Business Reorganization Committee

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Digging the Nail Out of the Coffin: LLC Law Responds to Olmstead

; Atlanta

The background itself is not so complicated. The FTC sued Peoples Credit First, LLC; Consumer Preferred, LCC; and their principals, Shaun Olmstead and Julie Connell, in federal district court in Florida for allegedly operating an advance fee credit card scam. In effect, the companies allegedly represented that consumers would receive a major credit card in exchange for an advance fee.  The Federal Trade Commission brought suit for violations of the FTC Act and obtained a temporary restraining order with an asset freeze.  In addition, the district court appointed a receiver. Ultimately, the FTC secured a $10 million judgment against Olmstead and Connell. [2]

The FTC sought to enforce that judgment and collect from Olmstead and Connell’s single member LLCs.  Under the Florida LLC Act (Fla. Stat. § 608.433(4)), a judgment creditor only may reach a member’s interest in an LLC through a remedy device called a “charging order.”  In many states, a charging order (borrowed from partnership law) functions as a sturdy but not impenetrable shield from creditors.  In other words, a creditor’s remedies are restricted to a charging order that prohibits distributions made to the LLC owner.  Some LLC statutes (such as Florida’s) define the charging order as the exclusive creditor remedy, meaning that the creditor cannot take the actual ownership interest in the LLC or seize the LLC’s assets. [3] Instead, the creditor must patiently await the distributions designated for that member to come its way.  Of course, if no distributions arise, the creditor could wait indefinitely for payments that may never come.

Consequently, the charging order only affects an economic right belonging to the LLC member, i.e., the right to distributions. [4] The specter of straightforwardness ends here.  Enter the single member LLC.  By definition, a single member LLC has but one member, and, until recently, the trend has been to use it as an asset protection vehicle rather than as an income generator or even for a business purpose. [5] For example, a single member LLC may hold that person’s primary residence.  This manipulation of the traditional LLC structure seems contra to one of the purposes of the corporate model – protection of both the LLC members and the LLC interest from the reach of one member’s creditors.  Indeed, the charging order itself is intended to protect the other members of the LLC by limiting the remedy to the distributions owed the debtor-member. [6] 

Meanwhile, back in Florida, Olmstead and Connell appealed the FTC’s judgment to the United States Court of Appeals for the Eleventh Circuit. [7]  Scratching its head at the mess caused by a Lone Ranger LLC (i.e., the single member corporate form), the Eleventh Circuit certified this question to the Florida Supreme Court for guidance: “Whether, pursuant to Fla. Stat. § 608.433(4), a court may order a judgment-debtor to surrender all ‘right, title, and interest’ in the debtor‘s single-member limited liability company to satisfy an outstanding judgment.” [8]  The Florida Supreme Court, however, thought the question – as posed by the Eleventh Circuit – was restrictive and oversimplified. [9] Instead, the court rephrased the question as “[w]hether Florida law permits a court to order a judgment debtor to surrender all right, title, and interest in the debtor‘s single-member limited liability company to satisfy an outstanding judgment.” [10]

The court answered that question in the affirmative, finding that the charging order remedy was neither exhaustive nor exclusive. [11]  Accordingly, the court concluded that under §608.433(4), a creditor could levy and execute upon the full interest in the single member LLC. [12] The majority regarded the charging order as having the same effect as an assignment – the general creditors’ remedy – and since the Florida statute did not expressly state that the charging order was in fact the exclusive remedy, the single member LLC would be subject to the same general creditors’ remedies available under Florida law. [13] 

In knee-jerk reaction fashion, the Florida Supreme Court felt duty-bound to eliminate the situation where a single-member LLC abuses corporate structure by refusing to make any distributions that might be subject to a judgment creditor’s charging order.  If the judgment creditor’s remedy was limited to the charging order, the best a creditor could do is hurry up and wait.   In effect, the holding allows judgment creditors to own and control the debtor-member’s interest in the single member LLC. [14]

Of course, this opinion did not come without dissent, and, to be sure, the majority opinion itself is not the poster child of logic.  Two justices vehemently disagreed with the majority, and the dissent itself is twice as long as the majority opinion. [15]  The dissent expressed concern that the majority opinion both hijacked the legislative process by effectively rewriting the statute and upset the landscape of LLC creditors’ remedies as a whole. [16] The dissent suggested other, less intrusive methods of achieving the same result, including the option of allowing the issue to be resolved in bankruptcy where the interest becomes property of the estate.   [17]

To that end, several bankruptcy courts have enforced remedies beyond the charging order by holding that a debtor's bankruptcy filing effectively assigns the “entire membership interest in the LLC to the bankruptcy estate,” giving those rights to Trustee – including the “right to control the management of the LLC.” [18] Of course, this presupposes that the judgment either forces the debtor into bankruptcy or unsecured creditors can force the debtor into bankruptcy under 11 U.S.C. § 303.

Conclusion
As it stands, Olmstead has rewritten the landscape of single member LLCs in Florida, and its precedential ruling could be persuasive in other states where the LLC statutes have similar latent ambiguities either in remedies or single member LLC provisions.  Instead of mending a perceived flaw in the LLC statute, Olmstead’s Draconian fix may have a chilling effect on the creation of single member LLCs rather than clamping down on single member LLCs run amok.

For now, however, the the repercussions are unclear. Moreover, Olmstead appears to be a case decided on narrow facts, the totality of which need be present in order for the court to open the single member LLC to creditor remedies beyond the charging order.  Consequently, the bark may be worse than the bite.  Nonetheless, legislatures in states with similar LLC schemes should (and some already have) take note of the opinion, and certainly the Olmstead dissent made a deliberate call for action, announcing that the “[l]egislature, as the architects of this statutorily created entity, has the authority to provide a more streamlined surrender of these rights.” [19]  

In Florida, proposed legislation has been percolating to curtail the effects of Olmstead.  A revised Fla. Stat. §608.433 might expressly provide that a charging order is the “sole and exclusive” remedy that a judgment creditor has against an LLC.  To ameliorate using certain LLC vehicles to perpetuate fraud and hide assets, a revision might also carve out an exception for single member LLCs that allows creditors to reach the interest if there is evidence of an intent to hinder, delay or defraud creditors or a showing that distributions under a charging order will not pay the judgment debt.

Challenges to the sanctity of the LLC entity, however, is something that extends beyond the borders of Florida.  Recognizing a business opportunity in attracting new LLCs, some states have already responded to Olmstead by crafting provisions friendly to single member LLCs. Consequently, with new legislation, Olmstead’s effect may be limited to modernizing LLC statutes to combating fraud while preserving the protections of a single member LLC. Six months after Olmstead appeared on the radar screen, states have strategically amended their LLC statutes in order to clarify any ambiguity. [20] Other states almost certainly will follow suit. Given the legislative investment, Olmstead is not the specter of death for LLCs, but only a harsh wake-up call to the shortcomings of the current statutory framework.

1. Olmstead v. Federal Trade Comm’n, __ So. 3d. __, 2010 WL 2518106 (Fla. 2010).

2. Federal Trade Commission v. Peoples Credit First, LLC, 2006 WL 1169677 (M.D. Fla. 2006). 

3. Fla. Stat. § 608.433(4).

4. Fla. Stat. § 608.402(23). 

5. In re Albright, 291 B.R. 538, 540 (D. Colo. 2003).

6. Olmstead, 2010 WL 2518106 at 9 (Fla. 2010).

7. Fed. Trade Comm‘n v. Olmstead, 528 F.3d 1310, 1314 (11th Cir. 2008).

8. Id.

9. Olmstead v. Federal Trade Comm’n, __ So. 3d. __, 2010 WL 2518106 (Fla. 2010).

10. Id. at 2 (emphasis added).

11. Id. at 11.

12. Id. at 15.

13. Id. at 12 – 15.

14. Id. at 15.

15. Id. at 13.

16. Id. at 17 – 18 (Lewis, J., dissenting).

17. Id. at 42 – 44 (Lewis, J., dissenting).

18. In re Albright, 291 B.R. 538, 540 (D. Colo. 2003); see also In re Modanlo, 412 B.R. 715, 727-31 (D. Md. 2006); In re A-Z Electronics, LLC, 350 B.R. 886 (Bankr. D. Id 2006).

19. Id. at 45 (Lewis, J., dissenting).

20. See Wisc. Stat. § 17-15-145; Tex. Bus. Code  §§ 101.112(c) and 153.256(c); Del. Code § 18-703 (d).