Reverse Piercing: A Single Member LLC Paradox
35 Pages Posted: 29 Jan 2009 Last revised: 23 Apr 2009
Date Written: January 28, 2009
All states permit a limited liability company (SMLLC) to be formed with only one member and asset protectionists seek shelter for clients under its protective liability umbrella to shield assets from the obligations of its only member. Surprisingly, member creditor access to the assets of the SMLLC depends upon the context of the obligation. A secured creditor of a member can protect itself by obtaining the member's advance consent to admit the creditor as a substituted member should the creditor foreclose and purchase the interest. The substituted member may then liquidate the SMLLC. Since federal bankruptcy laws trump both state LLC law and operating agreement, creditors of a member filing bankruptcy will have access to the assets of the SMLLC but at the expense of sharing asset values with other creditors. Federal tax liens have a superior but often dubious status achieved by assuming the SMLLC assets are in some cases the property of the only member. However, rules outside secured creditor, federal bankruptcy and tax rules are not as favorable. A transfer of the membership interest to an unsecured creditor who purchases at a foreclosure sale generally allows the creditor to assume ownership of only the right to receive future distribution when and if made. Unfortunately, unless the transferor debtor consents to admit the transferee as the substitute member, the transferor generally continues as the only member with control over the timing of the distributions. Thus, while the debtor member no longer owns a financial interest in the SMLLC, that member nevertheless guards the entity holding the assets and is in a position to favor its own economic interests over those of the creditor owner of the entire economic interest. While fraudulent transfer and conveyance laws are generally ineffective, the reverse piercing doctrine offers limited protection. This Article traces the plight of the creditor in these unique circumstances and suggests statutory clarifications.
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