As many of you might know, there is a new LLC Act that goes into effect on January 1, 2018 for all LLCs in Minnesota. I have previously written about how many of the changes might affect older businesses that operated under the old law. However, there is also a change that many may not realize. The Asset Protection features of the LLC in Minnesota were weakened.
LLCs and Partnerships have been attractive ways to protect assets in Minnesota for many years. A Charging Order essentially allows for a creditor to receive any distributions from the LLC or the Partnership that the debtor might receive. If the company doesn’t declare a distribution then the creditor isn’t able to get cash either. However, due to IRS rules, the creditor still must recognize income related to the debtor’s share even if none is ever actually paid out.
This often allowed for an LLC Member to simply stop taking distributions. Whether or not the creditor recovered then became a waiting game. If the LLC member could do without the money then the longer that he waited the more pressure that the creditor might feel to settle the debt. Since judgments are normally only good for ten years in Minnesota, it was possible, but unlikely that the debtor could wait until the creditor’s rights were extinguished.
However, that has all changed now. The Charging Order is the exclusive remedy in Minnesota and many other states for Partnerships and LLCs. That is what initially made them so attractive as business entities and asset protection tools. However, this protection has wavered over time. While the Charging Order is still a very effective and desirable Asset Protection feature, the law now can allow for other avenues.
In recent years, courts have begun to allow creditors to foreclose the interests of debtors in LLCs and Partnerships. Courts have long recognized that these are not corporations and that business owners should be able to choose their partners without the interference of creditors. This allowed for the orderly operation of the business and was in line with the fact that members only had the money invested in the company at risk.
Many courts soon began to allow the creditor to foreclose the interest anyway. This allowed for a public auction of the ownership of the Partnership or the LLC. Many times, this meant that the creditor ended up with the interest. Most times, the winner at the auction did not receive any right to vote on company or partnership business. The partners and members were still free to not admit them as full partners or members.
The rights of the transferee often were defined in the Operating Agreement also. If this was not carefully drafted, the creditor would then accede to voting rights in the entity itself. Minnesota Partnership interests can be foreclosed at any time. This has been a feature of the Partnership statute for years.
However, LLCs have not had this issue. Minn. Stat. § 322B.32 provided that the Charging Order was the exclusive remedy of a creditor. The statute was silent as to foreclosure of the interest. This made them preferable to Partnerships because the Partnership statute allowed for foreclosure “at any time.” This made an LLC in Minnesota have strong Asset Protection properties.
The new LLC Act allows for foreclosure of the Partnership interest. Minn. Stat. § 322C.0503 subd. 3 allows a creditor to foreclose the interest if a Charging Order doesn’t allow them to be paid within a reasonable time. A debtor could then still be faced with the loss of income and negotiating with the purchaser of the auction to buy the interest back. This does tip the balance more in favor of the creditor under the new Act.
Minnesota LLCs are still a very valid and powerful part of your Asset Protection plan. However, the new Act provides for the foreclosure of a Member’s interests if the LLC decides to not distribute enough cash to pay off the creditor in a reasonable time. There are other provisions of the Act that might allow the skilled Asset Protection Attorney to limit the losses in this event. LLCs should be taken as just one part in a larger whole of an Asset Protection plan. If you have any questions or concerns about your Asset Protection then contact us today for a Free Consultation.