LLC Protection for Members' Personal Debt in Virginia
In all states, the general rule is that the money or property of a limited liability company (“LLC”) cannot be taken by creditors to pay off the personal debts or liabilities of the LLC’s owners.
Example: John, Meghan, and Louis form an Virginia LLC to operate their website design 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 a creditor of an LLC owner is allowed to take against an LLC in Virginia for an LLC owner's personal debt.
Charging Order - Exclusive Remedy
Virginia permits personal creditors of an owner of a Virginia LLC to 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 Virginia 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 because they can’t order any distributions. Thus, they are not a very effective collection tool for creditors.
Example: The collection agency obtains a charging order from a Virginia court ordering the website design 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.
Virginia’s LLC law says that the charging order is the exclusive remedy that personal creditors of Virginia LLC members have to get at an owner’s LLC interest (Virginia Code § 13.1-1041.1).Thus, unlike some states, Virginia does not permit an LLC owner’s personal creditors to foreclose on the owner’s LLC financial interest or get a court to order the LLC dissolved and its assets sold. This makes Virginia a more friendly state for people who want to form LLCs to protect their assets from personal creditors.
What About Single-Member Virginia 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 prevents personal creditors of an LLC member from being able to take over a 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 concern about protecting LLC members from another member's personal creditors 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 charging order remedy.
In 2012, Virginia considered but did not enact legislation that would have broadened the rights of personal creditors of a SMLLC owner to allow them to execute directly against the SMLLC assets. The LLC statute in effect does not distinguish between multi-member and single-member LLCs and the remedies available to creditors. Thus, it appears that creditors of Virginia SMLLCs are limited to the charging order remedy described above. However, even when the LLC law states that charging orders are the exclusive remedy, courts in some states have applied a different rule for SMLLCs, particularly in cases where the SMLLC owner has filed for personal bankruptcy. It's possible that a court in Virginia would do the same; this is an unsettled and evolving area of law. It is also possible that in some cases the laws of another state would be applied to a Virginia LLC--for example, where a Virginia LLC does business or owns property in another state.
One way to avoid the potential liability problems that exist with SMLLCs is to make sure your LLC has at least two members. However, any members you add must be legitimate co-owners of the LLC. If the additional LLC owner is 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.