Does an LLC protect its owners from an outside creditor?

Date: January 6, 2015
Author: Jason Piland

Does an LLC protect its owners from an outside creditor?Operating a business as a Limited Liability Company ("LLC") in Tennessee has become a popular option. Even though Tennessee charges initial and annual filing fees, for many business owners, that cost is worth every penny. LLCs in Tennessee have two often-touted advantages: they (1) protect the company's owners from personal responsibility for the company's liabilities (such as loans and lawsuits) and (2) allow the owners to avoid the tax disadvantages of forming a C-Corporation. But there is another reason to form an LLC in Tennessee: it protects the company and its members from the personal creditors of one of the members.

What if an LLC's member (the law's term for an owner) has a personal creditor? For example, what if the member has a court judgment against him? How does that affect that member's and the other members' ownership interests in the LLC?

In a situation like this, Tennessee law provides one remedy: a "charging order." This court order is comparable to a wage garnishment order and directs the LLC to pay the LLC member's income (his share of profits and distributions) to the creditor directly. However, the creditor cannot touch the member's ownership interest, reach the company's assets, or affect any management decisions of the LLC. This is often called "charging order protection." The General Assembly's rationale to provide charging order protection is that an "innocent" member of an LLC should be shielded from the other members' debts. Thus, the innocent members must be able to operate the company free from fear of outside influence.

This rationale does not hold up as well when the LLC has only one member. There are no innocent members to protect from the one's creditors. In fact, at least one court in another state with charging order protection similar to Tennessee has noted this legal anomaly. That court ended up holding that charging order protection does not apply to single-member LLCs. This ground-breaking opinion reasoned that because there are no other members for the law to protect, the assets of the LLC became fair game for the creditors. Tennessee does not have any cases that speak to this issue either way. So, while charging order protection technically applies to single-member LLCs in Tennessee, the jury is out as to whether this kind of protection will continue in the future.

Are you a Tennessee LLC member seeking protection from an outside creditor? Or are you a creditor seeking to obtain a charging order against a Tennessee LLC member?

At Fidelis Law, PLLC we are available to help you and your company seek protection from an outside creditor or help creditors in obtaining a charging order against a Tennessee LLC member. Contact us today to speak with an attorney.