Trusts have long been one of the most important tools used by estate planning lawyers to ensure that a person’s assets ultimately benefit the people they are intended to benefit. For example, estate planning attorneys sometimes use spendthrift trusts to protect the estate from creditors of either the person implementing the estate plan or the plan’s beneficiaries. In recent years, limited liability companies have also become important estate planning tools, especially for estates that include businesses, in part because they provide certain protections against creditors of the owners of the LLC, similar to the protection provided by spendthrift trusts, that are not offered by corporations, the usual alternative to LLCs.
The LLC is a relatively new creature, intended to combine the limited liability of a corporation (i.e., a liability shield between the owners of the company and the company’s creditors) with the income tax structure of a partnership. LLC law draws some of its principles from the law of corporations and other principles from the law of partnerships. One of the areas in which corporation and partnership law differ is the nature of ownership of a corporation or partnership, which in turn affects the extent to which a creditor of an owner can acquire the economic fruit of the business and the rights of the owner to control and manage the business.
Ownership of a corporation is represented by a share of stock. The corporation is an entity distinct from the owners of the stock (called stockholders or shareholders), and the shareholders do not directly own any of the assets that belong to the corporation. The owner of a share of stock has the right to receive the economic fruit of the business, delivered in the form of dividends paid to the company’s shareholders, and certain rights to control the business, primarily through a right to vote in an election of directors who are entrusted with its management and operation. Generally, shares of stock in a corporation are freely transferable, and a person who buys or otherwise receives the stock, no matter who that person is, acquires the right to receive any dividends paid by the corporation and the right to vote in the election of directors. Although there can be more than one class of stock, representing different economic and noneconomic rights, and the transferability of stock, and even the voting rights of shareholders, can be restricted by contractual agreement, the fundamental model is that stock in a corporation represents a relatively inseparable bundle of economic and noneconomic rights that are freely transferable from one person to another.
Partnerships, on the other hand, are very different. (Note that there are different types of partnerships, including general partnerships, limited partnerships, and limited liability partnerships. For simplicity, we’ll concentrate on general partnerships.) Although a partnership is generally treated as an entity distinct from its partners, some aspects of partnership law make the partnership look more like a collection of people (i.e., the partners) rather than a separate entity jointly owned by partners. More importantly for these purposes, the rights of the owners of a partnership (i.e., the partners) to control it and to receive its economic fruit are often much more complicated than the rights of a shareholder of a corporation. The details of those rights are, for the most part, controlled by an agreement among the partners called, appropriately enough, a partnership agreement, but the basic model is that a partner’s rights, especially noneconomic rights, are not freely transferable. Generally speaking, even though a partner may be able to assign his or her right to receive the economic fruit of the partnership (mostly in the form of distributions of cash from the partnership to the partners), a partner can generally not assign his or her rights to participate in the control and the management of the partnership. Only a partner has that right, and generally a person can become a partner only with the consent of the other partners.
In Part II, we’ll examine how these principles of corporation law and partnership law have been integrated into LLC law and how that affects the utility of LLCs for estate planning and asset protection purposes.