To Open with the Single-Member LLC or Not to Open a Single Member LLC, that is the question.
Protecting your personal assets is a key component of creating a Limited Liability Company ("LLC"), among several other tax advantages if you choose to file your LLC as an S-Corp, more on that in another blog. The number of members of an LLC, whether single-member or multi-member, will have a drastic effect on the asset protection your interest in the LLC may receive from your personal creditors.
Generally, the personal creditor of a member of an LLC will be able to acquire a charging order against the debtor’s interest in an LLC to satisfy the judgment. A charging order requires the LLC to pay the debtor-member’s distributions directly to the creditor instead of the member. Nine times out of ten, a charging order is the sole remedy for creditors of multi-member LLCs. A charging order as a credit satisfaction mechanism is in contrast with the creditor being able to instead fill the shoes of the debtor-member and potentially take part in the operations and decisions of the LLC. A creditor of a single-member LLC may be able to achieve the latter if the charging order is proven ineffective.
After the Florida Supreme Court’s decision in Olmstead v. FTC, Fla. Sup. Ct. No. SC08-1009 (2010), a charging order is not the exclusive remedy available to a creditor of a single-member LLC. The Olmstead decision prompted Florida to enact statutes 605.0503 and 608.433 to clarify that charging orders are the exclusive remedy for creditors of multi-member LLCs and the non-exclusive remedies for creditors of single-member LLCs. In the single-member LLC context, a creditor must prove that distributions under a charging order will not satisfy the judgment within a reasonable time. If the court is satisfied with the evidence, it may order the sale of the debtor's interest in the LLC at a foreclosure sale. At a foreclosure sale, the purchaser obtains the member’s entire LLC interest, becomes the member of the LLC and the debtor-member ceases to be a member of the LLC.
To avoid the potential of a creditor filling your shoes as the member of your single-member LLC, having more than one member is necessary. With multiple members, whether a wife, sibling, employee or trusted friend, the court will likely be forced to apply a charging order as the sole remedy. The exact percentage of ownership is up for debate so speak with your local business law attorney about best practices for creating a multi-member LLC. It is clear that if the second member is merely on paper as a sham, the courts will likely treat the LLC as a single-member LLC. To avoid this, the co-owner must contribute to the business and be treated as if they are an unrelated member, i.e., receive a share of the LLC profits, participate in decision making and receive financials.
It is important to note that the above only relates to the satisfaction of personal liability from a single-member LLC, not the ability of a creditor of an LLC attacking your personal assets, to which the court may pierce the LLC veil.
By default, an LLC, including single-member LLCs, are assumed to be separate from their owners. For a court to allow an LLC-creditor access to your personal assets, the creditor must pierce the LLC veil. There are various factors the court will consider when deciding whether to pierce the LLC veil. Such factors include whether the LLC maintained LLC formalities such as having a separate bank account, signing contracts in the name of the LLC, using LLC funds for purely business purposes, among other factors. Evidence suggests that the court is more likely to pierce the veil of a single-member LLC than a multi-member LLC.
In addition to following LLC formalities, a strongly drafted Operating Agreement will include several “creditor protection” provisions that will limit the options of a creditor. These Operating Agreement provisions provide greater protection to the LLC than what is provided by the LLC Act and thus are highly recommended as opposed to a simple boiler plate Operating Agreement or simply just filing the LLC with the state.
An experienced business law attorney can help you draft a creditor protection Operating Agreement. You should always consult with your local business law attorney before starting to operate your limited liability company.