Watch Out For This Vulnerability When Forming A Florida LLC

Before doing business or owning assets through a single-member Florida LLC, you should consider either adding a nominal partner or using a Delaware single-member LLC instead. Florida is the most popular state for business formation. Florida has more active business entities than even the state of Delaware. More than 2.6 million entities are active in the state of Florida.

 

 

Starting a Florida LLC is a popular way to protect investments in real estate, boats, and businesses. Unfortunately, there is a peculiar vulnerability for single-member Florida LLCs. The good news is that Multi-Member Florida LLCs and Delaware single-member LLCs qualified to do business in Florida do not have this vulnerability.

Most states do not limit a creditor of an LLC Member to a charging order. In fact, most states are not very friendly to creditor rights. That is why entrepreneurs should “forum shop” for the most business-friendly state when starting an LLC. It may be convenient to form a Florida LLC as a single owner, but it may not be advisable. Better would be to be aware of “the charging order being the exclusive remedy of a creditor” under the Delaware LLC Act. Then be aware that under the “Internal Affairs Doctrine” that a Florida court typically applies the Delaware LLC Act instead of local judgment creditor law when determining the remedy available to a judgment creditor of a member. It is important that this planning be done before any liability is foreseeable. If you form a company after a contract breach or an accident, all planning may be reversed through local fraudulent transfer laws. You want to avoid transferring assets in defraud of a creditor. Instead, plan and structure your company in advance before problems arise.

The Vulnerability

In Olmstead v. FTC 44 So. 3d 76, 83 (Fla. 2010), the Florida Supreme Court reduced the asset protection abilities of single-member Florida LLCs and by extension, the question was whether this case would also in peril Multi-Member Florida LLCs. Olmstead fundamentally altered the legal protections from creditors of the member in a Florida LLC. Stemming from a fraudulent credit card scheme, the case questioned the extent of creditor rights against which the debtor was the Florida LLC’s member. The Florida Supreme Court ultimately ruled that creditors could potentially seize the entire LLC interest in a foreclosure to satisfy the debt of the member rather than being limited to a “charging order”. A “charging order” is a type of lien on distributions from a company to a debtor and is addressed below.

This decision cast doubt on the exclusive nature of charging orders for single-member Florida LLCs and potentially multi-member Florida LLCs. In response, the Florida legislature enacted the “Olmstead Patch”, which patched the hole for Multi-Member Florida LLCs but not single-member Florida LLCs. To this day, if a creditor can prove that receiving payments from a charging order would take too long to satisfy a debt, a court can order the sale of the entire single-member Florida LLC interest. These new subsections in Florida Statutes §608.433 are designed to equip courts with the authority to address situations where a judgment creditor faces obstacles in collecting a judgment against the sole member of a single-member Florida LLC. Under specific circumstances and upon a judgment creditor’s motion, courts may impose remedies exceeding the limited distribution right if sufficient evidence exists to justify such action.

What Is A Charging Order?

The origins of charging orders can be traced back to 19th-century English partnership law. The Partnership Act of 1890 in England provided that rather than obtaining a writ of execution against assets held by a partnership to satisfy a judgment debt for one of the partners, a creditor of a partner must obtain an order from a court charging the partner’s economic interest in the partnership. The modern-day, U.S. version of a charging order allows a creditor to collect distributions from a company owned by a debtor, similar to wage garnishment. Charging orders do not provide management and voting rights of a typical LLC membership interest. Jay D. Adkisson, in Asset Protection: Concepts & Strategies for Protecting Your Wealth, describes a charging order as, “simply a court document that directs the managers of the LLC to divert distributions that would otherwise go to the debtor member to the creditor unless the judgment is paid.”

What Does A Charging Order Do For Creditors?

A charging order is often a less-than-ideal remedy for creditors as it only grants a lien on future distributions from the LLC rather than ownership of the debtor’s interest. A creditor may face significant delays in recovering its funds, especially if the LLC’s operating agreement limits distributions or allows for discretionary management fees to be paid to its member or members.

What Is An Example Of This?

It might help to use an example of someone named Donald who owns a private jet in the name of “Art of the Deal LLC” that is stored at the Palm Beach International Airport. Some might recommend that Melania owns 1% of his jet rather than have Donald own 100%, in case he has civil liability that is not ensured and his personal creditors start to look for his assets to collect on their judgment. The question is can the personal creditor foreclose on his LLC interest and take possession of his jet or is the creditor limited to a charging order where Donald may be able to continue to use his jet and not pay the creditor anything, because the jet has no income, just expenses.

How Can A Single-Member LLC In Florida Reduce Risks From Creditors?

One method a single-member LLC may use to reduce the risks to creditors is to grant a membership interest to a nominal member, such as a 1% non-voting interest. This ensures that the nominal owner is not going to reap the benefits of significant ownership interest in the Florida LLC but still classifies as a Multi-Member Florida LLC.

Another option is using a Delaware single-member LLC. Delaware offers superior asset protection for single-member LLCs compared to Florida. Unlike Florida, Delaware extends charging order protection to single-member LLCs, shielding owners from personal creditor interference. To do this the business owner should form a Delaware LLC and then qualify it as a foreign LLC in Florida. This method is a strategic option for business owners seeking to maximize liability protection while benefiting from Delaware’s business-friendly legal environment.