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Using an LLC to Protect Assets From Creditors
Limited Liability Companies ("LLCs") have been the primary tool for many years to protect assets from creditors. One of the asset protection benefits of the LLC is the protection afforded by what is known as a "charging order." The concept of the charging order was developed to protect the multi-members LLC ("MMLLC") so that the LLC assets were not subject to claims of creditors of one of the members. If enforced by a court as intended, an effective charging order will prevent a creditor of an LLC member from attaching the assets of the LLC. Instead, the charging order provides a mechanism whereby the creditor steps into the economic benefit of the debtor-member and will receive future profits allocated to such member until such time as the judgment is satisfied. There is no requirement for the LLC to actually distribute any profits. The creditor with the charging order has no right to control, vote, participate, or otherwise compel such profit distributions. The result is that a charging order holding creditor may be faced with the prospect of not collecting anything.
As LLCs developed, states introduced the concept of the single member LLC (SMLLC). The issue raised by the creation of the SMLLC was whether a charging order would still be granted when there were no other members for the court to protect.
The first answer to this question came out of Colorado in 2003 with the Albright case. In Albright, the Colorado court interpreted the Colorado statute and determined that the charging order protections were not available in the context of the SMLLC at issue. In the recent case of Olmstead v. Federal Trade Commission, the Supreme Court of Florida disregarded the charging order protection in the case of a SMLLC.
The courts in Albright and Olmstead were applying the LLC statute in their respective states. Unfortunately, neither state had a particularly compelling statute to interpret. Neither the Colorado nor the Florida LLC statute provided express language that made it clear that the charging order is the sole and exclusive remedy of an LLC.
In fact the Supreme Court of Florida, in Olmstead, stated that its charging order provision establishes a nonexclusive remedial mechanism, further stating that there is no express provision in the statutory text providing that the charging order is the only remedy that can be utilized.
Consequently if practitioners want charging orders to be the exclusive remedy for LLCs, and in particular SMLLCs, they must utilize LLCs formed in states whose legislation says that a charging order is the exclusive remedy. States such as Alaska, Arizona, South Dakota and Nevada, have enacted express provisions in their LLC statutes clarifying that charging orders are the exclusive remedy for a creditor of an LLC member. In Alaska and South Dakota, the LLC act goes even further to specifically state that no other remedies are available to a court.
Therefore, when planning for a situation that will involve a SMLLC, it is critical that you choose a jurisdiction with express statutory provisions stating that the charging order is the exclusive remedy for the court.
Protection from creditors is also provided by a MMLLC. If properly created the MMLLC may prevent a creditor from becoming a member in the MMLLC without the consent of the other members.
This article is a summary of complex legal issues. Readers interested in asset protection should consult legal counsel.
This article was written by Edward J. Castellani, J.D., C.P.A. and published in BRIEFS (November, 2010). Mr. Castellani can be reached at 517.377.0845 or at ecastellani@fraserlawfirm.com.
