LLC Protection for Members' Personal Debt in Ohio
Ohio limited liability company ("LLC") law does not provide LLCs with nearly as much protection from member’s 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 charging orders 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 Ohio to collect on a judgment obtained by a personal creditor of a member. However, creditors of Ohio LLCs are not limited to this method of collecting. Unlike some states, Ohio 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 creditor might even be able get a court to order the LLC dissolved and its assets sold to pay the creditor’s judgment.
This makes Ohio one of the least attractive states in which to form an LLC as far as protection from personal creditors goes.
What About Single-Member LLCs?
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, Ohio is not one of these states. Ohio's LLC law makes no distinction between multi-member and single-member LLCs. Thus it appears that creditors of Ohio SMLLC owners are limited to the same remedies as those described above for multi-member LLCs.
Nevertheless, it is possible that in some cases the laws of these other states would be applied--for example, where an Ohio SMLLC does business or owns property in another state. In addition, the protections that LLC state laws provide to SMLLCs may be ignored by the Federal Bankruptcy Courts if the SMLLC owner files for bankruptcy.
To obtain the fullest limited liability possible in all states and in the event of bankruptcy, an Ohio LLC should have at least two members. The second member must be 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.
Should You Consider Forming Your LLC in Another State?
You do not have to form your LLC in Ohio 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 Ohio, you could form an LLC in Delaware to own and operate it because it has a more favorable LLC law. Doing so will not save you Ohio taxes because your LLC will have to qualify to do business in the state and pay the same taxes as any other LLC. However, forming an LLC in a state with a favorable LLC law could provide you with more limited liability than forming it in Ohio.
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 protecting assets, you may want to form your LLC someplace other than Ohio. 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 Ohio 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.