Limited liability companies (“LLCs”) have become the business entity of choice. The corporation has waned in popularity, likely due to the exposure of corporate stock to shareholder creditors. Although corporations insulate shareholders from “inside” operational liabilities, an indebted shareholder must generally surrender corporate stock to a judgment holder. The judgment holder then often becomes a shareholder (with all shareholder voting and liquidation rights).
Outside Creditor Protection
LLCs insulate owners from “inside” business liabilities, similar to corporations. However, unlike corporate stock (available to creditors of a shareholder), member equity held in a protective LLC may not generally be reached. An “outside” creditor (of an LLC member) cannot acquire voting equity in a protective LLC (nor reach LLC assets). Claims on LLC interests are generally limited to a charging lien.
LLC statutes offer so-called “charging order” protection of LLC equity. The charging order (adopted from partnership law) establishes a creditor lien on distributions paid on “charged” LLC equity. Creditors of a member (holding the lien) are limited to LLC distributions paid to the debtor member. The charging order lien entitles the creditor only to company distributions (if any) payable to the debtor/member, but not to any liquidation, voting or management authority.
In protective jurisdictions, the holder of a charging order has only an economic interest (in distributions). Such a creditor may not sell the ownership interest, force distribution of company assets or vote on any company matters. The charging order limitation is what creates “outside asset protection” (as the “outside” creditor of an owner cannot get “into” the assets of the LLC). This outside limitation on creditors (if properly implemented in a protective jurisdiction) generally prevents involuntary equity transfers.
LLCs therefore insulate owners (known as “members”) from both (i) company “inside” operational liabilities (similar to corporations) and (ii) “outside” claims to equity (not offered by corporations). The strength of a state or foreign country’s LLC statute determines the degree of outside protection. The combined protection makes corporations archaic (and avoids the need to form partnerships, which offer the charging lien limitation but expose general partners to business obligations).
Development of LLC Statutes
Although the limited liability company is relatively new to the United States, similar entities have operated in other countries for centuries. The first American LLC statute was adopted in Wyoming (1977). All 50 states and several foreign jurisdictions have passed LLC organizational statutes. However, the level of protection varies dramatically from state to state (and country to country). For instance, several states limit collection rights on LLC equity “exclusively” to a charging lien. Other states actually permit attachment and foreclosure of LLC equity. Several factors must be considered in forming the most protective entity for the proposed business or investment arrangement.
State LLC law has developed sporadically from a patchwork of uniform acts and cases. The charging order language was first proposed in the Uniform Partnership Acts (1914 and Revised in 1997), the Uniform Limited Partnership Act (1976) (regarding limited partnerships) and the Uniform Limited Liability Company Act (ULLCA). The uniform acts are proposed to the state legislatures by the National Conference of Commissioners on Uniform State Laws. Such Acts do not strictly limit the creditor of a partner or member to distributions payable to the debtor/owner.
The uniform acts actually authorize the creditor to foreclose partnership/LLC economic interests (subject to a charging order). Under the Acts, a charging order constitutes a lien on the debtor’s distributional interest, which may be foreclosed. The purchaser at the foreclosure sale permanently obtains the debtor’s distributions rights. To make matters worse, a creditor with an ULLCA charging order may seek judicial dissolution of the LLC.
Although ULLCA allows foreclosure of distribution rights, the real exposure is the judicial propensity to disregard any limitation on creditor remedies. In several cases, the judge has permitted attachment of the debtor’s membership interest, exposing LLC managerial control and assets. This has happened in Colorado, Florida, Idaho and Maryland, regarding single-member LLCs.
The foreclosure right creates a trap for unaware residents of states with compromised LLC statutes. The use of ULLCA based LLC (not limiting the creditor “exclusively” to a charging order) is ill-advised. Superior charging order protection is available in other states (and countries). The states and commonwealths which have adopted ULLCA [or the Revised Uniform Limited Liability Company Act (RULLCA), which also includes foreclosure rights] are as follows: Alabama, California, Connecticut, D.C., Florida, Hawaii, Idaho, Illinois, Indiana, Iowa, Minnesota, Montana, Nebraska, South Carolina, South Dakota, Utah, Vermont, Washington, West Virginia, Wyoming and the Virgin Islands.
LLC statutes which limit creditors exclusively to a charging order generally eliminate exposure of member equity. Protective LLC organizational statutes preclude collection rights beyond a charging order. Several states have implemented protective LLC charging order provisions. Note that a few states have adopted the uniform act but revised the charging order language to preclude foreclosure. Such states include Arizona, Arkansas, Connecticut, Delaware, D.C., Florida (for multi-member LLCs), Idaho, Illinois, Kentucky, Louisiana, Maryland, Minnesota, Mississippi, Nebraska, Nevada, New Jersey, North Dakota, Oklahoma, Rhode Island, Texas, Virginia and Wyoming.
Several states (Alaska, Delaware and Nevada) statutorily protect equity in single-member LLCs. These statutes address the bankruptcy and state court trend to expose equity to creditors of a sole member.
North Carolina is one of the first states where a court explicitly acknowledged the charging order limitation. In Herring v. Keasler, the Court of Appeals prevented a creditor from seizing and selling the debtor’s North Carolina LLC interest. The original creditor, Branch Banking & Trust Company (BB&T) obtained a judgment against Bennett Keasler, for nearly $30,000. BB&T assigned the judgment to Max Herring, who attempted to collect on the judgment by seizing Mr. Keasler’s interests in several LLCs. The trial court refused to liquidate Mr. Keasler’s LLC interests. Affirming the trial court’s decision, the appeals court prohibited transfer of membership interests to Mr. Herring, unless the LLC’s operating agreement so authorized.
Interestingly, Florida initially adopted exclusivity language for its limited partnership but failed to limit creditors of LLC members (to the charging order) in its LLC statute. The prior Florida LLC statute was dismantled by the Florida Supreme Court in 2010 (Olmstead v. FTC, 44 So.3d 76 (FL 2010), to expose equity in the single-member Florida LLC (and arguably all Florida LLCs). The Florida statute was then revised to specifically protect multimember Florida LLCs and explicitly expose equity in single-member Florida LLCs.
California is the first state to suggest that equity held by a second member must have substance (as a condition to the LLC being treated as protective of member equity). A California appeals court essentially negated the protective multimember LLC status of a Delaware LLC. The LLC was owned 99% by the defendant/husband and 1% by his wife. In Curci Investments, LLC v. Baldwin,1 a creditor sought to add a California debtor’s multimember LLC as an alter-ego, codefendant. The debtor/member had defaulted on a $5.5 million loan and reneged on a court-approved settlement.
The creditor sought charging orders on 36 business entities in which the debtor had an interest. No distributions were ever made by the LLCs (after having been liened). However, during the six years prior to the charging orders, $178 million was distributed from one of the LLCs (JBPI, LLC). JBPI had also “loaned” more than $42 million to three family partnerships (benefitting trusts for grandchildren and children), but the loans were never repaid. JBPI was controlled by the debtor and held his and his spouse’s assets.
As a Delaware multimember LLC, the charging-order limitation should have protected the assets inside JBPI. The appellate court considered “whether the ends of justice require disregarding the separate nature of [JBPI, LLC] under the circumstances.” The court ruled that the judgment creditor is limited to the remedy of a charging order, “except where the existence of the LLC should be disregarded under a reverse veil-piercing theory.” Disregarding a second member and/or the LLC itself allows for “outside access” to LLC assets (avoiding the charging order limitation); this is known as “reverse veil piercing.”
The court permitted access to LLC assets, distinguishing prior cases and statutes, to provide a collection remedy. The court distinguished cases that rejected reverse piercing because such cases involved corporations rather than LLCs. With a corporation, the creditor can foreclose corporate stock (a remedy that already exists).
The court eliminated the multimember issue by reference to California’s status as a community property state. In a community property state, the co-member spouse is liable for debts of the other spouse. Also, such a (husband-and-wife) LLC, includes no “innocent member” prejudiced by the foreclosure. The ruling could represent the beginning of the end of protected LLC equity, if a second member holds only a nominal interest.
Other courts have rejected the reverse-veil piercing theory [(In re Glick, 568 B.R. 634 (Bankr. N.D. Ill. June 8, 2017), noting that neither Illinois nor Delaware law recognize outside reverse piercing theory].
In Greenhunter Energy, Inc. v. Western Ecosystems Technology, Inc., the Wyoming Supreme Court upheld a ruling permitting the creditor of a corporation’s wholly owned subsidiary to “pierce the corporate veil” (of the subsidiary). The ruling made the parent company responsible for the debts of its subsidiary. Veil piercing is an extraordinary remedy typically reserved for fraudulent conduct. The remedy is rarely permitted unless an entity is found to be the mere “alter ego” of its owner (making it unfair to shield the owner from the subsidiary’s debts). In Greenhunter, the Wyoming Supreme Court acknowledged that the two companies (parent and subsidiary) maintained separate bank accounts and business records. The court, however, took the unprecedented step of considering consolidated federal tax returns as suggesting an alter ego relationship. The court permitted the plaintiff to pierce the subsidiary (to reach the parent’s assets).
The Internal Revenue Code permits a single-member LLC to be taxed as a disregarded entity. The single-member LLC “outside protection” of owner equity and operational liability coupled with “disregarded” tax treatment (avoiding the need for a tax return) can be very convenient. The Wyoming Supreme Court’s decision to confuse tax treatment with legal liability runs counter to proper application of LLC protections.
Other factors may also be considered. If stability is a concern, Delaware is a traditional choice and Nevada similarly relies on Delaware’s longstanding body of favorable corporate law. If privacy is a concern, Delaware (which requires almost no public disclosure) is the best domestic option.
The types of assets to be owned by the LLC should also be considered. It makes little sense, for instance, to rely on the protections of a Nevada LLC to own real estate in Vermont. The practical reality is that litigation is likely to occur in the state where assets are situated and local courts tend to apply local law.
Entity selection requires constant study of legal trends.
 Sergeant v. Al-Alseh, 137 So.3d 432 (Fla. 4th DCA 2014).
 The National Conference of Commissioners on Uniform State Laws (also known as the Uniform Law Commission (ULC) was established in 1892, and provides states with non-partisan guidance to critical areas of state statutory law. More information can be found at www.nccusl.org/Narrative.aspx?title=About%20the%20ULC
 Uniform Limited Liability Act (1996) § 503(e)(3), drafted by the National Conference of Commissioners on Uniform State Loans.
 Herring v. Keasler, 563 S.E. 2d 614, 615, 620 (N.C. App. 2002).
 Wyoming Supreme Court Case No. 5-14-0036 (November 7, 2014).
 See Wells Fargo v. Barber, et al. 85 F.Supp. 3d 1308 (M.D. Fla. 2015); But see JP Morgan Chase Bank, N.A. v. McClure, et al., 393 P.3d 955 (Co. 2017), where the Colorado Supreme Court determined that a member’s interest exists in the State of LLC formation (for purposes of enforcing a charging order); and Arayos, LLC v. Ellis, 2016 WL 1642676 (S.D. Alabama 2016), where the court ruled that it has no authority to act on an LLC interest if the LLC was organized in another state; and Sergeant v. Al-Alseh, 137 So.3d 432 (Fla. 4th DCA 2014), where the court ruled that it lacked the authority to enforce collection of stock certificates located outside Florida.
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