LLC Protection for Members' Personal Debt in Minnesota
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 Minnesota 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 LLC law in effect until January 1, 2018, Minnesota provides LLCs with fairly strong protection from a member’s personal creditors. Under a new LLC law that will take effect on January 1, 2018, Minnesota LLC members will have somewhat less protection from personal creditors.
Charging Orders – The Standard Creditor Remedy
Like all states, Minnesota’s 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.
Minnesota’s old LLC law (which remains in effect until January 1, 2018) provides that a charging order is the only legal procedure that personal creditors of a Minnesota LLC member can use to get at a member/debtor’s LLC ownership interest. Thus, Minnesota’s old LLC law does not permit an LLC owner’s personal creditors to foreclose on the owner’s LLC ownership interest or get a court to order the LLC dissolved and its assets sold. This makes Minnesota a particularly friendly state for people who want to form LLCs to protect assets from personal creditors.
Foreclosure Allowed Under New LLC Law (effective January 1, 2018)
Minnesota’s new LLC law, which takes effect January 1, 2018, changes the rule that obtaining a charging order is the only remedy a personal creditor of an LLC member has against an LLC. The new law allows a creditor to foreclose on the debtor-creditor’s LLC interest. Under this procedure, a court orders that the debtor-member’s financial rights in the LLC be sold. To obtain a foreclosure order, the creditor must show the court that the judgment debt will not be paid within a reasonable time with the charging order alone.
The buyer at the foreclosure sale—often the creditor or other members of the LLC—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. However, the buyer may not participate in the management of the LLC or order that any distributions of money or property be made.
As a practical matter, getting a member-debtor’s LLC interest foreclosed upon can be an expensive and difficult undertaking; but, the ability to do so gives a creditor more leverage in dealing with the debtor. Often, the debtor/member or other LLC members will settle the claim to prevent the foreclosure.
Dissolution Not Allowed
Like most states, Minnesota does not permit personal creditors of an LLC member to have a court order that the LLC be dissolved and its assets sold to pay off the creditor. This is how it works under both the old and new LLC laws.
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 single-member LLCs and don't limit personal creditors of owners of SMLLCs to the charging order remedy.
Minnesota’s old and new LLC laws make no distinctions between multi-member LLCs and SMLLCs. However, this is an unsettled and evolving area of the law. 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 Minnesota LLC. This will give you more protection in the event you file for bankruptcy, or if you or your LLC 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.
Should You Consider Forming Your LLC in Another State?
You do not have to form your LLC in Minnesota 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 Minnesota, you could form an LLC in Nevada because it has a very debtor-friendly LLC law that does not allow judgment creditors to foreclose on a charging order. 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 Minnesota. However, doing so will increase your costs 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 Minnesota.
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 a state like Nevada, Delaware, or Wyoming that have very debtor-friendly LLC laws. But there is no guarantee that Minnesota or other courts in other states will always apply the law of the state where you formed your LLC, rather than the less favorable Minnesota 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.