A question that I get way too often is this: What is the best state to create a limited liability company (LLC) for charging order purposes? After all, they tell me, some states claim to have better charging order law than others. My answer usually surprises most people, which is that it doesn’t really matter. To understand why I give this answer, let’s take a look at 79 Madison LLC v. Ebrahimzadeh, 2022 WL 867901 (N.Y. Super.App.Div., Dept. 1, March 24, 2022).
The facts of this case are easy. The debtor had a judgment against him in New York. The debtor conceded that he owned a 100% membership interest in Corniche Capital, LLC. There was conflicting evidence whether Corniche was a Wyoming LLC or a Delaware LLC. The New York court ordered the debtor to turn over his membership in Corniche to the judgment creditor.
Here, one must understand that in New York, and unlike in most states, a charging order is not the exclusive remedy that is available to a creditor seeking to satisfy a judgment against the debtor’s interest in an LLC. Instead, a New York court may enter a turnover order instead of a charging order if the court determines that the debtor has obstructed the creditor’s attempt to enforce the judgment.
The debtor opposed the turnover order on the basis that under either Wyoming or Delaware law, a creditor’s remedy is restricted to a charging order and thus the turnover order was unavailable to the judgment creditor in New York. But why should Wyoming or Delaware law apply at all? The debtor argued that because of the internal affairs doctrine, a court should apply the law of the state where an LLC was formed (referred to as the formation state) and not that of where the judgment was entered and was being enforced (the forum state).
The New York Appellate Division disagreed:
“However, the internal affairs doctrine applies to relationships between a company and its directors and shareholders []; it does not apply where the rights of third parties external to the corporation are at issue”.
[Internal quotation marks and citations omitted]
Thus, New York law would apply to determine the remedies that were available to a creditor in a New York judgment enforcement proceeding as the forum state, and not the laws of Wyoming or Delaware as the formation state. Thus, the Appellate Division affirmed the turnover order for the debtor’s interest in Corniche.
ANALYSIS
Note that the Appellate Division referenced a corporation as opposed to an LLC. While the opinion does not explain this, the obvious reason (at least to those of us who practice in this area) is that the internal affairs doctrine for LLCs derives from corporate law, and thus the limitations of the internal affairs doctrine should likewise apply to LLCs.
The takeaway from this opinion is obvious: A creditor holding a judgment against a debtor/member of an LLC is a party who is external to the LLC and thus is not subject to the internal affairs doctrine as it relates to the remedies of a creditor. Thus, at least as it relates to charging order protection, it usually doesn’t matter which state the LLC is formed in, since the laws of the forum state (where the judgment is being enforced) will govern.
To extrapolate this result one step further, all these states which are marketing themselves as having superior charging order laws are selling legal fluff at least to the extent they imply that their laws can be exported to the forum state. Thus, most folks who simply form their LLC in-state will, in most circumstances, be as well off from a charging order perspective as with an LLC formed in one these marketing-centric states.
There is one area where this might be true, and I will only briefly mention it because it is a very complicated subject, but a creditor’s alter ego challenge to an LLC might or might not fall within the internal affairs doctrine and thus be subject to the laws of the formation state instead of the forum state. Just note that there is an issue here and some heavy research will be required in a given case.
At the end of the day, the answer to the question of which states have the better LLC laws is that it ultimately doesn’t matter. A corollary to that answer is that the best state to form an LLC is very likely the one that you are in. Consider that if one forms an out-of-state LLC that will conduct business in-state, the LLC will have to qualify to do business in-state anyway. If that is the case, then all one has accomplished by forming an out-of-state LLC is to double the annual fees being paid to the Secretaries of State.
Is it worth it? In the vast majority of cases, probably not.