Bar News - August 15, 2003
The Ashley Albright Case: Is Single-Member LLC Statutory Business Asset Protection Dead in NH
By: John Cunningham
Editor's note: LLC issues like those addressed in the following article will be explored at the Sept. 26 NHBA•CLE "New Hampshire Corporation and Limited Liability Company Law and Practice." See Upcoming Programs for more information on the program and to register.
BY A SUBSTANTIAL margin, limited liability companies are now the entities of choice for New Hampshire business start-ups. In the 2003 calendar year, 4,756 LLCs were formed under New Hampshire law, as compared with only 1,680 corporations.
Although New Hampshire's LLC Act, Chapter 304-C:1-85, was adopted only 10 years ago, there are at present 18,701 New Hampshire LLCs as compared with 25,851 New Hampshire business corporations. Within a few more years, New Hampshire LLCs will undoubtedly outnumber New Hampshire corporations.2 Internal Revenue Service filing statistics indicate that half of all New Hampshire LLCs are single-member LLCs - meaning there are currently about 9,000 single-member LLCs in New Hampshire.
The preeminence of LLCs in New Hampshire is attributable in part to the uniquely strong liability shield that they confer on their owners (called "members") and to their unique contractual flexibility. It is also attributable, however, to the fact that LLC acts provide LLCs with a business organization law feature called statutory business asset protection - a provision wholly absent in corporate statutes. The case law has always made clear that this LLC feature is available to multi-member LLCs.3 The availability of statutory business asset protection to single-member LLCs has always been less clear - but one could always hope.
However, on April 4, 2003, the United States Bankruptcy Court for the District of Colorado rendered its decision In re: Ashley Albright, Debtor, Case No. 01-11367 - ABC, Chapter No. 7 (2003 Bankr. D. Co. LEXIS 291). In my view, Albright tolled the death knell for single-member LLC statutory business asset protection not only in Colorado, but across the country. This article briefly describes the facts and holding of Albright and discusses its probable impact on New Hampshire LLC practice.
The Concept of Business Asset Protection
Business asset protection, for those not already familiar with it, may be illustrated as follows:
Jane and John jointly form JJ, a two-owner auto repair shop. At the time of its formation, Jane contributes $70,000 worth of tools, equipment and vehicles to JJ and John $30,000. On the basis of their contributions, Jane owns 70 percent of the new company and John 30 percent. Six months after they form the company, Jane, while driving her car in her individual capacity and not on company business, accidentally runs over and kills a brain surgeon and incurs a $10 million negligence judgment. The surgeon's estate brings an action in New Hampshire Superior Court to attach Jane's interest in JJ.
If Jane and John have formed JJ as a corporation, the judge will, in effect, award Jane's 70 percent of JJ's stock to the estate, which will then elect a new JJ board and slate of officers, who, in turn, will cause JJ to sell all of its assets and to distribute 70 percent of the proceeds to the estate and 30% to John.4
However, if Jane and John have formed JJ as an LLC, the court will very probably rule under RSA 304-C:475 that the estate is entitled only to a "charging order" - i.e., an order requiring that if JJ determines to make any interim or liquidating distribution of its profits or other assets to Jane, it must instead make this distribution to the estate to the extent of the unsatisfied judgment.
In other words, if JJ is an LLC, Jane and John will be able to protect its assets from Jane's creditors. If they form it as a corporation, they will not.
Albright Facts and Holding
The facts, the LLC business organization law issues and the federal bankruptcy code issues in Albright are complex, but they can be briefly summarized as follows: At the time of her bankruptcy, Ms. Albright owned a single-member LLC that, in turn, owned valuable parcels of real estate (the "Real Estate"). The bankruptcy trustee moved the bankruptcy court for permission to sell the Real Estate and to distribute the proceeds to the bankruptcy estate for ultimate distribution to creditors. The debtor in bankruptcy opposed this motion on the grounds that (i) the trustee could take these actions only if it obtained control of the LLC; but (ii) under the relevant provisions of the governing LLC act (the Colorado act), this control would pass to the trustee only with the consent of all of the LLC's members - a consent the debtor was unwilling to grant.6 In essence, the court ruled (i) that the intent of the "member consent" provision of the governing act was to protect non-debtor members of multi-member LLCs from losing the goodwill value of their LLC membership because of personal debts of controlling members; but (ii) that in the case of single-member LLCs, enforcing this purpose made no sense.
Implications of the Albright Case in New Hampshire
The Albright case has several important implications for New Hampshire LLC lawyers and members.
- The likely persuasiveness of Albright in non-Colorado jurisdictions. Obviously, Albright is precedent only in Colorado and, indeed, only before the judge who decided the Albright case, since other bankruptcy judges, even in Colorado, are free to disregard its holding. However, Albright will undoubtedly be cited not only in the courts of Colorado but also in those of New Hampshire whenever a question is raised as to whether statutory business asset protection under the New Hampshire LLC Act is available to single-member LLCs. In my view, Albright is likely to be highly persuasive in New Hampshire courts.
- The application of Albright in non-bankruptcy cases. It is true that the Albright decision by its terms addresses only the rights of trustees in bankruptcy under Chapter 7 of the bankruptcy code, not the rights of creditors. However, the rationale underlying the decision applies fully as much to creditors as to bankruptcy trustees, and it will undoubtedly be cited - and cited persuasively - in New Hampshire creditor cases. Furthermore, Albright may provide a new incentive to New Hampshire creditors of members of single-member LLCs to force these members into bankruptcy as a means of enforcing creditors' rights.
- The impact of Albright on single-member LLC formation practice. In light of Albright, if a New Hampshire lawyer represents clients that are either entities or individuals forming single-member LLCs, and if statutory business asset protection is important to these clients, the lawyer should recommend to them that they not use single-member LLCs, but rather, that they make every effort to find a second "accommodation" member and to form their businesses as two-member LLCs.7
- Albright and LLC conversion practice. Furthermore, in light of Albright, New Hampshire individuals and entities that are already conducting their businesses as single-member LLCs and that need business asset protection should consider admitting a second member. For individuals who own single-member LLCs, the best co-member is normally a spouse or another close relative with whom they constitute what amounts to a single economic unit. For entities that own single-member LLCs, the issue can be more complicated. However, if the entity already has another subsidiary or has reasonable grounds for forming one, that other subsidiary may make an excellent second member.8
- "Peppercorn" second members. At the conclusion of its opinion, the Albright court noted that if Ms. Albright had had even a "peppercorn" co-member - i.e., a co-member with even an "infinitesimal" interest in her LLC - the court would have denied the above motion by the trustee. This comment by the court should be taken with a large grain of salt, since, especially if the facts are at all unfavorable for the debtor in question, any New Hampshire court would be inclined to disregard the "peppercorn" co-member, especially if it were obvious to the court that the only real purpose of the majority member in having a minority co-member was to provide the majority member with statutory business asset protection. My own advice to New Hampshire LLC clients that need business asset protection is that the second member should have at least a five percent interest in the LLC and preferably a 10 percent interest.9
- Albright and LLC legislation. In light of Albright, should lawyers who work with the New Hampshire Legislature in updating New Hampshire business organization laws seek to amend these acts to make clear either (i) that single-member LLCs do afford business asset protection or (ii) that they do not? My sense is that in view of the merits of the Albright issue, as discussed above, no state legislature is likely to amend the state LLC act to support the availability of LLC business asset protection to members of single-member LLCs. My sense is also that, in light of Albright, no amendment is necessary to clarify that this protection is unavailable. Thus, in my view, no such legislative project would make sense.
The outcome of the Albright case is unlikely to surprise any knowledgeable New Hampshire LLC lawyer. Rather, the case merely confirms what most or all of us have long believed - namely, that no court in any factual or legal setting is likely to rule that New Hampshire single-member LLCs provide statutory business asset protection.
However, the publication of the Albright case makes it all the more important that New Hampshire lawyers steer business founders who need business asset protection away from single-member LLCs and toward multi-member LLCs or, alternatively, toward the use of leasing entities separate from their operating entities. The case also mandates that New Hampshire lawyers urge clients that need business asset protection but that are currently operating through New Hampshire single-member LLCs to consider adding a second member.
At the same time, New Hampshire lawyers should make it clear to their clients that Albright has no impact whatsoever on the strength of the single-member LLC liability shield. That shield is a strong as ever.10 Indeed, because of the liability shield that New Hampshire single-member LLCs provide to their owners and for many other reasons, including important tax reasons, the value of single-member LLCs remains great - but not as great as before the publication of the Ashley Albright case.
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Mr. Cunningham is of counsel to Ransmeier & Spellman, P.C., Concord, New Hampshire. His practice is focused on, among other things, the law and taxation of limited liability companies. He is the author of DRAFTING LIMITED LIABILITY COMPANY OPERATING AGREEMENTS (Aspen Law & Business), the leading U.S. LLC practice manual and formbook. He wishes to express his gratitude to his colleagues at the Ransmeier firm for their comments on earlier versions of this article; but the views expressed in the article are not necessarily those of any other lawyers of his firm, and he alone bears responsibility for any error in the article. |
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Indeed, given the clear business organization law advantages of LLCs over business corporations under New Hampshire law, it is almost always a mistake to form a new New Hampshire business as a corporation rather than as an LLC. Furthermore, because of these advantages, many New Hampshire sole proprietorships, general partnerships and business corporations - and especially those with substantial business assets - should be converted to LLCs. |
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See, e.g., Herring v. Keasler , 2002 N.C. App. LEXIS 585). |
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See generally, RSA 511:21-A and related RSA provisions. |
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Section 47 provides in relevant part that "[o]n application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the limited liability company interest of the member with payment of the unsatisfied amount of the judgment with interest." |
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The corresponding provision of the New Hampshire LLC Act is RSA 304-C:46, I. |
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As an option to asking one's spouse to become the second member of one's single-member LLC, if the original member has established a trust for his or her children or for other beneficiaries or if it will be useful to create such a trust for estate planning purposes, the original member may find it convenient to admit that trust as the second member. |
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Conversions of single-member LLC to two-member LLCs can raise significant federal income tax issues. Fortunately, the IRS has addressed the most important of these issues in Rev. Rul. 99-5, 1999-1 C.B. 434. |
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Obviously, however, if the sole or principal purpose of the first member in admitting the second is to defraud creditors, then, regardless of the percentage interest of the second member, the court will disregard that member under the Uniform Fraudulent Transfer Act or under 11 U.S.C. Section 548 (the fraudulent transfer provision of the bankruptcy code). |
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Indeed, because LLC statutes impose only very limited statutory formalities in connection with the formation and operation of entities formed under them, plaintiffs' lawyers cannot plausibly allege failure to comply with statutory formalities as a ground for piercing the veil of either single- or multi-member LLCs. By contrast, such an allegation may have significant weight in a corporate veil piercing case. For this very practical reason, the liability shield of both single- and multi-member LLCs is arguably substantially stronger than that of corporations, especially in the case of small, closely held entities, many of which fail to comply with statutory formalities. |
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