LLC Protection for Members' Personal Debt in Massachusetts
Last updated: November 8, 2016
This article covers what actions judgment creditors can take against a limited liability company (LLC) for a member’s personal debt under Massachusetts 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. Massachusetts 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.
Creditors Not Limited to Charging Orders
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 obtain 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, Massachusetts 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, Massachusetts’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 Massachusetts LLC member debtor don’t necessarily end with foreclosure. Creditors in Massachusetts 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. This makes Massachusetts one of the least attractive states for liability protection for LLC owners against other LLC owners' personal debt.
The reason personal creditors of LLC owners/members are limited to a charging order (in most states) or foreclosure of the debtor-owner's interest is to protect the other members of the LLC. It doesn’t seem fair that other LLC members should suffer because one member incurred personal debts that had nothing to do with the LLC. This rationale, however, disappears when the LLC has only one member. As a result, in some states, creditors have more rights to collect against single-member LLCs (SMLLCs).
Massachusetts is not one of the state that makes a distinction with creditor remedies between SMLLCs and multi-member LLCs. This means that a creditor of an SMLLC should have the same rights as the creditor of a multi-member LLC. In Massachusetts, these rights are not limited to a charging order, but may also include foreclosure, and possibly forcing a dissolution of the LLC. Because there are no co-owners’ interests to protect with an SMLLC, there is even a stronger rationale to allow creditors of a SMLLC these additional remedies against an SMLLC owner.
Should You Consider Forming Your LLC in Another State?
All of the foregoing makes Massachusetts 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 Massachusetts 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 Massachusetts, you could form an LLC in Nevada or Delaware to own and operate it. Doing so will not save you Massachusetts state taxes because your LLC will have to qualify to do business in Massachusetts 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 Massachusetts. 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 Massachusetts.
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 states like Nevada, Delaware, or Wyoming that have very debtor-friendly LLC laws. However, there is no guarantee that Massachusetts courts will always apply the law of the state where you formed your LLC, rather than the less favorable Massachusetts 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.