Texas has long been a safe harbor for debtors. For over one hundred years, individuals have physically relocated to Texas to avoid their creditors. Today, the Texas Constitution, the Business Organizations Code, and the Property Code make it possible for individuals and businesses to establish structures designed to shield substantial income and assets from judgment creditors.
One of the most generous protections provided by Texas law is the homestead exemption. Homestead protections are contained principally in sections 50 to 52 of Article XVI of the Texas Constitution, section 50 and in Texas Property Code chapters 41 and 42. In Texas, the homestead exemption provides complete protection for your primary residence from forced sale for purposes of paying debts and judgments. As a general rule, to qualify for an exemption you must own your home and it must be your principal place of residence. Except as limited by federal law, the exemption is unlimited in amount and secures a shelter for the family.
For urban homesteads, up to 10 acres of land and the improvements thereupon qualify for the exemption. For rural homestead owned by a family, the homestead may consist of up to 200 acres and improvements. For that of a single adult, up to 100 acres and improvements qualifies.
This protection, however, does have a number of exceptions. Permitted liens include purchase money, taxes (both state and federal), owerty upon divorce, home improvement loans, home equity loans, reverse mortgages, liens pre-dating the establishment of homestead, refinance loans, or the conversion or refinance of a lien on a mobile home that is attached to the homestead. All other liens are void. The homestead exemption offers complete protection to the property, so no matter how much the home is worth an ordinary judgment creditor cannot force its sale in the absence of fraud. Furthermore, the proceeds from the sale of the homestead have limited protection as well. Property Code section 41.001(5)(c) states: “The homestead claimant’s proceeds of a sale of a homestead are not subject to seizure for a creditor’s claim for six months after the date of sale.” Lastly, only individuals, not business entities, may take advantage of homestead protections.
Personal Property Protections
Considerable personal property is also exempt from execution. Personal property valued at up to an aggregate of $60,000 for a family or $30,000 for a single person is not subject to creditor liens. In determining the value of the foregoing property, the amount of any liens or security interests is deducted from the fair market value of the property.
Property Code sections 42.001 et seq. specifically list the amount and types of exempt personal property, including, but not limited to, home furnishings, jewelry, and motor vehicles. In addition to the specific personal property exemptions specifically listed, Texas Property Code section 44.003 provides that all property in the state of Texas is exempt from attachment, execution, and seizure in satisfaction of a claim of another state, or political subdivision of another state, for failure to pay that state or political subdivision’s income tax on benefits received from a pension or other retirement plan.
Family Limited Partnerships and Limited Liability Companies
Clearly, if one has investment property not subject to the homestead exemption, the aforementioned protections are not sufficient. The Family Limited Partnership (FLP) and the Limited Liability Company (LLC) are two of the primary asset protection tools used in Texas for assets that are not exempt under Texas law. Assets such as cash, stocks, and bonds held personally, may be protected by a family limited partnership. If a creditor wins a lawsuit against you and obtains a judgment, the creditor may take possession of certain assets of the debtor. FLPs provide asset protection from potential creditors of a partner because a partner’s creditor cannot seize the partnership interest and thereby become a partner. Instead, the remaining partners continue to control the partnership and the creditor typically receives only a “charging order” against the debtor-partner’s interest.
A charging order gives a creditor the rights of a mere “assignee” of the partnership interest to the extent of the debt. As assignee, the creditor receives only the partner’s share of income, as determined by the general partners, plus the right to inspect the books of the partnership. The creditor gets no voting rights, control, or any other power in the partnership. The creditor cannot sell partnership assets, liquidate the partnership to satisfy the debt, or force a distribution of profits. Although the creditor cannot require a distribution of profits, the creditor is required to pay income tax on its pro rata share of any income received by the partnership. This feature of partnership law makes an interest in a FLP an unattractive asset to creditors. Consequently, most creditors would rather negotiate a settlement favorable to the debtor than become an assignee of the partnership interest. High-risk assets such as rental properties should not be placed into a FLP along with your stocks and bonds. If a lawsuit should arise from the rental property, the creditor can sue the FLP itself and obtain the assets owned by the partnership.
High-risk assets, such as rental properties, should be placed in a limited liability company, not in a FLP. Under Texas law, the members and management of a LLC are not personally liable for the activities of the LLC. Additionally, the membership interests in a LLC are subject to the same “charging order” laws, and creditors cannot seize the membership interest. Partnership and LLC interests are subject only to a charging order, which means that if distributions occur, and only if they occur, then the creditor may attach them.
An owner’s creditors cannot seize or force a sale of the owner’s interest. The owner’s creditors can only obtain a court charging order remedy to direct the LLC to pay to the creditor any income distributions that would otherwise flow to the debtor-owner. This is the same charging order remedy that a limited partner’s creditor has against an interest in a family limited partnership. The creditor gains only the financial rights of the debtor-owner, not control or ownership rights.
Asset Protection for Business Operations
A limited liability company provides asset protection business owners. The LLC is considered a separate legal entity from its owners. Thus, an LLC provides its members a full liability shield from the debts of the business as well as the negligent conduct of the company’s other owners and employees. Generally, an owner is not personally liable for the company’s debts or legal liabilities. Instead, liability for company obligations and activities is limited to the assets of the company. Members would only be risking their capital investment in the company. Therefore, creditors of the LLC cannot seize personal assets of the member owners absent a personal guaranty. However, LLC members are still liable for their own fraudulent or tortious acts even if the acts are committed in the service of the LLC.
A widely utilized asset protection structure involves separating assets from company activities through the use of two LLCs. One company should hold title to the assets (a holding company) and the other should manage and engage in the daily business operations (a management company). The holding company should be a series LLC while the management company may be either a traditional or series LLC.
The holding company must avoid contractual privity with creditors, while the management company is the face of the business entity. It collects rents, signs leases, deals with contractors and vendors, employs personnel, leases office furniture and vehicles, and otherwise engages with the public. It is a separate, stand-alone entity with no real assets. The management company will then become the target for any potential litigation, but it will not have assets to be collected upon successful judgment.
Total asset protection is not achievable, even in Texas. The key to effective asset protection is preparation and establishing a sound transactional structure to deter lawsuits and exhaust a litigious plaintiff’s resources. Business owners seeking asset protection should not attempt to undertake this endeavor without competent representation. A knowledgeable attorney will be able to structure your business to professional and personal needs.