Monday, July 9, 2012

Dubious Nature Of LLC-Peddler Claims That Some States Have More Debtor-Friendly Charging Order Laws Than Others

From a recent column in Forbes:

  • You see the advertisements all the time: “Form your LLC in Wyoming!” or “Create your LLC in Delaware”, or “Get the Nevada Advantage with Your LLC!”

  • Several states have healthy industries that consist of little more than forming corporate entities in those states. They often attract such business by making claims that the laws of their states are more debtor-friendly than those of other states, thus presumably providing greater asset protection for the owner.

  • In most states, Limited Liability Companies (LLCs) and partnerships in their most common variations (GPs, LP, LLPs, and LLLPs) have a benefit that corporation do not, which is that creditors cannot simply levy on the stock in such entities — they have no stock, technically — but instead creditors must obtain acharging orderthat has the effect of placing a lien on the debtor’s interest.

  • That lien operates to pay to the creditor if any distributions are made to the debtor’s interest, but if not distributions are made then the creditor gets nothing, and the creditor is not normally entitled to take assets out of the entity either.

  • As mentioned, a few states claim to havebetter charging order laws”, which means charging order laws that are more friendly to debtors and less friendly to creditors. Presumably, so says the marketing of those from these few states, a creditor will be stymied by their states laws and unable to obtain a creditor-friendly charging order.

  • But that theory hinges on the real question: Whose law applies? If somebody forms, say, a Wyoming LLC, but the LLC is actually doing business in California such that the California courts could enter their own charging order against the entity, must Wyoming respect the California court’s judgment even if the opposite decision might have been reached under Wyoming law?

  • This issue comes down to one involving the U.S. Constitution, and more particularly the Full Faith & Credit clause that says that the courts of one state must respect and give power to an order of the courts of other states, just as if a court in-state had issued that order.

  • That brings us to today’s question:

    Is a Charging Order the sort of order that is entitled to Full Faith & Credit by the courts of other states?

  • A recent opinion from a federal bankruptcy court says “Yes”.
For the ruling, see In re Inman, Case No. 10-17707-EPK, Adv. No. 11-01033-EPK, 2012 WL 2309359 (Bankr. S.D. Fla. June 18, 2012).
Editor's Note: Those 'judgment infected' real estate operators getting the bright idea of forming an out-of-state LLC to take title to real estate in an effort to stymie their judgment creditors may have second thoughts about using this asset protection technique in light of this ruling, which essentially provides something of a creditors' roadmap for collecting on outstanding debts in those situations.

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