Charging Orders and S-Corps: Why LLCs Offer Superior Asset Protection Against Creditor Takeovers Compared to Corporations

When structuring a business, asset protection is a critical consideration. Many entrepreneurs mistakenly assume that electing S-Corp status for their corporation provides the same liability safeguards as forming an LLC. However, a key distinction lies in charging orders - a legal remedy that determines whether creditors can seize ownership or control of your business. Here, we'll explain why corporations (even with S-Corp tax elections) lack charging order protection, while LLCs shield owners from creditor takeovers. We’ll explore federal and North Carolina legal definitions, real world examples, and actionable insights for safeguarding your business.

What Is a Charging Order?

A charging order is a court-authorized lien that allows creditors to intercept distributions from a business entity to satisfy a member’s or owner’s personal debt. Crucially, it does not grant creditors management rights or ownership of the business itself.

Federal Definition: In Brooksby v. Avirta, a 2022 federal district court case in North Carolina, the court clarified that a charging order is “the exclusive remedy by which a judgment creditor of an interest owner [in an LLC] may satisfy the judgment from or with the judgment debtor’s ownership interest”. The ruling emphasized that creditors can only claim distributions if and when the LLC makes them, without interfering in operations.

North Carolina Definition: Under N.C. Gen. Stat. § 57D-5-03, a charging order is “a lien on the judgment debtor’s economic interest” and “the exclusive remedy” for creditors seeking to collect from an LLC member’s ownership stake. For example, in First Bank v. S&R Grandview, LLC, the North Carolina Court of Appeals ruled that a charging order does not transfer management rights or membership status to creditors—only the right to receive distributions.

Why LLCs (Even S-Corps) Protect Owners, While S-Corp Corporations Do Not

LLCs: Charging Order Protection

LLCs—including those taxed as S-Corps—provide robust asset protection. Creditors cannot seize ownership or control; they’re limited to intercepting distributions.

Legal Safeguards:

• Federal Precedent: The Brooksby case affirmed that creditors of LLC members cannot force distributions, liquidate assets, or participate in management.

  
  

• North Carolina Law: N.C. Gen. Stat. §57D-5-03(d) states that charging orders are the only way creditors can collect from an LLC member’s interest, preserving the “corporate veil” between personal and business liabilities.

Example: Imagine an LLC member defaults on a personal loan. The creditor obtains a charging order, entitling them to the member’s profit distributions. However, if the LLC reinvests profits instead of distributing them, the creditor receives nothing. The LLC continues operating normally, and other members retain control.

S-Corp Corporations: No Charging Order Protection

Corporations—even those with S-Corp tax status—offer no charging order protection. Creditors can seize shares, take voting rights, and potentially control the business.

Legal Vulnerabilities:

• Federal Law: Unlike LLCs, corporations are governed by shareholder property laws. In Brooksby, the court noted that corporate shares are considered personal assets, fully subject to creditor claims.

  
  

• North Carolina Precedent: While no state-specific S-Corp cases exist, N.C. Gen. Stat. §55-6-27 allows creditors to “levy upon” corporate shares, granting them full ownership rights.

Example: A shareholder in an S-Corp faces a personal lawsuit. The creditor obtains a court order to seize 51% of their shares. The creditor now controls board decisions, can liquidate assets, or dissolve the corporation to satisfy the debt.

Real-World Scenarios: LLCs vs. S-Corps

Scenario 1: The Debtor LLC Member

A North Carolina LLC (taxed as an S-Corp) owns a rental property. One member defaults on a personal loan, and the creditor obtains a charging order. The LLC sells the property and plans to distribute $100,000 to members. The creditor receives the debtor’s $25,000 share but cannot force the sale or influence management decisions. The LLC continues operating, and other members are unaffected.

Scenario 2: The Debtor S-Corp Shareholder

An S-Corp corporation owns a manufacturing plant. A shareholder’s personal creditor seizes 60% of their shares through a court order. The creditor votes to sell the plant, liquidate assets, and dissolve the corporation. The original owner loses their business entirely.

Key Takeaways for Business Owners

1. Choose an LLC for Asset Protection: Even if taxed as an S-Corp, LLCs limit creditors to charging orders.

   
   

2. Avoid S-Corp Corporations for High-Risk Ventures: Shareholders risk losing ownership and control.

   
   

3. Understand State Laws: North Carolina’s LLC Act (Chapter 57D) offers stronger protections than corporate statutes.

Charging orders are a pivotal factor in business structuring. While S-Corp taxation offers pass-through benefits, only LLCs provide robust defense against creditor takeovers. By leveraging federal and North Carolina legal frameworks, business owners can shield their assets and ensure long-term stability. Always consult a corporate attorney to align your entity choice with your risk profile and goals.

This article integrates federal and state legal principles, real-world examples, and actionable advice to empower business owners. For further guidance, consult a North Carolina business attorney familiar with LLC and S-Corp structures.

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Howard Law is a business, regulatory and M&A law firm in the greater Charlotte, North Carolina area, with additional services in M&A advisory and business brokerage. Howard Law is a law firm based in the greater Charlotte, North Carolina area focused on business law, corporate law, regulatory law, mergers & acquisitions, M&A advisor and business brokerage. Handling all business matters from incorporation to acquisition as well as a comprehensive understanding in assisting through mergers and acquisition. The choice of a lawyer is an important decision and should not be based solely on advertisements. The information on this website is for general and informational purposes only and should not be interpreted to indicate a certain result will occur in your specific legal situation. Information on this website is not legal advice and does not create an attorney-client relationship. You should consult an attorney for advice regarding your individual situation. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.