Limited Liability Companies (“LLCs”) are among the most popular business entities in Massachusetts because they provide liability protection, flexible management, and valuable estate planning opportunities. However, many Massachusetts business owners overlook one critical issue when forming an LLC: the membership structure of the company.

Whether your LLC has one member or multiple members can significantly impact how the LLC is treated when a creditor obtains a judgment against the LLC or a member of the LLC. For this reason, it is strongly advisable for Massachusetts LLC owners to adopt a comprehensive Operating Agreement, even though Massachusetts law does not require one.

Why an Operating Agreement Matters

Massachusetts LLCs are governed by the Massachusetts Limited Liability Company Act as codified under M.G.L. c. 156C (the “Act”). While an operating agreement is not required to have a legally operative LLC that is in good standing with the Commonwealth, failing to execute an operating agreement will leave all applicable provisions of the LLC subject to the default rules and provisions of the Act. The Act specifically excepts any provisions that are “expressly set forth in any written operating agreement.” This is important because the Act grants any founding members the ability to contract around these default provisions by creating their own operating agreement that is specific to their interests and their business purpose.

An Operating Agreement is one of the most important documents for any LLC. It establishes the rights and responsibilities of members, outlines voting and management authority, governs how membership interests may be transferred, any rights of first refusal to other members in the event a member wishes to sell their interests, and addresses succession planning if a either a manager or member dies or becomes incapacitated. The Operating Agreement is where you and the other founding members can spell out important considerations that you likely won’t want left to the statute to determine for you.

Without a properly drafted Operating Agreement, disputes between owners can become significantly more difficult to resolve, and creditors may have greater opportunities to challenge the structure of the LLC.

For family-owned LLCs holding investment properties, vacation homes, rental real estate, or other long-term family assets, an Operating Agreement can also be incorporated into your overall estate plan to help preserve assets across generations and provide clear guidance regarding management and inheritance rights.

Other Important LLC Requirements

Along with a well drafted Operating Agreement, it is also imperative that the manager and members of the LLC take adequate steps to honor the structure of the LLC. This is vital to ensure the LLC benefits from the “limited liability” structure, meaning the members of the LLC are not held personally responsible for the LLCs debts, liabilities, or lawsuits. At all times the LLC must be treated and maintained as a completely separate legal entity.

To avoid the potential that a creditor can “pierce the corporate veil” it is important to take the following steps:

• Open and maintain a separate business bank account in the name of the LLC. In addition, never commingle personal funds with LLC funds;
• Most single-member LLCs do not require a separate tax identification number from the IRS, because they are viewed as a “disregarded entity” for tax purposes. This means that the sole member of the LLC can use their own social security number for tax purposes, and report all LLC income on their own individual income tax return. For multi-member LLCs (two or more members) however, you must obtain a separate tax ID with the IRS. This would then require a separate tax filing at the LLC level, and the issuance of a K-1 for the share of LLC income tied to each member;
• Ensure all contracts are signed off by the named manager of the LLC, and not in the individual capacity of any manager or member;
• Keep proper records and documentation for all LLC meetings, decisions, or notice requirements pursuant to any applicable operating agreement;
• File all necessary documents with the Massachusetts Secretary of State’s office. All MA LLCs must file an initial “Certificate of Organization” stating the unique LLC name, manager, registered agent, business purpose, and other information in order to be able to operate and do business in Massachusetts. Additionally, all MA LLCs must file an annual report and pay the $500 filing fee each year in order to remain in “good standing.”

Failure to comply with the above procedural mechanisms increases the liklihood that a judgment creditor can attack your LLC by "piercing the corporate veil." This occurs when a court disregards a businesses entity structure, such as an LLC, which in turn allows creditors to go after the underlying LLC assets, and the members personal assets, thereby removing the primary benefit of an LLC which is the limited liability to its members. While this is typically an extreme remedy, it can occur if the court determines that the LLC is being abused, LLC and personal assets are being commingled, or if the LLC members and managers are failing to comply with corporate formalities. 

Charging Orders and Massachusetts LLCs

Massachusetts law provides a statutory remedy known as a “charging order” for creditors of LLC members. Under Massachusetts General Laws Chapter 156C, Section 40, a creditor may obtain a charging order against a member’s LLC interest. The statute states in full:

“On 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. To the extent so charged, the judgment creditor has only the rights of an assignee of the limited liability company interest. This chapter does not deprive any member of the benefit of any exemption laws applicable to his limited liability company interest.” M.G.L. c. 156C, § 40.

This statutorily limited remedy ensures that unlike an interest in other types of entities, the membership interest itself cannot be taken to satisfy a judgment creditor. Moreover, it ensures that the creditor only has the rights of an “assignee.” This means the creditor only has rights to any distributions made by the LLC that otherwise would have gone to the member. However, they have no rights to the membership interest or the ability to participate in the management of the LLC.

Traditionally, charging orders were intended to protect the non-debtor members of a business entity by preventing a creditor from directly taking control of the company or forcing liquidation of company assets. Instead, the creditor is generally limited to receiving distributions that would otherwise go to the debtor-member. They cannot, however, overtake the membership interest and the decision-making and voting rights that may come with it. This remedy also grants the LLC flexibility, because they can elect not to issue any profit distributions to the members and reinvest such proceeds, which would leave the creditor with nothing, and no adequate alternative to collect.

However, Massachusetts law does not expressly state that a charging order is the “exclusive remedy” available to creditors. This distinction becomes especially important as it relates to whether your LLC is structured as a single-member or multi-member LLC.

The Risk of Single-Member LLCs

Only a handful of states (Alaska, Delaware, Nevada, South Dakota, and Wyoming) have statutes that expressly provide that a charging order is the “exclusive remedy” available to creditors of LLC members. In states like Massachusetts, however, the statute is silent on this issue, leaving interpretation to the courts.

As a result, single-member LLCs in Massachusetts may be more vulnerable to creditor attacks than multi-member LLCs.

One of the most important cases on this issue is In re Albright, 291 B.R. 538 (Bankr. Colo. 2003). In Albright, the Court ruled that the assets of a single member LLC could be used to satisfy the creditors of Ashley Albright, who was the sole manager and member of a Colorado LLC. The court denied that the charging order remedy is designed to protect the debtor’s partners and not the debtor in the case of a single member LLC, since in the case of a single member LLC there are no such members to protect. And as a result, the court ruled that the Chapter 7 bankruptcy trustee became the sole member of the LLC, and in turn was able to liquidate all LLC assets (real estate) to satisfy the judgment.

The reasoning behind Albright has been influential nationwide because courts have recognized that the policy rationale supporting charging order protections largely disappears when there are no non-debtor members whose interests need protection.

Accordingly, individuals using LLCs solely for asset protection purposes should carefully consider whether a single-member LLC structure is appropriate, particularly in Massachusetts where the statutory protections are less definitive than in states with “exclusive remedy” language. While not yet supported by case law, in theory this concern can be alleviated by adding a second member to the LLC, even if that second member holds a minority interest as little as 1% or even less.

Estate Planning Benefits of LLCs

LLCs are not only a strong choice of entity for small businesses operating in Massachusetts, but they can also be a powerful estate planning and asset management tool when structured properly. LLCs are commonly used to hold title to:

• Investment properties;
• Vacation homes;
• Rental real estate;
• Family businesses; and
• Other appreciating family assets.

For a full overview of the advantages and disadvantages of holding real estate in an LLC, read our legal blog here. By transferring ownership interests through an LLC rather than directly transferring underlying assets, families can often simplify management, centralize control, and facilitate long-term succession planning. Membership interests in an LLC are often incorporated into Trust planning as well as a means to avoid any membership interest being subject to Massachusetts Probate Court upon the death of a member.

For non-Massachusetts residents, there can be additional benefits to placing your Massachusetts real estate into an LLC for estate tax purposes. By placing your real estate into a Massachusetts LLC, you convert the real estate into an “intangible” asset pursuant to M.G.L. c.156C § 38 which states in full:

“The limited liability company interest is personal property. A member has no interest in specific limited liability property.” M.G.L. c. 156C, § 38.

Massachusetts has its own state-level estate tax exemption, which is currently set at $2 Million Dollars. Many people don’t account for the fact that the Massachusetts estate tax still applies for non-residents that own Massachusetts real estate, even if they are a full time resident of another state that does not have state-level estate taxes (such as New Hampshire or Florida). This means the Massachusetts property held in an LLC would not be includable in the calculation when determining estate taxes due for non-residents owning Massachusetts property, which could otherwise be as high as 16%.

Lane, Lane & Kelly has you Covered for all of your Estate Planning, Real Estate, and Business Planning Needs

LLCs can be extraordinarily effective tools for liability protection, estate planning, and long-term family wealth preservation, but only when they are structured properly. The distinction between single-member and multi-member LLCs can have significant implications for creditor protection in Massachusetts, particularly given the evolving case law surrounding charging orders.

An experienced estate planning, real estate, and business law firm such as Lane, Lane & Kelly, LLP in Braintree, Massachusetts has the knowledge to assist you with structuring your assets to create a holistic plan that benefits you and your family for generations to come. Contact us today to either review your LLC structure and operating agreement, or to create an LLC and estate plan that fits your unique circumstances.

This blog is made available for educational purposes only as well as to give you general information and a general understanding of the law, not to provide specific legal advice. By reading this blog you understand that there is no attorney client relationship between you and Lane, Lane & Kelly, LLP.

Please be advised that nothing in this article is intended to be used as specific tax advice. Lane, Lane & Kelly, LLP is not a certified Tax Specialist. For specific questions, please contact a qualified tax expert or accountant. The information in this article is intended for educational purposes only.