Does the state you incorporate in determine how much someone can collect from you after losing a lawsuit?
The answer is yes. Read on to see how this works.
What Is a Charging Order?
A charging order is a lein on distributions from an LLC. When someone sues you and you lose the lawsuit, they will want to collect. Hopefully, you have enough insurance and it ends there. But, if your insurance coverage is low or the claim exceeds your insurance limits, the judgement creditor may look to collect against your other assets. That’s why it’s important to have some form of asset protection. It’s also worth noting that different states enforce this law differently, so the state an LLC is incorporated in can make a big difference.
If your real estate or brokerage assets are in a strong state LLC (such as Wyoming or Nevada) all the attacker gets is a charging order. This means they only receive any distributions that come out of the LLC. If no distributions are made, no monies are collected. However, in a weak state like California the judgment creditor can force the sale of the assets held by the LLC. This is why you want to use a strong state where the charging order is the exclusive remedy available to the judgment creditor.
Garnishment to Collect Lawsuit Winnings
Garnishment is another method of collection in which the same judgement creditor can get an order to receive a portion of your paycheck. The courts won’t give them 100% of your workplace earnings, but they can give the judgement creditor a percentage of your paycheck. In Arizona, for example, a maximum of 25% could go towards collection and you get to live on the remaining 75%. Each state has a different percentage.
How does garnishment relate to charging order?
If you do business through an LLC, you make distributions to yourself for services rendered. That is your paycheck and could protect you from losing more if someone were to file a lawsuit against you. Depending on the state in which you form your LLC a judgement creditor could revive a reduced percentage of your distribution based on the garnishment rules.
In the Arizona case of U.S. v. Alexander the court held that garnishment limits applied to charging orders. For a complete discussion of the case click here.
If you can prove that income or distributions from your LLC is compensation for personal services you can limit the charging order to a percentage of your earnings. So instead of receiving 100% of the distributions (as with a charging order) the percentage may be reduced to just 25% (as with an Arizona garnishment.)
Information is power. Use these asset protection rules to your advantage.