Charging Orders and LLCs

Charging Orders and LLCs

Limited liability companies are known for protecting their members’ personal assets against liability for business obligations. But a legal mechanism called a “charging order” can also protect LLC assets from being used to satisfy members’ personal debts.

Charging order laws also preserve an LLC’s management structure by preventing a creditor from taking over the role of a member who owes debts.

What Is a Charging Order?

Like anyone else, a member of an LLC may accumulate debts or be involved in a lawsuit that results in a judgment. A creditor typically has several ways to collect that judgment, including garnishing wages or placing a lien on property.

When a debtor’s assets include a membership interest in an LLC, the creditor may want to use that membership interest to satisfy the debt. To do this, the creditor must obtain a charging order from a court. A charging order places a lien on the member’s LLC interest and protects the remaining members from having to dissolve the business or accept an uninvited business partner.

With a charging order, a creditor can collect distributions or assets that are due to be paid to the member-debtor. The creditor is not allowed to take the LLC’s other assets or its other members’ distributions. The member-debtor can continue to play an active role in the business: a charging order doesn’t allow the creditor to step in and start running the LLC.

This last benefit is significant because many LLCs are small businesses that are actively managed by members who depend on one another’s skills and a good working relationship to make the business succeed. Few small businesses would want a creditor or ex-spouse to step in as a business partner.

Charging Orders and Taxes

Generally, the money collected as a result of a charging order is after-tax money. Thus, the LLC member’s distribution is paid to a creditor, but the member must still pay taxes on the distribution amount.

Variations Among State Charging Order LLC Laws

Charging orders are a longstanding feature of state partnership law, but their application to LLCs is relatively new. As a result, while all states provide for charging orders, the laws vary from state to state, and new issues are continually being decided by the courts. In general, some states are more friendly to debtors, while other states have charging order statutes that tend to favor creditors.

In some states, a creditor that obtains a charging order is only entitled to a member’s distributions, while in other states the creditor can foreclose on the member’s interest in the LLC. In addition, some states don’t extend charging orders to single member LLCs, since there are no non-debtor LLC members that need protection.

Obtaining Charging Order Protection

Once you form an LLC by filing articles of organization with the state, your LLC automatically has charging order protection under your state’s laws. The exact nature of the protection will depend on state law and it may not extend to a single-member LLC.