LLC Protection for Members' Personal Debt in Florida
In Florida, like in most states, the general rule is that the money or property of a Florida 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 Florida LLC to sell scuba diving 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 so you need to check the laws of your state. This article covers what actions creditors in Florida are allowed to take against an LLC for an LLC owner’s personal debt.
Charging Order - Exclusive Remedy for Multi-Member LLCs
Florida, like all states, permits personal creditors of an owner of an Florida LLC to obtain a charging order against the debtor-owner’s membership interest. 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 Florida 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 scuba shop. However, Jack, his creditor, cannot just take over his LLC ownership interest or have it sold. All he can do is get a Florida 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.
Florida amended its laws in 2011 after a Florida Supreme Court case, Olmstead v. Federal Trade Commission, created uncertainty as to whether or not charging orders were the exclusive remedy available to creditors of a multi-member LLC member/owners. In the Olmstead case, the court held that creditors of a single-member LLC owner could foreclose on the membership interest of the debtor's LLC interest. In the wake of that case, Flordia adopted the "Olmstead Patch" in 2011 to clarify that the Olmstead ruling allowing creditors to foreclose on a personal debtor's LLC interest does not apply to multi-member LLCs. The new law specifically provides that the charging order is the exclusive remedy available to creditors of a multi-member LLC owner/member and then specifies circumstances under which creditors could seek foreclosure against single-member LLC owner/debtors. Florida incorporated these same rules in its new LLC Act adopted in 2013, effective for all Florida LLCs as of January 1, 2015.
Florida's new LLC Act makes it a very friendly state for people who want to form multi-member LLCs to protect assets from personal creditors because it explicitly provides that charging orders are the only remedy available to those creditors.
Special Rule for SMLLCs in Florida
The reason many LLC state laws limit the remedies available for personal creditors of LLC owners to a charging order is to protect the members (owners) of the LLC from personal debts of other LLC members that are unrelated to the LLC and its business. With a charging order, creditors aren't allowed 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. However, the rationale for limiting creditors' remedies disappears with a single member LLC ("SMLLC") because there are no other LLC members to protect. As a result, some states have made a distinction between the remedies available for creditors of multi-member and single member LLCs.
Florida is one of the states that has adopted different rules for single and multi-member LLCs. In the Olmstead case (discussed above), the Florida Supreme Court held that creditors of a single-member LLC owner could foreclose on the debtor's LLC interest. Florida amended its laws in 2011 to clarify that the Olmstead ruling applied only to single-member LLCs and not multi-member LLCs. Under the new rules, if the charging order remedy proves ineffective against a SMLLC, the creditor can ask the court to order that the SMLLC be sold in a foreclosure sale. Whoever purchases the SMLLC in a sale acquires all the former owner’s rights and becomes the new sole owner of the SMLLC. To get a court to order foreclosure, the creditor must show that the SMLLC debtor-owner will not be able to pay its debt within a reasonable time. This rule was first adopted by the Florida legislature when it amended Section 608.433 of Florida Statutes in 2011 (the "Olmstead Patch"). This same rule was incorporated in the new Florida LLC Act which is effective for all new LLCs as of July 1, 2014 and for all Florida LLCs starting January 1, 2015.
Because of the SMLLC rules in Flordia, an LLC should have at least two members if you are concerned about liability protection from personal creditors. If you have only two members, the second owner 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 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 Your LLC in Another State?
You do not have to form your LLC in Florida even if it is where you live or do business. You can form an LLC in any state--for example, even though your business is in Florida, you could form an LLC in Wyoming to own and operate it because it has more favorable LLC laws. However, there is no guarantee that the courts of Florida or other states where your LLC does business will apply the laws of the state where you formed your LLC instead of another state's LLC laws. This is a complex legal issue with no definitive answer. Consult an experienced business lawyer if you are considering forming your LLC in a state with more favorable laws.
For more information on LLCs and the limited liability protections they offer, see Limited Liability Protection and LLCs: A 50-State Guide.