One of the best asset protection features of LLCs is "charging order protection". This is a concept borrowed from partnership law that comes from olden times.
To give you an idea of how charging orders work, consider the following example:
1. You have lots of assets. One of your assets is a 50% ownership interest in an LLC which owns and operates a rental property.
2. You are sued in an incident unrelated to the rental property. You lose and a $1M judgment is entered against you.
3. The other party in the incident is now your creditor, and you are a debtor. The creditor starts seizing your assets to cover the $1M.
4. The other party tries to seize your 50% interest in the rental property LLC.
In most states, under the law of "charging orders", the creditor cannot take your LLC interest. The only thing the creditor is entitled to is a "charging order" against your interest. A charging order is simply a lien which tells the LLC that if it decides to distribute any money to you, to give that money to the creditor instead. The creditor cannot force the LLC to actually distribute any money, nor participate in any way in management of the LLC, nor even usually get information on the LLC's activities. In New Jersey, this concept of charging orders as the sole remedy of a creditor is codified in N.J.S.A. 42:2B-45.
This charging order concept is very beneficial to you as a debtor in the example. The key is that the creditor cannot force the LLC to make any distributions. The creditor may sit with its charging order for years, never receiving anything unless the LLC chooses to make a distribution. This usually gives you leverage to negotiate a settlement with the creditor where you pay less than the amount owed, and in return the charging order is removed and the judgment considered satisfied.
Traditionally, the chink in the armor of LLC charging order protection has been single member LLCs. The law of charging orders was originally created to protect the other members of the LLC from having to deal with a stranger entering the company. Its original intent wasn't to protect the debtor himself. Therefore, in a single member LLC, courts have been eager to ignore charging order protection and give a creditor sole and complete ownership of an LLC. See, e.g., In re Ashley Albright, 291 B.R. 538 (D. Colo. Bkrpt. 2003).
In New Jersey, despite the fact that N.J.S.A. 42:2B-45 states that charging orders are the exclusive remedy of a creditor, when the issue is finally taken up by a New Jersey court, many believe the court will follow the example of other states and will refuse to apply charging order protection to a single member LLC. This week, Nevada passed SB405, which seeks to address those fears by stating unequivocally that a creditor of a member of a single member LLC is solely entitled to a charging order. Nevada likely hopes this will cause people all over the country to form LLCs in Nevada.
If you checked out my website, you know I generally don't recommend forming a Nevada LLC if you don't live in Nevada. This new statute doesn't change that fact. If you are not a Nevada resident, and you carry on most of your activities outside of Nevada, any lawsuit against you isn't going to be in the courts of Nevada. It will likely take place in the courts of your home state. Your home state court is likely going to apply the charging order law of your home state, not of Nevada, despite your LLC being organized in Nevada.
Some people reading this post right now are thinking I'm wrong because of a conflict of laws doctrine known as the "internal affairs doctrine". Without boring everyone else to tears, this doctrine basically holds that when it comes to the affairs of the owners of a company, the law of the state of organization (i.e. Nevada) applies, regardless of which state suit is brought in. The "internal affairs doctrine" is real, and as a result, I do sometimes form Delaware LLCs for clients whose operating companies have more complex management needs.
The problem with application of the "internal affairs doctrine" to the Nevada statute is that when it comes to a single member LLC, charging orders aren't an "internal affair" since there are no other owners to protect. It is rather a collection procedure issue, which is an area where local law applies regardless of the state in which an entity is organized.
If you have any questions about in which state you should form an LLC, feel free to contact me.
The problem with application of the "internal affairs doctrine" to the Nevada statute is that when it comes to a single member LLC, charging orders aren't an "internal affair" since there are no other owners to protect. It is rather a collection procedure issue, which is an area where local law applies regardless of the state in which an entity is organized.
If you have any questions about in which state you should form an LLC, feel free to contact me.
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