Today, a well know legal professor (expert in business organizations law) filed a brief in a landmark Florida case that addresses a fundamental single member LLC matter. If the court agrees with his position, this could mean the definitive end to any charging order protection for the single member LLC.

State LLC laws have never differentiated between a limited liability company that has one member and one that has multiple members when it comes to liability protection.  It is well recognized that every LLC provides a layer of protection stating that owners are not personally liable for business liabilities merely because they are owners.  This is known as forward liability protection.

However, an LLC in most states also offers what is known as reverse liability protection or charging order protection.  This protection basically states that if a member is personally sued for a non-business related obligation and is found liable, the creditors cannot take full ownership of the member’s LLC interest in the LLC.  The creditor’s rights are limited to the economic interests.  In effect, this allows the member to retain the control he had in the LLC business.

The philosophy behind the charging order is not really to give protection to the liable member but to protect other owners of the LLC from business disruption and problems.  They should not fall victim to one member’s personal liabilities by having to deal with an unknown creditor coming in and affecting the business by having management or voting rights.

Now this reasoning does not really apply in a single member LLC context because there are no other members to protect.  A well known bankruptcy court has nullified charging order protection in a single member LLC in the context of a bankruptcy.  While conservative legal practitioners interpreted this ruling to mean there is no longer charging order protection for a single member LLC, the ruling technically applied in only a bankruptcy context.

However, this Florida case addresses the matter in a non-bankruptcy circumstance and so its conclusions will have significant ramifications and applicability in the general area of LLC protection.

More details can be found at this link:

http://www.wmitchell.edu/news/articles/default.asp?articleId=11766&story=Professor-Kleinberger-files-brief-in-landmark-Florida-single-member-LLC-asset-protection-case

However, another liability concern relates to what is known as “reverse” liability. If a business owner is sued in his personal capacity for something totally unrelated to his LLC business, is the LLC business protected from being taken over by the person who obtains a judgment against the business owner personally?

The LLC laws of most states contain a “charging order” provision in them which is a great benefit of owning a business through a limited liability company.

The charging order provisions generally state that a creditor of a member of an LLC can only seize the economic rights of the LLC ownership interest held by that member. In other words, the creditor can never get the full ownership and never have voting or management control over the LLC business. What does this mean?

It means that you, as an LLC owner, will continue to be able to run the LLC business as before, and you, as a manager (along with other managers) can decide not to pay out any profits distributions related to ownership interests. This would result in the creditor not receiving any money for foreclosing on the LLC ownership interest AND actually being liable for the tax related to profits of the LLC business that were retained in the company.

Given this, most creditors will not look to take any LLC ownership interests because the potential result could be that the creditor will have to pay taxes on profits he never gets.

LIMITATIONS OF CHARGING ORDER PROTECTION

While charging order protection provisions are found in most state LLC statutes, an important bankruptcy case held that charging order protection would not apply to single member LLCs. This is because the reason for the charging order is to protect other members of your LLC business and the LLC business itself from business interruption related to the personal liabilities of one of its members. With a multi-member LLC, the interests of a personal creditor of one member should not take precedence over the LLC and the other innocent members.

However, if the LLC is owned only by one member and it is that member who is personally liable to a creditor, then in bankruptcy, the law will ignore the charging order protection and could allow the creditor to foreclose on the entire LLC ownership interest and business. To be safe, practitioners are advising that charging order protection should not be relied upon in any single member LLC situations either within or outside of bankruptcy.

This article discusses charging orders generally, but each state has its own scope and details for charging order protection so if this is an important issue to you, please check with your local attorney to receive specific advice for your jurisdiction and circumstances.