LLC Protection for Members' Personal Debt in Connecticut
This article covers what actions judgment creditors can take against a limited liability company (LLC) for a member’s personal debt under Connecticut law. State laws on creditor rights against an LLC vary, with some providing more protection from creditors for an LLC and its owners than other states. Under its existing LLC law, Connecticut does not provide LLCs with as much protection from member’s personal creditors as do many other states. However, this is changing. Connecticut has adopted a new LLC law that will take effect on July 1, 2017. The new law will provide Connecticut LLC members with strong protection against personal creditors.
The Old LLC Law
Like all states, Connecticut’s old LLC law provides that a personal creditor of an LLC may seek to enforce its judgment by 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-member’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. Frequently, creditors who obtain charging orders against LLCs end up with nothing because they can’t order any distributions and the LLC can choose not to make any.
However, unlike many states, Connecticut’s old LLC law does not specifically provide that obtaining 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 a member’s interest. If this occurs, 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. Moreover, the creditor might even be able get a court to order that a LLC member-debtor turn over or assign his or her entire interest in the LLC to the creditor. This way, the creditor would become full owner of the interest--that is, obtain the debtor’s management rights in the LLC, as well as financial rights to receive distributions.
This has made Connecticut one of the less attractive states in which to form an LLC as far as protection from personal creditors goes.
The New LLC Law
Connecticut’s new LLC law (Connecticut Uniform Limited Liability Company Act) makes life much harder for personal creditors of Connecticut LLC members. The new LLC law says that the charging order is the only legal procedure that personal creditors of Connecticut LLC members can use to get at a debtor’s LLC ownership interest. Thus, Connecticut will no longer permit an LLC owner’s personal creditors to foreclose on the owner’s LLC financial rights, or order the debtor-member to assign his or her entire interest to the creditor.
However, there is one creditor-friendly provision in the new law that allows a creditor with a charging order to have a court appoint a receiver to oversee the profits or other money due or to become due to the debtor-member. The receiver can access the LLC’s financial records to ensure that no money is paid to the debtor-member without the creditor knowing about. The court is also allowed to issue other orders as needed to enforce the charging order.
The new law makes Connecticut a very friendly state for people who want to form LLCs to protect assets against personal creditors.
Connecticut SMLLCs Under the New Law
The reason many state laws limit the remedies available for personal creditors of LLC owners to a charging order is to protect LLC members (owners) from the personal debts of other members that are unrelated to the LLC and its business. Without charging order protection, LLC members could be forced into sharing management and control of the LLC with a member's personal creditor. Charging orders avoid this outcome by giving creditors the right to distributions only. With a single-member LLC (SMLLC), there are no other members to protect so the rationale for limiting creditors to a charging order disappears. Recognizing this, the LLC laws and court decisions in some states make a distinction between multi-member and SMLLCs and don't limit personal creditors of owners of SMLLCs to the charging order remedy.
Connecticut’s new LLC law specifically provides that it applies to one-member LLCs as well as multi-member LLCs. Thus a personal creditor of the owner of a SMLLC will be limited to the charging order remedy—a remedy that can be particularly ineffective against a SMLLC since the owner can simply avoid making any distributions that would have to be turned over to the creditor. This helps make Connecticut a friendly state for those who want to protect their assets by forming an SMLLC.
However, this is an evolving area of law and different rules regarding SMLLC owner’s protection from creditors could apply in a bankruptcy. Some bankruptcy courts have held that when an SMLLC owner files for bankruptcy, the SMLLC becomes part of the bankruptcy estate and the bankruptcy trustee may dissolve it and sell its assets to pay the bankrupt owner's creditors. If you are really concerned about protecting the assets in your SMLLC against personal creditors, you might want to consider adding another member to your Connecticut LLC. This will give you more protection in the event you file for bankruptcy or if you become subject to the LLC laws of a state that provide less protection to SMLLCs. If you decide to do this, the second member must be 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 an SMLLC. 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.
For more information on LLCs and the limited liability protection they offer, see Limited Liability Protection and LLCs: A 50-State Guide.