LLC Protection for Members' Personal Debt in New Jersey
In New Jersey, the general rule is that the money or property of a New Jersey limited liability company (“LLC”) cannot be taken by creditors to pay off the personal debts or liabilities of the LLC’s owners.
Example: John, Tony, and Carmine form a New Jersey LLC to operate their trash disposal business. 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 New Jersey.
Charging Order Is Not the Exclusive Remedy
In New Jersey, personal creditors of an owner of a New Jersey LLC can 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 with a charging order in New Jersey 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.
Example: The collection agency obtains a charging order from a New Jersey court ordering the New Jersey 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.
Under New Jersey's new law, effective March 18, 2013, personal creditors of LLC members also have the right to foreclose on the LLC member/debtor interest upon a showing that their debt will not be paid within a reasonable time. This means that in addition to a charging order, creditors can seek to foreclose on the LLC ownership interest and have a court order the sale of the LLC member's interest.
Under New Jersey's prior law, a charging order was the exclusive remedy available to personal creditors of New Jersey LLC members. New Jersey LLC law was revised to give personal creditors of LLC owners significantly more rights against LLC owner/debtors than they had under the prior law.
Should You Consider Forming Your LLC in Another State?
You do not have to form your LLC in New Jersey 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 New Jersey, you could form an LLC in Nevada because it has a more favorable LLC law. Doing so will not save you New Jersey state taxes because your LLC will have to qualify to do business in New Jersey and pay the same taxes as a New Jersey LLC. However, forming an LLC in a state with a favorable LLC law could provide you with more limited liability than forming it in your home state.
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 and your state has an unfavorable law, you may want to consider forming your LLC in another state. 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 apply the law of the state where you formed your LLC. 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.