Especially useful for small business owners, the LLC can mold to almost any business model. Most of the concepts explained below are better explained in the STARTright videos available in your member account. Limited Liability Companies mesh the best parts of the corporation and partnership.
Like anything, an LLC is weak when used in ways it was not intended. I am writing a series of blog entries addressing best practices when using an LLC. As always, I will follow the STARTright philosophy and try and convey basic concepts using visual diagrams. This allows you the business owner to make the right decisions.
Today, lets talk about single member LLCs. Unlike partnerships or corporations, the limited liability company provides two directions of protection.
- The corporate veil protection: The veil protects the members personal life if the LLC is sued.
- The partnership / charging order protection: The charging order protects the company and the member’s investment if one of the members is sued in his or her personal life.
LLCs receive Partnership Charging Order Protection
Single member LLCs are potentially weak if the owner is hoping to protect the LLC if he gets sued himself. I say potentially, because in law everything is a matter of a two step analysis:
1. Initial Philosophy: laws are usually created to meet a societal need.
2. Evolving Trends: After a law is introduced, the courts assess whether to change the original interpretation of the law to meet evolving societal needs.
The original charging order philosophy protected guys A, B from having to accept D as an unwanted partner if C, the person they originally went into business with gets sued. They don’t want to have to deal with D.
LLC charging order protection intended to stop unwanted partner.
To prevent this unwanted member scenario as shown in figure 3, the charging order is all D can get out of C’s membership as shown in figure 2 above. The charging order limits D. He must wait for A and B to decide to distribute money. No distributions = no money.
The Single Member Hitch: When a the member of a single member LLC is sued, there is no other members to protect from D.
LLC has no one else to protect.
Two bankruptcy courts have used this flaw in the LLC protection to allow creditors of a business owner to completely take over his LLC and liquidate it for cash. The first case was in Colorado and the nation held its breath to see what would happen next. The next case was in Idaho and actually used the Colorado case to base its decision on. This means the trend is starting to move in the direction of denying charging order protection to single member LLCs. The two cases are linked in pdf format below. Next I will talk about how a single member LLC owner can remedy this problem.
Albriet: Colorado Bankruptcy Case
A-Z Electronics: Idaho Bankruptcy Case
Subscribe
As a business law attorney and founder of STARTright, Spencer Rose is the driving force behind STARTright, and the voice behind STARTright Talk. A graduate of Boston University School of Law, Spencer developed STARTright to help entrepreneurs navigate the waters of starting a new business, especially the legal and tax aspects. "Talk is my opportunity to write about all kinds of aspects affecting entrepreneurship and business building." 
Forming An LLC With A Straw-Man Member Does Not Necessarily Fix The Single-Member LLC Problem | STARTright Talk
on May 20th, 2009
@ 4:19 pm:
[...] a reader finished my article discussing the problems of having a single member LLC, she wrote me asking how to add a “No-equity, non-managing” member. She was [...]