Traditionally, small businesses have operated as corporations in order to provide the liability shield that they offer. However, over the last two decades or more, the LLC has become the new entity of choice. It reduces the amount of compliance and bookkeeping because there is no need for a board of directors resolution every time somebody wants to take a corporate action. Moreover, there is simplified bookkeeping either because of partnership tax treatment or disregarded entity tax reporting if it is a single member LLC.
It is likely, however, that a large motivation behind the formation of many LLCs is that the LLC has what is referred to as “Charging Order” protection. What this means is that if a member of the LLC becomes subject to claims or debts a creditor has a hard time getting the debt satisfied by means of attacking the assets of the LLC or even the debtor member’s interest in the LLC outright. The Charging Order in many states is the exclusive remedy for a creditor who is trying to attack the debtor member’s interest. Unfortunately, California is not one of the “exclusive Charging Order remedy” states. In California the Charging Order can become more broad and, in fact, even result in liquidation of the LLC.
The Charging Order is really like a garnishment of wages in that it attaches to the debtor member’s distribution interest in the LLC. If any distributions are made are made from the LLC to the debtor member, then instead it goes to the creditor who has obtained the Charging Order. Historically, the purpose of the Charging Order was intended to protect the other non debtor members of the LLC who would not be forced into an involuntary business relationship with the creditor. This has resulted in cases and some states holding that the Charging Order does not apply where there is a single member LLC only (because there are no non debtor members).
Many state courts have amplified on the Charging Order restricting distributions and loans in order to prevent any what they term of the use of the Charging Order for debtor protection.
There are two issues that should be considered in the formation of an LLC. Number one is to consider forming the LLC in the jurisdiction which has the best Charging Order protection laws. Nevada and Wyoming fit into this category. Secondly, it may be appropriate to utilize a modular structure in conjunction with the LLC. In this regard, the LLC is really not owned by the client, but by the client’s Asset Protection Trust either domestic or offshore. Further insight into the strategy is available by contacting Jeff Matsen at Bohm Wildish & Matsen, LLP. Mr. Matsen has written a book on Asset Protection Planning for Consumers that has been published by the American Bar Association and a Chapter of his book goes into the use of LLCs and the Charging Order as well as the Modular Structuring Strategy.