How to Solve the Single Member LLC Dilemma

Client presents with a single member limited liability company. The emerging case law is that single member LLC’s are not entitled to charging order protection. This makes sense since the original purpose of the charging order remedy was to protect partners in a partnership from being forced to accept a bankrupt partner’s creditors as their new partner. However, since a single member does not face that risk, there is no need for the charging order remedy and courts in several states have held that creditors can foreclose the interest and sell the LLC’s assets to pay debts. Although no case in Michigan has yet held that creditors of a single member LLC can foreclose on the assets of the LLC to pay the member’s debts, it is this author’s opinion that it is only a matter of time and Michigan asset protection planners need to figure out how to protect the single member’s membership interest from creditor claims.

One solution is for the LLC to issue additional membership interests to new members for fair value thereby transforming the LLC from a single member to a multi-member LLC. Make sure an outside valuation expert provides support for the consideration paid by the new member. Also, amend the Operating Agreement to reflect the new multi-member status of the LLC. If these maneuvers are challenged by creditors, we would take the position that the debtor member has not transferred anything and therefore there can be no fraudulent transfer under the Fraudulent Transfer Act. However, does this strategy work if there is no independent business justification for bringing in a new member? What if the testimony in the collection suit demonstrates that the single member orchestrated the admission of the new member with the intent to hinder, delay or defraud his creditors. It would be our position that even under these circumstances, the single member has made no transfer so how can there be a fraudulent transfer.

As more sophisticated asset protection strategies are employed in the years to come we can expect to see courts struggling with trying to analyze the transactions under existing laws as well as legislators enacting laws to stem perceived abuses.