NASE Blogs


Thursday, March 24, 2011

Wyoming was the first state to authorize Limited Liability Companies (LLCs) in 1977.  Since then all 50 states have adopted the LLC form of business and LLCs have become the most common choice of business entity.  Nevertheless the actual protection LLCs provide for shielding their "members" personal assets from a successful lawsuit by a creditor has yet to be fully determined.  In short, as things in the legal world go, 34 years isn't very long and there haven't been enough cases decided by the supreme courts in enough states to be absolutely certain how much personal asset protection an LLC will offer.  That said, there is apparently a substantial amount of confidence on the part of attorneys who specialize in business formation that LLCs will protect their business clients because the formation of LLCs continues apace and legitimage multi-member LLCs with well-thought-out, binding operating agreements are very likely to work as they are intended. 


There is one area, however, where LLCs have come under direct fire.  The area of concern is what is known as the "single-member LLC" or SMLLC.  Beginning in about 2003 courts in various states began to make a distinction between LLCs with only one member and LLCs having more than one member.  One reason is that LLCs were initially a means of extending liability protection to partnerships.  As things developed in the law it became possible to form single-member LLCs and the partnership aspect which was originally at the root of LLC formation was disregarded or lost.  In an important recent case a Florida court allowed a creditor having a court judgment against a single-member LLC to take possession of the member’s entire interest in the LLC.  As the new owner of the LLC that creditor was then free to do whatever it wanted to with the business including the power to sell either the entire LLC or its assets.  When considered together with decisions from courts in Colorado and other states this result suggests that the general trend might be for courts to strip an SMLLC member of his or her rights of ownership, particularly in bankruptcy cases. 


If you are considering forming an LLC you should strongly consider forming it with at least one other member to avoid the possibility that a court might rule that your single-member LLC is not protected from being taken by a creditor having a court judgment.  If you already own a single-member LLC you probably should consider adding one or more additional members.  Before you do anything, find out what the laws of your state say about modifying LLCs. 


It is strongly suggested that you do the following, at a minimum:


1) Require any other member to be a real member who paid fair market value for his or her membership interest in the LLC.  The other member(s) must have access to the books and be involved in operation of the business, and more.  Otherwise your LLC could be liable for what has been labeled a “peppercorn” membership not considered to be legitimate.  The result could be that the other member(s)’ interest is disregarded by a court and you wind up with the vulnerable single-member LLC you wanted to avoid.


2) Although some states allow an LLC to be formed without an operating agreement, the absence of such an agreement suggests that the LLC isn’t legitimate.  A well-thought-out operating agreement with the other member(s) consenting to all of its provisions regarding all members’ liabilities and obligations is an absolute must. 


Again, above all, consult an attorney with substantial experience in business matters before you form and LLC and in particular, if you thought you wanted to form or operate a single-member LLC! 


Summary of LLC asset protection:  The asset protection offered by an LLC having more than one member is generally believed to be good and in some cases, even better than the asset protection offered by a corporation.  However, because of recent court decisions single-member LLCs are suspect.   


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