Another Asset Protection Strategy…But Does It Work?

Although their styles may differ, most asset protection planners will approach their initial client meetings in much the same way. We will listen to the client’s concerns and determine if the client has existing or identifiable future creditors or if the client, with no creditor issues at all, simply desires to be prudent and adopt a plan that will protect his assets from unknown future creditors. We will also carefully review the client’s assets and income streams to ascertain which ones are free from creditor claims and which may be vulnerable.

One of the assets that a client may own is stock in a closely held corporation. In Michigan, as well as in most other states, a judgment creditor can seize the shares owned by our debtor client to satisfy the judgment. However, if the client’s interest in the closely held company was in the form of a membership interest in a multi-member limited liability company, the creditor could not seize the membership interest. Instead, the creditor’s remedy is limited to a charging order (see section 450.4507 of the Michigan Limited Liability Company Act)and the debtor retains ownership of his membership interest. This inevitably leads to the question of what strategies can be employed to protect the shares of the closely held corporation when our shareholder’s creditors are already knocking on the door.

Some debtors have attempted to transfer their shares in the corporation to a limited liability company in exchange for a membership interest. In this fashion, the debtor’s interest in the corporation is not held directly and the creditor is left only with the charging order remedy. However, a 1995 Florida case held in an analogous situation that the transfer was fraudulent as to the debtor’s creditors even though there was an exchange purportedly for equivalent value. The court observed that there was no independent business reason for the transfer and, viewed from the creditor’s perspective, the value of the membership interest was considerably less than the value of the shares contributed to the LLC.

Another possible approach is to sell the shares for a note with terms that are commercially reasonable but are otherwise not particularly attractive to a creditor. Following seizure of the note, the judgment creditor might well consider accepting a substantial discount in exchange for a cash payout.