LLC Protection for Members' Personal Debt in Alaska
In general, the money or property of a limited liability company (“LLC”) cannot be taken by creditors to pay off the personal debts or liabilities of the LLC’s owners.
Example: Sarah, Eli, and Payton form an Alaska LLC to sell hi-tech skiing equipment. It turns out that Eli owes $10,000 to Jack, a former business partner, who sues him in court and obtains a judgment against him. While Jack can attempt to collect on his debt from Eli’s personal assets, he cannot take money or property owned by LLC to satisfy Jack’s personal debts. For example, he cannot get any of the money held in the LLC’s bank account.
However, there are other ways that creditors of an LLC owner might try to collect against the LLC for the owner’s debt. These include:
1) obtaining a charging order requiring that the LLC pay the creditor all the money due from the LLC’s payments to the debtor-owner
2) foreclosing on the debtor-owner’s LLC ownership interest, or
3) getting a court to order the LLC to be dissolved and all its assets sold.
State laws vary widely on what creditors are allowed to do. In some states, a charging order is the exclusive remedy for personal creditors of an LLC owner. The rationale for limiting a creditor’s remedies to a charging order is to protect the other LLC owners from having an outside creditor step into the shoes of the debtor member and share in the management and control of the LLC. In other states, charging orders are allowed but creditors are also either expressly allowed to foreclose on their debt or seek dissolution of the LLC, or the law is silent as to what other remedies are available.
This article covers what actions creditors in Alaska are allowed to take against an LLC for an LLC owner’s personal debt. To see the rules about personal creditor’s rights against LLC owners in other states, see Single-Member LLCs and Asset Protection: A 50-State Guide.
Charging Order -- The Exclusive Remedy
Alaska’s LLC law says that a charging order is the only legal procedure that personal creditors of Alaska LLC members can use to get at a debtor’s LLC ownership interest. The law specifically states that other remedies, including foreclosure, are not available. Thus, Alaska does not permit an LLC owner’s personal creditors to foreclose on the owner’s LLC ownership interest or get a court to order the LLC dissolved and its assets sold. This makes Alaska a very friendly state for people who want to form LLCs to protect assets from personal creditors of LLC members.
A charging order is an order issued by a court directing an LLC’s manager to pay to the debtor-owner’s personal creditor any distributions of income or profits that would otherwise be distributed to the debtor-member. Like most states, creditors in Alaska only obtain the owner-debtor’s financial rights with the charging order and cannot participate in the management of the LLC. Thus, the creditor cannot order the LLC to make a distribution subject to its charging order. Very frequently, creditors who obtain charging orders end up with nothing because they don’t have the right to order distributions.
Example: Eli has only $500 in his bank account and no valuable personal property. The only thing of value he owns is his 33% interest in the successful ski shop. However, Jack, his creditor, cannot just take over his LLC ownership interest or have it sold. All he can do is get an Alaskan court to issue a charging order. This means that any distributions of money or property the LLC would ordinarily make to Jack must be given to Jack instead until the entire $10,000 debt is paid. However, if there are no distributions there will be no payments.
Alaska also permits the court to charge interest against the LLC member while a judgment for the personal debt remains unpaid.
What About Single-Member Alaska LLCs?
The reason personal creditors of individual LLC owners are limited to a charging order is to protect the other members (owners) of the LLC. It doesn’t seem fair that they should suffer because a member incurred personal debts that had nothing to do with their LLC. Thus, personal creditors are not permitted to take over the debtor-member’s LLC interest and join in the management of the LLC, or have the LLC dissolved and its assets sold without the other members’ consent.
This rationale disappears when the LLC has only one member (owner). As a result, the LLC laws and court decisions in some states make a distinction between multi-member and single-member LLCs ("SMLLCs") and don't limit personal creditor remedies against SMLLCs in the same way they do with multi-member LLCs. However, to date, Alaska is not one of these states. Thus, it appears that creditors of Alaska SMLLCs are limited to the charging order remedy described above. Even when the LLC law states that charging orders are the exclusive remedy, courts in some states have applied a different rule for SMLLCs based on a fairness argument. It's possible an Alaska court would do the same; this is an evolving area of law. In addition, in some cases the laws of other states might be applied to Alaska LLCs--for example, where an Alaska SMLLC does business or owns property in another state.
One way to avoid the potential liability problems that exist with SMLLCs is to add members to your LLC. However, any members you add must be legitimate co-owners of the LLC. If the additional LLC owner is merely added on paper as a sham, the courts will likely treat the LLC as a single-member LLC. To avoid this, the co-owner must pay fair market value for the interest acquired and otherwise be treated as a "real" LLC member--that is, receive financial statements, participate in decision making, and receive a share of the LLC profits equal to the membership percentage owned.