Jeff Vandrew has good intro to how LLC asset protection works.
One of the best asset protection features of LLCs is “charging order protection”. This is a concept borrowed from partnership law that comes from olden times.
To give you an idea of how charging orders work, consider the following example:
1. You have lots of assets. One of your assets is a 50% ownership interest in an LLC which owns and operates a rental property.
2. You are sued in an incident unrelated to the rental property. You lose and a $1M judgment is entered against you.
3. The other party in the incident is now your creditor, and you are a debtor. The creditor starts seizing your assets to cover the $1M.
4. The other party tries to seize your 50% interest in the rental property LLC.
In most states, under the law of “charging orders”, the creditor cannot take your LLC interest. The only thing the creditor is entitled to is a “charging order” against your interest. A charging order is simply a lien which tells the LLC that if it decides to distribute any money to you, to give that money to the creditor instead. The creditor cannot force the LLC to actually distribute any money, nor participate in any way in management of the LLC, nor even usually get information on the LLC’s activities. In New Jersey, this concept of charging orders as the sole remedy of a creditor is codified in N.J.S.A. 42:2B-45.
This charging order concept is very beneficial to you as a debtor in the example. The key is that the creditor cannot force the LLC to make any distributions. The creditor may sit with its charging order for years, never receiving anything unless the LLC chooses to make a distribution. This usually gives you leverage to negotiate a settlement with the creditor where you pay less than the amount owed, and in return the charging order is removed and the judgment considered satisfied.
Note: Unlike Nevada, Delaware and a few other states, the California LLC statutes do not make a charging order the Exclusive remedy. This is why we typically recommend our clients create a Delaware or Nevada LLC to own their rental property.