Asset Protection

Creditor of California LLC Wins Judgment Against LLC Members

Question:  If a California LLC distributes all of its assets to its members and dissolves without paying a creditor, can the creditor collect the unpaid debt from the former members?

Answer:  Yes, but only to the extent of the value the member received.  The California Court of Appeals case of CB Richard Ellis, Inc. v. Terra Nostra Consultants, 178 Cal.Rptr.3d 640 (Cal. Ct. App. Oct. 7, 2014) confirmed this concept.

Jefferson 38, LLC, a California limited liability company, signed a listing agreement in 2004 with real estate broker CB Richard Ellis, Inc. (“CBRE”) to sell its land.  The LLC sold it land for $11,800,000, but CBRE was not paid anything.  In 2006 CBRE exercised a clause in the listing agreement to arbitrate the dispute over the commission.  CBRE won an arbitration award of $960,649.30.  The arbitration award was confirmed and judgment entered in the amount of $985,439.80 by the Los Angeles Superior Court.  The judgment was affirmed on appeal.

When the real estate was sold in 2005, the net proceeds of the sale were distributed to the members of the LLC shortly thereafter and the LLC ceased to engage in business.  On February 27, 2006, Jefferson 38, LLC, filed a certificate of cancellation with the California Secretary of State indicating that all of its members voted for the dissolution.

At this point in time the members of the LLC had caused the LLC to distribute all of the LLC’s assets to its members and legally dissolved the LLC while an outstanding claim was pending.  This is a scenario California LLC law attempts to prevent and that is disfavored by the courts.

Because the events that gave rise to this case occurred before January 1, 2014, the effective date of the California Revised Uniform LLC Act, the California Court of Appeals applied prior California LLC law to the case.    Former Section 17355(a)(1) provided:

“Causes of action against a dissolved limited liability company, whether arising before or after the dissolution of the limited liability company, may be enforced against any of the following:

(A) Against the dissolved limited liability company, to the extent of its undistributed assets. . . .

(B) If any of the assets of the dissolved limited liability company have been distributed to members, against members of the dissolved limited liability company to the extent of the limited liability company assets distributed to them upon dissolution of the limited liability company.”

The defendants argued that they should not be liable for the debt owed by the LLC to CBRE because they were paid long before the actual dissolution of the LLC.  The Court of Appeals rejected this argument because if that were the law LLC members could easily distribute assets to members rather than creditors and avoid personal liability simply by making the distributions long before the technical dissolution of the LLC.

Current California LLC law with respect to California LLCs making distributions to members is stated in Cal. Corp. Code § 17704.05, which states:

(a) A limited liability company shall not make a distribution if after the distribution either of the following applies:

(1) The limited liability company would not be able to pay its debts as they become due in the ordinary course of the limited liability company’s activities.

(2) The limited liability company’s total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the limited liability company were to be dissolved, wound up, and terminated at the time of the distribution, to satisfy the preferential rights upon dissolution, winding up, and termination of members whose preferential rights are superior to those of persons receiving the distribution.

Warning to Members of California LLCs:  Do not clean out your LLC’s assets and leave any unpaid creditors.  The general rule of prior and current LLC law that members of a California LLC are not liable for the debts, obligations, or other liabilities of the limited liability company does not apply when the members are paid before the LLC’s creditors.

By | 2016-12-13T21:20:14+00:00 October 26th, 2014|Categories: Asset Protection, CA Law, CA LLC Statutes, FAQs, Lawsuits|0 Comments

When LLC Member May Be Held Personally Liable For Signing Loan Agreement

Take care when you sign a contract on behalf of your LLC that you do not sign in a way that makes you liable as a party to the contract.  California LLC law contains the general rule that a California LLC that signs a contract is liable for the obligations created under the contract, not its members.  There is a big exception to the general rule.  If you will be signing contracts for a California LLC ignorance of how to sign the contract could cost you big bucks.

The Maryland case of Ubom v. Suntrust Bank, involved a a lawyer who obtained a line of credit for his LLC.  The member of the LLC signed a loan agreement that included language about a personal guaranty.  The member put his personal information such as his social security number and personal address in the guaranty section of the contract, but he did not put anything in the space that asked for the “Legal Name of the Guarantor.”

The loan agreement had a signature line for the “applicant” and a second signature line for the “guarantor.”  Mr. Ubom signed one each lien and wrote “Managing Attorney” after his signature.  The LLC defaulted on the loan and the lender sued the LLC and Mr. Ubom.

The lender claimed that Mr. Ubom was personally liable as a guarantor because language in the loan agreement stated that he guaranteed the loan.  The loan agreement said:

To induce Bank to open the Account and extend credit to the applicant, or to renew or extend such other credit, each of the individuals signing this Application as a “Guarantor” (whether one or more, the “Guarantor”) hereby jointly and severally guarantee payment to Bank of all obligations and liabilities of the applicant of any nature whatsoever and whether currently existing or hereafter arising, including without limitation, all obligations and liabilities under this Application and/or the Account, and reasonable fees and expenses of Bank’s attorney(s) incurred in the collection of such obligations (collectively the “Obligations”).

The court said that based on the language quoted above Ubom agreed to guaranty the debt.  The court said it did not matter that Ubom did not put his name in the on the “Legal Name of the Guarantor” line.

Before you sign a contract on behalf of your LLC you must carefully read the contract and make sure it does not contain any language that would obligate you as the signer.  If you are not sure that signing a contract for your LLC will not cause you to incur liability ask your attorney to review the contract.

By | 2016-12-13T21:20:14+00:00 July 29th, 2014|Categories: Asset Protection, Lawsuits, Operating LLCs, Why People Need an LLC|0 Comments

Why Form an LLC?

Question: I understand that if I form a limited liability company to operate my business and I am the only person who provides services on behalf of the business that I can be sued and be liable for my acts or omissions that cause harm to third parties. Instead of forming an LLC, can’t I just load up on insurance and not form an LLC to operate my business?

Answer: Yes, but it could be a costly mistake. When you operate a business, commercial insurance is always your first line of defense. Your business should never operate without appropriate insurance coverage. Consult with several experienced business insurance agents and get their advice as to the type of insurance and the coverage amounts that are appropriate for your particular business. Always buy as much insurance as you can afford of the type that is appropriate for your specific type of business.

You operate a business through a limited liability company because it is your second line of defense against things that can go wrong with the business. What if you have insurance and the insurance coverage is denied? What if a plaintiff gets a judgment that exceeds the amount of insurance coverage? If you don’t form an LLC to operate your business and a plaintiff gets a judgment that exceeds the amount of your insurance coverage against you as the owner/defendant, all of your personal assets are at risk and could be lost

Fundamental Fact of Business Life: Without an LLC to operate your business, you are 100% liable for every thing that goes wrong. Do you really want to be in that position and have all of your life savings at risk? It’s hard to predict how liability may arise, but if you operate the business through an LLC, the general rule is the owners are not liable for the debts or obligations of the LLC. Wouldn’t you rather start from the position that you are not liable for anything (except your own acts and omissions) instead of the position that you are liable for everything?

Bottom Line: I believe it is foolish to operate a business without adequate insurance coverage and without operating the business through a limited liability company or a corporation.

By | 2016-12-13T21:20:16+00:00 January 9th, 2014|Categories: Asset Protection, CA LLC Formation, FAQs, Why People Need an LLC|0 Comments

Who Should Borrow Money to Purchase Real Estate – Me or My LLC?

Question:  I intend to borrow money to purchase investment real estate.  Should I borrow the money or should my LLC be the borrower?

Answer:  If it is ok with the lender, it is best for the LLC to be the borrower.

I’ve been a real estate and business lawyer since 1980.  Based on my knowledge and experience the type of entity to form to hold  real estate is an  LLC.  When I represent buyers of multi-million dollar properties the lenders always require that the borrower form a single purpose LLC to own the real estate.  Over two thirds of the 4,200+ LLCs I have formed have been to hold investment real estate.

Your other choices are the corporation and the limited partnership.  Both of these types of entities have been replaced by the LLC as the entity of choice to own investment real estate.  A general rule is never own investment real estate in a corporation because of adverse tax consequences.  That’s why the limited partnership, not the corporation, was the entity commonly used to own investment real estate before the invention of the LLC.

When you have an LLC, you want the LLC to be the borrower that signs the promissory note and becomes obligated to repay the loan.  The general rule is that if the LLC is the borrower, the owner(s) of the LLC are not liable to the lender to repay the loan if the LLC defaults.

A sophisticated commercial lender will require you to form an LLC and have the LLC be the borrower and take title at closing and require you to guaranty the loan.  Single family home lenders and lenders that do not understand the legal reasons for having the LLC be the borrower will require a person or people to be the borrower.  If your lender will not let the LLC be the borrower then you must be the borrower and take title in your name and then transfer the real estate to the LLC after closing.

If you are an owner of an LLC that will borrow money, the best structure for you is for the LLC to borrow the money and sign the promissory note without you signing a guaranty by which you promise to repay the lender if the LLC defaults.  If you can do this, then if the LLC were to default on the loan and did not have sufficient assets to repay the loan, the lender would not be able to pursue you for the unpaid amount due to the lender.

By | 2016-12-13T21:20:16+00:00 January 3rd, 2014|Categories: Asset Protection, FAQs, Real Estate Issues|0 Comments

President of Corporation Personally Liable for Signing Contract

Improperly Worded Company Contracts can Cause Signer to be Liable

One of the primary reasons people form limited liability companies and corporations is to protect the owners from the debts and liabilities of the company. The general rule of California law is that the members of a California LLC and the shareholders of a California corporation are not liable for the company’s debts. One of the biggest exceptions to this rule arises when an owner signs a contract and becomes personally obligated to pay the company’s debt.

The Personal Guaranty

The most common type of contract that obligates an owner of a company to pay the company’s debts is called a “guaranty” or “personal guaranty.” A guaranty is a contract by which the signer/guarantor promises to pay or satisfy the debt of another person (the company). Guaranties are frequently required by landlords and lenders who know that if the company doesn’t pay, the debt will never be paid.

Contracts that Create Personal Liability

Owners and employees of a company can create contractual personal liability for themselves if they sign a contract on behalf of the company, but the wording of the contract does not make it clear that the signer is signing on behalf of a company.

If the signer of an LLC or corporate contract wants to avoid becoming personally liable for the debts of the company created in the contract, the language in the contract must clearly state that the party is the LLC or corporation and indicate the capacity of the signer.

Iowa limited liability company and corporate attorney Marc Ward reports on a recent Iowa case that where the court found that the person who signed a two page contract on behalf of a corporation was personally liable to pay the corporation’s debt under the contract.

The Iowa Court of Appeals opinion in Builders Kitchen and Supply Co. v. Moyer, N0. 0-655/09-0194 (September 2, 2009) is a deceptively simple case. On the one hand it represents the folly of not having even run of the mill contracts reviewed by lawyers before they are signed. And on the other hand, it is a warning to lawyers that things aren’t as simple as they appear.

Unfortunately for Moyer the contract contained a clause that said “I hereby personally guarantee to pay on demand any and all sums due that my/our company shall fail to pay.”

Mr. Moyer did not sign the signature block for the personal guaranty, but the court found he was liable anyway.

Proper Way to Sign Contracts

Right Way to Designate the Company in a Contract:

World Wide Widgets, LLC, a California limited liability company.

Note the LLC after the name and the written out “limited liability company.” Make sure both the abbreviation and the full designation are used. Typically the proper designation of the company should be in the first paragraph and in the actual signature block where the signer signs. If it is not, the signer should hand write the missing information above where he or she signs and/or on the first paragraph where the company is named.

Right Way to Designate the Capacity of a Signer in a Contract:

Homer Simpson, President (for a California corporation), or Homer Simpson, Manager (for a manager-managed California LLC), or Homer Simpson, member (for a member-managed California LLC).

Wrong Way to Designate the Company in a Contract:

World Wide Widgets

Wrong Way to Designate the Capacity of a Signer in a Contract:

Homer Simpson.

Beware of Personal Guaranty Language in the Contract

If a contract contains any language that would cause the signer to be a guarantor and impose personal liability on the signer, the signer who wants to avoid personal liability must take a pen and cross-out or strike-out all of the guaranty language. If you are signing a contract, you must read it and strike-out any language you don’t want and write on the document any additional language you want. You can modify with hand-written changes all pre-printed contracts before signing.

By | 2017-10-05T10:36:19+00:00 January 1st, 2014|Categories: Asset Protection, LLCs & Corporations, Operating LLCs|0 Comments

Olmstead vs. Federal Trade Commission

This Florida Supreme Court case involved the attempt by the Federal Trade Commission to enforce collection of a $10 million judgment it got against Shaun Olmstead and Julie Connell for their involvement with entities that operated an advance-fee credit card scam. The issue before the court was:

“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.”

Olmstead argued that the issue should be answered in the negative because the only remedy available to a creditor who has a judgment against a member of a Florida single-member LLC is a charging order.  The court said:

“we rephrase the certified question as follows: ―Whether 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. We answer the rephrased question in the affirmative.”

The reason the court allowed the creditor to get to the assets of the single member Florida LLCs is because the court ruled:

“that there is no reasonable basis for inferring that the provision authorizing the use of charging orders under section 608.433(4) establishes the sole remedy for a judgment creditor against a judgment debtor‘s interest in single-member LLC.

California LLC law is different from Florida’s LLC law.  California’s LLC member charging order protection is contained in California Corporations Code Section 17705.03, which states:

On application by a judgment creditor of a member or transferee, a court may enter a charging order against the transferable interest of the judgment debtor for the unsatisfied amount of the judgment. A charging order constitutes a lien on a judgment debtor’s transferable interest and requires the limited liability company to pay over to the person to which the charging order was issued any distribution that would otherwise be paid to the judgment debtor.

See “Olmstead Decision Does Not Make All Single Member LLCs Useless.”

By | 2016-12-13T21:20:23+00:00 June 24th, 2010|Categories: Asset Protection, Charging Orders, Lawsuits|0 Comments