A Limit on Creditor Control of the Nevada LLC

Nevada supports the survival of the LLCOne of the main reasons limited liability companies are formed is to limit the liability of the investors and operators of the company.  In Nevada, unless otherwise provided in the articles of organization or an agreement signed by the member or manager to be charged, no member or manager of any limited-liability company formed under the laws of the State is individually liable for the debts or liabilities of the company.  [NRS 86.371].

What about the reverse?  Can the company become liable or even controlled by a creditor of an individual member or manager of the LLC?  In other words, the individual member (or owner/investor) can incur debt outside of the operation of the LLC, debt which may have nothing to do with the LLC.The party to whom the member may owe those debts may seek to have any and all assets of the LLC member sold to pay those debts.  If the creditor goes to court and gets a judgment against the member, she becomes a judgment creditor.

The question arises: what rights does the judgment creditor have to go after the debtor’s involvement in a limited liability company?  Other members of the limited liability company naturally become concerned about their co-member’s creditor coming in like a bull in a china shop messing up the workings of the company.

Unlike California, the sole remedy is a “charging order” against the debtor member’s interest.  Nevada law says that remedies, such as 1) foreclosure on the member’s interest, or (2) a court order for directions, accounts and inquiries that the debtor or member might have made, are prohibited.  [NRS 86.401(2)(a))].  This is good news for limited liability company operators and bad news for creditors of those operators (members).  The only exception to this is that the operating agreement of the limited liability company and a debtor/creditor agreement can override this statutory limitation and provide additional remedies.  ([NRS 86.401(2)(a)].  (One assumes that the operating agreement may not allow less in the way of remedies because creditors have a right to rely on statutory authority and are not privy to private, unfiled, unrecorded LLC operating agreements).

In 2012, the Nevada Supreme Court held that the judgment creditor only can go after the member’s economic interest, which is defined to mean the profits, losses and distributions of the LLC assets.  The creditor may not participate in the management of the Nevada limited liability company.  This means the creditor may not step into the member’s shoes and vote at meetings or participate in any way in the management, including the situation where the member has been set up as a manager of the LLC.  [Weddell v. H2O, Inc., 271 P.3d 743, 745, 748].  The court calls these powers the member’s management rights.

The public policy behind this decision, as explained in the Weddell case, is to prevent the creditor from disrupting and interfering with the management rights of the other members, the members who are not debtors to the creditor with a charging order.  The LLC member has an “uncontested right” to choose his or her associates.  It also reinforces the foundational reason for investing in a Nevada limited liability company:  it enables limited members to invest money and to share profits without risking more than the amount they contributed.  [Weddell v. H2O, Inc., 271 P.3d 743, 748].

Now, just because the creditor cannot exercise management rights does not mean that the in-debt member will maintain his management rights.  A provision in the operating agreement, if such exists, can trigger the forfeiture of management rights.  The operating agreement in one of the LLC’s at issue in the Weddell case had a clause triggering an involuntary transfer procedure if any member’s interest was subject to a charging order.  Because the in-debt member had a charging order entered against his share of the LLC, the clause allowed another member to takeover as manager.  Still, the creditor did not get management rights.  However, the in-debt manager lost both his economic interests (to the creditor) and his management interests (to the other managing member).  [Weddell v. H2O, Inc., 271 P.3d 743, 750-751].

This article is not legal advice.  If you need the assistance of counsel with a limited liability company issue in California and Nevada, please contact us using any of the contact methods on our contact page.

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