LLC Protection for Members' Personal Debt in New York

Last updated: 10/28/2016

This article covers what actions judgment creditors can take against a limited liability company (LLC) for a member's personal debt under New York 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. New York 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 obtaining 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, New York 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, New York'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 New York LLC member debtor don't necessarily end with foreclosure. Creditors in New York could 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.

New York Single-Member LLCs

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 SMLLC owners to a charging order remedy even if that is the sole remedy provided by law for multi-member LLCs. New York law makes no distinction between SMLLCs and multi-member LLCs which means that a creditor of an SMLLC should have the same rights as the creditor of a multi-member LLC. In New York, these rights include a charging order, 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 an SMLLC these additional remedies against an SMLLC owner.

Should You Consider Forming Your LLC in Another State?

All of the foregoing makes New York 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 New York 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 York, you could form an LLC in Nevada or Delaware to own and operate it. Doing so will not save you New York state taxes because your LLC will have to qualify to do business in New York 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 New York. 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 New York.

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 has very debtor-friendly LLC laws. However, there is no guarantee that New York courts will always apply the law of the state where you formed your LLC, rather than the less favorable New York 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.