A Different Equity Stripping Plan

Equity stripping involves encumbering equity in an asset such as real estate or receivables in order to secure a loan. In some instances equity stripping may not be available because, for instance, the assets sought to be protected are not acceptable to lending institutions as collateral or the debtor’s credit does not warrant a loan regardless of the nature of collateral offered. Another problem with standard equity pledging is that the loan proceeds received become a pot of non-exempt cash in the debtor’s hands. One of my existing clients presented an interesting variation of equity stripping protection that could work in some otherwise difficult situations.

The client’s idea was for him and an associate to create a new business in the form of a limited liability company. The business could be an operating business or an investment enterprise. The business agreement would require each of the partners to guarantee a substantial amount of future capital contributions. To secure their future capital contributions the debtor and his associate each pledge non-exempt assets to the business entity and file a UCC-1. If the business entity can demonstrate validity, and if the parties demonstrate bona fide consideration for the pledge to make capital contributions, the proposed arrangement could effectively protect equity in the assets pledged. The debtor/client does not receive non-exempt cash in return for the asset pledge which cash would create a new asset protection challenge. Instead, the client gets only a LLC membership interest which is somewhat protected from judgment creditors by virtue of the limited charging lien remedy provided by Florida law.

I am not aware of any court decision concerning the validity and asset protection of a lien on non-exempt assets to secure a future capital contributions. As in the case of most asset protection tools, this solution works to the extent of its underlying business validity.

posted by Jonathan Alper, asset protection and bankruptcy lawyer, Orlando, Florida