Can creditors take your business assets to pay off your personal debts?
It depends on the type of business entity you’ve chosen and where it is located.
If the business is set up as a corporation, the shareholder’s personal creditors cannot directly take over ownership of the corporation’s assets, such as its bank accounts, to pay off a judgment against him. However, they can obtain ownership of the shareholder’s stock in the corporation. They’ll be entitled to the shareholder’s share of the corporation’s profits and to participate in the corporation’s management. If they obtain ownership of 51% of more of the corporate stock, they can have the corporation liquidated and its assets sold to pay off the shareholder’s debt.
If the business is an LLC instead of a Corporation, things will work out differently for John and his creditors. Just as with corporations, an LLC’s money or property cannot be taken by personal creditors of the LLC’s owners to satisfy personal debts against the owner. However, unlike with corporations, the personal creditors of LLC owners cannot obtain full ownership of an owner-debtor’s membership interest. Instead, LLC owners are not at risk of having another LLC member’s creditor step into the shoes of an LLC debtor/member and share in the management and control of the LLC.
All states permit personal creditors of an LLC owner to obtain a charging order against the debtor-owner’s membership interest. A charging order is an order issued by a court directing an LLC’s manager to pay to the debtor-owner’s personal creditor any distributions of income or profits that would otherwise be distributed to the debtor-member.
However, in most states, creditors with a charging order only obtain the owner-debtor’s “financial rights” and cannot participate in management of the LLC. Thus, the creditor cannot order the LLC to make a distribution subject to its charging order. Very frequently, creditors who obtain charging orders end up with nothing because they can’t order the LLC to make any distributions. As a result they are not a very effective collection tool for creditors.
A simple way to avoid the potential creditor problem is to make sure that your LLC has at least two members. The second member could be your spouse or another relative. Personal creditors are not permitted to take over the debtor-member’s LLC interest and join in the management of the LLC or have the LLC dissolved and its assets sold without the other members’ consent. However, this rationale disappears when the LLC has only a single member (owner) because there are no other LLC owner/members to protect.
A comprehensive operating agreement is particularly important for multi-member LLCs, since disputes may develop among the members.