Single Member LLC Charging Order Protection Is Under Attack

Single member LLC and charging order discussions are coming up a lot more these days. Folks may have heard that a single member LLC is bad, but they don’t know why. They like the idea of a single member LLC so they don’t have to give away some of their LLC and they may not know how much to give away so they have enough “multiple members.”

The negative spin on a single member LLC and the charging order protection comes from two law cases. One in Florida, Olmstead vs. Federal Trade Commission, held that creditors of the single member in a single member LLC could go directly against the LLC and take the assets of the LLC. This means if you have a single member LLC and creditors come against you , you could lose your business. The other similar case is the Albright case in Colorado.

Courts letting creditors go directly against the company’s assets isn’t anything new for corporations. If the single shareholder of a closely held corporation gets in trouble, his creditors can always take his stock in the corporation. Once the creditor gets a controlling interest in the corporation’s stock, the creditor will simply elect new officers and directors and control the corporation – along with all of its assets.

Partnerships are protected in a different way. The law will not let the creditors of one partner take over his share of the partnership. This is known as charging order protection.

It protects the non-debtor partners from the creditor by preventing them from seizing partnership assets and thereby keeping the creditor out of the partnership affairs.

The rationale behind the charging order applied initially only to general partnerships, where every partner was involved in carrying on the business of the partnership; it did not apply to corporations because of their centralized management structure. Over the yea, charging order protection was also extended to limited partners and LLC members.

Single Member LLCs Initially had Charging Order Protection

So initially the LLC was designed to have a double asset protection. It had the corporate shield aspect of a corporation and the charging order aspects of a partnership. The corporate shield protects the members of the LLC from the creditors that are coming against the LLC directly. The charging order protection protects the LLC itself from the creditors of the members.

Charging order type protection simply cannot be achieved by a corporation. The combination of the corporate shield and the charging order protection is unique to an LLC. That’s what makes the LLC a great business entity.

However, single member LLC charging order protection is under attack. Well, maybe not under attack, but a couple of state courts have taken a swipe at it.

In the two court cases mention above, the judge has gone against the charging order concept because the LLC involved only a single member.  The same happened in an Idaho case citing the Colorado case. So now in Florida, Idaho, and Colorado, it is necessary to have more than one member in an LLC if you want to be assured of getting the charging order protection.

Currently you also need to have a multiple member LLC in Utah in order to get charging order protection. This is because Utah has passed legislation that prevents a single member LLC from getting charging order protection. This may seem silly or unfair, but the point is that this is the way the law is moving. Your state may not currently have these laws (Wyoming passed a law confirming that same charging order), but it is wise to take heed of potential trends.

If you are serious about the protection your LLC gives you, check out your operating agreement and make certain you are protected. If you don’t have one you should get one. A good agreement should be about thirty pages and should define how you operate your company. I have a free agreement available at my website www.llcwizard.com. It is also a good idea to get the two hour audio tutorial I have prepared to go along with the advanced version of the free operating agreement. Now is a good time to protect yourself.