One of the purposes of organizing a business as a limited liability company, or LLC, is to separate a business owner's personal and business assets and obligations. Setting up a company that has the legal status of an independent entity effectively limits the ability of an owner's personal creditors to reach into his business assets to collect payment of personal bills. Ordinarily, the line between business and personal affairs remains intact for regular bills that an LLC owner, known as a member, might incur personally. An LLC can be set up as a single-member or multi-member LLC. If a personal creditor obtains a judgment against a member in either setup for nonpayment, however, the creditor can attempt to attach the member's interest in the LLC.
Fit your business needs with the right LLC package
An LLC is an independent legal entity that exists apart from its members under the law. Once the business is formed, the law gives it many of the same rights as an individual. In practice, this independence means that a single member's personal bills can only affect the LLC in limited ways. These ways are detailed in the state formation statute that authorized the creation of the business and any operating agreement that the owners have adopted to govern business affairs.
State LLC laws model the operation of LLCs after partnerships. The ownership interest in a partnership is based on contract law. Partnership interests are not freely transferable to third parties, like shares of stock in a corporation. The partnership only exists as long as all of the members agree to be in business together. This contractual requirement regarding agreement limits the ability of creditors of a single member to attach the member's interest in the LLC in satisfaction of a personal debt. A personal creditor cannot simply take possession of the ownership interest in the way that a creditor of a person who owns stock in a corporation can take possession of stock certificates.
The primary way that a personal bill can affect a new LLC is if a creditor has a personal court judgment against one of the members. In most states, the judgment gives the creditor the right to attach anything the debtor owns, including his share of business profits. Some states, such as New York, allow the creditor to attach the LLC member's profits from the business whenever they are distributed, but the creditor cannot impact the LLC's operation or force it to do anything proactive to retire the debt. Other states, such as Nevada, do not allow creditors to touch LLC ownership interests at all because of the partnership nature of the business entity.
Many state LLC statutes and the ordinary type of operating agreement that members sign, require a member to immediately sell his interest back to the company if the member enters personal bankruptcy or if a judgment creditor attempts to attach his interest in the LLC. The law protects the other members from having to be in partnership with a personal creditor of a member who may receive the interest or the profits of the interest by court order. Instead, the member is bought out and can use the proceeds to satisfy the debt without the situation impacting the business at all.
Some people attempt to avoid paying personal bills by transferring their assets to a new business entity, such as an LLC. A person can ordinarily transfer his assets at will, but he cannot use the transfer to defraud creditors. If certain personal bills exist at the time an owner starts a new LLC and he capitalizes the business with personal assets that should have been used to pay bills, creditors can attempt to put the member into bankruptcy. Then, creditors can attempt to nullify transfers to the LLC that happened after the debts came into existence.