Asset protection is one of the perceived benefits of using a limited liability company, particularly where the members are borrowers. In many states, a judgment creditor of a member of a limited liability company may not execute on or take title to the member’s interest in the LLC to satisfy its judgment, but rather is limited to obtaining a charging order as its sole remedy. A charging order provides that distributions from the LLC to the debtor member must be paid directly to the creditor (but often there is no assurance that distributions will be made, or when, because the manager of the LLC decides when distributions will be made). The charging order does not give the judgment creditor any ownership of the LLC, nor does it give the creditor any right to participate in management of the LLC. Thus, the debtor member retains ultimate ownership and control of the LLC. For this reason, LLCs are favored by asset protection and estate planning lawyers. However, for LLCs with one member, creditor protection is now questionable under a new Florida case.
Recently, the Supreme Court of Florida ruled in Olmstead v. FTC, Fla. Sup. Ct. No. SC08-1009 (2010) that a judgment creditor of the sole member of a single-member Florida limited liability company (LLC) could execute on the debtor’s entire right, title and interest in the LLC to satisfy the judgment. The debtor had argued that the judgment creditor’s exclusive remedy was to obtain a charging order.
In Olmstead, the Federal Trade Commission (FTC) received a $10 million judgment against Shaun Olmstead and Julie Connell, and sought to collect on the judgment by seizing two Florida single-member LLCs owned by Olmstead. The court analyzed a Florida statute generally applicable to execution of judgments giving creditors the right to take a debtor’s assets upon execution of judgments. That statute covered stock of corporations but did not explicitly refer to interests in LLCs. The court inferred that an LLC is a type of corporate entity and therefore “an interest in an LLC is personal property that is reasonably understood to fall within the scope of ‘corporate stock.’” Accordingly, absent any other statutory limitations, the court stated the FTC would be entitled to transfer Olmstead’s interest in the LLC to the FTC under Florida’s general execution statute.
The court also analyzed the Florida LLC Act. It interpreted the Act to provide that creditors may obtain a charging order, but that the charging-order remedy was not exclusive. Therefore, the court decided the Florida LLC Act did not displace the general execution statute, and creditors were not limited to a charging order. In contrast, many states’ limited liability company statutes provide that a charging order is the exclusive remedy for a judgment creditor.
The Florida court went on to state that the purpose of the charging order limitation is to protect other members of the LLC who are not debtors from having strangers participate in the management of the LLC. Since there are no such other members in a single-member LLC, this rationale for the charging order limitation is absent in the case of a single-member LLC. Accordingly, in a state where the Olmstead holding would not be precluded by statute, it appears to be limited to single-member LLCs (although this has not been decided by a court).
Arizona LLCs, including single-member LLCs, should not be affected by this ruling. The Arizona LLC Act expressly provides that a charging order is the exclusive remedy of a judgment creditor of an LLC member. Accordingly, an Arizona court is unlikely to follow the logic of Olmstead.
Like Arizona law, Nevada law (N.R.S. § 86.401(2)) and Delaware law (Del. L.L.C. Act § 18.703) expressly provide that a charging order is the exclusive remedy by which a judgment creditor of a member of an LLC may satisfy a judgment from the member’s interest of the judgment debtor.
Note, however, that regardless of whether state law provides that a charging order is the exclusive remedy for judgment creditors, the assets of a single-member can still be reached if a judge “Pierces the Veil” of Separate Liability. Empirical studies show that a substantial majority of the entities whose liability shields are pierced by the courts are single-owner entities. This is perhaps because the risk that an entity will be treated as an “alter ego” of an owner will often be greatly reduced if the entity has two or more owners rather than just one. The following factors can be important to avoiding this result:
- Maintain separate books and legal and financial records for the LLC that are completely separate from the member. Document the contribution of the member to the LLC, then show that the LLC used those funds (not member funds). A separate bank account for the LLC would be best.
- Make clear in documents of all kind that the LLC is a separate organization. LLC business should not be evidenced on correspondence bearing the letterhead or logo of the member without a clear disclaimer on the letterhead. Separate business cards and stationary for the LLC would be best. Obtain insurance coverage naming the LLC as insured.
- All relationships and transactions between the LLC and the member should be documented with arms-length terms. Consider an agreement dealing with IP, employment, facilities sharing, insurance, and expenses, especially if, for example, office space, conference rooms, equipment, administrative and accounting services, telecommunications and IT services will be provided by the member. Use of written intercompany agreements can be useful as evidence that an entity that conducts a business through a single-member LLC treats that LLC as an entity separate and distinct from the parent entity.
Click here to view this Client Alert as a PDF.
This Client Alert has been prepared by Lewis and Roca LLP for informational purposes only and is not legal advice. Readers should seek professional legal advice on matters involving these issues.