Note this was written in 2010, and a number of other states have followed Florida’s lead. See updated discussion of this topic here and here.
Single Member LLC charging order is protection is diminishing. I sent out an email a couple weeks ago about the Florida Supreme Court setting aside the “charging order” protection an LLC is supposed to offer. I now apparently have a lot of students that have “sliced their wrists” and are bleeding to death. (I faint at the sight of blood – not really – but please don’t do the wrist thing.)
Take a deep breath and step back from the edge.
The “charging order protection” protects the assets of the company from your personal liabilities and creditors. If you have an accident on the street, the kid breaks his neck on your trampoline, or you get divorced, your personal assets are at risk. The stock in your corporation and the membership interests in your LLC are personal assets.
If you have a corporation and your creditor gets the judgment against you, he will get the stock in your corporation. Once he has the stock, he elects new officers and directors and controls the assets of the corporation. He has your corporation and can sell the assets or do whatever he wants.
If you have an LLC, when your creditor gets the judgment against you, he will get the membership interests of your LLC. BUT, the LLC is different. The law says he can’t affect the management of the LLC, take the assets or do anything to disturb the LLC. All the creditor can do is get a charging order, which is basically a lien against your membership shares.
If and when your LLC makes a distribution (pays a dividend), the creditor with the lien will get the dividend. He will keep getting the distributions until his lien amount is paid off.
The Florida Court
The Florida court said that the creditor (the FTC in this case) didn’t have to get a charging order and wait for a distribution. The government could immediately take control of the assets of the LLC and sell them to satisfy the judgment. The charging order protection was set aside.
It was a single member LLC, and the guy was really bad. He had hurt a lot of people and the government and the courts wanted to get those assets really bad. The court basically said that the single member LLC was “his,” and because he could sell the interests at any time without anyone’s approval, the statute that talked about charging orders in an LLC did not prevent the court from creating a remedy other than the charging order.
If there had been multiple members, the court would have had to consider the economic interests of the other members, and they probably wouldn’t have set aside the charging order protection afforded the LLC. However, the way the court arrived at its decision, the charging order protection for all LLCs in Florida could be set aside.
The dissenting opinion in the case pointed out that although the court had continually qualified their discussion of their logic in terms of a single member LLC, the decision could be read to apply to all Florida LLCs.
Here’s What You Do
Please note:
- This is only in Florida.
- The court seemed to think their ruling only applied to single member LLCs.
- The corporate shield of a single member LLC was not affected.
- Other states haven’t made this ruling yet, and they may never make the ruling.
So what can you do?
Have a multiple member LLC. In non-community property states, that could be a spouse. I would give the other member about 5% or more interest. There is no magic number of 5%, but the IRS considers a “substantial investment” to be 5% or above.
If you have a single member LLC, just continue on (unless you’re in Florida). If your state comes out like Florida, then you may want to change to a multi-member LLC.
Remember that you are only losing the charging order protection. Your advisor, when you set up the LLC, probably never talked to you about charging orders. You got your LLC only for the “corporate shield” and never worried about charging order stuff.
Your “corporate shield” protection has not been affected by the Florida Supreme Court ruling, even in Florida with a single member LLC. So the Florida court took away something that 90% of LLC owners didn’t even know they had.
This whole Florida court thing is a big deal “legally,” but it isn’t something that you need to slice your wrists over. Your LLC (unless you are in Florida) will give you the same protection it always has, and the protection probably isn’t going to be taken away. It is certain your LLC corporate shield protection will not be taken away.
Just tuck the Florida court thing in the back of your mind and don’t resist setting up an LLC with spouse, kid, or someone else as a minor member.
By Lee R. Phillips
Hello Lee,
If the percentage doesn’t matter, 5% or whatever, should that be the managinging member for the LLC, and if an LP should the 5% or whatever be general manager for the LP?
Also, from a tax point of view, its better to have the spouse be the limited member with 95%,no control, bit the distributions do not have self employment tax. Is this a good set up?
What happens to the person holding the charging order if distributions are not made for a year or several years?
Thank you,
Daniel
Does it matter if my LLC is in Nevada, but my Company is here in FL ? Thanks
It’s best to have your LLC in the same state you live in. See my explanation at https://youtu.be/MhPyU0Amgs0
In reply to Daniel Hewko.
If the percentage doesn’t matter, 5% or whatever, should that be the managinging member for the LLC, and if an LP should the 5% or whatever be general manager for the LP?
The percentage doesn’t make the manager. In an LLC, the manager can be the majority owner or a minority owner. The issue hinges on if it is a member managed LLC or a manager managed LLC. If it is member managed, then the manager (president) has to be a member. If it is manager managed the manager does not have to be a member (owner) and the company has “centralized management.” In an LLC, you get to choose two of the four elements of a corporation. The four elements are 1. limited liability (you want that one) 2. centralized management (the management doesn’t also have to be owners) 3. Continuity of life (the company will continue on past the death of a member) and 3. transferability of interest ( the members can freely transfer their membership interests (stock). You only get two of the four. Liability shielding will always be one of the choices. The others are up to you. You write them into your operating agreement. It’s a funny thing, but a lot of people think the operating agreement is no big deal. It is a big deal, and you can’t just use a stock form. If somebody gets cute and writes all four elements into the agreement, when you get into court you don’t have an LLC.
In the LP (limited partnership) the general partner is the person designated as the general partner. They are personally liable for the acts of the LP. Some say have an LLC or corporation be the general partner. That works, but maybe you should consider an LLC only and bag the LP, because you’re probably not gaining a lot.
Also, from a tax point of view, its better to have the spouse be the limited member with 95%, no control, but the distributions do not have self employment tax. Is this a good set up?
I am not sure I follow the spouse being the “limited member portion of the question” I assume you are talking about a limited partnership. Distributions (dividends) paid out of the LLC or limited partnership are not subject to self employment tax. They come on a K1 tax form. You do have to pay “reasonable salaries” out before you start making distributions. Congress appears to be working hard to take this away from us and make all income subject to the self employment type taxes. Obama proposed a 13% tax on all distributions, so plans are in the works to gouge the little business guy once more.
What happens to the person holding the charging order if distributions are not made for a year or several years?
In theory the guy gets nothing if the LLC or limited partnership doesn’t make distributions. There are claims that a minority member can make to force distributions, if there is profit. As a practical matter, my litigator in the office would say the judge is going to figure a way to get the charging order holder some money. Charging orders are not a total shield, but they are a great asset protection tool, because they muddy the water and put you on the high ground to negotiate a good settlement to your problem. You need to look at asset protection as not a total shield, but a chance to choose the ground you want to fight on and what size club you get to use.
Hello Lee, I have a Florida SMLLC with nil assets. In case of a judgement, does the SMLLC have a strong enough veil to protect my personal assets outside the SMLLC? Thx… George Miller
A single member LLC still has a corporate shield which protects your personal assets so long as you keep up on your formalities. Being based in Nevada is not going to help you if the lawsuit arises out of your action in Florida. In that case the court is going to apply Florida law.