LLC Protection for Members' Personal Debt in Massachusetts
Like most states, the general rule in Massachusetts is that the money or property of a limited liability company (“LLC”) cannot be taken by creditors to pay off the personal debts or liabilities of the LLC’s owners. However, even though creditors can’t collect directly from an LLC for an owner’s personal debts, there are other ways creditors might try to go after the LLC for the owner’s personal debt. These include:
1) obtaining a charging order requiring that the LLC pay the creditor all the money distributed 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.
The laws on what creditors are allowed to do vary state by state. This article will look at what type of actions creditors of LLC owners are allowed to take against an LLC in Massachusetts. To see the rules about personal creditor’s rights against LLC owners in other states, see Single-Member LLCs and Asset Protection: A 50-State Guide.
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. If the LLC doesn't make any distributions, the creditor gets nothing. In most states, creditors with charging orders 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.
In many states, a charging order is the exclusive remedy for personal creditors of an LLC owner. The rationale for making a charging order the exclusive remedy is to protect the other LLC owners from having an outside creditor step into the shoes of the debtor member and share in the management and control of the LLC.
Massachusetts law states that personal creditors of an LLC owner can obtain a charging order against the LLC. However, unlike many other states, Massachusetts LLC law does not state that a charging order is the exclusive remedy. Thus, Massachusetts provides less protection to LLC owners because in addition to obtaining a charging order, creditors in Massachusetts may be able to foreclose on the debtor-member’s interest. If this occurs, the creditor becomes the permanent owner of all the debtor-member’s rights, including the right to receive money from the LLC. In addition, a creditor might be able get a court to order the LLC dissolved and its assets sold to pay the creditor’s judgment.
This makes Massachusetts one of the least attractive states for liability protection for LLC owners against other LLC owner's personal debt. By not expressly making a charging order the exclusive remedy, LLC owners in Massachusetts are at risk that personal creditors of LLC members will pursue other remedies, including foreclosure and ordering the dissolution of the LLC.
The reason some states limit the remedies available against an LLC owner to a charging order is to protect members (owners) of an LLC from another member's personal creditors. This rationale disappears when the LLC has only one member (owner). As a result, the LLC laws and court decisions in some states make a distinction between multi-member and single-member LLCs ("SMLLCs") and allow creditors of SMLLC owners to pursue additional remedies against SMLLC owner/debtors even if a charging order is the only remedy allowed for multi-member LLCs.
Massachusetts law makes no distinction for SMLLCs which means that a creditor of a SMLLC should have the same rights as the creditor of a multi-member LLC. In Massachusetts, these rights expressly include a charging order and, because that is not the exclusive remedy, creditors could pursue other remedies, such as foreclosure and possibly forcing a dissolution of the LLC. There is even a stronger rationale to allow creditors of a SMLLC to pursue these additional remedies against a SMLLC owner because there are no co-owners' interests to protect.
Should You Consider Forming Your LLC in Another State?
You do not have to form your LLC in Massachusetts 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 Massachusetts, you could form an LLC in Delaware because it has a more favorable LLC law. Doing so will not save you Massachusetts taxes because your LLC will have to qualify to do business in the state and pay the same taxes as any other LLC. However, 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 a state that provides the most limited liability to LLC owners? If your main interest in forming and maintaining an LLC is liability protection, you may want to consider forming your LLC someplace other than Massachusetts. 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 courts will always apply the law of the state where you formed your LLC instead of 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.