What is the LLC Charging Order for the Limited Liability Company?

Most business owners create a limited liability company for their business in order to protect their personal selves and their personal assets from the liabilities and obligations of the business.

However, another liability concern relates to what is known as “reverse” liability. If a business owner is sued in his personal capacity for something totally unrelated to his LLC business, is the LLC business protected from being taken over by the person who obtains a judgment against the business owner personally?

The LLC laws of most states contain a “charging order” provision in them which is a great benefit of owning a business through a limited liability company.

The charging order provisions generally state that a creditor of a member of an LLC can only seize the economic rights of the LLC ownership interest held by that member. In other words, the creditor can never get the full ownership and never have voting or management control over the LLC business. What does this mean?

It means that you, as an LLC owner, will continue to be able to run the LLC business as before, and you, as a manager (along with other managers) can decide not to pay out any profits distributions related to ownership interests. This would result in the creditor not receiving any money for foreclosing on the LLC ownership interest AND actually being liable for the tax related to profits of the LLC business that were retained in the company.

Given this, most creditors will not look to take any LLC ownership interests because the potential result could be that the creditor will have to pay taxes on profits he never gets.

LIMITATIONS OF CHARGING ORDER PROTECTION

While charging order protection provisions are found in most state LLC statutes, an important bankruptcy case held that charging order protection would not apply to single member LLCs. This is because the reason for the charging order is to protect other members of your LLC business and the LLC business itself from business interruption related to the personal liabilities of one of its members. With a multi-member LLC, the interests of a personal creditor of one member should not take precedence over the LLC and the other innocent members.

However, if the LLC is owned only by one member and it is that member who is personally liable to a creditor, then in bankruptcy, the law will ignore the charging order protection and could allow the creditor to foreclose on the entire LLC ownership interest and business. To be safe, practitioners are advising that charging order protection should not be relied upon in any single member LLC situations either within or outside of bankruptcy.

This article discusses charging orders generally, but each state has its own scope and details for charging order protection so if this is an important issue to you, please check with your local attorney to receive specific advice for your jurisdiction and circumstances.