How does the FLP protect assets?
The short answer is that a limited partnership interest cannot be claimed by the debtor-partner's creditors. The creditor can only obtain a charging order which entitles the creditor only to whatever profit distributions are made to the debtor-partner. But this is usually an empty remedy since few FLPs make profit distributions when one partner has a charging order creditor and the FLP is managed by the debtor-partner or her family members.
Though we have discussed several benefits of the LP, we have not yet discussed its biggest benefit from an asset protection perspective. This benefit is the charging order. To say the charging order is a benefit is actually a bit of a misnomer, because in actuality the charging order is a remedy available to creditors. However, the remedy is so limited that it is often ineffective. That is why, amongst the over 20,000 entities we have created for clients (most of which were susceptible to a creditor's charging order), very few clients have been subject to a charging order. Furthermore, if the LP is created and operated correctly, a creditor has no other way to reach LP assets other than the charging order.
So what is the charging order? The charging order is a statutory provision of law under the UPA, ULPA, RULPA, and Revised Uniform Limited Liability Company Act (RULLCA) which provides a creditor of a company's partner or owner may attach company distributions made to that individual. However, this is generally the only remedy available to the creditor. This is so because it would be unfair to the other partners – or to the partnership itself – if a creditor were able to disrupt partnership business. This would harm the other partners who are not parties to the debt. Consequently, the charging order does
not allow the creditor to control the entity, attach the entity's assets, or become a partner or owner of the entity. Of critical importance is the fact that, since a charging order holder cannot control the entity, they cannot control its profit distributions. In other words, if the entity never makes a distribution to the debtor-partner, then the creditor never receives a distribution. Their charging order then is essentially worthless. But a note of caution here: It is not a good idea to make distributions to all partners
except the partner whose interest has been assigned to a creditor via a charging order. A judge might see this as an overt attempt to thwart the creditor from receiving his due. In such an instance, it is conceivable that a judge could view such circumstances as being akin to a fraudulent transfer which might then lead the court to force a distribution from the entity. If someone wishes to have distributions made to the other partners or owners while keeping his distribution out of the hands of his creditors, then before the creditor threat arises, the partner should place his partnership interest in another entity that is also protected by the charging order. The distributions will then be made to the second entity and not to the individual directly.