Single Member LLCs: Are Your Assets Protected?

Although relatively new to the legal world compared to other forms of legal entities, Limited Liability Companies (LLC) have by far become the legal entity of choice for businesses. Data suggests that in recent years, more than 90% of new businesses started as an LLC. Some of the largest companies in the world have converted or re-established from corporations to LLCs. Well-known companies such as Apple, IBM, Nike, and many others are structured as an LLC.

For an individual starting a business, a single member LLC (SMLLC) is most often chosen. In the past, legal entities really were not geared towards having a single owner. Partnerships consisted of multiple individuals. Corporations had multiple shareholders. So, having a legal entity that consists of one owner — at least as much as it occurs today with SMLLCs — presents a different landscape.

I often get asked how much an SMLLC offers in the line of protection. After all, if John Doe sets up John Doe Enterprises, LLC, aren’t they one and the same? The short answer is “maybe.” The question is whether we are talking about the personal liability of John Doe or protection of the company’s assets.

Pros and Cons

Generally, assuming things are done properly, an SMLLC can give strong personal liability protection to the owner. In other words, liability stops at the company level and the owner’s personal assets are not reachable. However, when it comes to protecting the assets of an SMLLC when the owner is sued for personal reasons or personally owes a creditor, the amount of protection can vary greatly. This is especially important to farmers who may have land, equipment, or other high-value assets in an SMLLC.

One of the main advantages of an LLC is creditors and claimants are restricted from its assets. For example, with a corporation, a creditor or claimant cannot simply take the corporation’s assets. Rather, the creditor or claimant can obtain ownership of stock in the corporation. If the creditor or claimant obtains ownership in the corporation, the creditor or claimant is entitled to dividends and profit. In obtaining majority ownership, the creditor or claimant can liquidate the corporation and sell the assets.

Nearly every state prevents creditors or claimants from obtaining ownership of a member’s interest in an LLC. Rather, they are allowed to obtain a “charging order,” which is a court order that the LLC pays any distributions or income to that member’s creditor or claimant. For example, if I am one-third owner in an LLC, and someone obtains a charging order against me based on a debt, lawsuit, etc., whatever income I would receive as a one-third owner each year goes to satisfy the claim or debt against me. This is similar to a wage garnishment order. However, the creditor’s interest is limited only to my right to receive regularly occurring distributions from the LLC, and they cannot force the LLC to make a distribution.

The premise behind the charging order is that individual owners of an LLC should be protected against the actions of other owners that do not relate to the company. For example, if Larry, Curly, and Moe own an LLC, and Moe gets sued and has a judgment against him, should Larry and Curly suffer by the assets of the company being affected? The charging order makes sense in the context of LLCs with multiple members, and in the majority of states, it is a claimant’s exclusive remedy. But what about in the case of a SMLLC, where no other members that can be affected? This is where the laws begin to vary between states and asset protection dwindles.

On one end of the spectrum, states like Delaware, Nevada, and Wyoming provide exclusive charging order protection for SMLLCs. On the other end, states like Florida and New Hampshire have laws where the charging order is not the only remedy to be used against a SMLLC. Other states — many which have not yet addressed the issue with laws or court decisions — lie somewhere in the middle.

Strengthen the SMLLC

With very few states having definitive treatment of SMLLCs and whether or not charging orders are the sole remedy, what can a person do to strengthen their SMLLC? One option is to convert the SMLLC to a multi-member LLC. This can be done by bringing a spouse or other partner into the company. Sometimes a person chooses a SMLLC because they want it to be “their” business and not co-owned with a spouse, or because they want pass-through tax treatment eliminating the need to file a tax return. In my opinion, obtaining more protection by adding another member outweighs the reasons for having an SMLLC.

If an additional owner is added, it is important that it is legitimate. In other words, do not just add a person in name only or “on paper.” By doing that, you run the risk of the court setting aside the additional ownership interest and treating the LLC as an SMLLC. Legal counsel should be consulted to see what action needs to occur (i.e. rights, responsibilities, financial return) of the new member to pass the smell test.

Legal counsel will also be needed to overhaul the operating agreement. Since the business started as an SMLLC, the operating agreement (if one even exists) is geared toward a single member. When adding a member, the operating agreement serves as a contract between members. An updated operating agreement will determine ownership of the company based on multiple owners.

Do It in Delaware?

If a person does not have another owner to add to the SMLLC, one option is to establish the SMLLC in a state like Delaware, which has the charging order as the exclusive remedy. Historically, Delaware has had very favorable laws for legal entities, leading to many out-of-state businesses being established there. So, John Doe, who lives in Florida with no exclusive charging order protection, can set up a Delaware SMLLC and do business in Florida, hoping to increase the asset protection of the SMLLC.

However, there’s still a chance a Florida court applies Florida law to a claim rather than Delaware law. Also, John Doe will incur additional filing fees, registered agent fees, annual franchise fees, and registration in Florida, plus he must have a registered agent in Delaware. Going with an out-of-state SMLLC isn’t a simple choice.

Around 20 states now allow a Domestic Asset Protection Trust (DAPT), which is an irrevocable trust established to protect assets, rather than simply transferring them at death to someone else.

One possibility is to layer a DAPT with an SMLLC. This can provide a one-two punch of the liability protection of the SMLLC with the asset shielding of the trust. Because of state trust laws and state SMLLC laws, whether this can be done and/or is the correct move varies greatly based upon the state where the owner resides and the state where the assets and business are located.

At the end of the day, the SMLLC is a viable legal entity. It allows for strong personal liability protection. It allows for pass-through tax treatment and provides asset protection. However, how much asset protection it gives can vary greatly depending on where you live, and since many state laws are still evolving, they can be subject to change. If you have an SMLLC, especially one with a high amount of assets, seek legal counsel to make sure your assets are fully protected.

These articles are for general information purposes only and should not be construed as specific legal advice or to create an attorney-client relationship. Laws vary among states and information contained in this article may not be applicable to your state. If you have a legal issue, you should contact an attorney.

John J. Schwarz, II, is a lifelong farmer and has been an agricultural law attorney for 18 years and is passionate in helping farm families with legal matters. Natalie Boocher, an elder law attorney assisting clients with a wide range of long-term care planning and asset preservation, contributed to this article. They can be reached at 1-844-FARMLAW and www.thefarmlawyer.com. Read more at www.farmlegacy.blogspot.com .