As those of us residing in the Fargo-Moorhead metro area may travel back and forth over the border between North Dakota and Minnesota multiple times per day, we may not consider that the laws of each state can be significantly different. For an entrepreneur living in Fargo or Moorhead, her state of residence may be the deciding factor in whether she forms a limited liability company (LLC) in North Dakota or Minnesota. While it may seem logical to form an LLC in Minnesota if that is where you live, forming an LLC in North Dakota could provide you and other members with significantly more protection from creditors.
In general, a creditor who has obtained a judgment against a debtor with an interest in an LLC must first pursue repayment by obtaining a charging order from a court against the debtor’s ownership interest in the LLC. A charging order is a lien on the debtor’s transferable interest in the LLC, the transferable interest being the debtor’s right to distributions from the LLC (the debtor’s right to receive income and profits). After a charging order is obtained, the LLC must then pay to the creditor any distributions that otherwise would be paid to the debtor. A charging order does not give the creditor any right to participate in management; the creditor only obtains the right to distributions and therefore cannot direct the LLC to make distributions.
North Dakota law makes a charging order the exclusive remedy for a creditor pursuing repayment from a debtor’s interest in an LLC. N.D.C.C. 10-32.1-45(6)(b). Consequently, if a charging order is obtained against an interest in a North Dakota LLC, the creditor could end up collecting nothing because it cannot direct the LLC to make distributions, and there is no other requirement for an LLC to make distributions unless management chooses to do so.
In contrast, Minnesota provides the additional remedy of foreclosure to a creditor. Under Minnesota law, a judge may order a foreclosure of the debtor’s interest in the LLC if the creditor can show that the distributions from the LLC will not pay the judgment within a reasonable time. Minn. Stat. § 322C.0503, subd. 3. In a foreclosure proceeding, similar to the foreclosure of a home, the debtor’s interest in the LLC will be sold and the proceeds will be used pay the amount due to the creditor. The foreclosure will still only involve the debtor’s right to receive distributions and the purchaser will not become a member of the LLC. Minn. Stat. § 322C.0502, subd. 2. But, even though the purchaser will not have any right to participate in management of the LLC, the threat of a foreclosure will likely result in the remaining LLC members settling the debt with the creditor to prevent them from having financial obligations to a third-party not of their choosing. As a result, the ability of the creditor to foreclose provides a great deal more leverage to the creditor to force the LLC to settle the debt of its member.
It may not seem too important when you are just starting your company and do not anticipate failing to pay creditors, but being able to protect your interest in an LLC from creditors, and, just as importantly, being able to protect the LLC from other members’ creditors, is an important aspect of planning in the infancy of your company. While this is just one example of how deciding between a North Dakota and Minnesota LLC can affect your business in the future, there are sure to be other considerations specific to your business that may be even more impactful to your choice of where to form your LLC. So, if you are lucky enough to live in Fargo or Moorhead, and are considering forming an LLC, you should consult with an attorney before simply picking your home state in which to form the LLC. An attorney can help you evaluate whether a North Dakota or Minnesota LLC will provide you and your business with the greatest protections and advantages now and in the future.
If you are starting a new business or considering establishing an LLC, it may be wise to consult with experienced business attorney Steve Welle at O’Keeffe O’Brien Lyson Foss of Fargo, North Dakota. Steve may be reached by email or by phone at 701-235-8000 or toll free at 877-235-8002.