Florida recent joined California, Idaho, Iowa, Nebraska New Jersey, Utah, and Wyoming in adopting the Revised Uniform Limited Liability Company Act (RULLCA). RULLCA is uniform law recommended by the National Conference of Commissioners on Uniform State Laws (NCCUSL). This particular act governs limited liability companies. In one respect the thought of having a uniform business law adopted by all 50 states appears, on its face, to be appealing however, in reality these laws are often put together by ivory tower attorneys who do not understand the burdens faced by hardworking individuals. These acts tend to increase personal liability therefore indirectly encouraging more, not fewer, lawsuits. RULLCA is a case in point.
Real estate investors, business owners, and individuals concerned about personal asset protection are just some of the people who form LLCs to protect their assets from creditor attachments (often resulting from frivolous lawsuits) or themselves from personal liability associated with their business enterprise. If RULLCA is more widely adopted the LLC may lose its luster as an asset protection tool for two very important reasons.
RULLCA allows a creditor to take a member’s interest to satisfy a personal judgment. Several states i.e., Nevada, Wyoming, Alaska, Delaware, have adopted LLC statutes limiting a LLC member’s personal creditor to a charging order. If you are not familiar with the term, think of the charging order like a lien. If you have personal judgment your judgment creditor can file his judgment against your membership interest. If you attempt to sell your interest or take distributions from your LLC the proceeds must be paid to the judgment creditor. However, if you elect not to do either of the aforementioned then your assets remain safe and sound in your LLC. Proponents of RULLCA do not like this outcome and would much prefer a judgment creditor (more likely his attorney) to be able to collect against your LLC assets. The presumption you could remove assets beyond the reach of their twisted legal claims resulting in ridiculous judgments is abhorrent to this crowd hence, carefully worded into RULLCA is the ability to foreclose on your LLC interest.
Section 503(c) of RULLCA provides the following: Upon a showing that distributions under a charging order will not pay the judgment debt within a reasonable time, the court may foreclose the lien and order the sale of the transferable interest. The purchaser at the foreclosure sale obtains only the transferable interest, does not thereby become a member, and is subject to Section 502.
The act clearly provides a mechanism for a creditor to take your interest if you refuse to pay. This effectively extinguishes the charging order protection by nullifying a LLC member’s attempt to keep his assets beyond the reach of creditors i.e., if you do not make distributions to your creditor then the court will take your LLC.
If a state elects to adopt RULLCA the state does not have to eat the entire act whole. The state is free to adopt some provisions and not others. Wyoming is case in point. When Wyoming adopted RULLCA in 2010 the state had enough sense not to adopt Section 503(c). The legislators undoubtedly understood many people have opted to from LLCs in Wyoming for the charging order protections afforded under their statute. What the legislators did not change, or chose to ignore, is Section 405 and 406 which provides in part that if an LLC makes distributions to a member when the LLC’s obligations exceed its assets, the member can be held personally liable to the LLC’s creditors. To understand how might this occur consider the following scenario: Jim is the sole member of Real Investor LLC (RILLC). RILLC owns a multi unit building that provides Jim with great cash flow but with the recent real estate downturn has negative equity of $250k. Any distributions taken by Jim will, under Wyoming’s LLC Act, be considered improper and hence, retrievable by the LLC creditors. This is the second reason RULLCA should be avoided.
So what should a person do if their state has adopted RULLCA or, like Wyoming, has adopted portions of the act? The easy answer is to use a Nevada LLC to own their other LLC interests. Typically referred to as a holding LLC, the Nevada LLC will maintain the benefits commonly sought after when forming a LLC by adding a layer of protection between the LLC member and the LLCs created in less favorable asset protection states.