LLC Protection for Members' Personal Debt in New York

This article covers what actions judgment creditors can take against a limited liability company (LLC) for an owner's personal debt under New York law. New York is among the least debtor-friendly states: Its law gives LLCs much less protection from member's personal creditors than many other states.

General Rule: LLC Isn't Liable for Members' Personal Debts

In general, creditors can't take an LLC's money or property to pay off the debt of one of the LLC owners (called "members"). An LLC is a separate entity from its owners. Similar to corporations, the money or property held by an LLC belongs to the LLC, not the members individually. As a result, the LLC's property can't be taken by creditors to pay a member's debts.

This separation between the company and its owners helps shield the LLC members from the company's debts as well as from the debts of fellow members. In fact, personal liability protection is one of the primary reasons people form LLCs over other ownership structures.

Typically, you—as an LLC member—are only personally responsible for paying back your own debts. If a fellow member's personal debt has nothing to do with the LLC, then your assets are safe from that member's creditors. However, it's important to note that under New York law, most LLC members are personally responsible for paying unpaid salaries and wages to LLC employees. (N.Y. Ltd. Liab. Co. Law § 609 (2024).)

General Protections of New York LLC Members

When you personally owe a debt, creditors can take action to collect that debt, including getting a judgment against you. When a creditor gets the court to order you to pay a debt, the creditor becomes a "judgment creditor." Your state's laws will determine how a judgment creditor can go about collecting the judgment. And, if you're an owner of a New York LLC, you'll want to check the state's laws to see what the judgment creditor can take from your company if anything.

When you owe a debt and are an LLC member, you should generally consider three actions the judgment creditor can potentially take against you:

• The judgment creditor gets a court to order the LLC to pay your LLC distributions and income to them rather than to you (called a "charging order").
• The judgment creditor takes over your financial rights and interest in the LLC (called "foreclosure"), meaning they have full rights in your LLC distributions and in your share of the LLC's assets if the LLC dissolves.
• The judgment creditor forces the LLC to dissolve and collects the judgment from the LLC's assets.

In New York, the judgment creditor can take all three actions.

New York LLCs and Charging Orders

New York allows creditors of LLC members to obtain a charging order to collect on a judgment obtained against an LLC member. A charging order directs the LLC to pay to the creditor any distributions of income or profit that would otherwise be distributed to the indebted LLC member. These distributions are meant to pay the creditor back the debt owed plus any interest. In this case, the creditor only has the rights of an assignee of a membership interest. (N.Y. Ltd. Liab. Co. Law § 607 (2024).)

As an assignee of a membership interest, the judgment creditor with a charging order isn't entitled to participate in the management of the LLC or to exercise any rights or powers of a member. The judgment creditor is only entitled to receive the distributions and allocations of profits that the original indebted member would've been entitled to. (N.Y. Ltd. Liab. Co. Law § 603 (2024).)

Because a judgment creditor with a charging order can't participate in the LLC's management, the creditor also can't:

• order the LLC to make a distribution, or
• order the LLC to be sold to pay off the debt.

Very frequently, creditors who obtain charging orders end up with little or nothing: They can't order the LLC to make any distributions and the LLC can choose not to make any.

While a charging order doesn't guarantee payment for a creditor, it's not necessarily ineffective. The existence of a charging order can make it difficult or impossible for the indebted LLC member or the other members (if any) to take money out of the company's account without paying the judgment creditor first. For example, if one member wants to cash in on the LLC's profits, it'll be hard to do so without guaranteeing distributions for all members, including the judgment creditor.

Consider this example: Suppose Arturo, Maya, and Denny form a New York LLC to operate their catering business. Over the next six months, Denny racks up $25,000 on his personal credit cards. When he doesn't pay the charges, the accounts are turned over to a debt collection agency. The agency goes to court and obtains a $25,000 judgment against Denny. While the collection agency can attempt to collect the debt from Denny's personal assets, it can't take money or property owned by the LLC. For example, it can't get any of the funds held in the LLC's bank account.

However, the collection agency can ask the court to enter a charging order against Denny's LLC interest. With the charging order, the LLC must pay the collection agency any LLC distributions that would otherwise go to Denny.

Creditors Can Foreclose on New York LLC Members

In New York, judgment creditors aren't limited to charging orders to collect personal debts from LLC members. In other jurisdictions, the law explicitly says that a charging order is the only option for judgment creditors. In other states, the law lays out other options for creditors, like foreclosure or dissolution. Still, other states, merely say that a charging order isn't the exclusive remedy for creditors and leaves open the possibility of other judgment enforcement options. New York is the final case.

In addition to obtaining a charging order, creditors can potentially foreclose on the indebted member's membership interest in the LLC. In support of this remedy, New York's civil practice laws say that a money judgment can be enforced against any of the debtor's property that can be assigned or transferred. (N.Y. C.P.L.R. Law § 5201 (2024).)

Typically, when a member's LLC interest is foreclosed upon, the court orders that the member's financial rights in the LLC be sold. At the foreclosure sale, the buyer—often the creditor, the LLC, or other members of the LLC—becomes the permanent owner of all the member's financial rights. Again, the owner of the member's financial rights can both:

• receive money from the LLC, and
• obtain a share of the LLC's assets if it's dissolved.

But, again, the buyer can't participate in the management of the LLC or order that any distributions of money or property be made.

Because the law doesn't specifically provide foreclosure as an option for judgment creditors, foreclosing on a member's LLC interest can be expensive and complex. But foreclosure can also be faster than dissolving the LLC and more successful than a charging order, and it provides leverage in dealing with the debtor. Often, the indebted member or other LLC members will settle the claim to prevent foreclosure.

Returning to our previous example, let's suppose again that the debt collection agency has a $25,000 judgment against Denny for his unpaid credit card debts. The agency previously tried to enforce a charging order against the LLC to collect Denny's distributions. But after a year, the LLC hasn't made any distributions and the agency hasn't been able to collect anything.

Seeing that the charging order will get it nowhere, the agency obtains a court order to foreclose on Denny's interest in the LLC. To avoid the foreclosure of Denny's membership interest, the LLC settles Denny's personal debt with the agency for $25,000.

Judgment Creditor Can Dissolve the LLC

A creditor's rights over an indebted New York LLC member don't necessarily end with foreclosure. In some cases, creditors in New York can apply to get a court to order the LLC dissolved and its assets sold to pay off the creditor.

When dissolving an LLC in New York, the LLC must distribute its remaining assets to the LLC members. The judgment creditor should be able to collect the money from the distribution of these assets.

Let's return to our previous example one final time. Suppose the collection agency gets a court to order the dissolution of Arturo, Maya, and Denny's LLC. At the end of the day, the LLC is left with $90,000 in assets to distribute among its members. In accordance with the operating agreement, each member is entitled to one-third of the LLC's distributions upon dissolution. So, Denny would be entitled to $30,000, more than enough to pass on to the agency to pay his debt. In this case, the debt collection agency will receive $28,000—the $25,000 originally owed plus interest. And Denny will be left with the remaining $2,000.

What About Single-Member New York LLCs?

The LLC laws and court decisions in some states make a distinction between multi-member and single-member LLCs (SMLLCs). As a result, these states' laws often don't limit an SMLLC owner's personal creditors to a charging order remedy even if that's the sole remedy provided by law for multi-member LLCs.

How New York Law Treats Multi-Member vs. Single-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 an SMLLC doesn't involve other owners' interests, you have a stronger rationale to allow an SMLLC owner's creditors additional remedies against the SMLLC owner. In other words, foreclosing on the indebted member's membership interests in the SMLLC or forcing the SMLLC to dissolve would only affected the indebted member. However, the law isn't entirely clear around SMLLCs and member protection and other factors might come into play in a particular situation.

Moreover, in some cases, the laws of other states can apply—for example, where a New York SMLLC does business or owns property in another state. In addition, the protections that state LLC laws provide to SMLLCs might be ignored by the federal bankruptcy courts if the SMLLC owner files for bankruptcy.

Consider Forming or Converting to a Multi-Member LLC

If you want to potentially increase your protections against creditors as an LLC owner, consider adding another member to your LLC. If you decide to add another member, you should treat the second member as 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 an SMLLC.

For example, a legitimate co-owner of a business usually:

• pays a fair market value for the LLC interest they acquire
• receives financial statements
• participates in decision-making, and
• receives a share of the LLC profits equal to the membership percentage owned.

You can avoid the second member exerting control over the daily operations of the company by setting up a manager-managed LLC and naming yourself as the sole manager. In a manager-managed LLC, the manager makes the operational decisions for the LLC, including striking business deals and binding the LLC to business contracts. Non-manager members take a more passive role and usually just collect their distributions without directly involving themselves in the business. You can define these member and manager roles in an LLC operating agreement.

Should You Form Your LLC in Another State?

You don't have to form your LLC in New York even if it's the state where you live or have your primary office. You can form an LLC in any state. For instance, you could choose to form an LLC in Nevada or another debtor-friendly state.

However, creating your LLC outside New York will not save you New York taxes. Your LLC will still need 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 both the fees:

• to form your LLC in the other state, and
• 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 favorable LLC laws could provide you with more limited liability than forming it in New York. However, there's 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.

If you want more guidance on your particular situation, you should consult a New York business lawyer.

More Information on New York LLCs and Liability Protection

When owning an LLC in New York, it's helpful to be aware of your legal rights and obligations. You'll especially want to keep up with your company's ongoing legal requirements. You can find tips and guidance on running your New York LLC by checking out the following articles:

• New York business licenses
• LLC biennial report and tax filing requirements in New York
• how to convert your LLC to a corporation in New York, and
• how to start a New York business.

You might also be interested in the Starting a Business in New York section of our website. This section provides guidance on starting different kinds of businesses in the state, including a restaurant, a child care business, and a cleaning business, among others.

You can also check out our section on LLCs and asset protection. This section has articles on strategies to strengthen your LLC's asset protection and when you might be personally liable for LLC debts.

If you have specific legal questions or a particularly complicated debt or liability issue, you should talk to a New York business lawyer. They can answer your questions and help you develop a plan to tackle your personal debt and protect your business.