The Charging Order…Asset Protection Lawyers Overrate Its Power

Michigan Asset Protection Lawyers constantly extol the protection that Michigan limited liability companies provide debtors as a result of the charging order remedy. As the story line goes, a creditor with a judgment against an LLC member of a multimember LLC cannot reach LLC assets directly. Instead, it obtains a charging order and distributions otherwise payable to the debtor member must now be paid directly to the creditor. Since the debtor often has influence over whether distributions are made, this gives the debtor a negotiating opportunity with his creditors. However, in the real world the charging order may not be as powerful as advertised.

In dealing with the IRS, you frequently see the government attempting to collect debts owed by members of LLC’s by levying directly on the assets of the Michigan LLC. How can the government do this you ask. Isn’t the government bound by the charging order rules under Michigan law? Indeed the government has acknowledged in published notices that in the case of multimember LLC’s it will honor the charging order rules…so what gives?

The IRS will attack on the theory that the LLC is an alter ego or nominee of the debtor member. If it gets area counsel to sign off it can immediately levy without warning to the LLC. The theory is that the LLC is really the taxpayer under another name and all of the adminstrative protections have already been given to the taxpayer. This attack can be devastating and put the LLC out of business. The only defense is a wrongful levy action. But this is a complicated and expensive Federal Court lawsuit that may go on for years and in the meantime the LLC is out of business.

To minimize the chance of this happening the debtor member must avoid any indicia that the LLC is his alter ego. This means the LLC must not pay personal expenses of the debtor member out of the LLC’s bank account, do not commingle personal funds with LLC funds and insure that all distributions to members are pro rata in accordance with their membership interests. Moreover, if the LLC is a family entity it will be subject to heightened scrutiny so you need to be particularly careful in such cases.