In re Modanlo is a Maryland bankruptcy court case that involved an LLC formed in Delaware.  The filing of the bankruptcy petition by the only member of a Delaware LLC caused the automatic dissolution of the LLC under Delaware law.  Notwithstanding the automatic dissolution of the LLC, the bankruptcy trustee could, under Delaware LLC law, revive the company by amending the LLC's Operating Agreement and appointing himself as the new manager of the company.  The court rejected the sole member/debtor’s argument that the bankruptcy estate only held an economic interest in the LLC and that the trustee could not participate in the LLC’s management or become a member.

The court said that because there were no other members to protect, the purpose of preventing a creditor from becoming a substituted member of the LLC does not apply when the LLC is a single member LLC.  The court held that "using principles of statutory construction and adopting the reasoning of the bankruptcy court in In re Albright, sections 18-702 (assignment of limited liability company interest) and 18-704 (right of assignee to become member) of the Delaware LLC Act do not apply to single member LLCs.

In substance, Albright permits creditors of a single member LLC member to acquire all of the rights inherent in the member’s LLC interest. This includes all non-economic rights that the member is granted by the operating agreement. Given this development, what action can a member of a single member LLC take to get any asset protection?
 

If you are the only member of a single member LLC and you want to maximize asset protection from top down creditors, your options include the following:
 

1. Never file for bankruptcy. This is the best solution, but if you have a creditor problem, you may not be able to prevent your creditors from putting you into an involuntary bankruptcy; and
 

2. Add a second member so your LLC is a multiple member LLC. This may work, but adding a member also has its potential problems:
 

• No court case has said what the minimum amount of an LLC the second member must own. You could go with 1%, but a court might say that's a "peppercorn" interest and it will be disregarded because it is not large enough to be considered a second member. We don't know yet how much the second member must own;

• If you do add a second member, be sure that the member pays fair market value for the interest the second member acquires. If 1% of your company is worth $10,000 and you give 1% to your child for $1,000, you could have a fraudulent transfer;

• The second member must be a "real" member for all purposes. This means that the member is entitled to financial statements, access to books and records, the right to vote on certain matters affecting the company, a right to get a share of the profits equal to the membership percentage owned, and other rights of a member in an LLC. If the second member is sham member or a member only on paper, the court will disregard the second member's interest and find that you have a single member LLC; and

• The new multi-member company will need a good comprehensive Operating Agreement that governs the rights and obligations of all of the members.