Wednesday, June 30, 2010

Forum Shopping for Favorable LLC Law: Make Sure the Charging Order is the Exclusive Remedy Available to Creditors

LLCs are currently a very popular form of legal entity largely due to its flow-through partnership taxation feature coupled with its corporation-like limited liability protections. As most LLC owners know, LLCs provide significant liability protection from the threat of “inside liabilities” provided the proper formalities are adhered to and the separate entity status of the LLC is maintained . Inside liabilities are the types of debts and obligations that arise during the course of the LLC’s business and operations.

What many LLCs owners may not know is that LLCs can also provide significant liability protection from “outside liabilities.” Outside liabilities are any other type of liability an LLC owner may incur as a result of non-LLC related activities. For example, if an LLC owner is sued as part of a personal injury claim that has nothing to do with the LLC’s operations, the owner could potentially face a liability that has originated outside the scope of the LLC if a judgment is awarded against him. However, such an award may be of little use to a judgment creditor if the LLC owner established his LLC in a state with favorable LLC laws.

In general, a state with favorable LLC laws is one that provides the charging order as the exclusive remedy available to judgment creditors attempting to attach an LLC owner’s interest in his LLC. A charging order is a judicial remedy that allows a judgment creditor to act as an assignee of the LLC interest he is attempting to attach. As such, the judgment creditor does not receive any ownership or managerial rights in the LLC, thus, rendering him incapable of forcing distributions from the LLC or seeking judicial liquidation in an effort to satisfy the award. Consequently, the judgment creditor is essentially forced to wait for distributions to be made from the LLC which he can then try to intercept as payment in satisfaction of the award.

As can be seen, the LLC is capable of providing powerful asset protection features especially if formed in a jurisdiction that limits the available remedies against an LLC for outside liabilities to a charging order. However, not all jurisdictions provide for such exclusivity. Nevada is an example of a state that does provide the charging order as the exclusive remedy. Nevada’s LLC statutes contain sole remedy charging order language in NRS 86.401(2)(a) (This section [p]rovides the exclusive remedy by which a judgment creditor of a member or an assignee of a member may satisfy a judgment out of the member’s interest of the judgment debtor).

States that do not have exclusive remedy language can potentially result in forced judicial liquidations of LLC assets or forced partnerships that were clearly never intended to be. Therefore, it is advisable to seek out a jurisdiction that expressly limits a creditor’s remedy for an outside liability to a charging order. As an example, in Florida, the state’s Supreme Court recently decided (Shaun Olmstead, et. al., v. The Federal Trade Commission) that charging order protection did not apply to an LLC because the LLC statute regarding charging orders did not expressly state that the charging order was the exclusive remedy available. Consequently, the LLC owners did not receive the degree of asset protection they thought they were receiving when establishing their LLC in Florida. Thus, the importance of “sole remedy” language is apparent in this situation which indicates that one must be very selective in deciding which jurisdiction to use in establishing limited liability entities so as to achieve maximum asset protection.

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