Single Member LLCs (SMLLCs)

Recall that with a corporation, shareholders are twice removed from the operations of the corporation because the shareholders elect the directors, and the directors elect the officers who actually run the corporation. Thus, if the creditor attaches shares of a corporation, the creditor will not directly influence operations until there has been at least one meeting of directors at which new officers can be elected.

In a limited partnership or LLC, however, the change of ownership from the debtor to a creditor could directly impact the operations of the entity and affect the remaining non-debtor members. The primary purpose of the charging order is thus to protect the non-debtor members from being involuntarily forced into a partnership with a the debtor member’s creditor.

However, there is only one member in a SMLLC, so there are no non-debtor members to protect. It also defies common sense that a creditor would not be able to get at the assets of an entity where the debtor is the only owner.

Some planners argue that even though it may not make any sense to have charging order protection where there is only one member, the language of the statute is nonetheless protective. Some states, such as Arizona, have modified their LLC acts in such a manner that suggests protection of the debtor’s indirect interest in the assets of the entity, even if the creditor has charging order.

Planners who believe that SMLLCs are protected by charging orders in the same manner as other LLCs and partnerships argue that, unless it is apparent that the creditor’s judgment may never be satisfied by distributions from the SMLLC, the creditor should not be allowed to invade the LLC.

After years of speculation and the lack of any solid case law, the issue of whether SMLLCs are afforded the protections of the charging order was finally addressed by a U.S. bankruptcy court, In re Albright, No. 01-11367 (Colo. Bkrpt. April 4, 2003). The judge in Albright held that charging order protection does not exist for a SMLLC because there are no non-debtor members to protect. The court granted full economic and non-economic rights to the trustee, allowing the bankruptcy trustee to manage the debtor’s LLC. The trustee subsequently sold the LLC’s property and distributed the net proceeds to the bankruptcy estate for satisfaction of creditors’ claims.

Thus, until Albright is overturned or rejected by other courts, the safe presumption will be that SMLLCs probably do not provide charging order protection.

Based on Albright, sometimes I hear planners blurt out, “Single Member LLCs provide no asset protection!” This is wrong. The lack of charging order protection is a far cry from concluding that SMLLCs are “worthless” as asset protection vehicles. SMLLCs may still provide substantial protection for owners against the liabilities of the entity itself, which are so-called “internal liabilities”.

For example: SMLLC owns a strip mall and is successfully sued by one of the tenants. If the SMLLC is adequately capitalized, is not the alter ego of the sole member, and is not used to perpetuate a fraud, the tenant may not assert liability against the member.

There is no reason that a SMLLC should be treated much differently from a sole shareholder corporation. Historically, sole shareholder corporations have contained liability within the entity and shielded the liability away from its owners.

To summarize, even if SMLLCs do not offer the same charging order protection as multiple-member LLCs, they can still be very valuable business planning vehicles. Certainly, it is preferable from a liability standpoint to own one’s business in a SMLLC than to run it as a sole proprietorship. But of course, where external liability is a concern and it is feasible to add another member, that should be done so that charging order protection arises.

SMLLCs and LAMBs

An interesting question regarding SMLLCs is the consequences of the partial sale of a debtor’s interest in a single member LLC’s to a third party (sometimes referred to as a “LAMB” for “Late Arriving Member”). Does the sale of the debtor’s interest to a LAMB invoke charging order protection in an SMLLC, even if there were no other members at the time the claim arose?

The answer depends on when that the court tests the single member status for charging order purposes. My gut feeling is that this should be at the time that the application for the charging order is made because the purpose of the charging order is to protect non-debtor members. If this is true, then it means that you can maintain an LLC with a single member, but later add a member and charging order protection will arise. Although a sophisticated creditor may argue that the post-claim transfer of the LLC interest was a fraudulent transfer, I’m not convinced that is a winning argument so long as the transfer is not done at the last minute, was for value, and can be justified on other straight-faced business grounds.

Cases:

• In re Ashley Albright, Bkrptc. Colo. (2003) -- Federal bankruptcy judge denies charging order protection for single member LLC and allows bankrtupcy trustee to take possession of the SMLLC's assets to benefit creditors.