Olmstead--a lever from member's creditor to full multi-member LLC membership?
The FTC sued the defendants in the U.S. District Court for the Middle District of Florida for unfair and deceptive trade practices in violation of [section]5(a) of the Federal Trade Commission Act. The court entered a judgment against the defendants, jointly and severally, for injunctive relief and more than $10 million in restitution, and ordered assets of the members frozen and placed in receivership. The assets placed in receivership included several nonparty, single-member Florida LLCs owned by either Olmstead or Connell. The order required Olmstead and Connell to surrender all the assets in their nonparty, single-member LLCs. (2) That order went well beyond the scope of the charging order remedy provided by F.S. [section]608.433(4), which states:
On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the limited liability company membership 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 such interest. This chapter does not deprive any member of the benefit of any exemption laws applicable to the member's interest.
Olmstead and his accomplice defendants appealed the order to the U.S. Court of Appeals for the 11th Circuit, arguing that a) the plain language of the statute does not distinguish between single-member and multimember LLCs, and b) a charging order is the exclusive remedy that a judgment creditor may obtain against the membership interest of a member of a Florida LLC, including a single member LLC. The FTC argued that the charging order remedy originated in common law to protect nondebtor partners from being forced unwillingly into partnership with a creditor of a debtor-partner and that this rationale does not apply to single-member LLCs because there are no nondebtor members whose interests need protection, and, therefore, a charging order should not be the sole remedy. (3) The 11th Circuit concluded that Florida law was not sufficiently clear for the court to determine whether the district court's surrender order was permissible under the Florida LLC charging order statute, F.S. [section]608.433(4), and certified the following question to the Florida Supreme Court: "[W]hether pursuant to Fla. Stat. [section]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 a judgment." (4)
The Florida Supreme Court Opinion
On June 24, 2010, the Florida Supreme Court issued its opinion in Shaun Olmstead, et al., v. Federal Trade Commission, 44 So. 3d 76 (2010). In a five/two decision, the majority first rephrased the 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." (5) By pulling back the judicial lens of the controlling law from the narrow focus of the LLC charging order statute to the wide angle vista of the entire body of Florida law, the majority prefigured its ultimate holding. The majority answered the question in the affirmative, holding that 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. The holding was based on the following premises:
1) F.S. [section]608.432(2)(b) only entitles the assignee of a membership interest a right "to share in such profits and losses, to receive such distribution or distributions, and to receive such allocation of income, gain, loss, deduction, or credit or similar item to which the assignor was entitled, to the extent assigned," (6) unless all members other than the assigning member consent to admit the assignee as a member with a member's rights to vote and participate in management. The assignee does not have any right to vote, participate in management, or obtain information.
2) But the sole member of a single-member LLC, unlike a member of a multi-member LLC, has the unfettered power and right to voluntarily transfer the entire interest in the LLC, including control of the management of the LLC, because there are no other members whose consent is required. Therefore, the limits on the rights that a member can assign under F.S. [section]608.432(2)(b) do not apply to the voluntary transfer of rights in single-member LLCs.
3) F.S. [section]608.433(4) provides a charging order remedy for a judgment creditor of a debtor-member of an LLC and limits the rights of a judgment creditor under a charging order to the rights of an assignee.
4) F.S. [section]608.433(4) should not be interpreted to give a judgment creditor of the sole member of an LLC less extensive rights than the rights that are voluntarily assignable by the judgment debtor (the court cited In re Albright, 291 B.R. 538, 540 (D. Colo. 2003), which rejected the argument that the bankruptcy trustee was only entitled to a charging order with respect to the debtor's ownership interest in a single-member LLC, and holding that "'[b]ecause there are no other members in the LLC, the entire membership interest passed to the bankruptcy estate'"). (7)
5) The charging order provisions in both the Florida Revised Uniform Partnership Act, F.S. [section][section]620.81001-.9902 (2008), and the Florida Revised Uniform Limited Partnership Act, F.S. [section][section]620.1101-.2205 (2008), expressly provide that the charging order is the exclusive remedy that a judgment creditor may have against the partnership interest of a debtor partner. But F.S. [section]608.433(4) does not expressly state that a charging order is the exclusive remedy that a judgment creditor may have against the membership interest of a debtor member of an LLC. Therefore, the legislature must not have intended a charging order to be the exclusive remedy.
6) F.S. [section]56.061 provides that various categories of real and personal property, including "stock in corporations," "shall be subject to levy and sale under execution."
7) An LLC is a type of corporate entity, and an ownership interest in an LLC is personal property that is reasonably understood to fall within the scope of "corporate stock."
8) Therefore, a charging order is not the sole remedy that a judgment creditor may obtain against the membership interest of the debtormember of a single-member LLC, and under the provisions of F.S. [section]56.061, a court may order the judgment debtormember of a single-member LLC to surrender all right, title, and interest in the debtor's single-member LLC to satisfy the outstanding judgment.
Although the penultimate sentence of the holding is limited to single-member LLCs, the opinion establishes the following findings of law: a) "[S]ection 608.433(4) ... does not expressly establish the charging order as an exclusive remedy" (8); b) "an LLC is a type of corporate entity, and an ownership interest in an LLC is personal property that is reasonably understood to fall within the scope of 'corporate stock'" (9); and c) "[s]ection 608.433(4) does not displace the creditor's remedy available under section 56.061 with respect to a debtor's ownership interest in a single-member LLC." (10)
Opinion Not Limited to Single-member LLCs
The opinion does not expressly limit the applicability of the following findings to single-member LLCs: 1) The LLC charging order is not an exclusive remedy; 2) an LLC is type of corporate entity, and 3) an ownership interest in an LLC is personal property within the scope of corporate stock to single-member LLCs.
These findings have introduced significant uncertainty with respect to multimember LLCs. The most damaging of the findings are that an LLC is a type of corporate entity and that an ownership interest in an LLC is personal property within the scope of corporate stock. No authority was cited for these findings, and there was no analysis or rationale articulated for them. These findings undercut the quasi-partnership nature of the LLC, and they are inconsistent with the theory of the Florida LLC Act, which is more similar to the Florida Revised Uniform Partnership Act, F.S. [section][section]620.81001-.9902 (2008), and the Florida Revised Uniform Limited Partnership Act, F.S. [section][section]620.1101-.2205 (2008), than it is to the Florida Business Corporation Act, F.S. [section][section]607.0101-.193. Furthermore, most LLCs are excluded from the definition of "corporation" in the Florida Income Tax Code: "The term 'corporation' does not include proprietorships, ... partnerships of any type, ... limited liability companies that are taxable as partnerships for federal income tax purposes." (11)
The statute does not address the tax issue with respect to single-member LLCs that are disregarded entities for federal income tax purposes. However, the legislative record demonstrates that the intent was to have single-member LLCs treated in the same manner as they are treated for federal income tax purposes. (12) Also, the investment securities chapter of the Florida Uniform Commercial Code states, "An interest in a partnership or limited liability company is not a security unless it is dealt in or traded on securities exchanges or in securities markets." (13) But "a share ... issued by a corporation ... is a security." (14)
If indeed an LLC "is a type of corporate entity" and an ownership interest in an LLC is personal property within the scope of corporate stock rather than a type of partnership entity, then why should the rights of an assignee of an LLC membership interest be more limited than the rights of an assignee of corporate shares of stock? Why then does F.S. [section]608.432(2)(b) essentially limit the rights of an assignee of a membership interest to the distributions and income and loss allocations from the LLC properly allocable to the membership interest assigned? The FTC admitted that the charging order remedy originated in common law to protect nondebtor partners from being forced unwillingly into partnership with a creditor of a debtor-partner. Why did nondebtor corporate shareholders not have the same protection? Why do the LLC model act and most, if not all, state LLC acts limit the rights of an assignee of a membership interest like those of an assignee of a partnership interest instead of granting an assignee full rights like the assignee of shares of corporate stock? The answers to these questions lie in the origins of the partnership, the corporation, and the LLC.
Origin of the Partnership
The concept of the partnership has been with us since the dawn of commerce, i.e., two or more individuals, but in any event, a relatively small group of individuals, joining together to operate a closely held trade or business. The livelihood and financial security of each partner depended on both the trustworthiness and diligence of the other partners. Accordingly, the law naturally developed to prevent a stranger from forcing himself or herself into the partnership. Thus, the concept that a judgment creditor may access distributions from the partnership to its debtor-partner to satisfy the debt, but may not "step into the debtor-partner's shoes" and participate in the management and operation of the business, is inherent in the nature of a partnership. The charging order is the modern statutory device that codified the common law and by which a judgment creditor's rights against the debtor-partner's interest in a partnership is limited essentially to the distributions from the partnership to the debtor-partner.
Origin of the Corporation
By the late 16th century, the needs of some business and commercial ventures had grown well beyond the capacity of a small group of partners to provide. For example, there was demand in Western Europe for large quantities of goods made in the Far East. Sailing from the North Sea to the Far East and back to trade goods was a risky adventure that required a vast amount of capital. Not infrequently, ships were sunk and the ship, sailors, and goods were lost. The partnership was not an effective vehicle to raise the amount of capital necessary for such business ventures. The corporation was invented as the vehicle to raise large amounts of capital from thousands of investors for risky, long-term business ventures that require investment of vast sums of capital well in advance of the realization of profits.
To convince thousands of individuals to invest in a long-term, risky venture managed and operated by individuals they did not know, it was necessary to limit the liability of the investors for the debts and obligations of the corporation to protect them from losing their other assets if the venture went bust.
Smaller enterprises could continue to operate as partnerships. (15) The earliest examples were a half-dozen Dutch East India joint stock companies for the Dutch East Indies trading industry, which eventually merged into the United Dutch Chartered East India Company in 1602.
Not long after, exchanges were developed where shareholders could buy and sell shares in the joint stock companies. (16) Thus, unlike the partnership, the concept of the corporation from the beginning contemplated that shareholders were fungible in the sense that their contribution to the corporation was only their capital investment and not their labor, talent, or skills. Consequently, there was no rational basis to limit a judgment creditor's rights against his debtor-shareholder's shares in a corporation to the dividends debtor's shares because neither the corporation nor the other shareholders knew the other shareholders or cared very much who held the shares and exercised the voting rights associated with the shares.
Accordingly, modern statutes provide that the assignee of corporate shares succeeds to all of the rights of the shareholder, including voting rights, and creditor rights statutes, such as F.S. [section]56.061, allow a judgment creditor of a shareholder to attach, execute, and sell the corporate shares owned by the judgment debtor.
Thus, the rights of assignees and judgment creditors to "step into the shoes" of assigning shareholders and debtor-shareholders and the more limited rights of assignees and judgment creditors of assigning partners and debtor-partners are inherent in the origins of the corporation and the partnership. While the partnership and the corporation have been part of the commercial landscape for centuries, the LLC is a newbie. But, like the partnership and the corporation, the LLC was invented to fill a need.
Origin of the LLC
Because of U.S. tax laws, the corporation was not an ideal vehicle for many types of commercial activity, such as owning, improving, and leasing real property, drilling for oil and gas, etc. But the partnership was not ideal either. The general partnership's joint and several liability of its partners for the partnership's debts and obligations was always problematic and became more so with the advent of strict liability environmental laws and other liabilities that could not be adequately or reasonably insured against.
The limited partnership could be structured with a corporate general partner to provide the necessary limited liability against the partnership's debts and obligations, but its management structure was not ideal for a closely held business or closely held real property venture where the management structure of a general partnership was needed. Something new was needed. As a result, the LLC was invented as a quasi-partnership that provided 1) the needed limited liability against the enterprise's debts and obligations, 2) the management structure of a general partnership, and 3) the income tax structure of a partnership.
LLC statutes adopted the charging order from partnership statutes to limit the rights of judgment creditors against debtor-members' LLC interests in exactly the same way and for exactly the same reasons as charging orders limited the rights of judgment creditors against debtor-partners' partnership interests. An LLC is a form of partnership born of contract. (17) That is why the original LLC acts imposed a two-member requirement. (18) But an LLC is also a creature of statute and an entity separate from its members, which is essential to the limited liability shield for its members and which results from the statute and not the member's contract. (19)
In 1982, Florida was the second state in the U.S. to pass an LLC act. (20) The LLC concept was considered new in U.S. law, but in 1874, Pennsylvania enacted a law authorizing a limited partnership association that was similar to the modern limited liability firm in Europe and Latin America. (21) Aside from the isolated 1874 Pennsylvania act, the origin of the LLC concept appears to have begun in Germany in 1892 with the enactment of the Gesellschaft mit beschrnkter Haftung, better known as GmbH. (22) Other countries followed by enacting similar legislation:
Portugal (1917); Brazil (1919); Chile (1923); France (1925); Turkey (1926); Cuba (1929); Argentina (1932); Uruguay (1933); Mexico (1934); Belgium (1935); Switzerland (1936); Italy (1936); Peru (1936); Columbia (1937); Costa Rica (1942); Guatemala (1942); and Honduras (1950). In France, by the late 1940s, the limited liability entity known as "societes de responsabilite limitee" was more popular than the more traditional stock corporation and comprised approximately one-third of all French filings.
In addition to limited liability, the LLC laws of the above countries have the followed four basic characteristics which distinguish it from other business forms: (1) requiring use of the word "limited" in the entity's name; (2) the corporate concept that entity's existence is separate from its members; (3) the partnership concept that members control admission of new members to the entity, and (4) the partnership concept that the entity is dissolved by death of a member, unless otherwise expressly stated in the articles of association.... (23)
Originally, Florida law imposed 5.5 percent corporate income tax on all LLCs, and the Florida LLC Act did not allow single-member LLCs. Accordingly, if an LLC's membership was reduced to one through death of a member or other causes, the LLC automatically dissolved. There was resistance to using LLCs subject to an income tax not imposed on S corporations and partnerships and that would automatically be dissolved and cease to exist if the death or other loss of a member reduced the number of members to one, potentially exposing the last member to personal liability for the obligations of the former LLC and to unwanted tax consequences. As a result, wide use of the LLC in Florida did not develop until the LLC act was amended in 1998 by S.B. 704 (effective in 1999) to eliminate the Florida corporate income tax on LLCs treated as partnerships, S corporations, or disregarded entities for federal income tax purposes and to allow single-member LLCs.
The 1998 Florida legislative session did not originally address single-member LLCs in S.B. 704. Its focus was on eliminating the Florida corporate income tax on LLCs treated as partnerships or S corporations for federal income tax purposes. But in the final week of the legislative session, S.B 704's sponsor moved successfully to amend the bill to permit single-member LLCs. (24) Consequently, no distinctions were drawn between multi-member LLCs and single-member LLCs, and there was not a great deal of thoughtful analysis devoted to the consequences of simply permitting single-member LLCs within the overall framework of the LLC act.
LLC: A Type of Corporate Entity and Alternative
We have seen that the LLC in both its current statutory form and in its history is conceived as more like a partnership than a corporation, that the Florida income tax code excludes the LLC from the definition of corporation unless it elects to be treated as a taxable "C" corporation for federal income tax purposes--which few, if any, do--and that the Florida Uniform Commercial Code treats shares of corporate stock as securities, but not member interests in LLCs unless they are dealt in or traded on securities exchanges or in securities markets.
Why then did the Florida Supreme Court without analysis or citation of authority simply decide that "[A]n LLC is a type of corporate entity, and an ownership interest in an LLC is personal property that is reasonably understood to fall within the scope of 'corporate stock'"? (25) It is the single-member LLC that makes an LLC structurally different from a limited partnership since by definition a partnership must have at least two partners to exist. And it is this structural difference that the Florida Supreme Court faced in attempting to balance the rights of creditors against the rights of nondebtor members of an LLC since there were no nondebtor members whose interests needed protection. There was only the interest of the federal creditor that needed protection and indirectly the consumers whose interests had been violated by the defendant single-members' scam.
The arguments before the court were focused exclusively on whether the charging order of F.S. [section]608.433(4) was the exclusive remedy for a judgment creditor seeking to satisfy its judgment against the interest of the defendants' single-member LLCs. The defendant single-members argued only that the charging order was the exclusive remedy. The federal judgment creditor argued that the only reason to limit the rights of a judgment creditor against the LLC interest of the debtor-member was to protect the rights of the other nondebtor members, but since there are no other members to protect in a single-member LLC, there is no good reason to so limit the rights of the judgment creditor. Unlike the partnership and limited partnership statutes that expressly state that the charging order is the exclusive remedy, F.S. [section]608.433(4) is silent.
Logic and justice were strongly in the FTC's favor and against the defendant single-member debtors. The court could rule in favor of the FTC if it could find a way to apply the levy and sale under execution provisions of F.S. [section]56.061. It was easy to find that the charging order was not the exclusive remedy for a judgment creditor against the membership interest of an LLC. But the court needed a way to apply F.S. [section]56.061. To do that, it found that "[A]n LLC is a type of corporate entity, and an ownership interest in an LLC is personal property that is reasonably understood to fall within the scope of 'corporate stock.'" (26)
Was there an alternative to F.S. [section]56.061 that would not put nondebtor members of multi-member LLCs at risk of being forced to accept judgment creditors as members? Unfortunately, no such alternative was presented to the court. Any other acceptable alternative would have resulted in the defendant debtor, single members suffering the same fate, so there was no incentive for them to argue an alternative. Apparently, the FTC either was confident its "charging order is not an exclusive remedy" argument would prevail for single-member LLCs, or it simply did not think of an alternative.
There was, however, a narrower path of reasoning to reach the same result in a single-member LLC that would not have created havoc in the business world for multi-member LLCs. The court could have taken the following path:
1) Since the charging order statute for LLCs, F.S. [section]608.433(4), does not prohibit the foreclosure of a charging order against an interest in an LLC as F.S. [section]620.1703 does for LPs and LLLPs, in the absence of such a statutory prohibition, a court may order the foreclosure of a charging order against an interest in an LLC.
2) Upon foreclosure, the new owner of the single-member LLC interest would be the permanent sole owner of the LLC and may do as he or she pleases without any incursion upon anyone else's rights or expectations.
3) Deciding that F.S. [section]608.433(4) does not prohibit the foreclosure of a charging order against an LLC interest does no harm to the nondebtor members of multi-member LLCs because it does not put them at risk of having attachment, levy, and sale of a member's entire interest under F.S. [section]56.061, including the right to vote, to participate in management, and to force distributions instead of reinvestment of profits to grow the business. It would only provide that after a charging order has been issued, a court may order the foreclosure of the debtor-member's LLC interest, so that the judgment creditor will still have only the limited right provided by F.S. [section]608.432(2)(b) "to share in such profits and losses, to receive such distribution or distributions, and to receive such allocation of income, gain, loss, deduction, or credit or similar item to which the assignor was entitled," but on a permanent basis instead of a temporary basis.
4) In addition, there is a tax disincentive for a judgment creditor of a debtor-member of a multi-member LLC to foreclose on the interest because after foreclosure, the creditor is the owner of the interest, will receive a K-1, and will be liable to the IRS for the interest's allocable share of taxable income, whether or not there are any distributions--but the creditor will not be a member and will not have a right to vote or participate in management of the business or decisions whether to make distributions.
The current uncertainty with respect to multi-member LLCs can only be corrected by an amendment to the statute or a subsequent opinion of the Florida Supreme Court in a multi-member LLC case. Alternative amendments the Florida Legislature may consider include:
1) The legislature could follow other states and simply amend F.S. [section]608.433(4) to declare that it is the exclusive remedy by which a judgment creditor of a member or member's transferee may satisfy a judgment out of the judgment debtor's transferable LLC interest, as F.S. [section]620.8504 does for partnerships and limited liability partnerships, and protect both multimember and single-member LLCs.
2) If the legislature desires for Florida to be competitive with those states offering the most protection to LLC members, it could follow certain other states and Florida limited partnerships and limited liability limited partnerships under F.S. [section]620.1703. Amended F.S. [section]608.433(4) would declare that a) it is the exclusive remedy by which a judgment creditor of a member or member's transferee may satisfy a judgment out of the judgment debtor's transferable interest in the LLC; b) other remedies, including foreclosure on the member's interest in the LLC or a transferee's transferable interest and a court order for directions, accounts, and inquiries that the debtor-member might have made, are not available to the judgment creditor attempting to satisfy the judgment out of the judgment debtor's interest in the LLC; and c) may not be ordered by a court. This would protect both multi-member and single-member LLCs.
3) The legislature could amend F.S. [section]608.433(4) to state that it is the exclusive remedy by which a judgment creditor of a member or member's transferee may satisfy a judgment out of the judgment debtor's transferable LLC interest, but provide that the court may order a foreclosure of the interest in a single-member LLC subject to the charging order at any time and that the purchaser at the foreclosure sale has the rights of a transferee, as does F.S. [section]620.8504 for partnerships and limited liability partnerships. This would protect the nondebtor members of multi-member LLCs and allow judgment creditors to become the sole owner of a single-member LLC.
Meanwhile, practitioners will consider advising their clients to consider organizing LLCs in other states where the charging order is both the exclusive remedy and foreclosure is not allowed, which includes Alaska, Oklahoma, and South Dakota. Alternatively, practitioners may recommend a Florida limited liability limited partnership (LLLP) in appropriate circumstances. Neither of these solutions will work for professionals seeking certain protections exclusive to Florida professional associations and professional LLCs.
(1) Federal Trade Commission v. Peoples Credit First, LLC, et al., 2005 U.S. Dist. LEXIS 38545 (M.D. Fla. Dec. 18, 2005).
(3) FTC v. Olmstead, 528 F.3d 1310, 2008 U.S. App. LEXIS 11393 (Fla. 11th Cir. 2008).
(4) Id. (emphasis supplied).
(5) Olmstead, 44 So. 3d at 78 (emphasis supplied).
(6) Id. at 79.
(7) Id. at 81, quoting In re Albright, 291 B.R. at 540.
(8) Id. at 81.
(9) Id. at 80.
(10) Id. at 83.
(11) Fla. Stat. [section]220.03(1)(e).
(12) 3 Fla. H.R.J. 2405 (Reg. Sess. 1998); Louis T.M. Conti, Florida Joins the Union with Respect to LLCs, 72 Fla. B. J. 51 (1998).
(13) Fla. Stat. [section]678.1031(3).
(14) Fla. Stat. [section]678.1031(1).
(15) Niall Ferguson, The Ascent of Money, 121 (Penguin Books 2008).
(17) Daniel S. Kleinberger, Agency, Partnerships and LLCs, 448 (Aspen Publishers Online 2008).
(19) Id. at 489.
(20) Conti, Florida Joins the Union with Respect to LLCs, 72 Fla. B. J. 51 (1998).
(21) Eder, Limited Liability Firms Abroad, 13 Univ. Pitt. L. Rev. 193 (1952); Limited Liability Company Reports, LLC History, http://www.llc-reporter.com/16.htm.
(22) Limited Liability Company Reports, LLC History, http://www.llc-reporter. com/16.htm.
(24) Conti, Florida Joins the Union with Respect to LLCs, 72 Fla. B. J. 51 (1998).
(25) Olmstead, 44 So. 3d at 80.
A. Edward McGinty is of counsel in the Tampa office of Shumaker, Loop & Kendrick, LLP. He practices in the areas of complex business and real property transactions, mergers and acquisitions, tax, asset protection, and estate planning.
This column is submitted on behalf of the Business Law Section, Michael J. Higer, chair, and Melanie E. Damian and Peter F. Valori, editors.
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|Title Annotation:||Business Law|
|Author:||McGinty, A. Edward|
|Publication:||Florida Bar Journal|
|Date:||Mar 1, 2011|
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