In Nevada, the general rule is that the money or property of an Nevada limited liability company (“LLC”) cannot be taken by creditors to pay off the personal debts or liabilities of the LLC’s owners.
Example: John, Oliver, and Mirana form an Nevada LLC to operate their small hotel. John, a big spender, owes $38,000 on his personal credit cards. When he doesn’t pay, the accounts are turned over to a collection agency which obtains a $38,000 court judgment against him. While the collection agency can attempt to collect on the debt from John’s personal assets, it cannot take money or property owned by the LLC. For example, it cannot get any of the money held in the LLC’s bank account.
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 Nevada.
Charging Order - Exclusive Remedy
Nevada law was changed in 2011 to specify that a charging order is the exclusive remedy available to personal creditors of a Nevada LLC member. A charging order is an order issued by a court directing an LLC’s manager to pay to the owner’s personal creditor any distributions of income or profits that would otherwise be distributed to the member. 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 or otherwise foreclose on the LLC owner's interest.
Example: The collection agency obtains a charging order from an Nevada court ordering the Nevada LLC to pay to it any distributions of money or property the LLC would ordinarily make to John until the entire $38,000 judgment is paid. However, if there are no distributions, there will be no payments.
Nevada’s law states that foreclosure and other equitable remedies are not available to creditors of an LLC owner. However, an LLC member and creditor can agree in writing that other remedies will be available to the creditor and that agreement will be upheld provided it does not conflict with the LLC's articles of incorporation or operating agreement.
Single-Member LLCs Get Charging Order Protection Too
The reason personal creditors of individual LLC owners are limited to a charging order is to protect the other members (owners) of the LLC. It doesn’t seem fair that they should suffer because a member incurred personal debts that had nothing to do with their LLC. Thus, personal creditors are not permitted 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 without the other members’ consent. 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 don't limit personal creditors of owners of SMLLCs to the same remedies as multi-member LLCs.
However, unlike some states that have chosen to allow creditors to go after a SMLLC's assets, Nevada's LLC law specifically provides that a charging order is the exclusive remedy available to personal creditors of LLC owners "whether the limited-liability company has one member or more than one member." Thus, Nevada law makes clear that both multi-member LLCs and SMLLCs are entitled to the charging order protection. This makes Nevada one of the most favorable states for forming an LLC for liability protection.
However, just because you form your SMLLC in Nevada doesn't necessarily mean that Nevada's LLC laws will always apply to it. It's possible that in some cases the LLC laws of other, less debtor- friendly, states would apply--for example, where a Nevada LLC does business or owns property in another state. In addition, the protections Nevada and other state LLC laws provide to SMLLCs may be ignored by the federal bankruptcy courts if the SMLLC owner files for bankruptcy.
To avoid possible liability problems with a SMLLC, a Nevada LLC should have at least two members. While the second owner can be a spouse or relative, that person must be a 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 owned.
Finally, your LLC will not provide you with any liability protection for a debt or other liability you incurred before you formed your LLC.
For more information on LLCs and the limited liability protections they offer, see Limited Liability Protection and LLCs: A 50-State Guide.