Those of us who were practicing business attorneys in the early 1990’s will remember the first inkling of a new entity called a “limited liability company”. In 1993, Michigan adopted its Limited Liability Company Act, MCL 450.4101 et seq. (the “Act”).
The LLC has become the dominant business form, at least in Michigan. Except for big publicly traded companies, almost all new entities, especially small businesses and family businesses, are LLC’s. Amendments to the Act effective December 16, 2010 modified Section 507, which limits a judgment creditor of a member of an LLC to a “charging order” as a sole remedy.
In Michigan’s troubled economy, it is not unusual for an LLC member to have a judgment entered against him or her individually. The issue then arises as to the right of that creditor to enforce that judgment against a member of the LLC and the assets owned by the LLC.
While the LLC entity was, in some sense, the love child produced by a union of a corporation and a partnership, the dominant genes in that union came from the partnership side. The treatment of the debtor who is a shareholder in a corporation has always been different than the treatment of the debtor who was a partner in the partnership. A judgment creditor or bankruptcy trustee can seize the shares of stock held by a shareholder, and step into the shareholder’s shoes.
A partnership, however, has always been considered to be a different animal. Partners can generally not be forced to take on a new or different partner without their consent. Most old-time law firm partnership agreements provide that the partners must affirmatively decide to have a new or substituted partner coming into their “family”. A creditor of a debtor-partner cannot force themselves into partner status, or force the sale of partnership assets. The creditor has generally been left with the sole remedy of a “charging order” against the partnership, allowing the creditor to be entitled only to any actual distribution made with respect to that partnership interest.
The charging order is also the procedure for the LLC member’s creditor. In the LLC context, however, the exclusivity of a charging order as the remedy for a creditor of an LLC member, especially in single-member LLC’s has been questioned in recent years. In cases around the country, creditors or bankruptcy trustees have been allowed to go beyond a charging order, forcing the sale of assets owned by the LLC, and collecting against those proceeds.
Section 507 specifically disallows those attacks. In Michigan, a judgment creditor’s sole remedy is a charging order. The creditor cannot force the sale of real estate owned by the LLC or the dissolution of the LLC so they may receive cash for the debtor’s share. Many LLC’s, such as those owning real estate, may not make regular distributions, leaving the creditor unable to collect. The debtor-member remains an LLC member, and retains all rights and powers except the right to receive distributions. Some commentators say that Michigan now has the strongest asset protection wall in the nation.
This is not an absolute unbreakable wall. You need to look closely at the situation before setting up an LLC for creditor protection purposes. There are still fraudulent transfer issues: if you set up a single-member LLC an hour before the appeals period runs on a million dollar judgment, you may well not be safe. The theories of “piercing the veil” and “alter ego” may also still be alive. In general, however, the amended section 507 is one more reason why the LLC is the most popular type of entity for family businesses or small businesses in Michigan.