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Asset Protection. Most people set up a limited liability company for asset protection, that is protection against the consequences of losing lawsuits. But, since LLCs have become so common and there are many non lawyers who are glad to put them together for you. Many people set them up without expert advice and make many mistakes.
Choice of Law. When you set up an LLC, you have to file “Articles of Organization” with a state government. The laws of the state in which your file the initial Articles then becomes the law that applies to the LLC. You do not have to choose the state in which you live or in which the property is located. Just as with Delaware Corporations, you can shop around and choose the best state in which to form your LLC. Many people who form their own LLCs incorrectly assume they have to set up the LLC in the state in which they live.
Enterprise Liability. LLC protections against lawsuits have two completely different aspects. These two are not usually understood by most people. The first one is protection against enterprise liability. That is, if you own a rental house in your own name, and the tenant has a big party and someone slips and falls on a broken beer bottle, the injured party goer may sue you for their damages. If the party person gets a judgment for $2,000,0000 against you and your insurance pays up to its top limit of $500,000, then the party person can come after your home, bank accounts, stocks, bonds, shares in your business corporation and maybe your IRA until they get the rest of $1,500,000.
Limited to the LLC Assets. If you own the house in an LLC, then in most states, the maximum that the party goer will get from their judgment is the liability insurance on the house and the equity in the house. Your liability is “limited” to what is owned by the LLC. The judgment creditor gets a judgment against the LLC and not you, unless they can prove you were at the party and threw the beer bottle at the injured party goer. LLCs and Corporations, if properly maintained, provide this “enterprise liability” protection.
Creditor Protection. There is a second type of liability protection that refers to “creditor protection”. In Virginia and Delaware, an LLC provides you greater protection than a Corporation formed in any state or LLCs formed in many other states.
Personal Judgment. You are in auto accident. At trial, the jury doesn’t like you, finds you at fault and renders a $2,000,000 judgment against you personally. You were driving so you are personally at fault and the judgment is against you and all of your assets. Your limit on your insurance pays $500,000 to the creditor and the creditor comes after you for the $1,500,000 balance. When entered in a court of record, that $1,500,000 judgment automatically becomes a lien against any real estate you own in your name in the county of that court and quickly goes on your credit report.
Personal Judgment Protection? You put your rental house into an LLC to protect against liabilities coming out of that enterprise. Will your LLC also protect you against the auto accident liability?
Collection Process. When a judgment is entered against you by a court, that is the beginning of the collection process. First, the judgment creditor can have the court issue a subpoena for you to appear in court to list all of your assets. Next, the creditor takes this information and starts to levy on your assets. For certain assets, the creditor may request that the judge order a court sale of the asset.
Sale on the Court House Steps. Prior to the change of the
law in Virginia, a creditor could get a court order requiring the sale of your membership interests in your LLC to pay for a personal judgment. Today, this could happen still with an LLC formed in the District of Columbia, Maryland and many other states.
Charging Order Sole Remedy. When looking for a state in which to form an LLC, you look for the phrase in the state’s LLC law: “… the entry of a charging order is the exclusive remedy of the creditor” or similar language. This means that the creditor can only get a court order requiring you to pay over any money you take out of the LLC, but can not require a sale or seizure of your membership interest by court order as they are able to for your bank account or stock portfolio.
Encourages Favorable Settlements. Where state law of your LLC says that the charging order is the exclusive remedy, the creditor has to wait for distributions to come out of the LLC for the creditor to get paid. If the LLC distributes nothing, the creditor gets nothing. This is “creditor protection” and encourages settlements of the creditor’s claims and large reductions in the amount you will have to pay the creditor. Careful people will own most of their cash and brokerage accounts in an LLC for this reason.
Choose the Right State. If you choose the wrong state to form your LLC, you will not have this creditor protection. If you choose Virginia, Delaware and certain other states, you will. Can you live in Maryland and have the advantages of a Virginia LLC? Most state LLC statutes state that the law of the state in which you set up the LLC determines the rules applicable to that LLC. You should choose the state with the best law for what you are trying to do.
Counterattacks. It is possible that a local Judge may try to get around the state law and order a sale of the LLC interest. But, there appear to be very few cases on this issue at this time, probably because there is enough uncertainty to the creditor that these cases get settled. The results in a federal bankruptcy court may be different. There are additional costs for multistate registrations, but, with the right state, you have built a high hurdle for the aggressive creditor to jump over. We will cover how to keep the hurdles high in later blogs.
Choose Wisely. Choose the right state law for your LLC.
Choice of Law. When you set up an LLC, you have to file “Articles of Organization” with a state government. The laws of the state in which your file the initial Articles then becomes the law that applies to the LLC. You do not have to choose the state in which you live or in which the property is located. Just as with Delaware Corporations, you can shop around and choose the best state in which to form your LLC. Many people who form their own LLCs incorrectly assume they have to set up the LLC in the state in which they live.
Enterprise Liability. LLC protections against lawsuits have two completely different aspects. These two are not usually understood by most people. The first one is protection against enterprise liability. That is, if you own a rental house in your own name, and the tenant has a big party and someone slips and falls on a broken beer bottle, the injured party goer may sue you for their damages. If the party person gets a judgment for $2,000,0000 against you and your insurance pays up to its top limit of $500,000, then the party person can come after your home, bank accounts, stocks, bonds, shares in your business corporation and maybe your IRA until they get the rest of $1,500,000.
Limited to the LLC Assets. If you own the house in an LLC, then in most states, the maximum that the party goer will get from their judgment is the liability insurance on the house and the equity in the house. Your liability is “limited” to what is owned by the LLC. The judgment creditor gets a judgment against the LLC and not you, unless they can prove you were at the party and threw the beer bottle at the injured party goer. LLCs and Corporations, if properly maintained, provide this “enterprise liability” protection.
Creditor Protection. There is a second type of liability protection that refers to “creditor protection”. In Virginia and Delaware, an LLC provides you greater protection than a Corporation formed in any state or LLCs formed in many other states.
Personal Judgment. You are in auto accident. At trial, the jury doesn’t like you, finds you at fault and renders a $2,000,000 judgment against you personally. You were driving so you are personally at fault and the judgment is against you and all of your assets. Your limit on your insurance pays $500,000 to the creditor and the creditor comes after you for the $1,500,000 balance. When entered in a court of record, that $1,500,000 judgment automatically becomes a lien against any real estate you own in your name in the county of that court and quickly goes on your credit report.
Personal Judgment Protection? You put your rental house into an LLC to protect against liabilities coming out of that enterprise. Will your LLC also protect you against the auto accident liability?
Collection Process. When a judgment is entered against you by a court, that is the beginning of the collection process. First, the judgment creditor can have the court issue a subpoena for you to appear in court to list all of your assets. Next, the creditor takes this information and starts to levy on your assets. For certain assets, the creditor may request that the judge order a court sale of the asset.
Sale on the Court House Steps. Prior to the change of the
law in Virginia, a creditor could get a court order requiring the sale of your membership interests in your LLC to pay for a personal judgment. Today, this could happen still with an LLC formed in the District of Columbia, Maryland and many other states.Charging Order Sole Remedy. When looking for a state in which to form an LLC, you look for the phrase in the state’s LLC law: “… the entry of a charging order is the exclusive remedy of the creditor” or similar language. This means that the creditor can only get a court order requiring you to pay over any money you take out of the LLC, but can not require a sale or seizure of your membership interest by court order as they are able to for your bank account or stock portfolio.
Encourages Favorable Settlements. Where state law of your LLC says that the charging order is the exclusive remedy, the creditor has to wait for distributions to come out of the LLC for the creditor to get paid. If the LLC distributes nothing, the creditor gets nothing. This is “creditor protection” and encourages settlements of the creditor’s claims and large reductions in the amount you will have to pay the creditor. Careful people will own most of their cash and brokerage accounts in an LLC for this reason.
Choose the Right State. If you choose the wrong state to form your LLC, you will not have this creditor protection. If you choose Virginia, Delaware and certain other states, you will. Can you live in Maryland and have the advantages of a Virginia LLC? Most state LLC statutes state that the law of the state in which you set up the LLC determines the rules applicable to that LLC. You should choose the state with the best law for what you are trying to do.
Counterattacks. It is possible that a local Judge may try to get around the state law and order a sale of the LLC interest. But, there appear to be very few cases on this issue at this time, probably because there is enough uncertainty to the creditor that these cases get settled. The results in a federal bankruptcy court may be different. There are additional costs for multistate registrations, but, with the right state, you have built a high hurdle for the aggressive creditor to jump over. We will cover how to keep the hurdles high in later blogs.
Choose Wisely. Choose the right state law for your LLC.
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