For many small entrepreneurs the main reason to form a company in Colorado is for asset protection from liability.? The most often selected entity for this liability protection is the Limited Liability Corporation or LLC because the LLC offers great flexibility for its members in terms of organization and taxation options.? A new marketing campaign by several incorporation companies attempts to convince small businesses to form their new LLCs in states other than Colorado by offering ?charging order protection?.? The truth is, all states offer some charging order protection for an LLC but the laws of some states favor the debtor and the laws of some states, Colorado included, favor the creditor. Additionally, recent case law seems to indicate that single member LLCs formed in any state may not have charging order protection.
In general, the assets of an LLC cannot be taken by creditors to repay the liabilities of LLC members.? Often one of the only ways to reach the debtor?s interest in an LLC is by obtaining a charging order. Developed out of partnership law, a charging order allows a creditor to be paid any distributions or assets of the LLC that are due to the judgment debtor. If the LLC does not make any distributions then the charging order is avoided. However, in Colorado not only can a creditor obtain a charging order but a creditor may be able to foreclose upon a member?s LLC interest.? This foreclosure option is not always available in other states which limit creditor?s remedies to a charging order only and hence the claim that the state offers charging order protection.? While the foreclosure option is available in Colorado, it is difficult and often expensive to pursue. As there is very little case law in this area so it is still unclear how foreclosure of a membership interest should take place in Colorado.
Notably, a charging order does not give the creditor the right to participate in the running of the LLC. A charging order is specific to the judgment debtor and is not intended to force other members of the LLC to share governance of the LLC, become business partners with the creditor, or force dissolution of the LLC without the consent of all the members. Single member LLCs do not need protection from charging orders since, by nature, they only have one member. The result is that in some states, Colorado included, courts may choose to order the judgment debtor of a single member LLC to assign the interest in the LLC over to the creditor.
So because other states advertise better ?charging order? protection, does that mean that you should never form an LLC in Colorado?? While there may be other advantages to forming an LLC in another state, charging order protection is not one of them.? First, the LLC will incur fees and potentially taxes in more than one state. Second, based on the Full Faith and Credit laws, courts of one state will give power and effect to the orders of courts from another state as, if the judgment or order was issued by an in-state court.? For example, charging orders were recently held to be entitled to ?Full Faith and Credit Protection? under In re Inman, (Bkrtcy.S.D.Fla., Slip Copy, June 18, 2012).? Accordingly, even if your LLC is formed under another state?s law, if a charging order is obtained in Colorado, it will likely be respected by the courts of the state in which your LLC was formed.
If the only goal for your LLC is asset protection from personal creditors, then in Colorado, it may be more advantageous to form a multimember LLC over a single member LLC.? Of course the members of the LLC must be actual active members and not simply members on paper to create the illusion of a multi-member LLC.
Smart Tip:? Consult with an experienced corporate attorney to assist with LLC formation in Colorado or any of the other states in which you intend to establish a business.