Charging order protections are court orders for creditors, allowing them to receive distributions from a business that would otherwise be paid to a debtor. Charging order laws vary by state, but they should balance a creditor’s rights with the importance of maintaining the business’s operational integrity.
What are limited liability entities?
Limited liability entities (LLEs) are business structures, such as corporations, limited liability companies (LLCs), and limited partnerships that help protect a business owner’s personal assets.
LLEs can do any of the following:
- Own property
- Enter into contracts
- Incur liabilities
- Sue and be sued
- Be prosecuted for crimes
These business entities are considered “persons” under the law and are separate from the business owner. Typically, owners of an LLE have no personal liabilities to meet the LLE’s obligations. A creditor to an LLE is limited to the assets of the LLE when seeking recourse.
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What is a charging order?
Charging order protection allows creditors to put a court-ordered lien on distributions made from a business entity without giving the creditor management rights in the business.
Using charging order protection, creditors can seek payment from a business entity in which the debtor is a partner, member, or owner. At the same time, the business owner and their partners are assured the business management is not impacted. Charging orders are similar to garnishing wages to recoup the dollar amount of the judgment.
How does a charging order affect the debtors’ partners in the business?
A charging order allows the creditor to put a lien on distributions that would be paid to the debtor. The interests of other members in the LLC are protected.
Personal creditors of one member of an LLC cannot lay claim to distributions made to other members of the LLC, nor can they be involved in the LLC’s management, dissolve the LLC, or sell the business’s assets without agreement from the other members.
If the LLE is a corporation instead, the debtor’s personal creditors cannot take ownership of the corporation’s assets but can assume ownership of the debtor’s stock in the corporation. By doing so, they become co-owners in an incorporated business. They may be entitled to the debtor’s corporate profits and participate in the corporation’s management. If they own the controlling shares in the corporation (51% or more), they may be able to liquidate the corporation and recoup the money owed to them by the debtor.
Charging order protection is much more effective if the business structure is an LLC than if it is a corporation. In most states, getting a charging order is the only way creditors can seek recompense from a debtor’s ownership in a business. Some states allow creditors to foreclose on the debtor’s financial rights in the business. However, they cannot participate in the business’s management and may now be considered a partner for income tax purposes.
What about one-member LLCs?
The primary purpose of a charging order is to allow a creditor to collect payment from a debtor who is a member of an LLC without affecting the other members, since they do not owe the creditor.
But what if there are no partners to protect, and the owner is the only debtor? Some states will distinguish between single-member and multiple-member LLCs and provide either the same protection for single-member LLCs as multi-member LLCs or less protection. Some states have not addressed this issue.
What is the corporate veil?
Since corporations and LLCs are separate legal entities from their owners, owners rarely have personal legal and financial responsibilities for their LLC’s legal and financial obligations. Because an owner’s liability is limited to their investment in the company, this limited liability is commonly referred to as a corporate veil.
The corporate veil protects the owner’s and shareholder’s personal assets from the company’s obligations. However, this protection is not absolute. If the creditor can prove that the LLC is just a shell or an alter ego for the owner, the owner acted irresponsibly, or the corporation’s actions were fraudulent, the corporate veil may be pierced.
Asset protection is a strategy to protect assets and wealth from creditors or claimants. Effective asset protection requires planning ahead. It can minimize the time, money, and energy spent defending against claims.
Not all states recognize charging orders, and some allow for other remedies. If you are interested in discussing asset protection using an LLC or other business structure to protect your assets from future creditors, schedule a call with our experienced New York Estate Planning Attorney at 855.631.3457 to learn more about how to protect those most important to you.