LLCs and asset protection

Here at Shenwick & Associates, many of our clients are looking to protect their assets (as we've covered extensively in our recent e-mails). This month, we're going to look at the intersection of business law and debtor and creditor law in discussing the use of limited liability companies (LLCs) as a tool for asset protection.

Unfortunately, New York law provides LLCs with less protection from a member's personal creditors than many other states. In most states, an LLC's money or property can't be taken by creditors to pay off the personal debts or liabilities of a member of the LLC. Instead, creditors are limited to obtaining a charging order against the LLC.

A charging order is the vehicle that gives a creditor a lien against the debtor/member's LLC economic interest in the LLC, which lasts until the judgment is satisfied. This lien is only against whatever distributions that the LLC makes to the debtor/member, if any and doesn't give the creditor any of the other rights that an LLC member has, i.e. voting rights.

New York case law provides that a charging order may not be a creditor's sole remedy against a LLC. In 3 West 16th Street, LLC v. Ancona, the plaintiff/creditor claimed that that codefendant Ancona acted with fraudulent intent when he transferred real property to the codefendant LLCs.

For the Supreme Court of the State of New York, New York County, Justice Singh wrote:

New York's LLC law does not provide that a charging order is a creditor's exclusive remedy against a member. That means that a creditor may be able to foreclose on the member's interest in the limited liability company and become owner of its financial rights in the company, and thus, obtain more authority than a mere assignee. However, that appears to be a rare event. (emphasis added)

The facts and circumstances of each case is important from a debtor/creditor perspective. For more information about LLCs, debtor/creditor law and bankruptcy law, please contact Jim Shenwick.

Spendthrift Trusts

Here at Shenwick & Associates, as part of our bankruptcy, creditors' rights and asset protection planning practice, we get many questions about spendthrift trusts.

A spendthrift trust is a trust that is settled for the benefit of a person (usually a person who is believed to be unable to control his or her spending) that gives a trustee authority to make decisions as to how the trust funds may be spent for the benefit of the beneficiary. In this post, we are specifically not discussing trusts that are self–settled (where the grantor/settlor is also the beneficiary). Creditors of the beneficiary generally (but with exceptions, discussed below) cannot reach the funds in the trust, and the funds are not actually under the control of the beneficiary.

To qualify as a spendthrift trust, the trust agreement should generally include a spendthrift provision–a provision that creates an irrevocable trust preventing creditors from attaching the interest of the beneficiary in the trust before that interest (cash or property) is actually distributed to him or her. Also, the trust agreement should not provide for mandatory distributions to beneficiaries (which allows the accumulation of income), but should provide for distributions at the discretion of the trustee. However, once a distribution is made from the trust to the beneficiary, creditors can attach that distribution.

In New York, there are two ways a creditor can attach the income a beneficiary receives from a trust. One way is via § 7-3.4 of the Estates, Powers and Trust Law, which provides that if a trust doesn't provide for accumulation of income (i.e. all income from the trust must be distributed at least annually), then a judgment creditor can reach all of the income due the beneficiary in excess of the amounts required for his or her education and support.

The other way is through § 5205(d) of the Civil Practice Law and Rules (CPLR). This section of the CPLR governs personal property exempt from the satisfaction of money judgments. Subsection (d) provides that a creditor can reach 10 percent of the income interest of a trust. However, if a court determines that the reasonable needs of the beneficiary and his or her dependents can be met by less than 90 percent of the trust income, then a greater percentage of the income can be reached by the creditors.

In a Florida bankruptcy case that applied the provisions of the CPLR to a New York spendthrift trust, the bankruptcy court took into account the beneficiary's total income and support from all sources, held that half of the trust income was unnecessary to meet the reasonable needs of the debtor and her dependents and concluded that such income could therefore be reached by the beneficiary's creditors.

In bankruptcy, spendthrift trusts are exempted under § 541(c)(2) of the Bankruptcy Code, which provides that "[a] restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable non-bankruptcy law is enforceable in a case under this title." So if a spendthrift trust is validly created pursuant to applicable state or federal (i.e. qualified retirement plans) law, then the spendthrift trust will not be property of a debtor's bankruptcy estate and not be subject to reach by creditors or the bankruptcy trustee.

To learn more about spendthrift trusts or protecting your assets from creditors both inside and outside of bankruptcy, please contact Jim Shenwick.

For Whom the Tax Debt Tolls

Here at Shenwick & Associates, many of our more challenging personal bankruptcy cases involves past due tax debts. We've previously written about the complex rules involving the dischargeability of taxes here and here.

This month we want to discuss the concept of "tolling." There are several types of events that serve to stop the clock on various time periods that determine when an income tax becomes dischargeable:

• A prior bankruptcy case. The filing of a bankruptcy case will toll both the rule that a tax must be more than three years past its due date to be dischargeable in bankruptcy (the "3 year rule") and the rule that a tax must have been assessed for more than 240 days to be dischargeable in bankruptcy (the "240 day rule")

• An request for a due process hearing or an appeal of a collection action taken against a debtor. The same rules apply.

• An offer in compromise. We recently wrote about offers in compromise, which are offers to compromise (or settle) a tax debt for less than the full amount due. The submission of an offer in compromise will toll the 240 day rule. If the taxpayer makes an offer in compromise within 240 days of filing for bankruptcy, the 240 day time rule will be suspended for the time during which the offer in compromise is pending, plus an additional 30 days.

• Tax litigation. Litigation with taxing authorities in U.S. Tax Court or other venues will toll both the 3 year rule and the 240 day rule.

• A request for an extension of time to file a tax return. Filing for an extension will: (a) delay the start of the 3 year rule to the extended due date; (b) delay the start of the rule that a tax is not dischargeable in bankruptcy until more than two years from the filing date (the "2 year rule") until the actual filing date; and (c) delay the start of the 240 day rule until the tax is actually assessed.

To get an idea of how your past due tax debts might be handled in bankruptcy, please contact Jim Shenwick.