A Family Limited Partnership (“FLP”) may be recommended in many situations. Such a situation often arises when a person has contributed or intends to contribute assets to a family business and would like to incorporate a family member into the business while retaining a degree of control over the assets. One of benefits of using an FLP in that situation is the potential to deter or limit the claims of future creditors to those assets. How can an FLP deter or limit those claims?
First, in an FLP, the ability of a business creditor to reach the incoming family member’s personal non-exempt assets to satisfy a business obligation can be limited. In the absence of good planning, a general partnership may arise by default when a family member joins the business and is viewed as an owner. Each of the partners in a general partnership is generally liable for all the partnership’s obligations, including an obligation arising from a wrongful act of another partner carrying out the partnership’s business. Thus, the incoming family member as a general partner could provide another pocket from which a partnership creditor could satisfy its claims. In an FLP, on the other hand, the incoming family member can be brought in as a limited partner. As such, his or her exposure is limited to the partner’s investment in the partnership unless the partner agrees otherwise. The new partner, however, should avoid giving the impression that the partner is a general partner when dealing with would-be creditors of the partnership and be clear about any other capacity in which the partner is acting to avoid any third-party reliance to the contrary.
Second, an FLP can deter or limit the ability of the incoming family member’s future creditors to reach assets contributed to the partnership. The member would not own the contributed assets, but would instead own a partnership interest in the FLP. A creditor’s exclusive remedy under Texas statute would be to obtain a charging order against that interest. A charging order does not give the creditor any ownership of the underlying interest or any associated voting rights. The creditor also would not become a partner in the partnership. A charging order, if obtained, entitles the creditor solely to partnership distributions that would otherwise be distributed to the owning partner. Furthermore, the terms of a partnership agreement may provide that the general partner has absolute discretion in deciding whether cash should be distributed or retained or invested for partnership purposes. Thus, a charging order is not a particularly desirable remedy for a creditor.
Two important caveats regarding a charging order as an exclusive remedy, however, are that: (a) creditors have had some success in other states in acquiring assets contributed to an entity where there were no other owners, and (b) the charging order remedy might not displace remedies afforded in a bankruptcy context or based on a fraudulent transfer claim. A person contributing assets to an FLP for asset protection reasons is often well-advised to do so as part of a comprehensive plan that includes an analysis of the person’s solvency and a reserve to account for current debts and potential liabilities.
An FLP’s effectiveness in protecting family assets from future creditors can be enhanced when used in conjunction with other limited liability entities or ownership arrangements. For example, a limited liability company may be formed to be the general partner of the FLP or to manage more risk-laden investments, such as rental properties. Also, a married couple as part of comprehensive plan may partition into separate property any FLP interest they own as community property or may gift some of their interest to their descendants, outright or in trusts, if gifts of the underlying assets were otherwise contemplated.
An FLP is an effective way of incorporating family members into a family business while at the same time deterring or limiting the claims of future creditors to those assets. An FLP can both (a) limit the access of the business’s future creditors to the incoming family member’s personal non-exempt assets, and (b) limit the access of that incoming partner’s future creditors to assets contributed to the business. The protection afforded by an FLP can be further enhanced when used in conjunction with other limited liability entities or ownership arrangements.
Of course, this is not an exhaustive discussion of the law applicable to these issues. For more information on this topic, please email Alex Longoria at email@example.com or call him at (832) 726-1000.