FTC v. Olmstead: Don’t Use Single-Member LLCs for Asset Protection

The recent decision of Olmstead v. FTC[1] could be a sign of things to come for single-member limited liability companies as an asset protection planning device.  In Olmstead, the Florida Supreme Court forced the member of a single-member LLC to transfer his LLC interest to the creditor, rejecting the member’s argument that the charging order should be the exclusive remedy to the creditor.

Under the laws of most states, LLCs are charging-order protected entities.  This means that a creditor’s remedies are restricted to a “charging order” against distributions made to the LLC owner.  If a charging order is the exclusive creditor remedy, the creditor cannot actually take the ownership interest in the LLC or seize the assets of the LLC.  The creditor must simply wait for distributions to be made to the member.  If none are made, the creditor is out of luck.

To understand the Olmstead decision, it is helpful to consider the policy behind charging order protection.  Say George and Dick establish an LLC to conduct consulting activities.  The LLC invests in real estate which will be used as a corporate office.  Dick is then involved in a hunting accident and ends up with a judgment against him.  Should Dick’s judgment creditor be able to seize Dick’s LLC interest or the corporate office owned by the LLC?  In most states, the answer is no.  But this is not to protect Dick.  It is for George’s sake.  George is an innocent party and should not be penalized for Dick’s misdeeds.  From a policy perspective, George should not be forced into partnership with the judgment creditor, nor should his interest in the business assets be placed at risk.  This rationale is embodied in the concept of charging order protection.

But does this same policy apply in the case of single-member LLCs?  Remember that the charging order is intended to protect the other members of the LLC.  When and LLC has no other members, there is no policy ground for protecting the LLC interest or the underlying asset from the reach of legitimate judgment creditors.

The policy of charging order protection underlies the tension in the Olmstead case.  The case involved assets—including single-member LLC interests— that were subject to a receivership.  The FTC obtained a $10 million judgment and asked the court to compel the debtor to surrender h is interest in the single-member LLC.  The debtor argued that Florida law provided charging order protection and thus that the creditor’s sole remedy should be the right to distributions from the LLC.

In a 5-2 decision (with a strong dissent), the Florida Supreme Court sided with the FTC, holding that the statutes governing LLCs (unlike other charging-order protected entities like limited partnerships and limited liability partnerships) did not clearly state that charging order was the exclusive remedy.  The Court stated:

[T]he statutory charging order provision does not preclude application of the creditor‘s remedy of execution on an interest in a single-member LLC. In line with our analysis, we rephrase the certified question as follows: ‘Whether Florida law permits a court to order a judgment debtor to surrender all right, title, and interest in the debtor‘s single member limited liability company to satisfy an outstanding judgment.’ We answer the rephrased question in the affirmative.

In other words, the Court felt that the absence of specific language making the charging order the exclusive remedy left the door open for other remedies.

This case should prompt the Florida legislature to clarify whether charging order protection is the exclusive remedy for LLCs.  Hopefully they will address the applicability to single-member LLCs while they are at it.  This should provide the much-needed clarity that is lacking in most states.  For example, Mississippi’s statute on “Rights of a Creditor” of an LLC provides:

On application to a court of competent jurisdiction by a judgment creditor of a member, the court may charge the limited liability company interest of the member with payment of the unsatisfied amount of the judgment, with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of the limited liability company interest. This article does not deprive any member of the benefit of any exemption laws applicable to his limited liability company interest.

Under the plain language of the statute, the charging order is the only remedy listed as a right of a creditor of a Mississippi LLC.  But it doesn’t specifically state that the remedy is exclusive.  This could leave the door open for an argument that other remedies should be available (although I believe this should not be the result under Mississippi law).

This ambiguity has been latent in state law for several years now, since the issue first arose in bankruptcy litigation.  Bankruptcy courts in Idaho, Maryland, Idaho and Colorado have used the Federal bankruptcy powers to enforce remedies other than charging orders against single-member LLCs.  We have long recommended that, if used for charging order purposes, LLCs should have at least two members and a valid business purpose.  Otherwise, the asset protection benefits of a charging order may vanish when needed most.