Entity Structures

Liability that arises from an activity — a rental tenant who slips, a business creditor who sues, a contractor injured on a side project — should be contained inside an entity. The mechanism is the corporate veil: the LLC’s or corporation’s liability does not extend to the member’s or shareholder’s personal balance sheet, absent piercing.

LLCs for rental property. The default vehicle is a separate LLC per rental property, or per geographic cluster, depending on the size of the portfolio. Liability arising from one property does not reach the others. Mortgages on the properties are usually held in the individual member’s name with the LLC as title-holder, since residential mortgage lenders often will not lend to LLCs; the structure works anyway.

Charging-order protection. The standard creditor remedy against an LLC member’s interest in the LLC is the charging order: a court order directing distributions otherwise payable to the member to the creditor instead. The creditor does not become a member, cannot vote, cannot force a distribution, cannot foreclose on the membership interest. A well-advised LLC stops making distributions; the creditor receives nothing and may eventually settle.

State law determines whether the charging order is exclusive. In Wyoming, Nevada, Delaware, Texas, and others, the charging order is the creditor’s sole remedy. In Florida and some other states, the charging order is exclusive for multi-member LLCs but a court can foreclose the interest of a single-member LLC (the Florida Supreme Court so held in Olmstead v. FTC, 2010), eliminating the protection. The takeaway: if charging-order protection is the point, organize in a charging-order-exclusive state, and consider whether a nominal second member is worth adding.

When the entity does not protect.

• Personal-conduct torts. If you, individually, hit someone with your car (even on business), the LLC does not protect you from your own negligence. The LLC protects the member from the entity’s debts, not from the member’s own acts.
• Personal guarantees. Bank debt to a small-business LLC almost always carries a personal guarantee. The guarantee, not the LLC, is what the bank collects on.
• Piercing the veil. Failure to observe formalities, undercapitalization, commingling of personal and entity funds, sham operation. The veil is pierced more often than owners assume.
• Single-member LLCs in foreclosure-permitting states (see above).

Family Limited Partnerships and Family LLCs. A multi-generational entity holding investment assets is treated in detail in chapter “Estate planning” as a transfer vehicle. Its asset-protection contribution overlaps: limited partnership interests have charging-order protection in most states, and a properly run FLP shields the underlying assets from litigation against any single family member.