Foreclosure of LLC Interest

When most of the LLC legislation was passed by the states in the early 1990’s it was believed that LLC’s could provide some good asset protection in situations like this because the membership interests were protected by a “charging order” in the same manner as partnership interests. Those membership interests in the LLC that you received were protected from foreclosure by a creditor under the original law. A judgment creditor was not legally permitted to seize LLC interests as he could with shares of stock or other property you own. The most the creditor was permitted was to wait for any distributions to come out of the LLC. There was no right to vote or control the LLC in any manner, just the right to wait for the possibility that someday you would distribute income or sales proceeds out of the LLC into his eager hands. Fat chance right? And that’s why the charging order remedy of the creditor was viewed as weak and ineffective and that was why you chose to transfer your property into the LLC as a part of your plan. It is certainly far better to attempt to limit a judgment creditor to a hypothetical claim against future distributions then to risk losing your valuable property and your savings nest egg right in a future lawsuit. Many early asset protection plans were established based on this fairly simple plan: 1) Transfer property or investments into an LLC; and 2) Hold all the LLC membership interests and maintain complete control and all the benefits of the property while limiting the creditor to an ineffective charging order remedy.

Olmstead v, FTC

In June of 2010 the Florida Supreme Court visited the charging order issue in a case involving a single member LLC (Olmstead, et. al., vs. The Federal Trade Commission, Supreme Court of Florida. Case No. SC08-1009 June 24, 2010). The court reasoned that the charging order limitation in Florida law was intended to protect other existing members from an uninvited and unwanted intrusion of a creditor into the affairs of the business. If you and your brother form an LLC to own property, it is certainly true that your brother (and you) will be financially injured if your membership interest is seized and your judgment creditor becomes the owner of your LLC interest. The intent of the law was to prevent that from happening by limiting a creditor merely to your share of the distributions – without any say in management. However, this same logic does not apply if you are the only member of the LLC since there are no other partners or members who are prejudiced or injured if your interests are seized. That certainly makes sense so far.

What surprised many experts was the Court’s holding that the Florida LLC Act does not provide that a charging order is the exclusive remedy available against an LLC membership interest. Instead the Court ruled that an LLC membership interest is subject to seizure by a creditor in the same manner as corporate stock. As a result, a creditor of a member of either a single member LLC or a multi-member LLC is permitted to seize a membership interest under Florida law. Although this decision is consistent with some recent court cases as well as the governing law in California and several other states, it was a surprise to those in the so-called asset protection friendly states such as Florida, Nevada, Delaware and New Mexico where it was believed that the charging order protection in state law could be relied on as the foundation of the asset protection planning.

In response to the confusion generated in Florida about the protection afforded LLC interests, on April 29, 2011, the Florida Senate passed legislation (HB 253) which was previously passed by the House of Representatives two weeks earlier. This legislation is designed to “fix” the uncertainty and confusion created by the Olmstead case with respect to “charging order” protection for members of Florida LLCs. This new legislation was then forwarded to the Governor for his signature. The legislation makes it clear that in the case of multi-member LLC’s (but not single member LLC’s, the charging order is the sole remedy of a creditor of a member.

For more details see Foreclosure of FLP Interest

Read full article Using LLCs for Asset Protection


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