Many investors in assets such as rental real estate or small operating business buy their investments or run their businesses though a limited liability company because unlike shares of corporation, the owners membership interest in an LLC cannot be levied upon by judgment creditors. The judgment creditors’ remedy is limited to a charging lien against distributions of cash, if any, that the LLC makes to its owners. I met with some people today who asked questions about the benefits of an LLC which questions indicated common misunderstandings about the LLC’s asset protection benefits. I’ll address each of the points raised by my client about he and some partners owning rental real estate in an LLC with several owners.
First, an LLC provides no asset protection against lawsuits brought against the LLC. For instance, if you own a parcel of rental real estate in an LLC and one of your tenants, or a guest on the property, brings a lawsuit against the LLC as the property owner, the LLC will not protect the property. If the plaintiff gets a judgment against the LLC the plaintiff can levy upon the property and foreclose the property to satisfy the judgment.
Second, if there is a judgment against one of several LLC members from a lawsuit brought against the owner individually, not against the LLC, the LLC cannot avoid a charging lien against the debtor owner by withholding distributions if at the same time the LLC distributes cash to the other non-debtor owners. Most LLC agreements require equal and pro-rata distributions among members.
Third, the client wanted to know if he could avoid charging liens by having his LLC pay money not to him, the owner, but directly to the bank who holds the mortgage on his personal residence. This too is a bad idea. Paying personal expenses directly from an LLC or a corporation is a prime basis by which a creditor could argue that the business entity is merely the alter-ego of the owner and not a separate legal entity. If the LLC is deemed to be the owner’s alter-ego the creditor can “pierce the veil” of the LLC in which case the creditor holding a judgment against the individual could directly attack the assets of the alter-ego LLC. Do not pay personal expenses directly from your LLC or corporate checking accounts. Have the business pay you money, and then you can pay your expenses.