LLC gurus have often pushed novice investors to organize their LLCs in Nevada or Wyoming or some other faraway state. The charging order is usually the reason why WY or NV are considered “investor friendly.”
Let’s consider a brief scenario. You own an LLC that holds several rental properties worth over a million dollars. It’s your only substantial asset besides some money in the bank and other personal property. One day, when you’re backing out of your driveway, you accidentally run over and seriously injure a neurosurgeon who is walking to work. He’s out of work for two months, and after he recovers, he sues you personally. The court finds you liable to the doctor for $1 million in lost wages, pain and suffering, etc.
The neurosurgeon’s lawyer realizes that your cash in the bank is not going to cover the judgment, so he tries to get the assets in your LLC. In many states, the doctor can ask the court to foreclose on your ownership shares of the LLC, thus permanently depriving you of ownership of that LLC and all its property. He can also ask for the court to force a sale of the LLC’s assets and a distribution of all the cash proceeds to the doctor.
The reason why WY and NV are so favorable to debtors is because their states statutes only allow our doctor-creditor to done thing to get his money back–he may only ask the court for a “charging order.” Literally, a creditor asks for a court order to charge the debtor’s membership interest, which means that the creditor gets whatever distributions the debtor would ordinarily be entitled to by the operating agreement. That is the only remedy available to that creditor.
The beauty of this protection is that one can write an LLC operating agreement in such a way that the LLC is never obligated to distribute any money, and thus that creditor will never get any money. What results is a sort of a standoff between creditor and debtor. While it may be true that the creditor can be more patient than the debtor, this also buys time for the debtor to make alternative arrangements to pay the debt without having a creditor force a fire sale of all the LLC’s assets at deep discounts.