After 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 basically asking how to set up a “straw man” member in her LLC?
Creating a straw-man member when forming an LLC doesn’t necessarily fix the single-member LLC problem. As I always try and do in these posts, if we understand the theory behind the law, we better understand how things play out in application.
The History Behind The Single Member LLC Scare
The landmark bankruptcy case, In re: Ashley Albright, (US Br Dist. of CO) single handedly cast a massive black cloud over the magical world of total LLC protection. Before that case, business owners would form an LLC seeking protection for there personal life if the LLC was sued (LLC corporate veil protection), and still shield the LLC from trouble in their personal lives. This applied even in bankrupcty. The LLC owner would continue to run the LLC and not distribute income or assets, and the Bankrupcty trustee was left holding a worthless assignment of economic rights. It was a glorious day. Well, in reality, that day still exists in most states. I personally have a few single member LLCs for various investments. Utah and Arizona, the two states where I do business aside from STARTright have been very careful to protect the single member LLC by ensuring charging order protection for single members of a Limited Liability Company.
Understanding The Theory Behind An LLC Co-Member
For those who want to take the very prudent and practical step to ensure their LLC warrants full charging order protection, the following will explain the thoughts to consider when adding another member. Whenever you are wondering about a legal question, ask yourself “WHY?”. Why do they have charging order protection for the limited liability company? The answer is this: because the LLC functioned more like a partnership than a corporation, legislatures and courts wanted to ensure the members of a limited liability company did not end up with a new unwanted partner if their real partner got sued and lost his membership. Thus, unlike corporate shares which may be fully attached in a creditor law suit, the member’s LLC membership may only be “charged” with the debt. So the underlying theory is to protect partners (LLC Members) who have a legitimate interest in the LLC from having to deal with an unwanted or un-bargained for partner if their previous partner gets sued. The law is meant to protect members of an LLC who have a legitimate interest.
Protecting that “legitimate interest” is exactly what the judge in Albriet based his opinion when deciding not to extend charging order protection the Single-Member LLC. He explained that a legitimate interest could potentially be as little as 5% or even smaller. He wasn’t saying. In reality, I think the circumstances define “legitimate”. Say your aging mother who lives on social security (if it can be called living) is made a 2% member of an investment LLC. She has no mangement responsibilities, and thus receives any income paid to her by the LLC at a 15% passive income tax rate. If the LLC makes $50K/month, she would receive $1,000 each month as a member of the Limited Liability Company. To her, this 2% interest is a massive part of her monthly income. Your aging mother has a massive interest in the LLC continuing to be run as is, even if you file for personal bankruptcy. This is how the judge will look at it.
Things To Be Concerned With When Adding A Co-Member
Things to be concerned with if you do go the “minimal co-member” route are as follows:
1. If you do not have an Operating Agreement (which you should have if you use STARTright to make an LLC) the default laws of the state could give the co-member rights over some situations. Also, some states have laws that unless superseded in a well written operating agreement, allow for foreclosure on the charging order which can get ugly.
2. If you have an Operating Agreement from STARTright or someone else, it is important to go through all the provisions that allow members to vote, and determine what you do and do not want the other member to have influence in — set the voting percentage in the provision appropriately.
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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." 
