July 12, 2017
In the recent Colorado Supreme Court decision (JPMorgan Chase Bank v. McClure, 2017 CO 22, 2017 WL 1321334 (Colo., April 10, 2017), the Court ruled that in order to enforce a charging order against an LLC, the creditor must bring the action to the jurisdiction where the targeted LLC was formed.
This has interesting ramifications. For example, if a person has created an LLC in a jurisdiction outside of Colorado that has strong pro-debtor laws to protect the LLC assets from its members’ creditors, and that debtor is sued in Colorado, any charging order that the creditor obtains against the debtor’s non-Colorado LLC will have no teeth. As such, the Colorado legal system cannot hold the debtor accountable if the debtor, as a manager of the LLC, continues to make distributions to himself from the non-Colorado LLC.
More specifically, let’s say a Colorado resident (who later becomes the “debtor”) forms an LLC in Nevada, which has strict charging order law making it more difficult for a creditor to reach the assets inside the LLC. Assume also that the LLC has a Nevada “distribution manager.” Further assume that a creditor arrives on the scene and is successful in having a Colorado court issue a charging order with regard to any LLCs owned by that debtor. According to the logic applied by the Colorado Supreme Court, the LLC interests owned by the debtor are treated as being in Nevada, and therefore outside of Colorado’s jurisdiction. As a result, the Nevada LLC’s manager cannot be directed by the Colorado courts to redirect distributions to the creditor. Apparently, this is true even if the manager were a Colorado resident, or even the debtor himself. The Colorado Supreme Court views the LLC as being located outside of Colorado, and therefore a Colorado charging order is simply not enforceable against any non-Colorado LLC. Also, the Colorado Supreme Court evidently would not view the full faith and credit clause of the US Constitution as requiring a Nevada LLC (in this example) to recognize a Colorado charging order, short of the Colorado charging order first being domesticated in Nevada.
This view of the US Constitution’s full faith and credit clause is certainly subject to some contrary views. However, what if the LLC were formed in Nevis, Belize or in another offshore jurisdiction. This takes the full faith and credit scenario to a whole different level. The US Constitution could not then be asserted at all to require the offshore LLC to honor any US order or judgment.
Reality check observation: Even though the state of formation was considered the location of the LLC in the above case, the logic applied by the Court was likely motivated by a sense of fairness. The Court did not make its decision to aid a debtor in a battle over whether a debt would be paid. Courts “of equity” many times lean towards applying laws in a way that would help a “wronged” creditor, rather than a debtor who is just trying to “get off the hook.” Instead, this Colorado case involved two creditors, one of whom filed an action in Colorado and one of whom initially filed in Arizona, and the Court was simply deciding which creditor had the superior claim. Therefore, applying this ruling to aid a debtor who should be held accountable for his financial obligations will likely not find solace in the above Court’s rationale. As such, short of having the LLC formed in one of the protective offshore jurisdictions with proper motives and LLC designs, LLCs have limited asset protection benefits.
By Edward D. Brown, Esq., LLM. CPA