Response to Attorney Question: Multiple LLCs

An attorney question came across my desk the other day and I thought I would share my response with the collective. She queried whether multiple LLCs or a single LLC was most appropriate to hold her client’s rental properties, and solicited experiences and opinions on how other attorneys deal with the issue, especially in light of the famed Olmstead decision, personal liability, adequacy of insurance, and tenants by the entirety (TBE) ownership structures.  What follows is my spark notes response:

Those are interesting questions and ones that I discuss with my clients and in presentations quite frequently.  Ultimately, the creation of multiple LLCs versus one LLC is client preference as risk tolerance; finances; property values; paperwork; mortgages; accounting; and the reasons behind why they want this type of liability protection, among other factors, are determinative of the cost-benefit in the client’s eyes.

When this question comes up, I usually start by defining for the client the difference between inside and outside creditors of the LLC, and ask them if they are looking for a structure that would protect from both.  As is mostly the case, clients neglect to consider the possibility that their property-holding LLC can be attacked from the outside in, hence outside creditors, and not just from the tenant.  Regarding inside creditors, there seems to be this myth that putting your property into an LLC is all you need to do to enjoy liability protection from the claims of a tenant; unfortunately, this is not the case as plaintiffs’ attorneys routinely pierce LLCs by alleging negligence directly against the member.  Thus, the use of property management companies, where warranted, will help transfer the risk of getting sued under a theory of negligence from the client to the property management company.

As for multiple LLCs versus one LLC, I just make the client aware that in the case of one LLC holding multiple properties, liability from one tenant can affect the entirety of the assets.  If your client owns all the properties outright, using one LLC to hold multiple properties is probably not a good idea, unless they strip out the equity of all the houses.  Equity stripping when combined with the one LLC approach is an alternative for the client that does not want to deal with the paperwork, cost, or accounting of having multiple LLCs, although multiple LLCs depending on the facts may still be a better fit.  In a perfect world, yes, having multiple LLCs would be the better alternative, although even then multiple LLCs may not even be necessary.

Insurance can be a good thing, especially a good umbrella policy, but I always advise the client on its ups-and-downs before recommending it.  First, and I am exaggerating here, but there is usually only a quarter of a page of what is covered in the policy followed by twenty page of exclusions, and a lot of times insurance excludes negligence or gross negligence, the very doctrine that plaintiffs’ attorneys use to make the member liable for the obligations of the LLC.  This is why I always tell clients to review their policies, or to have them reviewed.  On the flip side, plaintiffs’ attorneys love insurance companies, and sometimes that will be enough to deflect the liability away from your clients or the LLC.  In my opinion, insurance is best when used to complement a properly implemented LLC structure, and only somewhat good when used by itself.

Single member LLCs provide the same liability protection against inside creditors as do multi-member LLCs, so I am of the opinion that Olmstead has no bearing here.  In other words, and barring veil piercing, ownership of an LLC has no bearing on the efficacy of the entity to shield its owners from the debts or obligations of the company (inside creditors).  From my reading, Olmstead serves as a warning that charging orders are not the exclusive remedy for single member LLCs, and that outside creditors may foreclose on the debtor member’s LLC interest.  In that respect, single member LLCs are generally not recommended in Florida (but not b/c of inside creditor liability protection reasons).

Regarding your proposed ownership structure — 98% and 1% each — which as an aside is better than the 0.05% a client proposed to me the other day, I would ask the client the following: if a judge saw your membership interest breakdown, do you think he would respect it?  In other words, do you think a judge would look at it and think, or even suspect, that such a breakdown was done for the sole purpose of hindering the tenant creditor?  I think 1% is too de minimus, unless you have a valid reason for doing so other than liability protection, and doing such a breakdown in that way may give a potential creditor stronger arguments at persuading a judge to set it aside.  This argument may be a stretch depending on the facts, I know, but part of what I tell the clients is that it is my job to draft the documents and structure the ownership in a way that the courts will respect it, and to simultaneously take away arguments like this from the creditor.  To answer your question though, that structure will definitely be a multi-member LLC barring argument that one spouse is the alter ego of the other.

As far as liability from the tenant (the inside creditor), I do not see how TBE will help you because the tenant in effect would be a creditor of both husband and wife as they own own the property as such; however, regarding outside creditors, holding the property as TBE will protect the property from any creditors of the husband or wife.  As you suggest though, a better alternative would be to own part of the membership interest as TBE as opposed to the property directly.

There are many less known ways to reduce liability, so I advise clients on the use of non economic members, equity stripping, cross collateralization, liens, etc., but ultimately the strength of the structure and the techniques you use are highly dependent upon the goals of and the cost-benefit to the client, which is why I spend a lot of time educating any prospects on asset protection and property ownership through LLCs.