a limited liability company.  For example, New York requires a newspaper publication notice.  It also allows a manager-managed limited liability company only if this is specified in the Articles of Organization.  Most other states have no such requirements.  In Ohio, forming an LLC is relatively easy and very little information needs to be provided.  The same is true, for example, in Delaware.  But even in states where formation is relatively simple, trying to form an LLC without the help of an attorney could turn out to be a costly mistake in the long run.

So called charging order protection can also vary substantially from state to state.  A recent Florida Supreme Court decision held that a charging order was not the exclusive remedy for a creditor against a membership interest in a Florida LLC.  Delaware, on the other hand, has a specific statutory provision that makes a charging order an exclusive remedy.

As I mentioned in a recent post, offshore LLC statutes also provide varying degrees of asset protection.  It seems that Nevis is currently a good choice for an offshore LLC.

It is also important to periodically review your LLC arrangement after it is formed.  Statutes and case law can change quickly.

Nevis Is A Good Choice For An Offshore LLC

In the United States, forming an LLC in a particular state (such as Delaware) can provide significantly better asset protection advantages than forming that LLC in certain other states.  The same holds true for offshore LLCs.  Nevis is currently one of the best offshore jurisdictions for a limited liability company.

Forming a limited liability company in Nevis (a small island in the Caribbean) is relatively easy and can generally be done fairly quickly (usually within 4 to 5 working days).  The Nevis Limited Liability Company Ordinance of 1995 makes the structure of a Nevis LLC extremely flexible.  It is essentially a matter of contract among the members.  Nevis LLCs offer their members full privacy, as there is no public filing requirement regarding the identity of members.

Legal judgments obtained against a Nevis LLC in any foreign jurisdiction must be domesticated in Nevis.  This can prove to be expensive and time consuming; and Nevis attorneys are not allowed to work on a contingency basis.  A member's interest in a Nevis LLC has "charging order" protection similar to that offered by many states in the United States.  Currently, no taxes are imposed on assets or income of a Nevis LLC as long as those assets and income originate outside of Nevis.

Many considerations are involved in a decision to form an offshore limited liability company.  If a decision is made that an offshore LLC is appropriate, Nevis is currently a good location to form such an entity.

Multi Member LLCs After Olmstead

I have discussed the Florida Supreme Court's decision in Olmstead in other posts on December 20, 2010September 22, 2010 and August 2, 2010.  In addition to severely weakening the asset protection advantage of a single member LLC in Florida, the decision unfortunately calls into question the effectiveness of multi-member LLCs in that state.

There are various alternatives for those who are currently members of a Florida multi member LLC.  You can consider converting the LLC into a different form of entity (such as a limited partnership); change the management structure from a member managed form to a so-called manager-managed form; create non-voting interests for certain owners; or re-form the LLC in a state that has well settled charging protection law (such as Delaware, Wyoming, Nevada or Texas).  It may also be reasonable to wait and see if the Florida courts or the legislature clarify the situation with respect to multi-member LLCs.

In any event, it is critical to get the right professional help before making any changes your Florida LLC (or any other LLC).  Changing the ownership structure, management structure, or state of formation of an LLC can have tax and other considerations that may need attention.

For Florida attorneys, I recommend an excellent article in the Florida Bar Journal, Volume 84 (December 2010).  The authors provide a thorough review of the impact of Olmstead on multi-member Florida LLCs.

The Olmstead decision provides a stark reminder of two very important points:

  1. Asset protection law varies significantly from state to state; and
  2. Asset protection laws are constantly changing, both through statutory changes and court decisions.

Having a competent professional assist you with your asset protection planning is vitally important.  It is also important to have any asset protection plan reviewed periodically because the law in this area is evolving very rapidly.

Olmstead Decision Does Not Make All Single Member LLCs Useless

On June 24, 2010, the Florida Supreme Court ruled in Olmstead v. Federal Trade Commission that a charging order is not the exclusive remedy for a judgment creditor against a debtor's single member LLC interest.  This means that in Florida, a judgment creditor can essentially seize a debtor's single member LLC interest and gain full control of the LLC.  This was obviously a big blow to the usefulness of single member LLCs -- especially in Florida.

Some commentators are acting like all single member LLCs are now essentially useless.  But this is simply not the case.  First of all, charging order protection for single member LLCs is still available in other states.  For example, earlier this year Wyoming law was specifically amended to provide that for a single member LLC formed in that state, a charging order is the exclusive remedy of a judgment creditor.  Several other states offer the same protection.

Even in Florida, a single member LLC may still be an acceptable part of an overall asset protection plan.  Such an LLC still provides limited liability protection for the owner from a judgment against the LLC itself.  So heavily mortgaged real estate held in a single member LLC may still not raise a big concern from an asset protection standpoint.

It is obvious that a single member LLC formed in certain states will offer significantly better protection than a single member LLC formed in many other states.  Multi member LLCs generally offer better asset protection than single member LLCs.  But each situation has to be analyzed on its own.  Asset protection must be integrated with various personal, business, tax and estate planning considerations.

The Florida Supreme Court decision in Olmstead was definitely a blow to the usefulness of single member LLCs.  But a single member LLC (especially one formed in certain states other than Florida) can still be a valuable component of a viable asset protection plan.

Florida Supreme Court Limits Protection for Single Member LLC's

It has generally been assumed that when a creditor of an LLC member gets a judgment against that member, the only thing the creditor can do is to get a so-called "charging order".  Such an order does not give the creditor control of the LLC -- just a right to receive distributions if and when they are made.  This is one of the advantages of an LLC over a corporation for asset protection purposes.  If you own shares of a corporation, a creditor can generally gain control of those shares much more easily than it could gain control of an LLC interest.

But on June 24, 2010, the Florida Supreme Court ruled in the case of Olmstead v. Federal Trade Commission that because the Florida Limited Liability Company Act does not specifically make a charging order the exclusive remedy of a creditor, the creditor can use other remedies to gain control of a single member LLC interest.  This means a creditor can gain total control of the LLC.  Even worse, the Court's logic raises at least some concern about protection of multi-member Florida LLC interests.  Two dissenting justices on the Florida Supreme Court strongly disagreed with the decision and accused the majority of justices of rewriting the Florida statute.

Some states (like Delaware) make clear in their state statute that a charging order is the exclusive remedy of a judgment creditor.  So this recent Florida decision is of no concern to owners of single member Delaware LLC's.  But it does raise concerns about single member LLC interests in various other states.

Like many other asset protection attorneys, I will be studying this decision in much greater detail in the coming weeks.

This case is a reminder that asset protection law is constantly evolving, so it is advisable to periodically consult with an attorney even if you already have an asset protection plan in place.

Family LLC's

Family limited liability companies can be a convenient vehicle to hold and administer family investments.  They offer significant benefits from both an estate planning and asset protection standpoint.  Until recently, the entity of choice for family investments was a family limited partnership (often just called an FLP).  While there is nothing wrong with an FLP, we are now using LLC's more frequently.  There are some technical legal differences between the two forms of entity, but the benefits are basically the same.

Holding family investments (such as marketable securities and real estate) in a family LLC makes it significantly more difficult for a creditor to reach those assets than if they were held individually.  Keep in mind that not only you, but also your children and other family members could potentially have future creditor problems.  So an LLC can help protect the interests of all family members.

A family LLC can also be a useful vehicle for estate planning purposes.  Rather than making outright gifts to children, you can gift interests in the family LLC.  You may be able to take advantage of some discounts for gift and estate planning purposes.

The bottom line is that a family LLC can be a useful tool for both asset protection and estate planning purposes.

Ohio Appeals Court Affirms Basic LLC Protections

It is now well settled that a limited liability company insulates the owners from the debts of the company.

It is nevertheless reassuring when a court re-affirms basic LLC protections.  In Dover Phila Heating v. SJS Restaurants 185 Ohio App.3d 107, 2009-Ohio-6187, the Ohio Court of Appeals for the Fifth Appellate District confirmed once again that members of a limited liability company generally have no responsibility for the debts of the entity.  The case was decided in late 2009 and published in the April 5, 2010 Ohio State Bar Association Report.  Citing another Ohio case, Slimans Printing Inc. v. Velo Internatl., Stark App. No. 2004CA00095, 2005-Ohio-173, 2005 WL 100963, ¶ 13, the court noted that pursuant to Ohio Revised Code §1705.48(B),

Neither the members of the limited liability company nor any managers of the limited liability company are personally liable to satisfy any judgment, decree, or order of a court for, or are personally liable to satisfy in any other manner, a debt, obligation, or liability of the company solely by reason of being a member or manager of the limited liability company.

While there is nothing surprising in this recent decision, it is always good to see a court re-affirming the basic protections of a limited liability company.

Asset Protection Strategies for Your Business

There are a number of relatively simple strategies an organization can use to provide significant protection for its assets.

1.                        Separate Entities. Consider creating a separate entity (possibly a limited liability company) to hold real estate, machinery, or assets relating to a new line of business. If there were a future judgment against the corporation, the assets held in the separate entity or entities would likely not be subject to that judgment as long as appropriate formalities were followed. Tax issues can arise in connection with the transfer of assets, and these should be considered prior to any transfers. For example, the transfer of real estate out of a C corporation into a limited liability company could trigger a significant amount of tax, and thus make the transfer impractical. But if additional real estate or a significant piece of machinery or equipment is being acquired, having a new limited liability company purchase it (and then lease it to the corporation) could have significant advantages. 

2.                        Limited Liability Companies. 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; 
  • They have a great deal of flexibility in management structure. 

LLCs can 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. Creditors will have a much more difficult time gaining control of an LLC. Thus, many business owners now prefer to form an LLC instead of a corporation when the need for an additional entity arises.

3.                        Insurance. Review all of your business insurance with both your attorney and your insurance agent. Since your attorney is not selling any insurance products, he or she can often provide an objective review of the types and amount of your business insurance. Having adequate insurance is one of the most important (and generally one of the most cost effective) ways to provide protection for your business.

4.                        Update Corporate Records and Follow Required Formalities. Many closely held businesses do not keep their corporate record books up to date. In the event of a lawsuit against the company, a plaintiff’s attorney can attempt to “pierce to corporate veil”. This means the corporation will essentially be ignored and the owners (shareholders) will be personally liable for the corporate debts.  Following basic corporate formalities, including

  • Holding an annual shareholders meeting;
  • Holding regular meetings of the Board of Directors;
  • Avoiding any mixing of personal and corporate assets; and
  • Keeping corporate records up to date.

will all help to insure that the assets of the owner(s) of the business are insulated from any judgment against the business. One of the many advantages of an LLC over a corporation is that LLCs require fewer formalities in both their organization and operation. However, piercing of the LLC veil is also possible under various circumstances, including inadequate capitalization or failure to maintain a separate indentity (for example, failing to have a separate bank account for the LLC). 

5.                        Business Succession Plan. Many business owners lose sleep worrying about lawsuits and other potential legal claims. While these concerns are often justified, more businesses collapse from lack of a business succession plan than from a lawsuit bought by a party unrelated to the business. Lack of such a plan can lead to fights among family members, including litigation, which can be disastrous at both a business and a personal level. Paying attention in advance to at least some form of succession plan can save an enormous amount of trouble later. Life insurance should be considered as one part of the business succession arrangement. Good business succession planning is also a form of asset protection planning. 

6.                        General Legal Review of Business Operations. Is your business in compliance with applicable employment laws and other regulatory requirements? Has your employee manual been reviewed recently? One lawsuit will likely cost far more than a basic legal compliance review. A legal “check up” is like a medical check up: identifying one or more serious problems and taking care of them now can avoid a much greater problem later. 

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. 

   

Piercing the Corporate Veil

Corporations and limited liability companies (LLCs) provide significant liability protection to their owners.  Shareholders of corporations and members of limited liability companies generally are not responsible for debts of the corporation or LLC.  A recent Ohio case, however, serves as a reminder that creditors may attempt to "pierce the corporate veil" and hold an owner individually liable for debts of the entity. 

In RCO International Corporation v. Clevenger, 180 Ohio App.3d  211 (2008) the Plaintiff brought a breach of contract action against an LLC and its two members.  While the lower court granted summary judgment in favor of the owners, an Ohio appeals court held that the creditor may have made sufficient allegations against the owners, to sue them personally.  While the Plaintiff did not allege fraud, it did allege an illegal act (the company's sending a false invoice).  On the surface, the facts of this case did not seem to present a strong case for "piercing the corporate veil".  The decision, however, may have rested on certain procedural issues.  In any event, this recent case is a good reminder that simply forming a corporation or LLC does not in and of itself automatically give the owner limited liability in all circumstances. 

What can be done to prevent a creditor from "piercing the corporate veil" and holding an owner personally liable?

  • Make sure your corporation or LLC is properly set up.  If you are setting up an entity without the help of an attorney, you may not be taking all the necessary steps to make sure that the entity is properly formed.
  • Observe formalities once the entity is formed.  Corporations should hold annual meetings of shareholders.  There should be meetings of the Board of Directors.  An LLC should have an Operating Agreement, and the terms of that Operating Agreement should be followed.  Your entity should have a separate bank account and be treated as a separate entity.
  • Your corporation or LLC should have usual and customary insurance for whatever business it is conducting.  A court is far more likely to try and "pierce the corporate veil" if the owner has intentionally failed to provide customary insurance for the entity's activities.
  • Follow good business practices.  Forming an entity will not shield an individual owner from fraud or illegal acts.

The leading court decision in Ohio, Belvedere Condominium Unit Owners Association v. R.E. Roark Companies, 67 Ohio St. 3d 274 (1993), as well as decisions in many other states, make clear that if usual and customary practices are followed, a corporation or an LLC should provide limited liability protection for its owners.