Lender position and asset protection?

[Parker Cox]

When I started looking into this I thought it would be straight forward, but its not...

Thought experiment: 

I am in Ca and I have an LLC devoted exclusively towards my real estate investing. I have my own money as well as other investors' held under the LLC, who have gone in on my projects and are getting their promised annual percent return. But, with the cash that is in there, in the event that I/the LLC was sued, I need to understand how the cash within the LLC would be dispersed.

Does it get taken from my portion of the funds first as the head of the LLC? does it remove all the funds equally and we continue to all share the equal portions of whatever is left after settlement? or is it dispersed by loan/investor position? and if it is based on position, do I count as lowest position (least protected investment) or highest position (most protected investment)?

Thanks for your help

[Jer Fortenberry]

No one can really answer the questions about allocation of liability without knowing what your Operating Agreement says. There are two different types of creditors to think of in the LLC context:

• Owner Creditors - Liability of the owner. The concern is how to protect the entity's assets if the owner ends up with a personal judgement against him. 
• Entity Creditors - Liability of the entity. The concern is how to protect the owner's assets if the entity ends up with a judgment against it. 

It sounds like you are asking about entity creditors. If the entity is sued and loses (i.e., if you end up with a judgment against the LLC), the assets of the LLC would be used to pay the judgment. Any amount left over after the judgment is satisfied would either remain in the LLC or, if the LLC is liquidated, distributed to the owners. If it is distributed to the owners, it would either be in proportion to ownership or as otherwise provided in the Operating Agreement. Your position as "head of the LLC" doesn't help or hurt you unless you have some preferential rights as determined by your Operating Agreement.

The protection offered by the LLC in this context is that the entity creditors can only look to the assets of the LLC. Assuming that the LLC was properly formed and operated, the creditors of the LLC cannot come after you personally. If the judgment amount exceeds the value of the assets in the LLC, the creditors will end up with pennies on the dollar. This is why it usually makes sense to hold real estate in separate LLCs. Doing so allows you to contain the liability to each parcel of real estate.

The other type of liability (owner creditors) can also be addressed in the LLC context through what is known as charging order protection. But that's another topic.