LLC Protection for Members' Personal Debt in Texas (2024)

When the owner (called a "member") of a limited liability company (LLC) has personal debt, many states provide collection options for the member's creditors. These options directly relate to the indebted member's interest in the LLC and the company itself. Texas is one of the most debtor-friendly states, providing generous protection to LLCs and their members.

General Rule: LLC Isn't Liable for Members' Personal Debts

In general, states treat LLCs and their owners as separate entities. Texas is no exception. Any property that the LLC owns—for example, property in the LLC's name or funds in the company bank account—is the LLC's property alone. The LLC members don't own that property. Therefore, creditors can't generally take the LLC's money or property to satisfy a member's personal debt.

This separation is one of the key reasons people decide to form an LLC. For example, if a member personally files for bankruptcy, the LLC's assets will be safe. In addition, the LLC protects the business and its owners from exposure to any debts or personal liability the other LLC members might incur that are unrelated to the LLC's business.

On the other side, an LLC provides its members with personal liability protection from the company's business debts. If the LLC owes money to its creditors, the creditors usually can't sue the members personally for the debt.

General Protections of Texas LLC Members

When you personally owe a debt, creditors can take action to collect that debt, including obtaining a court judgment against you. When a creditor gets the court to order you to pay a debt, the creditor becomes a "judgment creditor."

When you owe a debt and are an LLC member, you should generally consider three actions the judgment creditor can potentially take against you:

• The judgment creditor gets the LLC to pay your LLC distributions and income to them rather than to you.
• The judgment creditor takes over your financial rights and interest in the LLC, meaning they have full rights in your LLC distributions and in your share of the LLC's assets if the LLC dissolves.
• The judgment creditor forces the LLC to dissolve and collects the judgment from the LLC's assets.

In Texas, the judgment creditor can only take the first action and not the other two:

• The judgment creditor can get a court to order the LLC to pay them any LLC distributions and income meant for you (called a "charging order").
• However, the judgment creditor can't foreclose on your financial interest in the LLC, meaning they can't take over your financial rights in your LLC.
• The judgment creditor also can't force your Texas LLC to dissolve.

Texas LLCs and Charging Orders—Exclusive Remedy

Texas's LLC laws are very friendly to LLC members with personal debt. In Texas, a creditor's sole remedy against an LLC member is a charging order. In other words, a charging order is the only legal procedure that personal creditors of a Texas LLC member can use to get at an indebted LLC member's ownership interest. (Tex. Bus. Org. Code § 101.112 (2024).)

To obtain a charging order, the creditor must have a judgment against the LLC member personally. After the judgment is entered, the creditor can apply to the court for a charging order. A charging order directs the LLC to pay to the creditor any distributions of income or profit that would otherwise be distributed to the indebted LLC member. Like most states, creditors with a charging order in Texas only obtain the indebted member's financial rights and can't participate in the LLC's management.

Because a judgment creditor with a charging order can't participate in the LLC's management, they also can't:

• order the LLC to make a distribution, or
• order the LLC to be sold to pay off the debt.

As a result, creditors who obtain charging orders against LLCs often end up with nothing because they can't order the LLC to make any distributions and the LLC can choose not to make any.

While a creditor might see a charging order as a weak remedy, the charging order isn't necessarily ineffective. For instance, the existence of a charging order can make it difficult or impossible for an indebted LLC owner or the other owners (if any) to take money out of an LLC business without having to pay the judgment creditor first. To avoid this costly inconvenience, the indebted LLC member or the other owners could seek to pay off or settle the debt. As a result, the creditor might not see any distributions from the LLC but they could, nevertheless, walk away with the debt settled.

For example, suppose Barbara, Menard, and Keith own a Texas LLC for their consulting business. Over the next few months, Keith takes on $20,000 in debt on his personal credit cards. When Keith doesn't pay the charges, his accounts are turned over to a debt collection agency. The agency goes to court and obtains a $20,000 judgment against Keith. The collection agency is limited to Keith's personal assets. It can't take money or property owned by the LLC. For example, it can't take any funds held in the LLC's bank account.

However, the collection agency can get a charging order against the LLC, and it does so. Barbara and Menard depend on their periodic LLC draws distributions as their income. However, their LLC operating agreement says that if one member collects an LLC distribution, all members are owed a distribution. So, if Barbara or Menard want to take a distribution, they must also pay out Keith's creditor per the charging order. Barbara, Menard, and Keith meet and decide to have their LLC pay Keith's $20,000 debt to get rid of the charging order against the LLC.

Foreclosure and Dissolution Not Allowed

Texas's LLC law explicitly says that a charging order is a judgment creditor's exclusive legal remedy. In other words, judgment creditors of Texas LLC members can only use a charging order to satisfy a judgment out of the debtor's membership interest. (Tex. Bus. Org. Code § 101.112 (2024).)

Consequently, Texas law doesn't allow judgment creditors to collect on a personal debt by:

• foreclosing on an owner's LLC ownership interest, or
• getting a court to order the LLC dissolved and its assets sold.

Explicitly limiting judgment creditors to only charging orders makes Texas a particularly attractive state to form an LLC for those looking to protect assets from personal creditors.

What About Single-Member Texas LLCs?

Some states distinguish between multi-member and single-member LLCs (SMLLCs) in their laws and court decisions. In these states, judgment creditors often aren't limited to charging orders for SMLLCs even if that's the sole remedy provided by law for multi-member LLCs.

The reason many state laws limit the remedies available for personal creditors of LLC owners to a charging order is to protect LLC members from the personal debts of other members that are unrelated to the LLC and its business. Without charging order protection, LLC members could be forced into sharing management and control of the LLC with a member's personal creditor. Charging orders avoid this outcome by giving creditors the right to distributions only. With an SMLLC, there are no other members to protect so the rationale for limiting creditors to a charging order disappears.

How Texas Law Treats Multi-Member vs. Single-Member LLCs

In 2023, Texas changed its LLC laws to clarify its application to multi-member LLCs and SMLLCs. In its section on how judgment creditors can enforce judgments against LLC members, Texas's LLC laws specified that the section applied to both multi-member and single-member LLCs. (Tex. Bus. Org. Code § 101.112 (2024).)

So, creditors of SMLLC owners are also limited to only charging orders to enforce their judgments and recover debts against SMLLC owners.

If you form an LLC in Texas, then Texas law will usually apply. However, this application isn't always the case. Another state's laws could apply if your LLC has property or does business in another state. Another state could be less debtor-friendly, particularly for SMLLCs.

Consider Forming or Converting to a Multi-Member LLC

If you're concerned about protecting your SMLLC's assets against personal creditors, you could consider adding another member to your Texas LLC to become a multi-member LLC. Owning a multi-member LLC instead of an SMLLC could give you more protection if:

• you file for bankruptcy, or
• your LLC is judged by the LLC laws of another state that provide less protection to SMLLCs.

If you add an additional member to your LLC, you'll need to treat them as a legitimate co-owner of the business. If the second owner is added merely on paper as a sham, the courts will likely treat the LLC as an SMLLC.

For example, a legitimate co-owner of a business usually:

• pays a fair market value for the LLC interest they acquire
• receives financial statements
• participates in some level of decision-making, and
• receives a share of the LLC profits equal to the membership percentage owned.

If you're interested in this solution but want to avoid the second member having control over the company's daily operations, you can set up a manager-managed LLC and name yourself as the sole manager. In a manager-managed LLC, the manager makes the operational decisions for the LLC, including striking business deals and binding the LLC to business contracts. Non-manager members take a passive role and usually just collect their distributions without directly involving themselves in the business. You can define these member and manager roles in your LLC's operating agreement.

If you want more guidance on your particular situation, you should consult a Texas business lawyer.

Should You Form Your LLC in Another State?

You don't have to form your LLC in Texas even if it's the state where you live or have your primary office. You can form an LLC in any state. For instance, you could choose to form an LLC in Nevada or another debtor-friendly state.

However, LLC owners might prefer Texas's business laws over those of other states. For example, Texas has no personal income tax, a particular advantage to owners of pass-through tax entities like LLCs. In addition, Texas has a relatively friendly franchise tax. Many small businesses will owe no franchise tax, and others will be taxed at a low rate. (You can learn more in our article on the Texas state business income tax.)

If you do choose to create your LLC outside Texas, expect to pay more. You'll be responsible for paying both the fees:

• to form your LLC in the other state, and
• to register to do business in Texas.

As mentioned previously, the formation state's LLC law will generally govern your LLC. When choosing a state to create your LLC, consider choosing one with favorable LLC laws that can provide you with more limited liability protections. You might decide that Texas is the best fit for your business due to its debtor-friendly laws and low taxes.

More Information on Texas LLCs and Liability Protection

When you own an LLC in Texas, you should keep yourself updated on your legal rights and obligations. You'll especially want to keep up with your company's ongoing legal requirements. You can find tips and guidance on running your Texas LLC by checking out the following articles:

• Texas small business licenses
• LLC annual report and tax filing requirements in Texas
• how to convert your LLC to a corporation in Texas, and
• how to start a Texas business.

You might also be interested in the Starting a Business in Texas section of our website. This section guides you through the process of starting different kinds of businesses in the state, including a home-based food business, a child care business, and a cleaning business, among others.

You should also take a look at our section on LLCs and asset protection. This section has articles on strategies to strengthen your LLC's asset protection and when you might be personally liable for LLC debts.

If you need answers to specific legal questions or have a particularly complicated debt or liability issue, you should speak with a Texas business lawyer. They can answer your questions, develop a plan to protect your business, and negotiate with your creditors.