Charging Order Protection for Doctors

Let’s suppose for a moment that you are a doctor, and you own a thriving medical practice. You work hard, you play hard, and you have a good nest egg saved up. And then one day at work you get a call from your teenage daughter to let you know that she has just rear-ended someone. She doesn’t think anyone got hurt, but she is not sure what to do.

Doctors know better than anyone how subjective pain is. Whether the other person in the crash is actually hurt is often difficult to prove objectively. But regardless of whether they are actually hurt, they can still bring a lawsuit.

And because your daughter was driving your car, you’re responsible (or if she is a minor and was driving any car). Your personal assets are now vulnerable.

You can’t just move your assets around, either. At this point, it’s too late. You try to hide your money now and you’re committing the serious tort of fraudulent conveyance.

There are a lot of precautions you can take ahead of time to protect your house in the hills and your savings account. (Talk to us, we’ll show you how.)

But what about your medical practice? You are set up in an LLC, and you and a couple partners own it together. Can a judgment creditor take your ownership interest in your medical practice? (We can show you how to set up a business so you aren’t actually the personal owner but still have the benefits of being an owner).

The short answer is, no, they cannot. That’s charging order protection. the judgment creditor’s exclusive remedy when it comes to your business is taking distributions that would have otherwise gone to you.

That is, unless you’ve drafted your operating agreement correctly.

See, there is something called a “mandatory distribution clause.” The mandatory distribution clause makes it, well, mandatory, to take distributions not he profits to take the profits off the books for tax purposes.

The problem with a mandatory distribution clause is this: if you have a judgment creditor who has served a writ of garnishment, the company has to give your distributions to the creditor.

The short-term solution is just to decide not to take a distribution. No distribution to you means no distribution to the creditor. Of course, that’s not an ideal situation—you are in business to make money, after all, and to do that, you have to take distributions.

If you have a mandatory distribution clause, then the judge will order you to honor your operating agreement and pay your creditor.

So step 1 to maximize charging order protection is to make sure there is no mandatory distribution clause.

But that will do you no good if you have partners and you have a “pro rata distribution clause,” which is also present in many operating agreements. The clause will say something like this: “Every time a distribution is made, it will be made equally, with each partner taking a share equal to their ownership interest.”

The problem with this clause is that if you don’t want to take a distribution to prevent your creditor from getting paid, and you have partners, that means they can’t take distributions either. And chances are they’ll outvote you and force a distribution so they can get paid, and then your money goes to the creditor.

But remember, the point is not just to protect your assets from creditors, but you want to be able to use the money, too. If you have to just keep it in the business forever, then it doesn’t really do you much good (and you still have to pay taxes on it).

That’s where IRS Ruling 77-137 comes in. That ruling dictates that judgment creditors who have a judgment must pay taxes on the judgment regardless of whether they have collected it (an account receivable is still a taxable asset). So you just have to get through the tax year.

You hold onto your distributions long enough for the judgment creditor’s CPA to tell the judgment creditor that they have a choice between paying taxes on money they’ve never collected (and are not likely to collect if you are set up right) or write off the judgment.

Which one do you think they’re going to choose?

To learn more, contact the experts at the Fortune Law Firm.