How does a family limited partnership work?
How effective is a flp?
The family limited partnership is a popular way to turn attractive assets (e.g., an apartment house) into unattractive assets. It is also a technique whereby an asset protection trust may own U.S. situs assets. The asset becomes unattractive to a creditor because, by placing the apartment house into the limited partnership the judgment creditor's remedy changes. The judgment creditor cannot execute directly upon the apartment house and force its sale. Instead, the remedy is outlined by the Uniform Limited Partnership Act which provides that "On application to a court...by a judgment creditor, the court may charge the partnership interest of the partner with payment of the judgment...[T]he judgment creditor has only the rights of an assignee of the partnership interest." (U.L.P.A. section 703.) This act also provides that "An assignment entitles the assignee to receive...only the distribution to which the assignor would be entitled." (U.L.P.A. section 702.) In short plain English, the creditor only gets what the general partner decides to distribute...which is often nothing.
The drafters of the Uniform Limited Partnership Act inserted this charging order concept into the act to prevent the creditors of a partner from disrupting the partnership business. However, these same provisions can be utilized in the family limited partnership context to prevent the distribution of funds to the judgment creditor. This is because under relevant partnership law the general partner, who is likely to be the settlor of the asset protection trust, can prevent distributions. The Internal Revenue Service has also held in Revenue Ruling 77-137 that the creditor with a charging order is treated as a substituted limited partner for tax purposes. As a result the judgment creditor is saddled with the tax consequences resulting from ownership without the capacity to force dissolution of the partnership or distributions from the partnership.
The asset protection trust is sometimes positioned as a limited partner. Care should be taken to make sure that the asset protection trust does nothing to potentially avail itself of the jurisdiction of any United States court.
Sometimes a family limited partnership will be utilized to effect an estate (but not income tax) savings due to a claimed reduction in value of limited partnership interests because of the limitations placed on the limited partner's ability to control the operations of the partnership.
Family limited partnerships have caught on as the "hot" asset protection tool. The charging order protection is being abused and is not holding up in many cases where the general partner set up a partnership specifically to avoid a preexisting obligation. In these cases the courts are allowing foreclosure against the partnership interest or are appointing receivers to dissolve the partnership and pay the proceeds to the creditor. Unless a family limited partnership is set up for valid estate planning (they can save some estate taxes) or business reasons a substantial time before the obligation arose, it is our opinion that they do not offer a good level of protection.