Corporate Conversion for Asset Protection Purposes
By: Adan A. Aulet, Esq. and Aimee K. Arce, Esq.
Historically, corporations and limited partnerships were the preferred business models to operate a closely held business. Today, however, limited liability companies (LLCs) are being established in multiples compared to corporations and partnerships. LLCs can be established with one or more members and provide the same limited liability of corporations without the statutory inflexibility. Further, LLCs offer the ability to be taxed in various ways: sole proprietorship (a disregarded entity), a partnership, a C corporation, or an S corporation.
LLCs with multiple members have one major advantage over the corporate structure: the creditor of a member may only obtain a charging order against the member’s transferable interest in the LLC. In other words, the ownership interest in the LLC cannot be used to satisfy the judgment against a member whereas the creditor of a shareholder of a corporation may foreclose the shares in the corporation. Many view this as a major advantage over the corporate structure. LLCs with a single member do not have the same advantage as a creditor can obtain a charging order followed by foreclosure of the debtor’s LLC interest. Nevertheless, when owners of businesses want to foreclose the ability of a creditor to force itself into the business, the Florida LLC provides a distinct measure of asset protection in comparison to the traditional corporation.
For instance, in the case of a debtor’s shares of stock in a corporation, a judgment creditor can levy and seize the debtor’s stock in the corporation. The creditor may thereafter exercise control over the business to the same extent as was exercised by the debtor. If the creditor controls enough of the shares of stock in the corporation, the creditor can potentially end the business and force liquidation of the corporation’s assets.
On the other hand, in the case of a debtor’s LLC interest, a judgment creditor’s remedies are limited to the right to receive the debtor’s right to distributions, or if a single member LLC, a charging order followed by foreclosure of the debtor’s LLC interest. The debtor will continue to own the LLC interest and conduct business without interference from the creditor. The creditor cannot end the business or force the LLC’s assets to be sold. Further, the creditor cannot vote on business matters, inspect or copy business records, or exercise any of the debtor’s rights in regards to business management. Unfortunately, many shareholders do not realize that creditors can attach to their corporate interest and wreak havoc on their business. In this regard, LLCs have proven to be a better asset protection entity than corporations.
Ideally, a new business would be organized as an LLC from its inception. If you already operate a business as a corporation, all is not lost. Florida law allows for the conversion of your business from a corporation to an LLC. This process is known as “statutory conversion.” All assets (real estate, bank accounts, intellectual property) of the corporation are the assets of the resulting LLC. All liabilities of the corporation (loans, accounts payable, etc.) are the liabilities of the LLC. Under Florida law, the one business entity involved in the conversion, which is originally the corporation, is deemed by default to continue in the form of an LLC.
Under Florida law, in order to convert your corporation to an LLC, you must first prepare a plan of conversion. The plan of conversion contains essential information about the conversion. It must provide, at a minimum, the name of the corporation and the LLC; the state law under which the LLC will be formed; and the terms and conditions of the conversion, including how the shares of the corporate stock or other securities will be converted into LLC membership interests. In addition, the plan of conversion must include, or have attached to it, articles of organization for the new LLC.
Next, the corporation’s board of directors must recommend the plan of conversion to the shareholders, and the shareholders must approve the plan. All shareholders entitled to vote must be notified of the conversion. Florida law provides that approval can be reached by a majority of votes in each share class entitled to vote unless alternative voting requirements are imposed by the board of directors or contained in the articles of incorporation.
Finally, assuming the plan of conversion is approved by the shareholders, you must file articles of conversion and articles of organization with the Florida Department of State.
When done correctly, you should be able to keep the original effective date of the corporation, tax identification number (“EIN”), and tax structure. The Internal Revenue Service views certain conversions as tax-free reorganizations allowing the change without any negative tax consequences.
Conversions may also be used to relocate non-Florida business entities (including non-Florida LLCs) to Florida provided that such is authorized by the law of the other state. Please keep in mind that while the process of converting your business from a corporation to an LLC may appear straightforward, however, converting your particular business may involve certain reporting and filing requirements with the IRS and other obligations. If you are interested in converting your business or obtaining asset protection advice, please contact our office to speak with an attorney.