Saturday, September 3, 2011

New Nevada Law Ensures Single-Member LLC Charging Order Protection

It has long been speculated as to whether charging order protection afforded to a limited liability company (LLC) extends to a single-member LLC. A charging order becomes relevant where an LLC member (owner) incurs "outside liability", that is, a liability arising from personal or other business activities, rather than from the LLC's business (which would be "inside liability", the type of liability one usually thinks about when discussing limited liability entities such as LLCs and corporations).

An example of inside liability is liability generated from the business operations of the LLC. With proper setup and corporate maintenance, such that any attempt to pierce the corporate veil is unsuccesful, the losses in the worst case scenario are limited to the capital contributed to the company by its founders.

An example of outside liability is a judgment against a business entity owner incurred as a result of a personal automobile accident exceeding any applicable liability insurance policy limits [FN1].

One advantage of the LLC (with so much misinformation around online, it is worth noting that there are also disadvantages of LLCs) is that in the case of outside liabilty, the judgment creditor is limited to a charging order. A charging order is a lien that entitles the creditor to any distributions from the LLC that would go to the member. With a properly-drafted operating agreement, the LLC will usually have great discretion about the timing and amount of such distributions, which generally leads to a settlement with the judgment creditor that is favorable to the judgment debtor.

The theory behind charging orders relate to the origins of limited liability companies. Basically, they are partnerships with limited liability protection. The charging order remedy limitation protects the other partners from having an unwanted partner enter the partnership without their consent. The flip side of this rationale is that, in a single-member LLC, there are no other partners to protect. Thus, in 2003, a U.S. bankruptcy court found that a single-member LLC's assets could be made available to the bankruptcy trustee to satisfy the owner/bankrupt's debts (In re Albright). While not binding on state courts, this decision has long case doubt on charging order protection for single-member limited liability companies. A further blow occurred in 2010, when the Florida Supreme Court found that the state's charging order statute did not apply to a single-member LLC (Olmstead v. FTC).

In response to this uncertainty and these unfavorable (although not binding) precedents, effective 2011, the Nevada legislature has amended its LLC charging order statue to expressly include single-member LLCs. Nevada is the first in the nation to do so, and its statue will surely encourage residents of other states to "forum shop" and choose Nevada LLCs over their home state's law. The change in law is effective October 1, 2011.


[FN1] Most states' automobile insurance minimums are woefully inadequate compared to the potential liabilities involved in operating a motor vehicle.
Nevada requires that automobile liability insurance policies carry minimum coverage of $15,000 for bodily injury or death of one person in any one accident; $30,000 for bodily injury or death of two or more persons on any one accident; and $10,000 for injury to or destruction of property of others in any one accident.

By way of comparison, California requirements are similarly inadequate: $15,000 for injury/death to one person; $30,000 for injury/death to more than one person; and $5,000 for damage to property.
As anyone who has been to a body shop or hospital recently can attest, these limits aren't going to cover much. Scrape the rear bumper of a luxury car, and the property damage limits are exceeded, and, more relevant to the discussion above, a serious accident resulting in death or disability, will obviously exceed the policy limits of even more reasonable insurance policy limits of $100,000 or more. Out of lack of attention or knowledge, or a desire to keep insurance affordable for lower-income drivers, these limits have not been raised to keep up with modern realities, assuming they were ever sufficient. In the meantime, it is recommended that you obtain higher policy limits and consider an umbrella policy on top of that, that are more in accordance with the realities of auto repair and health care costs and your net worth. Limited liability business entities should be only one piece of an overall liability minimization and contingency plan.

22 comments:

  1. Nevada and Deleware have some of the best laws to generate money for the state, while providing good asset protection for the party forming the LLC/Corp. Likewise, a few other states, including Montana and Wyoming have followed suit. Regardless of what Nevada does, it will always be far less the restrictions, far more fees, and far greated asset protection than California, New York or other states who chase businesses out of state.

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