'Patching' Up The Fla. LLC Problem
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NOTE: Since this article was written Florida has completely updated its Limited Liability Company Act. Formerly the Act was found in Chapter 608 FS. Now it is found in Chapter 605 FS.
On May 31, 2011, legislation designed to resolve the uncertainties created with respect to Florida limited liability companies by the Florida Supreme Court's holding in Olmstead v. Federal Trade Commission, 44 So. 3d 76 (Florida 2010) became effective. The new legislation modifies Florida Statutes and is referred to herein as the "Olmstead Patch."
The Olmstead Patch clarifies that the holding in Olmstead does not apply to Florida multimember LLCs (MMLLCs), and that the sole and exclusive remedy for a judgment creditor of a member of a Florida MMLLC is a charging order on the member's transferable interest. The Olmstead Patch also provides clarity as to when a judgment creditor of the member of a Florida single-mem ber LLC (SM LLC) will have the right to foreclose upon such membership interest. A copy of the legislation can be found here.
Why Is the Olmstead Patch Important?
According to the website of the Florida Department of State, as of January 2011 there were almost 550,000 LLCs organized in Florida (compared to approximately 743,000 corporations). During 2010, more than 138,000 LLCs were organized in Florida (compared to approximately 104,000 corporations). Further, while the exact number of SM LLCs cannot be determined with accuracy, anecdotally it appears that approximately 60 percent of Florida LLCs are most likely SM LLCs.
The Olmstead decision scared practitioners because the ruling could have been applied equally to judgment creditors of members of both Florida SMLLCs and Florida MMLLCs. It was that concern that led to an effort by three sections of the Florida Bar to propose a "patch" to the Florida legislature to resolve the significant uncertainty and confusion with respect to charging order protection for members of LLCs that was occasioned by the Supreme Court's decision in Olmstead.
The legislature concluded that the uncertainty created by Olmstead might persuade businesses and investors located in Florida to organize their LLCs under the laws of other jurisdictions where a charging order is the exclusive remedy available to a judgment creditor of the member. The Olmstead Patch expressly solves this issue for members of Florida MMLLCs. Further, the Olmstead Patch provides that a judgment creditor can only foreclose on the membership interest of a member ofa Florida SM LLC under appropriate circumstances and following appropriate court review.
The "Pick Your Partner" Principle and Charging Orders under Florida Statute Section 608.433
Section 608.433(1), Florida Statutes, states that "[u]n|ess otherwise provided for in the articles of organization or operating agreement, an assignee of a limited liability company may become a member only if all members other than the member assigning the membership interest consent." This provision follows what is commonly called the "pick your partner" principle and is the basis for changing order statutes with respect to partnership, limited partnership and limited liability company statutes around the country.
The "pick your partner" principle emanates from the idea that partnerships, limited partnerships and limited liability companies are voluntary organizations, and that no "partner" of a partnership or "member" of an LLC should be forced to associate and do business with another partner or member whom he does not know and does not freely choose to associate with.
Charging order protection gives a judgment creditor of a member of an LLC the economic rights of an assignee of the member's interest in the LLC. Under a charging order, the debtor still holds all noneconomic powers as a member of the LLC. The theory behind a charging order is that a judgment creditor of a member of an LLC can obtain the economic interests from the debtor's membership in the LLC without disrupting the business of the LLC or forcing other partners to accept the judgment creditor as a member. Charging orders "protect the autonomy of the original members, and their ability to manage their own enterprise."[1]
An often-cited shortcoming of charging order provisions is that such provisions do not allow a recovery to a creditor of the member of an LLC unless distributions are made to the members of the LLC. In some cases, this may work a hardship on the creditor in circumstances where the member may be in a position to effectively control all assets of the LLC. This potential use of a SM LLC to arguably avoid payment of a judgment debt of a member is part of the equitable facts that may have led the Florida Supreme Court to reach its decision in Olmstead.
The Florida Supreme Court's Ruling in Olmstead
The Florida Supreme Court ruled in Olmstead that Florida law permits a court to order a judgment debtor to surrender all right, title and interest in the debtor's SM LLC to satisfy an outstanding judgment against the judgment debtor member of the SM LLC. The court concluded that "the [Florida Limited Liability Company Act's] statutory charging order provision does not preclude application of the creditor's remedy of execution on an interest in a single member LLC."
The court stated that its conclusion "rests on the uncontested right of the owner of the single-mem ber LLC to transfer the owner's full interest in the LLC and the absence of any basis in the [Florida Limited Liability Company Act] for abrogating in this context the long-standing creditor's remedy of levy and sale under execution."
The ruling was premised on the court's view that the Florida legislature could have expressly stated in the statute that a charging order was the sole and exclusive remedy to satisfy a judgment due from a judgment debtor's membership interest in a Florida LLC, as they did in the Florida Revised Uniform Limited Partnership Act.
As a result, the court concluded that the general levy and sale after execution provisions contained in Section 56.061, Florida Statutes, that allow a sale of corporate stock to satisfy a judgment against a stockholder who owns corporate stock could be applied here, since, as the court stated in its ruling, "an LLC is a type of corporate entity and an ownership interest in an LLC is personal property that is reasonably understood to fall within the scope of 'corporate stock.'"
In his dissent, Justice Fred Lewis strongly criticized the majority opinion, stating that "[t]his is extremely important and has far-reaching impact because the principles used to ignore the LLC statutory language under the current factual circumstances apply with equal force to multimember LLCs and, in essence, today's decision crushes a very important element for all LLCs in Florida. If the remedies under the LLC act do not apply here because the phrase 'exclusive remedy' is not present, the same theories apply to multimember LLCs and render the assets of all LLCs vulnerable."
The determination that an interest in an LLC is a type of "corporate entity" and that an LLC membership interest is personal property akin to corporate stock under Section 56.061, Florida Statutes, was particularly problematic. The dissent noted that the majority cited no authority in ruling that an interest in an LLC is a type of personal property akin to corporate stock.
Indeed, the legislative history of Florida's LLC statute shows that LLC interests have historically been viewed by the Florida legislature as being far more similar to partnership interests than to corporate interests. The possibility that LLC interests might be treated as "corporate interests," despite the substantial differences between LLCs and corporations, could have had potential adverse consequences in a wide range of situations.
The Process that Led to the Olmstead Patch
Many commentators criticized the Olmstead decision. There was a serious concern as to the implications of the majority opinion on legitimate businesses organized as Florida LLCs. First, there were those who were concerned about the risk that Olmstead might cause to Florida MMLLCs ifjudgment debtors of a member of a MMLLC could potentially foreclose upon and gain access to such member's interest in the LLC.
Second, while there were some in the legal community who believed that in the context of SM LLCs the justification for the charging order remedy makes no sense, there were others who were concerned that if Olmstead was not clarified, a judgment creditor of a member of a Florida SM LLC could obtain foreclosure of the interest in the SM LLC even in a situation where the judgment against the member of the LLC would be paid within a reasonable period of time from distributions by the SM LLC.
In response to Olmstead, three sections of the Florida Bar sought legislative clarification on these issues. While a task force consisting of members of these three bar sections was already working on a comprehensive rewrite of Florida's limited liability company law, these bar sections believed that it was important that a "patch" be passed in the legislature to amend the charging order statute to deal with the concerns presented by Olmstead.
The Olmstead Patch
The Olmstead Patch amends Section 608.433, Florida Statutes, to provide:
With respect to Florida MMLLCs, the Olmstead Patch provides that: (1) a charging order is the "sole and exclusive remedy by which a judgment creditor of a member or mem ber's assignee may satisfy a judgment from a judgment debtor's interest in an LLC or rights to distributions from a members interest in the LLC," and (2) that the remedy of foreclosure on a judgment debtor's interest in the LLC is not available.
With respect to Florida SM LLCs, while a charging order is expressed to be the sole and exclusive remedy of the judgment creditor, where the judgment creditor can show a court that, under a charging order, distributions will not satisfy the judgment in a reasonable period of time, the court may order a foreclosure sale of the LLC interest pursuant to which the purchaser in such a sale becomes the member of the LLC and the debtor mem ber's ownership interest ceases.
The Olmstead Patch by its express terms does not apply to consensual grants of security interests in an LLC member's interest, to principles of law or equity that affect fraudulent transfers or to the availability of equitable principles of alter ego, equitable lien, constructive trust or other equitable principles not inconsistent with this statute.
The Olmstead Patch expressly states that courts have the continuing jurisdiction to enforce their charging orders in a manner consistent with amended Section 608.433, Florida Statutes, although the legislative history of the Olmstead Patch states that this language is intended to be limited to giving effect to the charging order.
The Olmstead Patch expressly states that it is intended by the legislature to be clarifying and remedial in nature and to have retroactive effect.
Planning Following the Adoption of the Olmstead Patch
For members of Florida MMLLCs, the Olmstead Patch should ease concerns that a judgment creditor of a member of a Florida MMLLC can obtain foreclosure or another remedy with respect to the member's interest in the LLC. With respect to Florida SM LLCs, while some may still argue that those who wish to form an SM LLC should organize their SM LLC in a state where the law expressly limits the rights of a judgment creditor of a member of an SM LLC to a charging order against the member's transferable interest, the clarity provided by the amended statute may be better than the protections arguably available if the member organizes his SM LLC in another jurisdiction.
First, it is possible that courts in other jurisdictions that have a charging order statute similar to Florida's pre-Olmstead statute, may reach decisions similar to that reached in Olmstead. Second, in light of Olmstead, other state legislatures may consider changing their laws to allow a judgment creditor to foreclose on a judgment debtor's membership interest in a SM LLC organized in their state.
Finally, is unclear how Florida courts will treat foreign SM LLCs with assets in Florida where the protections afforded to the members of those LLCs under the laws of their jurisdiction of organization are being used (arguably) to thwart the interests of the member's creditors.
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Thus, creators of new LLCs should consider, if possible, having at least two members if they are concerned about liability protection from the personal creditors of a member. If there are only two members, however, the second member should be treated as a legitimate co-owner of the LLC. If the second member is added merely on paper as a sham, the courts will likely treat the LLC as a single-member LLC. To avoid this, the second member should pay fair market value for the interest acquired and otherwise be treated as a "real" LLC member - that is, receive financial statements, participate in decision making, and receive a share of the LLC profits equal to the membership percentage.