Category: Competence in forming LLCs

HOLDING LLC MEMBERSHIPS THROUGH SINGLE-MEMBER LLCs—A TRAP FOR THE UNWARY?

By , January 11, 2011 8:50 am

In my LLC practice, I often run across LLCs whose ultimate owners hold their LLC memberships through single-member LLCs.  They do this because they think that they are obtaining two significant benefits—greater anonymity as LLC owners and an extra layer of statutory liability protection.

EXAMPLE.  Arthur Able and Bill Baker are equal members of AB, LLC.  AB, LLC, in turn, holds real estate with a fair market value of $1 million.  Arthur holds his AB membership directly in his own name.  Bill holds his through a single-member LLC named “Cosmic Holdings, LLC,” of which he is the sole member.

I think the above ownership structure creates a serious trap for Bill.  One of major benefits of holding property in an LLC is that all U.S. LLC acts except that of Pennsylvania provide LLCs and their members with statutory charging order protections.  (And I understand that Pennsylvania case law provides charging order protections for Pennsylvania LLCs and their members.) 

I will write about charging order protections at greater length in future posts.  However, in essence, LLC statutory charging order provisions provide that if a creditor holds an unsatisfied judgment against a member of a multi-member LLCs on the basis of a claim unrelated to the LLC’s business:

  • The creditor may obtain a lien (a “charging order”) against the LLC on the debtor-member’s right to receive distributions of LLC profits, requiring the LLC to distribute to the creditor any LLC profits it would otherwise distribute to the member to the extent of the judgment.
  • However, the creditor may not levy on the debtor-member’s voting rights or other management rights in satisfaction of the claim.

In my view, the fact that LLC statutes provide for charging order protections and that corporations do not is the single greatest business organization law advantage of LLCs over corporations.    

To explain:  In the above example, Bill, as noted, holds his ownership in AB through a single-member LLC.  What this means as a practical matter is that if Bill accidentally but negligently runs over and kills a brain surgeon on business unrelated to the LLC and the brain surgeon’s estate obtains a $20 million judgment against him, the estate can levy on his single-member LLC membership; it can obtain Bill’s voting rights; and, by exercising deadlock voting power, it can force the LLC to sell its assets and distribute Bill’s share of the proceeds to the estate.  This is because charging order protections only protect LLC members; they do not protect the members of single-member LLCs that are members of multi-member LLCs.

By contrast, assume that Arthur is the AB member accidentally killing the brain surgeon.  In this situation, charging order protections will enable the estate to obtain a charging order against AB, LLC; but, because Arthur holds his membership in AB directly, the estate cannot obtain Arthur’s voting rights and thus cannot force AB’s dissolution.

In short:  Think long and hard before advising your LLC formation clients to hold their memberships in multi-member LLCs through single-member LLCs.  First, your client will thereby lose charging order protections.  Second, as a practical matter, he won’t need a second liability shield; so why bother with a single-member LLC?  Third, in any law suit, the “anonymity” he thinks he will obtain through his single-member LLC will quickly turn out to be worthless.

WHAT LLC BUSINESS ORGANIZATION LAW DO YOU NEED TO KNOW IN ORDER TO BE COMPETENT TO FORM LLCs?

By , August 19, 2010 6:45 am

For the past several weeks I’ve been hard at work writing a law journal article that seeks to answer the above question under the Massachusetts LLC Act. 

I’ve concluded that in order to be able to form LLCs competently under that act, you need to possess a rather shockingly large amount of business organization law knowledge. 

Specifically, I’ve concluded that in order to handle non-tax choice of entity for your LLC formation clients, you need to know (i) the chief business organization law features of LLCs under the Massachusetts LLC Act and (ii) the similarities and differences among these features and those of all other types of Massachusetts business organizations. 

And I’ve concluded that in order to competently plan, negotiate and draft operating agreements for your clients you need to know:

  • The provisions of the Massachusetts LLC Act that are relevant to LLC formation practice (which, by my count, comprise 152 provisions);
  • Whether each of these provisions should be characterized as definitional, mandatory, default, non-self-enabling permissive or self-enabling permissive;
  • The tactical significance of these characterizations in forming Massachusetts LLCs;
  • Massachusetts LLC case law relevant to LLC formations;
  • The “gap issues” in Massachusetts LLC law—i.e., the issues on which this law is silent or ambiguous (so that, in the operating agreement, you won’t overlook any of these issues);
  • The principal business organization law issues relevant in Massachusetts LLC formations (so that you won’t overlook any of these issues) and the various alternative methods of resolving each of these issues in your clients’ best interest;
  • The rules of Massachusetts LLC law that govern Massachusetts LLCs that lack operating agreements (so that you can explain to your clients why they absolutely need to have these agreements); and
  • The potential adverse impact of these rules on Massachusetts LLCs and their members.

If the above question is one that you yourself have thought about, I’d be very grateful for your reactions to the above list.  In putting the list together, have I gotten just a bit carried away?