Carefully choose where you form your LLC.  LLC laws vary a lot from state to state, and in material ways. Choosing unwisely or uninformed could subject you and your LLC to greater risks of loss and liability. However you may feel about the issue as a matter of policy, you, as a business owner/manager have a choice. You should be informed and choose wisely.

            This entry focuses on creditor remedies where the debtor is a member of an LLC. Most LLC Acts establish rules that define how and under what circumstances a creditor can effectively lien the LLC interest held by the debtor. That lien, called a charging order, allows the creditor to receive distributions from the LLC that would otherwise have gone to the debtor. In addition, all states provide mechanisms by which the creditor can influence whether and when those distributions are made. In some cases, the creditor can force the LLC to be liquidated.

            While every state’s laws provide creditor remedies, the laws vary greatly from state to state. The variance is particularly great as to creditor remedies available where the debtor is the sole member of an LLC. This post focuses on these remedies. Some states set a relatively low hurdle for the creditor to access the LLCs assets. Other states (notably Delaware and Maine) require a creditor to clear a high hurdle. The creditor must show that the LLC veil should be pierced.

            John seeks to collect on a judgment against Bob. However, Bob does not have much cash or other assets that can easily be converted to cash.  Bob does, however, have a high net worth, thanks to interests in some LLCs.

            Can John access those LLC assets to collect on the judgment? Generally not. The best (and sometimes only) option available under most LLC statutes is a charging order on Bob’s interests in the LLCs. While there are a range of charging order statutes in LLC Acts around the country, generally speaking, a charging order makes the creditor only a little better off than it was without the order. It’s leverage.

            Some charging order statutes give creditors more leverage than others. Those states allow creditors to foreclose on an LLC interest. If a creditor can foreclose on the interest, the creditor has all rights to the interest. Section 503(b) of the Uniform Limited Liability Company Act (the 2013 version) (the “Uniform Act”) provides for foreclosure rights where the creditor shows that distributions under a charging order will not pay the judgment debt within a reasonable time.

            In addition, under Section 503(f) of the Uniform Act, the foreclosing creditor can effectively cause the LLC to be liquidated, if the debtor is the sole member of the LLC.

            The drafters of the Uniform Act support their approach on two bases. First, in the absence of a foreclosure right, the debtor could use the LLC simply as an asset protection device. LLCs were not intended to be asset protection devices per se. Second, where the debtor is the sole member of the LLC, allowing the creditor to cause a liquidation does not violate the pick-your-partner principal. That principle comes from a long-standing partnership legal principle known as delectus personae. Under that principle, partners are allowed to choose those with whom they partner. Since there are no other partners in a single-member LLC, the policy for the charging order as an exclusive remedy does not exist.

            Other statutes, such as Delaware and Maine, provide that the charging order is the exclusive remedy for judgment creditors. Under those statutes, there is no foreclosure right.

            While a creditor may not foreclose on an LLC interest of a Delaware or Maine limited liability company, the creditor may sometimes access a single-member LLC’s assets. Courts have the power to order such a result if the LLC is the alter ego of the single-member. In other words, before a court may order that a creditor can access the assets of an LLC wholly-owned by the judgment debtor only if the creditor makes a veil piercing case.

            Sky Cable, LLC v. DIRECT TV Inc., 886 F.3d 375 (4^th Cir. 2018) does a great job applying Delaware law on this issue. Judge Keenan, writing for the Fourth Circuit Court of Appeals, held that creditors of Randy Coley, the sole member of several LLCs, could satisfy their judgment against Mr. Coley with assets of those LLCs. The trial court found that Mr. Coley commingled cash of the LLCs with his personal funds, paid personal obligations (including the mortgage debt on his residence) with LLC cash, and also commingled assets among the LLCs. In short, he treated the LLCs like they were personal accounts. Further, the trial court found that Mr. Coley defrauded the creditor. Under the circumstances, piercing the LLC veil seems perfectly consistent with Delaware law and business entity policy.

            While the Uniform Act makes a good case for Section 503(f), the Delaware approach makes the best sense. The drafters of the Uniform Act support the Section 503(f) by considering the interests of the member(s) as against the interests of the creditor(s). That’s too narrow a view. There are other people who could be effected by a foreclosure. The LLC also may have employees, other creditors, vendors, or other third parties whose businesses could be adversely affected by allowing the LLC to be liquidated. By requiring the creditor to make an equitable case – a veil piercing case – for liquidating the LLC, the law allows a court to consider those interests as well.

            However you view the policy on this issue, as a business manager, the differences described above present you with a choice. Your choice could have a material impact on your business, on your investors, on your employees, on other third parties. It could also have a material affect on you and your liability as a manager. You owe those people (the investors in particular) a duty. Think about that. Choose wisely.

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