The Special Asset Protection Advantage of LLCs

Perhaps the most powerful advantage LLCs have is their unique level of asset protection. Unlike shares in a corporation, or assets held directly, in most states your ownership in an LLC is not considered by law to be personal property.

What that means is that if you are sued in court, your LLC interests (including all of the assets and property owned by that LLC), are not an asset that a creditor can seize and sell to pay off your debt. The most that a creditor can do, at first, is to have something called a Charging Order filed against your LLC interest. A Charging Order works in the same fashion as a garnishment of wages or a builder’s lien. If there is profit paid to you as a result of your ownership, it will be diverted to your creditor until the debt is paid. If your LLC posted a loss, then a creditor would also be able to take that loss, just as it would a profit. If you want to sell off any of the assets in the LLC, you would have to pay the creditor’s claim from the sale proceeds, before the asset sale would be allowed.

But even this great asset protection has limits. There’s nothing to stop a creditor from garnishing your wages or regular bank account, for example. And, in some states, if you make no efforts to pay off a debt, after a certain period of time your creditor can apply to have your LLC ownership interest foreclosed – which is exactly what it sounds like. That creditor would be given full ownership over your LLC interest, including voting rights. If that happens, then your creditor now has the power to vote to liquidate the LLC’s assets to pay off your debt.

It’s also important to understand that the strength of Charging Order laws varies from state to state. Some states, like Nevada, say that the Charging Order is the exclusive creditor’s remedy – they have no other option. But other states give creditors a choice of taking a Charging Order or applying for an immediate foreclosure on your ownership interests. This is especially true in situations where you have no other source of income to pay the judgment. You can find a list of states and the relative strengths of their asset protection legislation in the accompanying product materials.

If you aren’t sure how strong the laws are in your state, check with your legal advisor. If you find that you’re living in a state that doesn’t have the strongest charging order laws, you may want to make some changes to your Operating Agreement or business structure to help protect the LLC’s assets. In most Operating Agreements there is a clause that says the LLC has the right to repurchase the interests of a member before a charging order is granted against that member. This is especially important if you have several owners. You don’t want a lawsuit against one owner to impact everyone, and, once that suit has begun, the member being sued cannot dispose or move assets. But there is nothing to stop an LLC from protecting itself from a member by repurchasing interests that could otherwise put the entire business structure at risk.

And remember, this protection doesn’t apply to the LLC itself. If your LLC is sued for debts it owes, or for cause (e.g., a tenant is seriously injured on your property and your insurance doesn’t cover the damages), then the assets in the LLC are at risk. There is no way to completely protect your LLC’s assets, which isn’t that out of line, if you think about it. At some point there must be a measure of accountability built into our legal system.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable.

Got questions? Contact us! We’re here for you.

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