Single-member Llcs and Asset Protection
| Publication year | 2012 |
| Pages | 39 |
| Citation | Vol. 41 No. 3 Pg. 39 |
2012, March, Pg. 39. Single-Member LLCs and Asset Protection
March 2012
Vol. 41, No. 3 [Page39]
Business Law articles are sponsored by the CBA Business Law Section to apprise members of current substantive law. Articles focus on business law topics for the Colorado practitioner, including antitrust, bankruptcy, business entities, commercial law, corporate counsel, financial institutions, franchising, and securities law.
Coordinating Editors
Trygve E. Kjellsen of Lathrop and Gage LLP, Denver-(720) 931-3145, tkjellsen@lathropgage.com; David P. Steigerwald of Sparks Willson Borges Brandt and Johnson, P.C., Colorado Springs-(719) 475-0097, dpsteig@sparkswillson.com; Curt Todd, Denver-(303) 955-1184, ctodd@templelaw.comcastbiz.net (Bankruptcy Law)
About the Author
Herrick K. Lidstone, Jr. is managing director and a shareholder of the Greenwood Village law firm of Burns, Figa and Will, P.C. He practices in transactional law, including corporations, limited liability companies, financing, mergers and acquisitions, and ethics-(303) 796-2626, hklidstone@bfwlaw.com.
Single-member LLCs formed under Colorado law are not an effective tool for asset protection. Other states have enacted stronger asset protection legislation for the protection of members of single-member LLCs to the derogation of the rights of creditors, but these laws have questionable enforceability if addressed by Colorado courts.
Single-member limited liability companies (LLCs) are a unique creature authorized by the Colorado LLC Act (Colorado Act) and the limited liability acts of many other states.(fn1) When Colorado enacted the initial version of the Colorado Act, single-member LLCs were not permitted because LLCs were designed for partnership tax treatment, which required two or more members. With the adoption of the check-the-box regulations by the Internal Revenue Service in 1996,(fn2) partnership tax treatment for all partnership entities became much easier to ensure, and single-member LLCs became very popular. Under the check-the-box regulations, single-member LLCs are treated either as a disregarded entity (taxed at the single-member level) or as an association taxable as a corporation (if the box is checked).
Many persons look to single-member LLCs as an asset protection device-that is, a person can conduct business through a single-member LLC and avoid personal liability for the single-member LLC's obligations, while also protecting the assets of the single-member LLC from the single member's creditors. The purpose of this article is not to discuss insulating the member from the debts of the single-member LLC, which is a question involving (among other things) legal principles related to piercing the veil of the LLC.(fn3) The question addressed by this article is whether the use of a single-member LLC can protect the assets of the single-member LLC from the claims of the member's creditors.
This article concludes that, as an asset protection device, single-member LLCs are not an effective tool, especially in Colorado. It is important to note that asset protection strategies are seldom perfect and are generally intended to create barriers-making access to assets more difficult for creditors, although access is rarely impossible. When the U.S. government or a bankruptcy trustee becomes involved, asset protection strategies are subject to their most rigorous test and a single-member LLC, standing alone, probably will fail. A single-member LLC, when combined with a domestic or foreign asset protection trust or other entity, will create further barriers (but they are only barriers-not guarantees). Turning the single-member LLC into a multi-member LLC will have a better chance of succeeding than a single-member LLC standing alone. Structuring a single-member LLC with a "springing member"(fn4) or independent managers also may create a barrier to the creditor's ultimate goal of recovering the single member's debt from the LLC's assets. As discussed below, using a state law that provides greater asset protection for single-member LLCs than Colorado's may have limited impact in Colorado, but is another step to consider.
Single-Member LLCs and Liability Protection
When considering single-member LLCs, the risk of liability must be analyzed from two directions. First, there is the possibility of holding the member (or a manager or other person) liable for the debts incurred by the LLC. This is generally referred to as "piercing the veil," which is authorized by the Colorado Act,(fn5) but is in derogation of the basic rule that a single-member LLC benefits from the liability protection available to LLCs in general.(fn6) Second, a creditor of the single member may seek to enforce the member's debt against the assets of the LLC. This is generally referred to as "reverse piercing."
Creditors' Remedies
Creditors of a person (debtor) who is a member of a Colorado LLC have two methods for recourse against the debtor's LLC interest. These are charging orders and foreclosure against the membership interest.(fn7)
Charging Orders
Charging orders in the LLC context are authorized by the Colorado Act, as well as by the partnership statutes.(fn8) The Colorado Act specifically provides:(fn9)
On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the membership interest of the member with payment of the unsatisfied amount of the judgment with interest thereon and may then or later appoint a receiver of the member's share of the profits and of any other money due or to become due to the member in respect of the limited liability company and make all other orders, directions, accounts, and inquiries that the debtor member might have made, or that the circumstances of the case may require. To the extent so charged, except as provided in this section, the judgment creditor has only the rights of an assignee or transferee of the membership interest. The membership interest charged may be redeemed at any time before foreclosure. If the sale is directed by the court, the membership interest may be purchased without causing a dissolution with separate property by any one or more of the members. With the consent of all members whose membership interests are not being charged or sold, the membership interest may be purchased without causing a dissolution with property of the limited liability company. This article shall not deprive any member of the benefit of any exemption laws applicable to the member's membership interest.
In general, a charging order in a single- or multi-member LLC is unattractive to creditors. A charging order places the creditor at the risk of being allocated for tax purposes income or losses of the partnership or LLC, but with no right to receive any distributions. Furthermore, a charging order does not ensure that there will be any distributions even if the LLC is operating profitably with surplus cash. Whether to make distributions usually is in the discretion of the management of the LLC, and the holder of the charging order, as an assignee or transferee and even following foreclosure, has no right to obtain information about the LLC or to require the payment of distributions.
A 2002 case from North Carolina demonstrates the very limited usefulness of a charging order to a creditor.(fn10) A bank had obtained a judgment against a debtor (Keasler) and (through an assignee) attempted to execute on Keasler's LLC interests. The court denied the request for seizure and sale of the LLC interest, but granted the assignee a charging order. The charging order provided that the LLC must deliver to the assignee any distributions and allocations to which Keasler would be entitled to receive on account of his membership interest, but that the creditor-assignee would not obtain any rights in the LLC except as an assignee without the ability to require any distributions or satisfaction of the judgment. After the North Carolina Court of Appeals' decision, the assignee's counsel observed:(fn11)
The bad thing about having a charging order is that, at most, you get your principal and your interest-but only if the LLC works out until your judgment is paid. The charging order is worth less than selling the interest because you bear all the risk that the business will go bust before the judgment is paid. So it's worth much...
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