Over the past twenty years, tens of thousands of physicians have established limited liability companies (LLCs) or family limited partnerships (FLPs) as part of an outside business in order to own real estate, for estate planning and, most often, for wealth protection purposes. The bad news is that in our experience, most physicians’ LLCs and FLPs are not as protective as they believe them to be because their controlling agreement is missing key provisions, or they have not kept up the entity properly on an annual basis. We will focus on the issue of the content or language here.
Language in Operating or Partnership Agreement
An LLC or FLP is only as protective or tax-beneficial as its language dictates, and we have found that most physicians’ LLCs or FLPs are lacking here. Let’s use an analogy of a will. First, you want the will to be valid from a legal perspective—proper signatures, witnesses, etc. This is precisely the weakness of many LLCs and FLPs regarding their ongoing legal requirements. Even if that is properly managed, then—like a will—the LLC or FLP is only as effective as the language in its operational document. A will might dictate that all assets go to one family member, to all family members, or all to charity. Similarly, an LLC or FLP can be written to maximize discounting for gift tax purposes or not. It may be written for solid protection against outside lawsuits…or not. Specifically, on the lawsuit protection perspective, there are a number of key provisions that an LLC or FLP should have.
We will describe just two of them here.
- Language on Distributions: If a physician wants the LLC or FLP to effectively provide a solid shield for LLC/FLP assets against outside lawsuits then proper language regarding distributions is critical. It is especially important that the language not lock in the LLC manager or managing member or FLP general partner to make distributions evenly. This can be problematic if there is ever a lawsuit or judgment creditor against the physician and/or other LLC or FLP owners. Nonetheless, in the typical LLC and FLP “form” agreements we have reviewed over the years, this problematic language is the standard boilerplate. This can be a significant weakness and may undermine the entire purpose of the entity for the physician and his/her family.
- Language on Involuntary Transfers: In our estimation, 80% of the hundreds of LLC and FLP agreements we have reviewed do not have adequate provisions regarding involuntary transfers. In other words, what exactly are the rights of a judgement creditor (i.e., successful lawsuit plaintiff) against an LLC or FLP owner’s interests? Most often, the only LLC or FLP language related to this issue is reading the ability of the owner to transfer their interests voluntarily, and they may be quite permissive. If this is the only language related to the issue, a judge may very well interpret that permissiveness to the situation to allow a successful plaintiff to become an owner, have voting rights, and even to take control of the LLC or FLP. Even worse, if the LLC or FLP is completely silent on the issue, then the judge has even more leeway.Ideally, an LLC or FLP defines exactly what occurs in the event of a judgement creditor getting court order against an owner’s interest, or similar involuntary-type of transfer. The language should define not only what circumstances give rise to the clause but also restrict the rights of such an involuntary transferee to the greatest extent of the relevant statute. This is crucial to take advantage of the strongest “outside risk” protections that an LLC or FLP can afford. Without this language, the entity is certainly not ideally protected.
If you have any of these entities in place, make sure that you have them reviewed by experienced experts.
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This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently, accordingly information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.