What's New in 2023?
As we kick off 2023, OJM partner David Mandell provides a high-level update on new developments in asset protection planning that could impact the degree to which your personal and business assets are protected.
New LLC Cases Show the Importance of State Choice & Formalities
In past articles, we have written on the planning area of asset protection. As a reminder, it is a field of planning that involves legal, insurance, and financial disciplines, with the goal of shielding assets against future potential liability. Given the litigation risk inherent in the practice of medicine, real estate ownership, employment, business deals, and driving, many high-net-worth individuals, including physicians, have engaged in asset protection planning. For this reason, we want to provide a quick 2023 update on asset protection, focusing on two notable cases.
The first is a case involving a Delaware limited liability company (LLC), Manichaean Capital, LLC v. Exela Technologies, Inc. This case is important because Delaware has been considered for decades by asset protection experts to be one of the most protective states for LLCs. As such, many individuals have established LLCs there as part of their asset protection planning.
This case involved a complex corporate litigation. In a high-level summary, the plaintiffs here were owed tens of millions of dollars from an LLC, but that LLC didn’t have much capital in it. As a result, they petitioned the court at the beginning of the lawsuit to do something called “reverse veil piercing” – asking the court to allow their lawsuit to penetrate past the subsidiary LLC from which they were owed money up into the parent corporation.
Most attorneys expected this claim to be rejected by the Delaware court, because of Delaware’s protective LLC statute which stated that the much weaker “charging order” remedy (as opposed to the “reverse veil piercing” remedy) was the only recourse for plaintiffs in this situation. Surprising the experts, this court allowed the plaintiffs to move forward with the “reverse piercing” case – putting the asset protection world on notice that Delaware allows these types of claims against LLCs.
This decision puts the strength of Delaware LLCs for asset protection planning at risk. Some attorneys we know have now stopped using Delaware for such entities when they have other alternatives, while others are speaking with their clients about moving (called “re-domiciling”) their existing LLCs from Delaware to more favorable states, like Nevada or Ohio. For individuals and businesses using Delaware LLCs in their planning, this case is a significant one that should prompt a discussion with one’s asset protection advisor.
The second notable case concerns an LLC used to own real estate and lease it back to an operating business. In TBS Properties, LLC v. United States, an Arizona corporation was found liable for over $150,000 in unpaid taxes from 2015 to 2017.
The corporation owned and operated a restaurant in the Phoenix area. The real estate on which the restaurant operated was held in a separate LLC. This structure is one that thousands of medical practices and other businesses use throughout the U.S. – leasing the operating space for the business from a separate LLC.
In this case, in an effort to collect the corporation’s unpaid taxes, the IRS entered a lien against the real property owned by the LLC, asserting that the LLC was the “alter ego” of the corporation and hence was liable for its debts.
Here, the LLC moved to dismiss the case early on, arguing that the corporation owed the back taxes, not the LLC. But the court denied the motion, allowing the case to move forward, based on a few basic facts. Most important were that the corporation and LLC had no formal written lease agreement and that money flowed back and forth between the corporation and LLC without proper accounting.
In our books, articles, and videos, we emphasize the importance of following legal formalities if one wants to enjoy the protection that legal tools (including corporations, LLCs, and trusts) are designed to provide. Often, we see professional practices and other businesses in this same corporation-LLC real estate structure without leases or ignoring lease terms. Even worse, we see physicians and business owners setting up LLCs personally without operating agreements, annual meetings, and minutes. This case should stand as a firm reminder that formalities count.
The first quarter of 2023 may be a good time to revisit your asset protection planning and review these new developments with your advisor team.