Liability and Foreclosure of a Corporation vs. LLC

Many people wonder whether an LLC or S corporation makes more sense. One advantage, which is a big deal is whether a creditor can foreclosure your shares of a corporation or your membership interests? Why does this matter to you? Simply put, it matters to you because your creditor will have an easier time putting you out of business during a bankruptcy or a creditor issue. In this economy, many business owners have had creditor issues.

S corporation

An S corporation is a type of corporation that is used for small business owners with less than one hundred (100) shareholders and who are U.S. citizens or residents. With an S corporation, one must file an election to be treated as a small business. The advantage of an S corporation is the corporation and shareholder do not both pay a tax. With an Corporation, the corporation and shareholder pay tax when income or a distribution are taken from the business. Thus, a Corporation has a double tax and public companies are one of the few businesses that should be in a C corporation. Another advantage of an C corporation is the payment of health insurance premiums are tax deductible. The disadvantage of this is small business owners are finding that health insurance premiums and the increase in premiums is a huge liability issue (if not addressed appropriately).

An LLC is a hybrid between a Corporation and a Partnership. An LLC is a relatively new business entity, which offers the flexibility of a partnership and limited liability status of a corporation. An LLC may have more than one type of shareholders unlike an S corporation. With an S corporation, you may only have one class of shareholders. In contrasts, an LLC may have voting and non-voting shareholders. The ability to have non-voting and voting members (owners) is a major attraction for an LLC. The remedy for a creditor against an LLC is a charging order versus a foreclosure. If structured the correct way, your creditor cannot foreclose your LLC. With an S corporation, your creditor can take your position as the shareholder. This is not the case with an LLC if structured with voting and non-voting membership interests. A charging order gives the business owner that is being sued a huge advantage of the plaintiff creditor. The most a creditor can claim is a garnishment of the distribution that the member or creditor is entitled to as a creditor. For example, ABC Construction, LLC has a creditor, which has a $50,000 judgment against ABC Construction, LLC in Illinois. With an LLC, ABC Construction could foreclose ABC Construction and take over the shares of the business. Foreclosure is vital because the creditor has voting power and can destroy any hiding of assets that has occured or may occur in the future. In contrasts, an LLC if structured as voting and non-voting shares has a different impact. The creditor only has a right to a charging order, which is an order allowing the creditor to garnish a percentage of the money distributed to the shareholder(s). Thus, as a business owner, you structure most of your ownership of shares in non-voting shares/stock. This way, you may avoid creditor concerns and avoid bankruptcy court. Unfortunately, any smart entrepreneur understands that business is a risky business and one must plan for the worst-case scenario.

Sean Robertson, Esq.
Robertson Law Group, LLC
(312) 498-6080 or (630) 364-2318
RobertsonLawGroup@gmail.com