What if I'm sued personally? Can they take my TX LLC away?

Please note, this article only applies to TX LLCs and not to any LLCs outside of TX. You'd have to check the law in those other states.

Picture this:

You've taken care of your real estate business and it's properly separated into multiple entity structures; but, your ownership of the entities were not anonymous nor were they protected via another method such as an irrevocable trust. You were texting on your cell phone, run a red light, and really hurt Peter the Plaintiff. Just to be clear, you're being sued for something entirely unrelated to your real estate business. Peter sues you and wins; but your car insurance wasn't enough. Peter now tries to go after your personal assets to satisfy the amount of money still owed even after insurance paid. Peter knows you have a real estate company with hundreds of thousands of equity in it. Peter (really, Peter's lawyer) tries to go after your real estate. What happens?

Not much!

The TX LLC statutes are very protective of the "members" of an LLC. The law even says in Tex. Bus. Org. Code Section 101.112(d):

"The entry of a charging order is the exclusive remedy by which a judgment creditor of a member or of any other owner of a membership interest may satisfy a judgment out of the judgment debtor's membership interest." Emphasis added
What does that mean?

It means that all a creditor of a member can get against an LLC is a charging order. So what's a charging order? It's a special kind of lien against your LLC interest. In some states, that lien can be foreclosed just like a house; i.e., the judgment creditor can seize your interests and sell it at auction like any other property. But not in Texas!

Tex. Bus. Org. Code Section 101.112(c) states that:

"A charging order constitutes a lien on the judgment debtor's membership interest. The charging order lien may not be foreclosed on under this code or any other law." Emphasis added.

If you read more of Tex. Bus. Org. Code Section 101.112, you'll also note that there are even further protections, including that a creditor of a member does not have the right to obtain possession of any property of of the LLC.

Practically, all this means that a creditor is only entitled to "receive any distribution to which the debtor would have otherwise been entitled." This means the creditor only gets paid any distributions that you would have been entitled to.

Is there a way to take advantage of this law?

Absolutely! A smart lawyer will take advantage of this and create multiple classes of members. Let's call them Class "A" and Class "F" members. Class "A" will be your typical members. Class "F" members are any member who becomes subject to a charging order (and other 'triggers'). You draft it to where Class "F" members are not allowed any distributions without all or most of Class "A" members voting to allow the distributions.

An even better tactic would be to put this in the Certificate of Formation, to put the world on notice that if they sue you and get a charging order, that they would only be able to get distributions that a Class "F" member would get.

Another effective thing you can do with Class A and Class F members, is to still allocate profits to the Class F members, but never pay them any distributions. Since most entities are going to be flow-through taxation, and a member pays taxes based on income, not distributions. So, the Class F (the creditor) may actually have to pay taxes on money that they never received. It's good incentive for the creditor to either (a) never sue in the first place, or (b) settle the debt for pennies on the dollar.

Note, this strategy is not available to LLCs that elect to be taxed as an S-Corporation.


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