The Death of Single-Member LLCs?

Ordinarily, a ruling handed down by the Supreme Court of Florida will find its way into the law books with little fanfare and in relative anonymity. Such a fate was not in store for Olmstead v. FTC, wherein the Court held that a person who owns a single-member limited liability company, and who is personally sued (ex., for injuring someone while driving drunk), may be compelled to surrender the LLC, and everything that goes with it, in order to satisfy a personal judgment. Rather than anonymously passing into law, the Olmstead ruling has caught the attention of people who own single-member LLCs, as well as those who have judgments against them.

The Olmstead case started as a fairly routine matter in which the Federal Trade Commission (FTC) sued the defendants for deceptive and unfair trade practices for their participation in an advance-fee credit card scam. The FTC ultimately prevailed and obtained a judgment against the defendants in excess of $10 million. The case took a turn for the interesting when the FTC informed the lower court how it intended to go about satisfying the judgment—taking the single-member LLCs owned separately by the defendants.

Since the defendants did not personally have enough money or assets to satisfy the judgment, the FTC asked that the lower court order the defendants to surrender to the FTC all right, title, and interest in the defendants’ single-member LLCs. The FTC would thereafter liquidate the LLCs to generate money that can be used to satisfy the judgment. Essentially, the FTC wanted to go after the LLCs much like a creditor would any other personal property, like a boat or jewelry.

The defendants argued that the FTC’s approach is prohibited by Florida’s LLC Act. The only way that the FTC can seek satisfaction of the judgment through the LLCs, the defendants argued, is to resort to a charging order. A charging order is a statutory procedure whereby a creditor of an individual member of the LLC can satisfy its claim from the member’s interest in the LLC. The defendants made every effort to convince the Court that the charging order is the FTC’s exclusive remedy. Why? Because, charging orders often fail to provide any real remedy to creditors.

Under the LLC Act, a judgment creditor obtaining a charging order is treated as an assignee of the debtor’s membership interest in the LLC. As such, the assignee is only entitled to share in the profits and distributions that the debtor may receive from the LLC. However, since an assignee of a debtor’s interest is not entitled to participate in the management of the LLC—one cannot call a vote to distribute profits—the creditor holding the charging order is at the mercy of the other LLC members who would, in all likelihood, vote to not make any distributions to the creditor. It is this relative impotence of the charging order that provides LLCs with significant asset protection benefits.

Since the FTC knew that any remedy afforded by a charging order would be illusory, it argued to the Court that in the context of single-member LLCs, the charging order is not the exclusive remedy. Rather, the FTC argued that it is entitled to use another statutory provision which would allow it to treat the defendants’ LLCs like any other personal property for the purpose of satisfying the judgment.

The Court ultimately agreed with the FTC and held that a judgment debtor can be ordered to surrender all right, title, and interest in the debtor’s single-member LLC to satisfy an outstanding judgment. In making its decision, the majority concluded that the absence of the word “exclusive” in the LLC charging order statute was deliberate and significant, thereby precluding the conclusion that the charging order displaces any other remedies that may be available to creditors of debtors who are members of single-member LLCs.

As evidenced by the resulting buzz, the majority’s ruling is not without detractors, not the least of whom are the dissenting judges, who some believe wrote the more persuasive opinion. The dissenters state, in no uncertain terms, that the majority failed in their duty to interpret the law in favor of their desire to seek an equitable outcome. The only way the majority’s result could be achieved, argued the dissent, is for the legislature, not the Court, to change the law.

The dissenting opinion goes to great lengths to undermine the majority’s reasoning and is troubled by the majority’s decision to disregard the principle that in general, an LLC exists separate from its owners. Additionally, the dissent is critical of the majority’s decision to create an exception for single-member LLCs that does not exist in the law and is bothered by how it might be used in the multiple-member LLC context.

Rather than upset the traditional application of the charging order to single-member LLCs, the dissent describes alternative remedies available to the FTC, including dissolution of the LLC and seeking an order of insolvency. Though they may be more complicated than the “shortcut” created by the majority, they are prescribed by statute.

Notwithstanding the technical and legal arguments for and against the majority’s decision, many have questioned whether the Court was right in ruling the way it did. Some believe the Court arrived at an equitable solution, since the FTC was merely trying to remedy a fraud and prevent the perpetrators from hiding money. But do the ends justify the means or is this what people mean when they say bad facts make bad law?

Regardless of the answer, the ruling could lead to some questionable outcomes. For example, while few would express concern over the loss of a single-member LLC that does little more than warehouse its owner’s money, what would happen if the single-member LLC operated a robust business with dozens of employees and hundreds of customers? Would it be acceptable for the creditor to take over the LLC, fire every employee and leave the customers wanting?

Another questionable consequence, which was touched on by the dissent, involves a situation in which the single-member LLC is worth more than the value of the judgment. Is the creditor entitled to keep the surplus or must it be returned to the debtor? Or, consider an example involving a judgment in the amount of $500,000 and a single-member LLC that earns an annual profit of $250,000. Is the debtor entitled to simply take over the business and reap the rewards of a thriving business in perpetuity or would the creditor have to give the LLC back once the judgment has been satisfied? Clearly many questions remain regarding the fallout of the Court’s ruling.

Thus, it is possible that the Olmstead case will be considered during the next legislative session. The legislature may elect to change the law to either conform to the majority’s position or expressly reject it outright. The outcome may hinge on who has the stronger lobby—the large corporations trying to close loopholes that make it difficult to collect on judgments or the wealthy individuals who routinely use single-member LLCs to protect their assets from judgments.

Nevertheless, those who are members of single-member LLCs must understand that the Court’s decision is the current law and that they must proceed accordingly. Prudence demands, at a minimum, an evaluation of their current situation in light of the new risk. Responsive options include converting single-member LLCs to corporations, adding a member to their single-member LLC to (presumably) fall beyond the scope of the Court’s decision, and making defensive amendments to operating agreements. Some are electing to do nothing.

Unfortunately, the uncertainty surrounding the post-Olmstead future precludes a defensive response that will preserve the status quo in every situation. This remains to be the case despite the passage of time since the Court’s ruling. Moreover, creditors may begin to test the fringes of the Court’s decision in the multiple-member LLC context. Thus, those who are members of single-member LLCs, and even multiple-member LLCs, should remain informed about any developments and consult with counsel as needed.