LLC Protection for Members' Personal Debt in New York
New York LLC law does not provide limited liability companies ("LLCs") with nearly as much protection from members' personal creditors as do many states. In most 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 are limited to 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-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 nothing.
Charging orders can be obtained in New York to collect on a judgment obtained by a personal creditor of a member. However, creditors of New York LLCs are not limited to this method of collecting. New York LLC law does not provide that a charging order is the exclusive remedy of members’ personal creditors. Thus, in addition to obtaining a charging order, creditors 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 financial rights, including the right to receive money from the LLC. Moreover, the credit could attempt to get a court to order the LLC dissolved and its assets sold to pay the creditor’s judgment.
This makes New York one of the least attractive states in which to form an LLC as far as protection from personal creditors goes.
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 with SMLLCs which means that a creditor of a 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 a SMLLC, there is even a stronger rationale to allow creditors of a SMLLC these additional remedies against a SMLLC owner.
Should You Consider Forming Your LLC in a Different State?
You do not have to form your LLC in New York 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 New York, you could form an LLC in Delaware because it has a more favorable LLC law. Doing so will not save you New York taxes because your LLC will have to qualify to do business in the state where it operates and pay the same taxes as any other LLC operating in the state. However, 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 a state that provides the most limited liability to LLC owners? If your main interest in forming and maintaining an LLC is not running a business but protection of an asset within the LLC, you might consider forming your LLC someplace other than New York. 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 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 An Overview of Limited Liability Protection and LLCs.