PracticalDermatology

The reality of medical practice in the 21st century is that lawsuits and liability lurk in the background for dermatologists and physicians in all specialties. In the quest to protect themselves from future litigation, many dermatologists choose to engage in asset protection—and they are wise to do so. In the field of asset protection, there are many types of tools to utilize, including ownership forms with spouses, assets that are exempt under state or federal law, and trusts. Perhaps the most widely used legal structures for physicians are limited liability companies (LLCs) and family limited partnerships (FLPs).

In this first part of a two-part article, we will discuss what LLCs and FLPs are and how they can protect a physician’s wealth from litigation. In the second installment, we will discuss a few tactics a dermatologist can use to maximize the protections of LLCs and FLPs.

LLCs and FLPs: Similarities and Differences

We have combined LLCs and FLPs here because they are very similar—although LLCs are utilized much more frequently by most attorneys for the last 15-20 years. Both are legal entities created under state law, allow for two levels of ownership (passive and active), and enjoy the beneficial “charging order” protections that make them so valuable in this area of planning.

The LLC is more flexible than the FLP in a few ways, as only the LLC can be used for a single owner (called a “member”), while the FLP requires at least two owners (called “partners”). Also, the LLC has greater tax flexibility than the FLP—the LLC can be taxed as a partnership (as the FLP must be), but the can also elect “S” or “C” corporation tax status or, if only one owner, “disregarded entity” tax status.

Finally, while the person or entity controlling the FLP (called a “general partner”) has liability for the acts and debts of the FLP, this is not the case for the person or entity controlling the LLC (called the “manager” or “managing member”). These are some of the reasons why LLCs have become so much more popular than FLPs over the years.

How LLCs and FLPs Protect Assets

In order to understand how FLPs and LLCs provide protection, we must first examine both “inside” and “outside” risks.

Inside risks are those that threaten an LLC or FLP and its assets from the inside. These are risks that the legal entity faces because of its activity. Examples of inside risks for a medical practice would include lawsuits by patients for malpractice, or by its employees for wrongful termination. Neither the LLC nor the FLP can shield the business itself from such inside claims.

We just wrote that “neither the FLP nor the LLC can shield the entity itself from such inside claims,” but what about the owners of the entity? If there is a claim against the entity for, as an example, a slip/fall accident, are the owners’ assets vulnerable? As we explained above, this is a significant difference between the LLC and the FLP. In the LLC, none of the members are liable for the debts of the business, whereas the general partner of an FLP is liable. This is why active businesses or assets that could generate liability (i.e., rental properties) should never be owned through an FLP with a human general partner.

Outside risks are potential claims against the owners’ interests in the LLC or FLP. As an example, an outside claim might be a successful claim against a dermatologist for malpractice or a car accident that has led to the plaintiff wanting to access the assets of the LLC or FLP to satisfy the judgment. For outside risks, FLPs and LLCs are asset protectors because the law gives a very specific and limited remedy to creditors coming after assets in either type of entity. When a personal creditor pursues you, and your assets are owned by an FLP or LLC, the creditor cannot seize the assets in the LLC/FLP.

If the creditor cannot seize LLC/FLP assets, what can the creditor get? The law normally allows for only one remedy: the “charging order,” which a creditor can be granted by a court against a debtor’s interest in an LLC or FLP. Essentially, this order allows the creditor to get distributions.

In other words, the creditor must legally be paid any distributions that would have been paid to the debtor. The charging order is meant to allow the entity to continue operating without interruption and provide a remedy for creditors.

The Limitations of the Charging Order

As above, the charging order is a court order that instructs the LLC/FLP to pay the debtor’s share of distributions to his or her creditor until the creditor’s judgment is paid in full. Importantly, everything we will describe below assumes that an LLC or FLP agreement is properly drafted and all formalities are followed every year. If that is the case, the charging order does not give the creditor LLC/FLP voting or management rights or force the LLC manager or FLP general partner or to pay out any distributions to members/partners.

While the charging order may seem like a powerful remedy, consider its limitations. It is a temporary interest that may have to be renewed. In addition:

1. It is available only after a successful lawsuit
First, the charging order is available only after the creditor has successfully sued someone and won a judgment. Only then can the creditor ask the court for the charging order.

2. It does not afford voting rights—so they get no control of the entity or its assets
Despite the charging order, the LLC manager or FLP general partner continues to manage the entity and its assets. They make all decisions about whether the LLC/FLP buys assets, distributes earnings to its members or partners, shifts ownership interests, and so forth. The creditor with the charging order must stand outside the LLC/FLP and hope that distributions are made so they can use the order to take those distributions.

Using the LLC/FLP to Shield Assets

To use an LLC or FLP to shield assets, one must simply have the assets owned by the entity, rather than in the physician’s or spouse’s name. Then the physician and spouse can be made the parties in control of the entity and assets (LLC manager or FLP general partner), as well as the passive owners (LLC members or FLP limited partners).

What type of assets can be owned in such entities? LLCs can own both “dangerous” assets that could create liability (rental properties, boats, etc.) and “safe” assets that could not (cash, securities, artwork, intellectual property, etc.), so long as safe and dangerous assets are not combined in one LLC. FLPs should only be used to own safe assets.

Personally owned assets can easily be transferred into an LLC or FLP, typically without incurring any taxes or other hurdles – although working with an experienced attorney is essential. In the next installment of this article, we will discuss important success factors needed to achieve the desired protections that can be afforded by LLCs and FLPs.

The authors have recently completed Wealth Planning for the Modern Physician. To receive free print copies or ebook downloads of this book or Wealth Management Made Simple, text PRDERM to 844-418-1212, or visit www.ojmbookstore.com and enter promotional code PRDERM at checkout.

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