Beware of the Limited Partnership

Prior to the advent of the Limited Liability Company in Michigan, a common planning technique involved the Michigan Limited Partnership. The Limited Partnership allows for a General Partner who has control of the entity (and usually, liability for it, also). Other investors, known as Limited Partners, are equity-only owners. They do not participate in management (other than voting on major issues) and their liability is generally limited to the amount of their investment in the partnership. In the family business context, mom and dad would set up as the General Partners and would convey limited partnership interests to their children. This allowed them to retain essentially all control of the entity, while transferring equity ownership to their children, often over a period of time. Additionally, because of the limited nature of these interests, they could apply discounts to the transfer of these interests. For a number of years, the Family Limited Partnership (or FLP) was the only way to accomplish this.
However, there are some significant negatives to the Limited Partnership form of business. Often, clients (and sometimes lawyers who didn't do their homework) were unaware, for example of the detailed formal requirements for these partnerships. Unlike a general partnership, a Limited Partnership requires a formal filing in Lansing. The statute requires a detailed form of Articles of Partnership be filed. But more importantly, every time there is any change (even 1%) in ownership, the statute requires that these formal Articles of Partnership be re-filed. I am personally aware of several instances where partnership interests were purportedly transferred, but this re-filing was never done. The statute makes clear that any attempted transfer of a partnership interest without this re-filing is void!

 every time there is any change (even 1%) in ownership, the statute requires that these formal Articles of Partnership be re-filed

Another problem with this form of business is that the General Partner has no liability protection. In many cases, in order to protect the interests of the persons acting as General Partner, a corporation would be set up as the General Partner, adding yet another layer of complexity to these already formal and complex partnerships.
When the Limited Liability Company came along, it became a much better alternative for this type of planning. LLC's are perhaps the most flexible business organization available and it is possible to structure the ownership and management of an LLC so that it is essentially identical to a FLP. And, it can be done with all the flexibility of structure that is the hallmark of the LLC form of business. The filing required to establish an LLC in Michigan is much less formal and detailed than the Limited Partnership. There is no re-filing requirement on a transfer of ownership of any amount.

clients (and sometimes lawyer who didn't do their homework) were unaware of the detailed formal requirements for these partnerships

Within the LLC statute is a little-known provision for conversion from a Michigan Limited Partnership to an LLC. We have done a number of such conversions in the past couple years. As long as the Limited Partnership is in good standing, it is very simple to convert from the complex and problem-prone Limited Partnership form of business to the flexible LLC. It is something every current FLP owner should at least consider.

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MICHIGAN SINGLE MEMBER LIMITED LIABILITY COMPANIES

Michigan Limited Liability Companies have become the “entity of choice” for many business ventures in the State. When the Limited Liability Company (LLC) was first recognized in Michigan, single-member LLC’s were not authorized. 1997 amendments to the statute permitted them and for many of us as advisors, it seemed like telling our Sole Proprietor Clients that converting to a Single Member LLC was the proverbial “no-brainer.”

But is it a foregone conclusion that every sole proprietor business should become a Single Member LLC?

There are a number of advantages offered by the LLC form of entity. Most importantly, the LLC offers protection to the owner from liability which may arise from the activities of the business. Perhaps the next most important advantage is the ability to accomplish centralized filing of the entity statewide, at the Michigan Department of Labor and Economic Growth (DLEG). The DLEG filing gives the entity a statewide name and prevents others from using that name. It also allows the used of “assumed names” on a statewide basis. Another perceived advantage is that of protection of the individual member from his creditors. As we will see below, there may be some question about whether that confidence is misplaced. Additionally, as the “LLC” gains notoriety, the name may give the business a perceived bona fides as a business that it did not already enjoy as a sole proprietorship.

But there are always other considerations. Contrary to popular view, there is no “cookie cutter” business form that fits all or even most businesses. Careful consideration needs to be given to the actual goals and circumstances of the particular business activity. Often, when reviewing the efficacy of LLC status for a new client, we will conclude, after some thought and discussion, that another form of business (or businesses) better suits the client’s overall goals.

There are always tax and financial considerations. There are times when corporate, partnership, or other ownership form may create more advantage to the owner than an LLC. This may arise because of income tax rate structures, other activities of the owner, or government program options available to the business.

There is always a concern with whether a business operated by a married couple falls within the IRS default classification of single member or partnership. While there is some authority that the IRS will treat a married couple, filing jointly, as a sole-member LLC, there may be other reasons why the “partnership” form may be preferable.

One item that often catches an unsuspecting sole proprietor, recently turned Single Member LLC by surprise is insurance coverage issues. Insurers often take the position that they now have to cover not only the proprietor (individually), but the new (and technically separate) entity. This can involve multiple policies (and premiums) that didn’t previously exist.

It is also sometimes a surprise to the new LLC owner that their financiers do not readily embrace their newly formed entity. One of the biggest “liabilities” for most small business owners, is their business loans. Banks will typically require the owner(s), individually, to sign a personal guaranty of any business loans. Occasionally, commercial lessors of premises will also require personal guaranty. In my experience, employees of financial institutions often do not “understand” the premise of a Single Member LLC and will insist upon an Operating Agreement for the entity. On the theory that it is easier not to “fight city hall,” we have routinely prepared them as part of our setup, but have done so knowing that the LLC statute provides that they are “unenforceable” (MCL 450.4215).

Many advisors have touted the LLC (including the single member variety) as a method to protect the individual member from creditors. In a partnership, or limited partnership historical context, it is not possible for a judgment creditor to obtain control of the assets of such a partnership. The best that they can hope for is something called a "charging order." From a creditor's perspective, that has limited utility, and may even have some negative consequences (the IRS has taken the view that the holder of a "charging order" is liable for tax liability that passes through that order). The charging order analysis has been extended to the LLC, as it is very much like a limited partnership in that context.

I believe that we need to be very careful in advising our clients regarding “asset protection” schemes and methods, however. In 2003, a Colorado Bankruptcy Court held that the bankruptcy trustee could take possession of the assets of a Colorado Single Member LLC. Although the Michigan Statute is significantly different and would arguably yield the opposite result, many commentators take the view that a creditor will probably be able to get to the assets of a Single Member LLC if they have a judgment against the sole owner.

It is important to seek counsel experienced and knowledgeable in these issues when structuring a new business or converting an old one.

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