Asset Protection Denied with LLC: Single member LLC subject to court sale of interests; Charging Order Not Sole Remedy

No Surprise to US. Everyone is talking about the decision of the Supreme Court of Florida in Shaun Olmstead v. Federal Trade Commission as if this were starling new law undermining the basics of LLC planning. In our view, it was an expected result which we have been taking into account in our planning in recent years. See our blog from last year: You Choose the Wrong State: LLC Mistake Number Two.

Two Types of Protection. With an LLC, there are two potential ways an LLC can protect you. First, if your LLC owns a rental property and the tenant files suit for an injury which occurred on the property and wins the suit, then there is a judgment entered against the LLC. Unless you personally caused the injury, then the judgment is against the LLC and not you and your assets outside the LLC should not be at risk. This general rule applies to both LLCs and Corporations. Second, if you have a car accident and you are sued and lose the case and a judgment is entered against you for $3,000,000 and your insurance only covers $1,000,000, then the judgment creditor will come after all of your assets for the remaining $2,000,000, including your ownership in an LLC. If the applicable state law does not limit the creditor to a charging order as the exclusive remedy, there was always a concern that the creditor could obtain the assets in the LLC through a court ordered sale and seizure of your LLC interests to pay the $2,000,000. A court can order a sale of your corporate shares because most state statutes for Corporations do not limit the creditor to a charging order as the exclusive remedy.

Charging Order. A charging order is where the judgment creditor gets an order from a judge that says that, for example, if Frank owns an interest in an LLC, anytime the LLC makes a distribution of profits, then the creditor gets Fred’s share of the profits and not Fred. If the charging order is the exclusive remedy, then the creditor is not supposed to be able to get a court order for the sale of Fred’s interest in the LLC.

Courts Want to Preserve Their Power. As the Court in Olmstead points out, courts for centuries have had the power to order the sheriff to seize any of your real estate, bank accounts and furniture and sell it at auction to pay a judgment against you. Courts hate to give up this power. A court will only give it up where the legislature has said in no uncertain terms that the court power to order a sale is prohibited for a particular asset.

Exclusive remedy. The Olmstead opinion is 45 pages long and two Florida Supreme Court Judges disagreed with the votes of the majority. To boil down all of the esoteric legal discussion, the Florida legislature failed to use the words “exclusive remedy” in the reference to a charging order in the LLC statute. Florida had amended its partnership acts to provide that charging orders were an exclusive remedy for partnerships but not the LLC statute. In the Olmstead opinion, there were strong and well reasoned opinions on both sides and it was not a foregone conclusion that the majority would require the exclusive remedy language. We expected it because our experience and view of the world is that people generally do not give up their power unless they are forced to do so.

Fears Confirmed. This is a major decision in that if confirms the fears of those that you have to have the words exclusive remedy in the LLC statute to set aside the age old power of the courts to sell everything you have.

Back to the Basics. This does not change the basics of increasing your asset protection by using LLCs, asset protection trusts, corporations, and offshore planning:

1. Take Action Now Before Disaster Strikes. Any asset protection can be set aside if you do it when you are in trouble. You have to be proactive and do asset protection before disaster strikes. With local, state and federal laws compounding in complexity and world change happening at a dizzy pace, you have to build your defenses now because the future is not predictable.

2. Do Good, not Bad. The federal courts found that Olmstead had operated an advance-fee credit card scam and was ordered to pay more than $10 million in restitution. If the courts find that you did something really bad, they will find any way they can to get you.

3. Choose the Right State. Establish your LLC in a state where the state statute clearly says that a charging order is the exclusive or sole remedy of a creditor and do everything you can to make that law apply in your state.

4. Avoid Single Member LLCs. In Olmstead, all of the LLCs were single member LLCs and the court said there was no block to a creditor taking over a single member LLC. There may be a block if there were two or more members. For an LLC with serious assets, use multiple member LLCs and restrictions on transfers of interests in your documents.

5. Make Distributions Discretionary. If there is a charging order entered, your manager should be able to deny making distributions so as to encourage a settlement.

6. Optional Buy Out. If a charging order is entered, provide in your operating agreement a way for other members to buy out the person who has a charging order entered against them for a discounted value.

7. Manager LLCs. Set up the manager position to retain control in case of bankruptcy.

8. Layers of Protection. An LLC is only the first layer of protection. For more protection, use partnerships or LLCs to own the interests in the operating LLC and an offshore or onshore asset protection trust to own the partnership interests.

Take Action Now. Call us to review your asset protection. We will review your entire situation and recommend changes. The above list is only some of the basics and not all of the steps you need to take now. We have a national network of advisors in every state and can work with you in any state. With the dangers of this economy, many who hung on until now are going under. Asset protection only works when it is done before disaster strikes. With all of the turmoil and change, you must take care of this now.