Last updated: September 14, 2022

Charging order protection is a vital strategy for protecting your assets from lawsuits. LLCs have an added benefit of charging order protection, which offers distinct advantages over the asset protection strategies provided by corporations.

The goal of this article is to show you how a business entity such as a Limited Liability Company can protect your assets better than other entity types through a solid asset protection plan without sacrificing any of the liability protection you enjoy with a Limited Liability Company.

What is Asset Protection?

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It is a strategy to protect assets and wealth from judgment creditors or other claimants who attempt to seize your asset for payment on their claim.

Planning on how to protect your assets minimizes the time, money, and energy spent defending asset protection claims.

LLC protection is unique because it doesn't stop at merely sheltering assets from attack - protecting assets strategies encourage you to put those assets into service as an integral part of your overall business plan.

This asset-based approach helps you reduce taxes and provides liquidity by allowing the asset to be used in exchange for services rendered today instead of being tied up in legal red tape and court battles indefinitely.

What is Charging Order Protection?

While other strategies are available for protecting assets from creditors, LLCs have an added benefit called charging order protection.

A charging order is another name for a charging lien, which allows a creditor to get your assets if they are restricted by your limited liability company (LLC) or partnership.

A creditor generally cannot gain access to your personal assets unless he obtains a statutorily protected charging lien. Instead, the only thing a lender may do is ask for a distribution from your asset protection LLC.

Charging order protection is only available in LLCs and not in corporations or general partnerships.

Charging order protection can be stronger than other asset-protection strategies such as umbrella insurance because most creditors cannot seize your assets if an LLC member files bankruptcy.

Charging order protection in LLCs can be very valuable because creditors cannot seize assets that are owned by other LLC members if the first member files bankruptcy.

If an individual member goes bankrupt, then only the assets held in the name of that one individual are affected. All other assets are safe from seizure because they are owned by other LLC members.

As mentioned, asset protection can be very valuable because it allows you to plan for the future and minimize the risk of loss before a problem occurs.

Charging Order Protection Vs. Single-Member LLCs

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The typical Limited Liability Company is owned by one member (called a single-member LLC) and does not offer to charge order protection.

A Single-Member LLC is often used for LLC asset protection when the owner has no other entity in which to place his/her assets, or it is created with partners who are relatives.

Charging order protection is also available in multi-member LLCs, which are designed for business partners or people who want to place their assets into another entity.

Single Member LLCs offer charging order protection, but with one exception: if there is just one LLC member and it's an individual, then the creditor could seize the debtor's interest in the LLC--essentially converting it to a single-member LLC.

Charging Order Protection In Partnerships Vs. Multi-Member LLCs

In a partnership, creditors can take charging orders against each partner's interest in the business.

This business entity allows them to collect from each person's share of the profits until the creditor has been paid off. Then, the creditor must release the charging order.

Since only one partner is responsible for paying off the creditor, if that partner defaults on payments, it can jeopardize all of the remaining partners' financial interests in the business.

This risk is not present with a multi-member LLC because there are multiple owners who each have an ownership interest.

State Rules on Creditor's Remedies

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Most states recognize the charging order as the creditor's exclusive remedy.

So, asset protection is built into LLCs.

However, a few states do not recognize charging orders and allow other remedies such as:

  • Personal asset seizure (e.g., Texas)
  • Seizure of an assignment of the debtor's membership interest in the LLC (e.g., California)
  • Seizure of transfer of debtor's assets (e.g., Colorado).

To find out what remedies your state allows, review the statutes on charging orders and creditor's remedies for asset protection entities such as LLCs, partnerships, and S corporations.

Consequences

If the charging order is not paid by the LLC, then the creditor obtains the asset, which can be any asset of value. If there are many claims for charged order creditors, then the LLC will have to dissolve or foreclose.

Foreclosure

If a member's financial rights are seized, the creditor becomes the permanent owner of all of that person's financial rights, including the right to receive money from the LLC. The creditor is unable to force the LLC to pay money to it or anyone else, however.

The LLC and its members would most likely negotiate the debt with the creditor before foreclosure was issued. A creditor's ability to foreclose on an LLC membership interest puts individual creditors of LLC owners in a stronger bargaining position than they have under the state LLC laws that don't allow for foreclosures.

Dissolution

Personal creditors of LLC owners in a few jurisdictions are permitted to get a court order dissolving the company. In this case, the LLC would have to shut down and sell all of its assets. Personal creditors of LLC owners have the most severe option available.

4 Strategies to Enhance Charging Order Protection

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A key aim of asset protection is to make it as hard as possible for a creditor to access your assets, and the LLC is an important tool in this regard.

We can't always influence the charging order laws of a state, nor can we always anticipate which state's rules will apply in any specific lawsuit, but we may structure and rule our LLCs to improve charging order protection.

If the goal of your LLC is to safeguard an asset from your liabilities outside of it, you might wish to explore some of the following solutions to better protect your LLC's charging order.

1) Use Multiple Layers with a Holding Company Structure:

Since LLC asset protection strategies are about making it hard for a creditor to get what they want, consider creating several layers of LLCs. A holding company or umbrella LLC will serve as the highest layer, and its only asset should be owned in each lower-level LLC your form.

As you go further down, each LLC should own assets like real estate and investment accounts and should be asset protected in its own state.

2) Turn Your LLC into a Multiple-Member LLC:

The laws in some states only provide asset protection if the debtor and creditor are members of the LLC. These states usually give more protection to multiple-member LLCs than to single-member LLCs.

3) Place Restrictions on Distributions and Transfers

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Placing restrictions on asset transfers and distributions can help to prevent a creditor from seizing an asset if your LLC was dissolved.

Reducing the available cash flow in a multiple-member LLC may make it more difficult for a creditor to gain control of the asset without the consent of other LLC members.

Some operating agreements will have limitations on transferring LLC interests and often provide for automatic payouts at tax time, which is reasonable from an asset protection standpoint.

Provisions requiring the LLC to distribute profits just guarantee that the creditor will receive a payout.

In general, a creditor has the right to obtain anything the debtor is entitled to receive, and it's best if the debtor does not expect distributions.

Limiting or restricting the authorization of disbursements (such as requiring the approval of other members or the manager) makes it less likely a creditor will receive anything, thus negating any impact if one is granted.

4) Insert a Buy-Out Clause:

If the other LLC members are pleasant, include a buy-out provision that activates when specific collection action is taken against the debtor and allows the non-debtor (ex-member) participants to purchase out his or her interest in the LLC at a set price (usually minor).

Obviously, you don't want to sell your partnership interest to a complete

Although there are various advantages to thorough planning, there may also be drawbacks; therefore, you should always talk about these things with a professional to figure out what's best for you.

FAQs

What Happens after a Charging Order?

The creditor trying to collect through a charging order has the same rights as any other LLC member would have in dealing with the asset.

If there are no charging orders, then all asset transfers are approved by the debtor-member.

If you receive notice of a charging order, engage legal counsel immediately.

You can do this without being rude or suspicious. Remember, asset protection is a complicated subject and can usually be discussed in a way that doesn't make the debtor-member feel threatened.

How Long Does a Charging Order Last?

A charging order is effective until it's replaced by a judgment lien or the member who received the order voluntarily dissolves the LLC.

Is LLC Protected from Creditors?

An asset protection creditor is one who has obtained a charging order from the court. In other words, asset protection only applies to creditors with charging orders.

What Is a Motion for a Charging Order?

If the debtor-member does not agree to dissolve the LLC, then the creditor must file suit against all members of the asset protection LLC with a motion for charging order.

How Can I Protect My Assets?

The best asset protection for your business is through a well-thought-out entity structure and thorough planning.

Although asset protection strategies have been used by savvy entrepreneurs for years, asset protection is a complicated subject that can be discussed in a way that doesn't make the debtor feel threatened.

If asset protection planning is done correctly, it won't cost you anything, and it will help to grow your asset value faster. Many people have heard of asset protection but don't know what it really entails.

Should You Form Your LLC outside Our Home State?

Although asset protection and tax savings is a positive aspect, it will not be helpful if you don't have any asset or asset value to protect.

Therefore, asset protection planning should be done correctly to grow the value of your business.

LLC Asset Protection and Charging Orders....

In conclusion, asset protection is a complicated subject and can usually be discussed in a way that doesn't make the debtor feel threatened.

As asset protection strategies have been used by savvy entrepreneurs for years, asset protection is a complicated subject that can be discussed in a way that won't make the debtor feel threatened.

In closing, asset protection planning is done correctly, it won't cost you anything, and it will help to grow your asset value faster.

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