In Delaware, like in most states, the general rule is that the money or property of an Delaware limited liability company (“LLC”) cannot be taken by creditors to pay off the personal debts or liabilities of the LLC’s owners.
Example: Larry and LaVerne have formed a Delaware LLC called Sports Memories, LLC, to operate their sports memorabilia business in Wilmington. The business has been quite successful and has $50,000 in its own bank account. Unbeknownst to Larry, LaVerne has a gambling problem and owes $100,000 to the Lady Luck Casino. While the casino can attempt to collect its debt from LaVerne’s personal assets (such as her personal bank accounts and personal property) it cannot take money or property owned by the LLC to satisfy Laverne’s personal gambling debts. For example, it cannot get any of the money held in the LLC’s bank account.
However, there are other ways that creditors of an LLC owner might try to collect against the LLC for the owner’s debt. These include:
1) obtaining a charging order requiring that the LLC pay the creditor all the money due from the LLC’s payments 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.
States laws vary widely on what creditors are allowed to do so you need to check the laws of your state. This article covers what actions creditors in Delaware are allowed to take against an LLC for an LLC owner’s personal debt.
Delaware, like all states, permits personal creditors of an owner of an Delaware 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 Delaware 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 Lady Luck Casino gets a Delaware court to issue a charging order in the amount of $100,000 against LaVerne’s 50% ownership interest in the Sports Memories LLC. This means that any distributions of money or property the LLC would ordinarily make to LaVerne must be given to the Casino instead until the entire $100,000 is paid. However, if there are no distributions there will be no payments.
The charging order remedy without any right to order distributions is so weak many creditors don’t even try to use it.
Foreclosure and Dissolution
Andrei Papanicoglu, Filings Specialist at Evedex says that the charging order is the only legal procedure that personal creditors of Delaware LLC members can use to get at their LLC ownership interest. Thus, unlike some other states, Delaware does not permit an LLC owner’s personal creditors to foreclose on the owner’s LLC ownership interest or get a court to order the LLC dissolved and its assets sold. This makes Delaware a particularly friendly state for people who want to form LLCs to protect assets from personal creditors.
What About One-Member Delaware LLCs?
The reason personal creditors of individual LLC owners are limited to a charging order or foreclosure 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). Whether, and to what extent, single member Delaware LLCs are protected from outside creditors is not entirely clear. However, it’s quite possible that a single-member Delaware LLC benefits from none of the liability limitations that are in place for multi-member LLCs. For this reason, to obtain the full limited liability described above, a Delaware LLC should have at least two members. The second owner can be a spouse or relative.
To obtain the protection from liability afforded by an LLC, you must form the entity before you incur the debt or other liability. For more information, consult a business attorney.