Asset Protection: Inside v. Outside Creditors
Clients often come to my office requesting a limited liability company (an “LLC”) for “asset protection” purposes. They normally want to transfer an income-producing property out of their own name and into the name of an LLC, believing this will give them increased “asset protection,” but are not sure exactly what this entails. There are two different types of creditors from which clients need protection, and we call them “inside creditors” and “outside creditors.”
We recently had a client (named Client A for ease) who owned several residential rental properties in California, as well as a vacation home and a personal residence. In discussing the need for asset protection, Client A was worried about someone slipping and falling at one of the residential rentals, and thus suing Client A for damages. A tenant or other party that has a claim against Client A due to the ownership of the rental property is considered an “inside creditor.” By transferring the property to an LLC, Client A can insulate this creditor claim. The claimant would be suing the owner of the property, the LLC – and not Client A. The claimant would only be able to get a judgment against the LLC and it’s assets, not the personal assets of Client A, which may include the residence, vacation home, etc. This would insulate Client A’s other assets (i.e. personal residence, other properties) from being subject to collection efforts.
We recently had another client (named Client B for ease) who is an attorney. All attorneys, CPA’s, architects, doctors and other licensed professionals are personally liable for claims against them in the course of their profession, and this liability cannot be avoided. Client B also owned several residential rental properties in California, as well as a vacation home and a personal residence. In discussing the need for asset protection, Client B was not so worried about a slip-and-fall at a rental property, but a claim by a former client of Client B suing for malpractice. A former client has a claim against Client B for his activities, and not for ownership of any asset, and is therefore considered an “outside creditor.” This outside creditor, if a judgment is obtained, will be able to attach all of the personal assets of Client B. By transferring the rental properties to an LLC, the properties specifically are no longer an asset of Client B. A judgment creditor would be required to obtain a charging order against the LLC in order to collect against that asset – a much more difficult endeavor than if owned by Client B himself.
Asset protection planning can be utilized to protect against both “inside” and “outside” creditors. However, it must be done before there are actual or potential claims against the client. Any transfers done after there is a potential or actual claim may be considered fraudulent transfers and can be transferred back by a court on proper showing.
The attorneys at TLD can assist individuals with all facets of asset protection planning, from LLC formation and funding to advanced estate planning for asset protection. Please contact us if you have questions.
