06.01.2003 | Uncategorized

Single Member Limited Liability Companies: Too Much Risk?

Massachusetts now recognizes single member limited liability companies.  Prior to enactment of this legislation, business owners who chose to own property individually typically used corporations if they sought limited liability.  For numerous reasons, not the least of which are tax related, the use of single member limited liability companies has become a more desirable structure.  Single member limited liability companies are now quite common throughout the country and have displaced subchapter S corporations as the desired entity for individual owners of real estate.  A recent bankruptcy court case from the State of Colorado has created issues, however, that should prompt some owners to reconsider the use of single member limited liability companies.

The case is In Re AlbrightAlbright involved a bankruptcy filing by Ashley Albright.  Ashley Albright was the sole member and manager of a Colorado limited liability company.  The limited liability company owned real property and was not a debtor in bankruptcy.  Under Colorado law, and typical of most state laws regulating limited liability companies, Albright’s creditors main remedy appeared to be limited to obtaining a “charging order”[1] against Albright’s interest in the limited liability company.

The Chapter 7 trustee sought instead to take control of the limited liability company and cause the limited liability company to sell its real property and distribute the net sales proceeds to the bankruptcy estate.  The bankruptcy court ruled that the provisions of the Colorado Limited Liability Company Act which limit creditors rights to a “charging order” “exists to protect other members of a limited liability company from having to involuntarily share governance responsibilities with someone they did not choose or from having to accept a creditor of another member as a co-manager.”  The Court further stated that a “charging order” protects the autonomy of the original members and their ability to manage their own enterprise.  The Court emphasized that in a single member entity there are no non-debtor members to protect and, therefore, the “charging order” limitation serves no purpose in a single member limited liability company.  The Court concluded that, by virtue of the bankruptcy filing, the trustee became the sole member of the limited liability company and now controlled all governance of the entity, including decisions regarding liquidation of the entities assets.

The Court in Albright emphasized that its analysis was based on the single member status of the limited liability company.  It can be inferred that if there were two members, even if the second member owned a very minority interest (i.e. one (1%) percent or less), a different conclusion may have been reached.  Where the practical effect of having a second member is insignificant, it may be prudent in light of Albright to consider such a structure.  Employing a two member structure may result in the entity no longer being considered a “disregarded entity” for income tax purposes; thus, the entity may need to file its own tax return and provide K-1’s to each of its members.  All other aspects of the company should, however, remain the same.  The one member can be granted full control and authority, have exclusive voting rights and manage all affairs of the company.  Further, the use of multiple members would permit various repurchase rights and other governing standards to be embodied in an operating agreement that would further effect a bankruptcy court’s analysis and dampen the ability of aggressive creditors to reach important assets.  The cost of a tax return would be a small price to pay in order to protect the company’s assets from the reach of unwanted creditors.

[1] A charging order liens a member’s interest by requiring that any distributions from the company to the member be paid to the holder of the charging order.