The rules governing Limited Liability Companies (LLCs) and how they can protect you as a member vary from state to state. LLCs are fairly new entities and because of this, there is limited case law available for judges to turn to when making a ruling. What this means, is that, as more and more cases pertaining to LLCs are brought to the courts, the way your LLC can or cannot protect you may change.
Currently, there is much debate within the courts regarding whether or not a court my order a judgment-debtor (the losing party in a lawsuit who owes the amount of the judgment to the winner) to surrender "right, title, and interest in the debtor’s single-member LLC to satisfy an outstanding judgment." Many contend, "the only remedy available against their ownership interest in the single-member LLCs is a charging order.."
Essentially, a charging order is a mandate obtained from a court or a judge by a judgment creditor (the winning party in a lawsuit to whom the court decides is owed money), by which the distributional interest (all of a member’s interest in distributions by the LLC) of the judgment debtor in an LLC is charged with payment of the amount of judgment.
The charging order, when found applicable by a judge, protects the member in an LLC who is being sued from surrendering his/her right, title and interest in the LLC. However, as Shaun Olmstead found out in his case Shaun Olmstead v. Federal Trade Commission, protection through a charging order is not always granted. (See my previous post from last year regarding this case and its implications by clicking here)
Due to some shady business practices performed by Shaun Olmstead and Julie Connell, they were taken to court by the Federal Trade Commission (FTC). Once found guilty of "unfair or deceptive trade practices" (which are prohibited under Section 5(a) of the FTC Act), the duo was ordered to pay $10 million in restitution to the FTC. Because the two didn’t have $10 million dollars, the FTC wanted to liquidate assets of LLCs owned by Olmstead and Connell and take the proceeds as partial payment of the restitution owed.
This is where the situation becomes dangerous to members of an LLC. Most of us feel that our assets are fairly safe and secure once placed in an LLC. However, like I explained before, the laws governing the protection that LLCs can provide, vary from state to state and are being shaped by case law.
Olmstead and Connell argued that the courts could not take their LLCs and liquidate the assets in order to pay off the FTC. They claimed that a charging order (explained above) is "the sole remedy available to the judgment creditor of the owner of a single-member LLC." Conversely, the FTC argued that a charging order is not the only remedy and that asset forfeiture followed by liquidation is a viable option.
In the end, the Florida Supreme Court sided with the FTC due to the language used in Florida’s LLC Act. Similar laws with the respect to limited partnership interest and partnership interest use the term "exclusive remedy", whereas the language used in the LLC Act only uses "remedy".
Olmstead and Connell did break the law by engaging in shady business practices, however, their choices in their line of work should not compromise the protection of their assets through an LLC. To solve the issue of shady business practices the legislature could make an exception in the statue to remove LLC protections in such a situation; however, the decision reached by this Court undermines the LLC protections for all Florida residents.
As a member of an LLC or even someone thinking of forming an LLC in the future, one needs to be aware of the language used to draft the statutes in the state of your LLC’s formation. The exclusion of a single word such as "only", "sole" or "exclusive" may mean the difference between protection and vulnerability.
Accidents happen, and in our sue happy society, if you appear to have money it is very likely that one way or another someone is going to try to benefit from the fruits of your labor. You should view it as a duty to yourself and your hard work to protect what you have earned.
Here, at Anderson Business Advisors, we advise everyone, that when forming an LLC it is best to form their LLCs in states where the charging order is mandated as the "exclusive remedy" such as in Nevada or Wyoming. Because really, what good is asset protection if it doesn’t actually work?