Last updated: October 26, 2016
This article covers what actions judgment creditors can take against a limited liability company (LLC) for a member’s personal debt under Arkansas law. State laws on creditor rights against an LLC vary, with some more debtor-friendly states providing more protection from creditors for an LLC and its owners than other states. Arkansas is among the least debtor-friendly states: Its law gives limited liability companies much less protection from member’s personal creditors than that of many other states.
In many states, the general rule is that an LLC’s money or property cannot be taken by creditors to pay off the personal debts or liabilities of the LLC’s owners. Instead, creditors of LLC owners are limited to obtaining a charging order against the LLC. A charging order is an order issued by a court directing the LLC to pay to the debtor-owner’s personal creditor any distributions of income or profits that would otherwise be distributed to the debtor-member. But if there are no distributions, the creditor gets nothing. In most states, creditors with a charging order only obtain the owner-debtor’s “financial rights” 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 little or nothing.
Like all states, Arkansas allows creditors of LLC members to obtain a charging order to collect on a judgment obtained against an LLC member. But, unlike many less creditor-friendly states, Arkansas’s LLC law does not provide that a charging order is the exclusive remedy of LLC members’ personal creditors.
Thus, in addition to obtaining a charging order, creditors may be able to foreclose on the debtor/member’s interest. Under this procedure, a court orders that the debtor-member’s financial rights in the LLC be sold. The buyer at the foreclosure sale—often the creditor--becomes the permanent owner of all the debtor-member’s financial rights, including the right to receive money from the LLC or obtain a share of the LLC’s assets if it is dissolved. But a creditor’s rights over a Arkansas LLC member debtor don’t necessarily end with foreclosure. Creditors in Arkansas could also seek to get a court to order the LLC dissolved and its assets sold to pay the creditor’s judgment.
As a practical matter, getting a member/debtor’s LLC interest foreclosed upon or an LLC dissolved could be an expensive and difficult undertaking; but, the ability to do so gives a creditor much more leverage in dealing with the member/debtor.
The LLC laws and court decisions in some states make a distinction between multi-member and single-member LLCs ("SMLLCs"). This is because it doesn't seem fair that the members of a multi-member LLC should suffer because one member incurred personal debts that had nothing to do with their LLC. Thus, personal creditors are limited to the charging order remedy in many states. This rationale of protecting other LLC members disappears, however, when the LLC has only one member. As a result, in some states creditors have more rights to collect against SMLLCs.
Unlike many states, Arkansas law makes no distinction between SMLLCs and multi-member LLCs, which means that a creditor of a SMLLC should have the same rights as the creditor of a multi-member LLC. In Arkansas, these rights include a charging order, foreclosure, and possibly forcing a dissolution of the LLC. Because there are no co-owners’ interests to protect with a SMLLC, there is even a stronger rationale to allow creditors of an SMLLC these additional remedies against a SMLLC owner.
All of the foregoing makes Arkansas one of the least attractive states in which to form an LLC as far as protection from personal creditors goes. However, you do not have to form your LLC in Arkansas even if it is the state where you live or do business. You can form an LLC in any state--for example, even though your business is in Arkansas, you could form an LLC in Nevada, Wyoming, or Delaware to own and operate it. Doing so will not save you Arkansas state taxes because your LLC will have to qualify to do business in Arkansas and pay the same taxes as any other LLC. Indeed, your costs will increase because you’ll have to pay the fees to form your LLC in the other state plus the fees to register to do business in Arkansas. However, as a general rule, the formation state’s LLC law will govern your LLC. Thus, forming an LLC in a state with a favorable LLC law could provide you with more limited liability than forming it in Arkansas.
So should you shop around for the state that provides the most limited liability to LLC owners? If limiting liability is extremely important to you, you may want to form your LLC in a state like Nevada, Delaware, or Wyoming that have very debtor-friendly LLC laws. However, there is no guarantee that Arkansas courts will always apply the law of the state where you formed your LLC, rather than the less favorable Arkansas LLC law. This is a complex legal issue with no definitive answer. Consult an experienced business lawyer for more information.
For more information on LLCs and the limited liability protections they offer, see Limited Liability Protection and LLCs: A 50-State Guide.