Charging Order Protection and LLCs
Protecting the assets of a business from the personal creditors of one of the owners of the business is often an important factor in determining which type of entity is best suited for a particular business. In that respect, the concept of a charging order often provides a significant reason to choose a limited liability company over a Corporation in forming a new business. Under the laws of most states, a creditor of a member of an LLC cannot directly attack the assets of the LLC but can only obtain a charging order.
What is a charging order?
A charging order is an order from a court which directs the load liability company to pay to the creditor any distributions from the LLC that what otherwise be paid to the member whose membership interest is subject to the charging order.
Here is basically how a charging order works:
- You own various assets, among which is a 70% membership interest in an LLC. The LLC, in turn, owns and operates a shopping center.
- One of your creditors sues you and obtains a large judgment against you.
- Your judgment creditor begins actions to levy against your various assets (bank accounts, real estate, stocks and bonds) which together are insufficient to pay the judgment debt.
- Your judgment creditor tries to seize your 70% membership interest in the LLC. If he is successful, the operating agreement of the LLC would give him, as 70% owner, the power to sell the shopping center and distribute the proceeds.
- Instead of taking control of the membership interest, however, he only is entitled to an order that compels the LLC to pay him the distributions that you would have received from the LLC. The judgment creditor has no right require that the LLC sell the property or even make distributions of current income.
The limited value of a charging order to a creditor provides a significant advantage to the debtor/member of the LLC. Since the judgment creditor cannot force the LLC to sell its assets or even to make distributions to its members, a debtor can frequently negotiate a settlement with the creditor that is more favorable to the debtor then if he owned a direct interest in the underlying property.
While state law frequently also applies the charging order concept to limited partnerships, the rules do not typically apply to corporations. If the same shopping center were held in a corporation, the judgment creditor would normally be able to seize the corporate stock and use its 70% voting control to cause the corporation to sell the shopping center and liquidate.
Charging orders and single-member LLCs
While charging orders apply nearly universally to LLCs with multiple members, the outcome is much more uncertain in the case of a single member limited liability company (SMLLC). The concept of the charging order was originally intended to protect the other members of the LLC (like other partners in a partnership) from having to deal with a third-party becoming involved in the company. The intent was not to protect the debtor/member himself from his creditors.
The issue was first addressed in a 2003 case in a Colorado Bankruptcy Court. In that case, the court held that the creditor’s charging order gave him sole and complete ownership of the LLC. Taking another approach, the Supreme Court of Florida in 2010 held that Florida’s charging order remedy was not the judgment creditor’s exclusive remedy, and ordered the debtor to surrender all right title and interest in its SNL LC to satisfy the outstanding judgment.
While some states, such as Nevada, have taken steps to provide in their LLC statutes that a charging order is a creditors exclusive remedy even in the case of a single member LLC, the most prudent course of action is to assume that courts will not give the protection of a charging order to a debtor who owns the entire membership interest in an LLC.
Consequently, if asset protection is a major concern, having multiple members in the LLC is clearly preferable to having a single member LLC.