What is a family limited partnership and what role does it play in asset protection?

A family limited partnership (FLP) is a limited partnership (LP) owned by family members, or family controlled entities (trusts, etc.). They work the same as any limited partnership. The FLP is commonly used for protection because it can protect a wide range of assets, maximize your creditor protection, and give you or your family continuing control over your assets.

For many years, the limited partnership has been a staple of asset protection planning. Although in many instances the limited liability company (LLC) is now preferable to the LP, limited partnerships are still popular, and are sometimes still the entity of choice.

Limited partnerships are a variation of the general partnership. General partnerships (commonly referred to as 'partnerships') have existed for thousands of years. They are typically small businesses wherein each partner may manage, act for, and bind the company. Although a general partnership is technically not a distinct artificial entity, as it is not created by the government, each partner usually contributes property to a general pool of partnership assets as necessary for it to conduct business, and it is often treated as a distinct entity.

As commercial law developed, general partnerships gradually began to demonstrate some glaring shortcomings. That brought about the limited partnership. Among these shortcomings is the fact that one partner can make a decision that could financially harm not only the partnership as a whole, but the personal wealth of the other partners. Like a sole proprietorship, general partnerships have no limited liability. Therefore, if one partner obligates the partnership to debts it cannot pay, the personal wealth of all partners is at risk of being forfeited to the partnership's creditors. The same is true with debts arising from lawsuits: if one partner is dishonest or commits a tort while working for the partnership, then a creditor could obtain a judgment against the wrongdoer, the partnership as a whole, as well as each individual partner.

The limited partnership's chief difference from the general partnership is that it has two classes of partners: General partners and limited partners. A general partner manages the company. However, the general partner has unlimited personal liability. Consequently, if the company is unable to pay its debts, its creditors can look only to the property of a general partner to satisfy those debts.

Limited partners do not have this same vulnerability. A creditor can only pursue a limited partner's assets to the extent those assets have been contributed to the partnership. This makes their liability similar to a corporate stockholder. This idea has been codified in the ULPA and its successors. At the same time, a limited partner is forbidden from managing or otherwise running the company. If a limited partner does manage the company then he will likely lose his limited liability.

Because general partners – even in a limited partnership – have unlimited liability, an LLC or corporation is often used as the general partner of an LP. This effectively gives the general partner limited liability. Although the LLC or corporation has unlimited liability for the debts of the LP, those debts do not generally extend to the owners or managers of the LLC or corporation. This arrangement is especially useful if multiple individuals manage the partnership. Instead of each person acting as a general partner where their actions could expose the other general partners to liability, they can each be a manager of a single LLC, a corporate officer, or board member of a single corporation. This would limit their exposure to the wrongful acts of the other managers, and allow everyone to participate in managing the LP.

Besides the distinction between limited and general partners, a limited partnership essentially operates like a general partnership. Consequently, LPs (before LLCs became popular) were often the entity of choice for small businesses. The reasons for this are threefold: Simple management structure, lack of a requirement to follow corporate formalities, and partnership tax (pass-through) treatment.