Multi-Member vs a Single Member LLC: Does it Make a Difference?
One of the main reasons to form a Limited Liability Company for a business is for asset protection of the individual Members if the LLC incurs a liability- the assets of the company might be at risk but unless the members have signed personal guarantees, personal assets are protected. An LLC or a corporate form can be equally successful in protecting this interest but the corporate form is much more complicated. An LLC can be relatively simple be it a Single Member LLC or a.
However, an LLC has another advantage over a corporation: what has been termed “charging order protection.” What does that mean? In a nutshell, it means that if a member of an LLC becomes a debtor (usually as a result of some action that may have no connection to the LLC at all such as a lawsuit over an auto accident) the Member’s creditor does not get the assets of the LLC nor does the creditor get the Member’s LLC interest outright. In many states, a creditor is prohibited by law from taking the membership rights of a member of an LLC, as a creditor is traditionally allowed do to the shares of a corporation. In the case of an LLC, the creditor can only get a lien against the debtor/member’s financial interest in the company. This means, more specifically, that a creditor gets a lien against what is known as the debtor/member’s “economic interest” in the LLC and can only obtain actual distributions that the LLC makes to the debtor/Member. The creditor does not receive anything unless the LLC makes a distribution.
The reason personal creditors of individual LLC owners are limited to a charging order is to protect the other members (owners) of the LLC. LLC law was an offshoot of partnership law and the belief is that Members of an LLC should get to “pick their partner” and therefore personal creditors should not be permitted to take over a debtor/member’s LLC interest and interfere with the management of the LLC. This “pick your partner” rationale doesn’t apply when there is only one member of an LLC. Therefore, some states like NH have made a distinction between multi-member and a single member LLC (SMLLC) while others such as Delaware specifically apply that principal to SMLLCs as well as MMLLCs .
The Dangers of a Charging Order to a NH Single Member LLC
Under New Hampshire’s LLC law, personal creditors of a Single Member LLC owner are not limited to the charging order remedy. If the creditor of an SMLLC owner can show a court that the distributions under a charging order will not satisfy the judgment within a reasonable time, the court will order that all the SMLLC owner’s rights—both financial and management—be sold in an execution sale. The purchaser of the interest—often the creditor—becomes the new owner of the SMLLC, and the old owner ceases to be a member of the LLC. This is an extremely powerful creditor remedy unavailable in many states and easily result in the loss of the company. If there are significant assets in the company, this can be a personal disaster as well as a business disaster.
Compare this rule the Delaware statute, which in 6 Del. C. § 18-703 provides that the “entry of a charging order is the exclusive remedy by which a judgment creditor of a member or a member’s assignee may satisfy a judgment out of the judgment debtor’s limited liability company . . . . whether the limited liability company has 1 member or more than 1 member.” Under the Delaware statute, it is clear that the charging order protection provided to LLCs applies to both SMLLCs and multi-member LLCs.
Delaware LLC vs NH Single Member LLC
Based on the current status of the law, if an individual wants to form a single Member LLC in New Hampshire we feel compelled to warn them that they will not have charging order protection and depending on the type of business we will encourage them to form a Delaware LLC or consider adding another member to their LLC, such as a spouse, so it won’t be a Single Member LLC. If the Member decides to add another member, the second member must be treated as a legitimate co-owner of the LLC. If the second owner is added merely on paper as a sham, the court may treat the multi-member LLC as a Single Member LLC. Another advantage of a MMLLC may be a business succession plan- the other member is already onboard.