Updated December 8, 2020
LLC Asset Protection Benefits are Jeopardized When Filed in Another State
I recently received an email from a client who was concerned about some information she received from a promoter of Wyoming LLCs. She was told a Wyoming LLC registered to conduct business in California will provide greater asset protection (charging order protection to be specific) than a California LLC. This misconception is fostered by internet pitchmen and one trick pony attorneys whose only concern is selling you an entity (typically Wyoming, Nevada, or Delaware) and not properly structuring your affairs. The information they provide is full of half-truths and misleading statements designed to obtain your hard earned money under the false premise of superior protection. Do not misinterpret my statement to detract from the beneficial use of entities structured in these states for I use Nevada quite extensively to protect my clients affairs. The key to any strategy is knowing when such an entity makes sense versus when it only increases costs with minimal benefits. The following is my response:
In my opinion, a WY LLC or a NV LLC registered to do business in California would not prevent the creditor of a member from enforcing a charging order against the LLC. Why? When it comes to asset protection and LLCs, we are concerned with two forms of liability: inside liability and outside liability. With inside liability, the primary concern is protecting ourselves as members from liabilities associated with the activities taking place in the LLC e.g., rental real estate. The protection for inside liability claims is derived from two places: state law and the LLC operating agreement, which is the document that governs how the LLC is operated and the protection it offers to its members. Most states are fairly uniform in their approach to inside protection although some, like Wyoming, have adopted the Revised Uniform Limited Liability Company Act and gone of the reservation making LLCs in these states less than desirable (here is a link to a prior post on this subject). Liabilities that occur inside a LLC remain inside and will not attach to the owners of the LLC. Of course, this is contingent upon having a solid LLC operating agreement that has adequate protection and indemnification provisions for the member and managers. Unfortunately, when I review a client’s operating agreement it is not uncommon to find two or three critical defects that, if exposed in a lawsuit, could spell disaster. Nevertheless, with the protection provided by state law and a good operating agreement, the LLC offers excellent protection from the liabilities associated with owning real estate. Thus, if you created a California LLC or a Wyoming LLC registered in California to hold your rental real estate, both entities will protect you from claims arising out of liabilities associated with the LLC’s assets. If, on the other hand, you simply set up a Wyoming LLC to hold the property without registering it California, the outcome may be less clear.
Outside liability protection is just the opposite. Rather than looking to the assets of the LLC for recovery, a creditor is seeking a judgment against a member of the LLC because it is the member that caused the harm and not the LLC. Most people I meet completely miss this point because so much attention is given to protecting you from your real estate that very little thought is given to your personal actions or, for that matter, those of your children who could also jeopardize your investments. You, by your everyday actions, are probably the greatest threat to your assets.
Every state has, to some extent, given LLC members what the law refers to as “charging order” protections. Unlike the situation with “Inside Liability” where the creditor can only look to the assets of the LLC and not the members individually for recovery, with outside liability the creditor is looking to recover against the member’s assets. Your LLC membership interest, like the stock you own in a publicly traded company, is an asset that is considered personal property. One important feature of this asset is its unique characteristics that prevent creditors from levying on it if they have a judgment against you personally. Approximately 23 states, Nevada and Wyoming included in this number, limit the judgment creditor to a charging order.
To read the rest of Clint Coons’ article visit his blog here.