Connecticut law does not provide limited liability companies (“LLCs”) with as much protection from member’s personal creditors as do many 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 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. 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 nothing.
Like all states, Connecticut allows creditors of LLC members to obtain a charging order to collect on a judgment obtained against an LLC member. However, creditors are not limited to this method of collecting. Unlike many other states, Connecticut 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 could seek other remedies against the LLC debtor, such as foreclosure or possibly even requesting a court to order the LLC dissolved and its assets sold to pay the creditor’s judgment.
Because Connecticut law does not specify that the charging order relief granted is the exclusive remedy for creditors, it provides less liabiity protection for LLC owners than the LLC laws of many other states which specifically state that a charging order or a charging order and foreclosure are the only remedies available for personal creditors of an LLC owner.
The reason many LLC state laws limit the remedies available for personal creditors of LLC owners to a charging order is to protect the other members (owners) of the LLC from personal debts of other members that are unrelated to the LLC and its business. With a single member LLC ("SMLLC"), the rationale for limiting creditors' remedies disappears because there are no other LLC members to protect. Because of this, 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 creditors of SMLLC owners to a charging order remedy even if that is the sole remedy provided by law for multi-member LLCs.
Connecticut law specifically allows personal creditors of LLC owners to obtain a charging order. However, the law doesn't limit creditors to the charging order remedy or make a distinction between multi-member and single member LLC owners. Because there are no co-owners’ interests to protect with a SMLLC, there is a stronger rationale to allow creditors of a SMLLC to pursue remedies other than the charging order, like foreclosure or even dissolution of the SMLLC.
To avoid issues with liability protection and SMLLCs, your LLC should have at least two members. The second owner can be a spouse or relative, provided the second member is treated as a legitimate co-owner of the LLC. If the second owner is added merely 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.
Should You Consider Forming an LLC in Another State?
You do not have to form your LLC in Connecticut 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 Connecticut, you could form an LLC in Delaware to own and operate it because it has a more favorable LLC law. Doing so will not save you Connecticut state taxes because your LLC will have to qualify to do business in Connecticut and pay the same taxes as any other LLC. However, forming an LLC in a state with a favorable LLC law might provide you with more limited liability than forming it in Connecticut.
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 and your state has an unfavorable law, you may want to consider forming your LLC in another state. However, there are other factors you should consider as well, such as how much it costs to form an LLC in the other state. Moreover, there is no guarantee that Connecticut or other states will apply the law of the state where you formed your LLC instead of the less favorable Connecticut 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.