Personal Debt Liability

April 13, 2006

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Placing assets within a business entity (i.e., limited liability company (LLC), corporation or partnership) is sometimes touted as an asset protection device, with respect to personal debts. While this strategy has considerable merit, it is misleading because, when used by itself, it dangerously and unnecessarily exposes these assets to a high risk of loss to the business's creditors.

In order to understand how protection of your business from personal debts is possible, you need to understand something called a "charging order," and how it affects limited partnerships (LPs), general partnerships, limited liability partnerships (LLPs), sole proprietorships, corporations and limited liability companies.

The charging order concept stems from a theory involving partnership property. For example, a partner in a general or limited partnership incurs a large personal debt from activities outside the partnership. Further, this debt cannot be satisfied from the partner's personal assets outside the partnership.

According to this view, the personal creditor of the partner can obtain what is termed a "charging order" against the partner's interest in the partnership, and become an "assignee" of this interest. In effect, the creditor attaches the partner's interest in the partnership.

However, according to the law, a partner does not actually own any specific assets in a partnership. His property interest is, in fact, his partnership interest itself, which is deemed a type of personal property. Because of this theory regarding partnership property, a personal creditor of a partner may attach the partner's interest, but the creditor may not directly attach the underlying partnership assets.