In the course of their business, bankers routinely encounter single member limited liability companies ("SMLLCs"), entities commonly used in real estate and small businesses. Despite the prevalence of SMLLCs, there is a fundamental legal uncertainty as to whether the assets of an SMLLC share the same level of protection from its member’s creditors as is provided to the assets of a multi-member LLC through the charging order remedy.
Depending on state law, bankers may or may not be able to reach the assets of their debtors’ SMLLCs through a charging order. Furthermore, changes to Ohio law have recently been discussed in the Ohio Legislature which attempt to remove any uncertainty and would prevent bankers and other creditors from reaching assets of a SMLLC through a charging order.
The following analysis discusses recent case law from around the country examining a judgment creditor’s ability to reach the assets of an SMLLC in which its debtor holds the sole membership interest. The LLC charging order is a remedy through which a creditor who has won a judgment may reach its debtor’s membership interest in an LLC. State LLC statutes generally require the unanimous consent of all members (other than the assigning member) in order for the assignee of an LLC membership interest, such as a creditor who has attached its debtor’s membership interest, to participate "as a member" in the management of the LLC. To protect this approval right of the other members in a multi-member LLC, a charging order entitles a creditor only to the debtor’s share of distributions and assets upon dissolution, and not to the right to participate in the management of the LLC. This prevents the judgment creditor from selling the LLC’s assets and distributing the proceeds to itself.
Where the debtor’s interest is in an SMLLC however, there are no other members to consent to the assignment of the debtor’s management rights. In such circumstances, whether a charging order will provide the same level of asset protection to a SMLLC as it would to a multi-member LLC, and thus prevent a creditor from satisfying its judgment through the sale of the SMLLC’s assets, depends upon the statutory framework of the state in which the LLC is organized.
Recent Case Law
The Kansas Revised Limited Liability Company Act ("KRLLCA") specifically provides that where the member of an SMLLC assigns its interest, "the assignee shall have the right to participate in the management of the business and affairs of the limited liability company as a member." (Kan. Stat. Ann. § 17-76, 112(f)). In October 2011, a court interpreting this provision held that it applies to a judgment creditor who becomes an assignee pursuant to the entry of a charging order. (Meyer v. Christie, No. 07-2230-CM (D. Kan., Oct. 13, 2011)). This explicit provision of the KRLLCA makes it clear that in Kansas a charging order does not provide the same level of asset protection to a SMLLC as it would to a multi-member LLC. Under the Kansas framework, a creditor can use a charging order to reach the assets of its member’s SMLLC to satisfy its judgment.
The Supreme Court of Florida’s 2010 determination of the issue, on the other hand, hinged on whether or not the statutory charging order was the sole remedy through which a creditor could reach its debtor’s SMLLC interest. (Olmstead v. FTC, 44 So. 3d 76 (Fla. 2010)). Although the court found that Florida’s charging order remedy "clearly does not authorize the transfer to a judgment creditor of all an LLC member’s ‘right, title and interest’ in an LLC," it also held that the charging order was not the judgment creditor’s exclusive remedy. (Id.) Florida’s generally applicable law subjecting a judgment debtor’s corporate stock to levy and sale under execution, combined with the "uncontested right of the owner of the single-member LLC to transfer the owner’s full interest in the LLC," permitted the court to order the debtor to surrender all right, title and interest in its SMLLC to satisfy an outstanding judgment. (Id.) While the Florida charging order remedy protects the rights of non-debtor members of a multi-member LLC, the availability of this additional remedy allows a creditor to go beyond the charging order protections and reach its debtor’s full SMLLC membership interest, including management rights.
Similarly, a U.S. Bankruptcy Court applying Colorado law has held that "the charging order limitation serves no purpose in a SMLLC, because there are no other parties’ interests affected." The court found that without the protections of a charging order as an exclusive remedy, a debtor’s bankruptcy filing effectively transferred her full membership interest in her SMLLC, including her management rights, to the bankruptcy estate. (In re Albright, 291 BR 358 (Banker. Court D. Colorado, 2003)). This allowed the Bankruptcy Trustee to obtain management rights and to cause the SMLLC to sell its assets and distribute the proceeds to the estate, without being hindered by the protections of a charging order.
Ohio Proposed Amendment
While Ohio courts have not addressed whether the same charging order protections offered to multi-member LLCs are also available to SMLLCs, changes to Ohio law recently discussed in the Ohio Senate Judiciary Committee begin to address this issue. If enacted, proposed amendments to Section 1705.19 of the Ohio Revised Code, to be contained in HB 48, would expressly provide that a charging order is the exclusive remedy of a creditor seeking to satisfy judgment against the LLC membership interest of a debtor. Furthermore, the amendment would prohibit any creditor of a member of an LLC from having any right to obtain possession of, or to exercise legal or equitable remedies with respect to, the property of the LLC. The proposed amendment does not differentiate between SMLLCs and multi-member LLCs.
Under the analysis used in the above cases, this change would most likely prevent a judgment creditor from obtaining management rights in an SMLLC, since there would be no specific statutory exception for SMLLCs and the charging order would be the exclusive remedy available to the creditor to reach the debtor’s membership interest. If the amendment is enacted and Ohio courts interpret the statute to provide SMLLCs with the same charging order protections as multi-member LLCs, creditors will be unable to recover judgments by forcing the sale of their debtors’ SMLLC assets and distributing proceeds.
Bankers should be aware of this possibility and take necessary precautions to avoid relying on unreachable assets of the debtor’s SMLLC as security for the credit they extend. In most cases, the straight-forward solution is prepare loan documentation reflecting the SMLLC as a borrower.