We started looking at various states for asset protection, specifically looking at what is called a “Charging Order.” Creditor’s rights laws against companies vary by state. Some are more friendly, others are not. How does Delaware stack up?
No Liability for Members’ Personal Debts
So you owe money and you own all or part of a company. It is well understood in corporations that you can’t take a company’s money or property to pay a shareholder’s debt. The general rule in all states for LLCs is the same. In addition to protecting LLC members from the business debts, the LLC also protects the business and its owners from the LLC member’s debts or personal liability unrelated to the LLC’s business.
The Only Legal Procedure
In Delaware, charging order are the only legal way you can get at a member’s LLC ownership interest. This order directs the LLC to pay you any distributions that would otherwise be distributed to the member. Like most states, creditors only obtain the debtor’s financial rights and cannot participate in management.
So how do you get a charging order? First you win a judgment against the LLC member personally. After winning the judgment, you apply to the court for a charging order. Even with a charging order, you cannot participate in company management. You cannot order the LLC to make a distribution or be sold to pay off debt. Frequently, creditors who obtain charging orders against LLCs end up with nothing because they can’t order any distributions and the LLC can choose not to make any.
A charging order may be weak but it is not necessarily toothless. A charging order can make it difficult or impossible for the member or the other owners to take money out of the LLC without having to pay you first.
Foreclosure and Dissolution Not Allowed
Delaware’s LLC law says that the charging order is the exclusive legal procedure that personal creditors of members can use to get at their LLC ownership interest. Thus, unlike some other states, Delaware does not permit you to foreclose on the owner’s LLC ownership interest or get a court to order the LLC dissolved and its assets sold. This makes Delaware a particularly friendly state for people who want to form LLCs to protect assets from personal creditors.
Is One a Lonely Number?
With a single-member company, there is no one else to protect so the rationale for limiting creditors to a charging order disappears. Recognizing this, some states have adopted special rules for these companies, allowing you to take over the member’s entire company interest, not just the right to receive distributions. Other states have adopted laws specifically recognizing the company’s right to the same charging order protection afforded to multi-member companies.
Delaware changed its law in 2013 to clarify the protection applies to both types. This makes Delaware one of the most friendly states for those who want to protect their assets by forming any kind of LLC. The law is evolving, however, and different rules regarding single member LLC protection are evolving in bankruptcy.
The best protection, however, is to add another member. This gives more protection in bankruptcy, or if the company becomes subject to state laws that provide less protection. There are rules, though. The second member must be treated as a legitimate co-owner of the company. If the second owner is added merely on paper as a sham, the courts will treat the company as a single-member entity. A new co-owner must pay fair market value for the interest acquired and otherwise be treated as a “real” LLC member–that is, receive financial statements, participate in decision making, and receive a share of the LLC profits equal to the membership percentage owned.
Next time we will check out South Dakota. Until then, good luck and good hunting.
The Fisher Law Office is known for its experience in asset protection, business counselling and development, business succession planning, estate planning and probate administration. Annapolis attorney Randall D. Fisher has practiced for over 20 years, is licensed in Maryland, Texas, Wyoming and the District of Columbia, and has clients all over the country. He maintains the highest peer review rating for ethics (AV Preeminent) by Martindale-Hubbell, and is a sucker for long walks on the fairways.