Although relatively new to the legal world compared to other forms of legal entities, Limited Liability Companies (LLC) have by far become the legal entity of choice for businesses.  Data suggests that in recent years over 90 percent of new businesses entered the world as an LLC.  Some of the largest companies in the world have converted or re-established from corporations to LLCs.  Well-known companies such as Apple, IBM, Nike, and many others, are structured as an LLC.  

For a single individual who is starting a business, most often a single member LLC (SMLLC) is chosen.  In the past, legal entities really were not geared towards having a single owner. Partnerships consisted of multiple individuals. Corporations had multiple shareholders.  So, having a legal entity that consists of one owner, at least as much as it occurs today with SMLLCs, presents a differing landscape than before. 

I often get asked how much a SMLLC offers in the line of protection.  After all, if John Doe sets up John Doe Enterprises, LLC, can it be looked at as one and the same as him?  The short answer is “maybe”, and the inquiry becomes whether we are talking about personal liability of John Doe or protection of the company’s assets. Generally, assuming things are done properly, a SMLLC can give strong personal liability protection to the owner.  In other words, liability stops at the company level and the owner’s other personal assets are not reachable.  However, when it comes to protecting the assets of a SMLLC, when the owner is sued for reasons removed from the company or personally owes a creditor, the amount of protection can vary greatly.  This is especially important to farmers that may have land, equipment, or other high value assets in a SMLLC. 

One of the main advantages with LLCs is the restriction on creditors and claimants reaching assets of the LLC.  For example, with a corporation, a creditor or claimant cannot simply take the corporation’s assets. Rather, the creditor or claimant can obtain ownership of stock in the corporation.  If the creditor or claimant obtains ownership in the corporation, the creditor or claimant is entitled to dividends and profit.  In obtaining majority ownership, the creditor or claimant can liquidate the corporation and sell the assets.  With an LLC, in almost every state, creditors or claimants cannot obtain ownership of a member’s interest. Rather, creditors and claimants are allowed to obtain what is called a “charging order”, which is a court order that the LLC pay any distributions or income to that particular member’s creditor or claimant.  For example, if I am 1/3 owner in an LLC, and someone obtains a charging order against me based on a debt, lawsuit, etc., whatever income I would receive as a 1/3 owner each year goes to satisfy the claim or debt against me. Think of this as similar to a wage garnishment order. However, the creditor’s interest is limited only to my right to receive regularly occurring distributions from the LLC, and they cannot force the LLC to make a distribution.

The premise behind the charging order is that individual owners of an LLC should be protected against the actions of other owners that do not relate to the company.  For example, if Larry, Curly, and Moe own an LLC, and Moe gets sued for some reason and has a judgment against him, should Larry and Curly suffer by the assets of the Company being affected?  Thus, the charging order makes sense in the context of LLCs with multiple members and in the majority of states, it is a claimant’s exclusive remedy.  But what about in the case of a SMLLC, where there is only one member and no other members that can be affected?  It is here that the laws among the states begin to vary, and asset protection dwindles.  

On one end of the spectrum, you have states like Delaware, Nevada, and Wyoming that provide exclusive charging order protection for SMLLCs.   On the other end, states like Florida and New Hampshire have laws where the charging order is not the only remedy to be used against a SMLLC.  In between these positions are other states, many who have not yet addressed the issue with laws or court decisions.  

With very few states having definitive treatment of SMLLCs and whether or not charging orders are the sole remedy, the question becomes what can a person do to strengthen their SMLLC?   One option is to convert the SMLLC to a multi member LLC.  This can be done where a husband adds his wife, or vice versa, or another relative is brought into the company.  Sometimes a person chooses a SMLLC because they want it to be “their” business and not co-owned with a spouse. Or, because they want pass through tax treatment so as to not be required to file a tax return.  I’ve even had people unable to tell me why they went with a SMLLC instead of a multi-member when they started the business.  In these forgoing instances, it seems logical that obtaining more protection by adding another member outweighs the reasons for having elected to start as a SMLLC.

If an additional owner is added, it is important that it is legitimate.  In other words, do not just add a person in name only or “on paper”.  If so, you run the risk of the court setting aside the additional ownership interest and treating the LLC as a SMLLC.  Legal counsel should be consulted to see what action needs to occur (i.e. rights, responsibilities, financial return) of the new member to pass the smell test.  In addition, you likely will need legal counsel to overhaul your operating agreement.  Since you started out as an SMLLC, your operating agreement probably is geared towards a single member. (if you even have an operating agreement at all).  When you bring in an additional member, the operating agreement serves as a contract between the members. So, you’ll need an updated operating agreement that lays out the playbook for the ownership of the company based upon more owners than just you. 

If a person does not have another adequate owner to add to the SMLLC, sometimes people will instead establish their SMLLC in a state, like Delaware, that has the charging order as the exclusive remedy.  Historically, Delaware has had very, very favorable laws for legal entities, leading to many out-of-state businesses being established there. So, John Doe, who lives in Florida with no exclusive charging order protection, can set up a Delaware SMLLC and do business in Florida, hoping to increase the asset protection of the SMLLC.  However, the question becomes if Florida will apply Florida law or Delaware law.  Also, John Doe will incur additional filing fees, registered agent fees, annual franchise fees, registration in Florida, and he must have a registered agent in Delaware.   Thus, going with an out-of-state SMLLC warrants considering several factors.

Approximately 20 states now allow for a Domestic Asset Protection Trust (DAPT), which is an irrevocable trust established to protect your assets, rather than simply transferring them at death to someone else.  Another remedy is to layer a DAPT with a SMLLC.  This can provide a one-two punch of the liability protection of the SMLLC with the asset shielding of the trust. Because you will be dealing with state trust law and state SMLLC laws, whether this can be done and/or is the correct move for you will vary greatly based upon what state you reside in and what state your assets and business are located in. 

At the end of the day, the SMLLC is a viable legal entity.  It allows for strong personal liability protection.  It allows for pass through tax treatment.  And, it gives asset protection.  However, as this article has discussed, how much asset protection it gives can vary greatly depending on where you live and, since many states have laws still evolving in this area, can be subject to change and/or uncertainty. If you have a SMLLC, especially one with a high amount of assets, it may serve you well to broach this topic with legal counsel to make sure your assets are protected to the fullest extent they can be. 

These articles are for general information purposes only and should not be construed as specific legal advice or to create an attorney-client relationship.  Laws vary among states and information contained in this article may not be applicable to your state. If you have a legal issue, you should contact an attorney.

John J. Schwarz, II, is a lifelong farmer and has been an agricultural law attorney for 18 years and is passionate in helping farm families with legal matters.  Natalie Boocher, an elder law attorney assisting clients with a wide range of long term care planning and asset preservation, contributed to this article. They can be reached at 1-844-FARMLAW and www.thefarmlawyer.com. Go to www.farmlegacy.blogspot.com for past articles.