Charging Order Protection States
Charging order protection states keep an LLC, safe from debts and creditors who may have private claims against an individual member of the LLC.3 min read
Charging order protection states keep an LLC, or limited liability company, safe from debts and creditors who may have private claims against an individual member of the LLC.
You may be aware that a limited liability company protects the personal assets of members against liability from business debts. The charging order protects the LLC itself, and other members, from liability against a member's private debts.
Charging order protection states also keep the LLC's management structure intact. This keeps a creditor with a claim against one of the members from taking that member's place in the LLC.
Why Are Charging Orders Necessary?
Anyone can get involved in a lawsuit or accumulate more personal debt than they can pay off. When this happens, creditors can collect their debt through putting liens on property or garnishing salaries.
A charging order puts a lien on a member's share of a limited liability company. This protects the LLC and the other members. They do not have to dissolve the business in order to pay off the private debts of a single member. They also do not have to accept a member's creditor as a business partner.
When charging order protections are in effect, the LLC member with private debts continues in his or her role within the business. The creditor cannot step in to manage the LLC in any way.
Why Do LLCs Need This Protection?
In many LLC examples, the LLC is a small business. The members of the LLC manage the business themselves. These members need to keep up a good working relationship. They depend on one another for business success.
Should someone like an outside creditor, or even an ex-spouse, step in to claim a place as a business partner, this could be destructive to the smooth operation of the business.
How to Get a Charging Order
If someone with debt has an LLC membership interest, creditors may count this as a personal asset and use it to help pay off the debt. To do this, a creditor must go to court to get a charging order. The creditor is not permitted to take distributions that belong to other members or any of the LLC's other assets.
Charging Orders and the Law
While the concept of the charging order is fairly old, it has not been used with LLCs for very long. Because of this, state laws about charging orders can vary widely. All states allow for charging orders, but some state laws show preference to creditors and others to debtors.
There are some states that will not give charging orders for LLCs that only have one member. This is because there are no other members in that LLC that need protection. In some states, a creditor is only allowed to take the distributions of a member who owes a debt. In other states, the creditor can foreclose the member's whole interest in the LLC.
Getting the Best Protection
For a charging order to be effective, an LLC must have its own separate EIN, or Employer Identification Number. Members must not mingle their personal assets with the business assets of the company.
Judges or the IRS may put a lien on the personal bank accounts of members if the LLC does not have a unique EIN or mingles business and personal assets. When an LLC only has one member, it is particularly important for the LLC to keep personal and business assets distinct.
While some people think of asset protection planning as an unethical way of hiding assets from creditors, this is actually not the case at all. Asset protection is perfectly legal and makes smart business sense. For an LLC to keep its assets protected, it is important to set up distinctions early in the life of the company.
When asset protection is done properly, it legally protects property from creditors holding any type of debt, from debt awarded in civil judgments to unpaid invoices. When members move assets around immediately before legal actions begin, this looks suspicious and can cause problems.
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