It is not how much they win rather it is how much they collect as I often state when referring to lawsuits. Many real estate investors understand the distinction and take steps that involve the use of corporations, land trusts, equity stripping and limited liability companies to minimize their overall risk exposure. The key to planning is understanding how these entities work in conjunction with one another to create an overall effective plan.
A good asset protection planner must know the difference between these entities from a tax and asset protection standpoint, where is the appropriate state to file the entity, and when one entity type should be used over another (this is not an exhaustive list). For example, this past week I met a real estate investor in Orlando while speaking at an asset protection workshop. This person, whom I shall refer to as Sally, was distraught over a lien that was about to be levied on her condo by the Condo Owner’s Association. Sally was completely beside herself because she thought she made the right move when she transferred her condo into a LLC for asset protection. Through conversing with Sally, she informed me that she had read and subsequently heard from her local REIA that rental property should be held by LLCs for asset protection. Sally wanted to know why no one had told her that in transferring her property she would face a fine for implementing this strategy. What Sally did not understand is generally speaking this is sound advice but not knowing the nuances of holding title will create problems as Sally discovered.
In Florida, it is very common for community associations to limit who may own property. When these communities where planned the developer and subsequent owners did not want landlords buying up the property and turning the community into a rental pool. To combat this, rules were adopted to prevent business entities from owning property within the community. If Sally had consulted my firm we would have told her to first utilize a land trust (see Land Trust Part 2 for more information on land trusts and holding title to property) to hold title to her property. After the property was recorded in the name of her trust, Sally could have easily transferred her trust into a LLC for asset protection and no one would be the wiser.
This post is not about land trusts but about not knowing or understanding the nuances of asset protection. Many of the people I met last week planned to embark on their own asset protection planning without realizing that it is the details that can spell the difference between success and disaster. Just because it sounds like the right thing to do does not necessarily mean that it will work. In a prior post, Running your Real Estate Business out of Nevada or Wyoming, I addressed the use of a Nevada or Wyoming LLC registered in a different state to hold rental real estate. Investors falsely assume that the charging order protections offered by Nevada or Wyoming will apply even if the investor is sued in the state where the LLC is foreign filed. I explained how a court would most likely apply the foreign state’s law in deciding what protections will be afforded to its members. In a recent Utah case, American Institutional Partners, LLC (“AIP”) v. Fairstar Resources LTD (“Fairstar”), this was exactly this issue.
In that case, Mark Robbins established AIP in Delaware then foreign filed it in Utah to conduct business. Mr. Robbins was later sued in Utah court and a judgment was entered against him in favor of Fairstar. Fairstar later reduced this judgment to a charging order against AIP and then sought to foreclose on Mr. Robbins interest in AIP i.e., Fairstar was seeking to take AIP from Mr. Robbins.
Unfortunately for Mr. Robbins, Utah’s LLC statute permits a creditor of a member in a LLC to foreclose on his interest i.e., the “charging order” is not the sole and exclusive remedy. Mr. Robbins thought he held an ace up his sleeve because AIP was a Delaware LLC registered to conduct business in Utah. Under Delaware’s LLC statute the charging order is the sole remedy therefore, he argued that Delaware law must apply. The Utah court disagreed and issued an order that Utah law applies to all judgment execution proceeding including the creditor’s foreclosure of the debtor’s interests in limited liability companies whether such LLCs are domestic or foreign. Only in internal matter of LLC business would Delaware law apply.
A different result would have been reached had Mr. Robbins not filed his Delaware LLC in Utah and instead chose to create a Utah LLC that was wholly owned by his Delaware LLC. In a structure such as this, the Utah court would not have had any jurisdiction over his Delaware LLC because it was not registered in Utah. MR. Robbins might have walked away with his assets in tact.