One of the most important and confusing aspects of starting a business is deciding what type entity to form. For many, a limited liability company (LLC) is an attractive option. LLCs offer flexibility in business structure, lack of corporate formalities, tax advantages, and limited liability. However, when this liability is limited can confuse even the most savvy business owner.
When can LLC creditors reach your personal assets?
Traditionally, limited liability meant that an LLC’s creditors could not reach the personal assets of the LLC’s members and vice versa. Generally, a creditor of the LLC can only collect the debt from the assets owned by the LLC. Thus, the LLC’s liability is limited to its own assets. This is referred to as “inside liability.”
For example, assume ABC, LLC, owes Vendor X $10,000 for supplies purchased by ABC. Assume ABC only owns tools, equipment, and office supplies worth $5,000. If Vendor X obtains a judgment against ABC and attempts to collect on this debt, it can only reach the tools, equipment, and office supplies owned by ABC. The personal assets, such as a boats or vacation homes, of ABC’s members are safe from Vendor X’s collection efforts.
When can an LLC member’s personal creditors reach the LLC assets?
Another common problem occurs when an LLC member defaults on personal debts and has a judgment entered against him or her individually. What happens if this judgment creditor wants to go after the LLC? Fortunately, Florida Statutes limit a judgment creditor’s exclusive tool for reaching LLC assets to a “charging order.” A charging order is essentially a lien on a member’s LLC share, giving creditors the ability to attach that member’s distributions from the LLC. The inability to reach the LLC’s actual assets for purposes of satisfying the member’s personal debt(s) is referred to as “outside liability.”
Returning to the example above, assume that First Bank is granted a judgment of $10,000 against Mark Member, a member with a 25% stake in ABC, LLC. ABC has done very well and now owns multiple stores and a fleet of company trucks. As a judgment creditor, First Bank can obtain a charging order (via appropriate motion with the court and corresponding order from the judge) against Mark’s 25% ownership interest in ABC. Then, whenever ABC makes a distribution of the profits to the members, First Bank will be entitled to Mark’s distribution to the extent necessary to satisfy the judgment. The hard assets of ABC are safe within the LLC, as are the other members’ profit distributions issued by the LLC. However, this protection from outside liability is limited depending upon the structure of your LLC, as further discussed below.
It’s Dangerous to Go Alone
One of the first decisions in forming an LLC is the number of members in the LLC. Many business owners enjoy the flexibility of operating alone, as a single-member LLC. However, a single-member LLC is robbed of most of the liability protection discussed above.
In 2010, the Florida Supreme Court ruled in a landmark case that single-member LLCs are not protected from outside liability. This allows a member’s judgment creditors to reach into the LLC to collect against the assets owned by the LLC. The Florida Statutes were later amended to reflect this decision. Therefore, a creditor with a judgment against the single-member LLC’s principal can now foreclose on the LLC and force the sale of the member’s interest in the LLC. For a single member this could mean a total loss of your business. However, for multi-member LLCs, protection from outside liability still applies and a charging order remains the sole remedy available to outside judgment creditors. This was just upheld last month by the Fourth DCA in Young v. Wear It’s At, LLC, ___ So.3d ____, 39 Fla. L. Weekly D1268b (Fla. 4th DCA 2014).
Accordingly, LLC formation can be complicated and stressful for new business owners, especially in light of the recent changes to the Florida Limited Liability Company Act that took effect earlier this year (see Andrew Levy’s February 10th blog post). Proper planning in the early stages can be vital to managing your future successes and minimizing your potential setbacks. We are here to help.