Where to domicile an LLC?
I am asked all the time, “What is the best state in which to form my LLC.” My answer is usually the same, which is the best state to form your LLC is the one that you are in. Today we have yet another good example of why this is so, as found in the opinion of the U.S. District Court for the Southern District of New York in Arrowhead Capital Finance, Ltd. v. Seven Arts Entertainment, Inc., 2025 WL 551357 (S.D.N.Y., Feb. 18, 2025). We pick up this case after a judgment for about $2.5 million has been entered in New York in favor of the plaintiff, being Arrowhead Capital Finance, Ltd., against defendant Seven Arts Entertainment, Inc.
Seven Arts owned a membership interest in a company called Picture Pro, LLC, which was formed in Colorado. Arrowhead moved the court in New York to enter an order requiring Seven Arts to turn over to Arrowhead the interest in Picture Pro. In response, Seven Arts and Picture Pro argued that since Picture Pro was a Colorado limited liability company, Arrowhead could not enforce its New York judgment against Seven Arts’ interest in Picture Pro there but must instead first register the judgment in Colorado and pursue the judgment there under Colorado law.
Under Federal Rule of Civil Procedure 69, a federal court applies the judgment enforcement laws of the state in which the court sits. Here that meant New York law and numerous opinions by the New York courts have established that a judgment creditor could get a turnover of a debtor’s LLC interest even if that LLC had been formed in another state. That brings us to:
“As a fallback position, PPL argues that Colorado law forecloses the turnover of membership interests in an LLC, and allows, at most, the turnover of SAE’s right to receive distributions. … This argument, too, is foreclosed by New York law. In particular, New York courts have found that state statutes that govern the internal operations of an LLC are trumped by New York law in turnover proceedings.”
Thus, Arrowhead was able to get its order requiring that Seven Arts turn over its membership interest in Picture Pro.
Analysis
The quirk in this case is that, unlike the vast majority of states, New York limited liability company law does not limit a creditor’s remedy against a debtor’s LLC interest to a charging order. If New York had such a restriction, then Arrowhead could not have gotten a turnover order for the Picture Pro interests but only a charging order that restricted Arrowhead’s enforcement to a lien and payment order against Seven Arts’ interest. But that is not the important point here.
The important point is the laws of the state where the judgment is being enforced apply in these situations, not the state where the LLC was formed.
As I have repeatedly pointed out in similar articles, all collection law is local. Courts will, with only very few exceptions, apply the judgment enforcement laws of the state in which the court sits without regard to the laws of other states which might have an interest in the proceedings. Attempts to import the judgment enforcement laws of another state are a very long-shot proposition. This isn’t just for LLCs either as we see local laws almost invariably applied to trusts, corporations, partnerships, and pretty much anything else where assets can be found.
Because of the venue rules, a person is most likely to be sued in their state of residence. Moreover, in LLCs and partnerships are characterized as intangible personal property, see, e.g., ULLCA § 501, and such property is deemed to exist wherever the owner is located. A judgment is thus most likely to be entered against a person in their state of residence and the judgment enforcement laws of that state will apply.
There are two ramifications to all this.
First, if an LLC is intended to protect the assets from the creditor of a member, then it must be effective under the judgment enforcement laws of the debtor’s state of residence. This necessarily implies that the overall asset protection structure, and not merely the entity, must be designed with the idea that it will withstand a creditor challenge under local state law. This is true with all asset protection planning.
Second, creating an LLC (or any other entity or trust) in another state probably creates few, if any, real advantages. Since the laws of that state are unlikely to apply in the judgment enforcement context, forming the LLC out-of-state will likely cause few advantages. If the out-of-state LLC also has to register in the debtor’s state of residence, then some might suggest that the only thing that has been accomplished is that annual fees have been doubled.
To mount the soapbox for a second, the choice of where to put entities in asset protection planning is one of the last considerations and not the first. Only after the asset protection blueprint has been developed do considerations of where to place particular entities finally arise. This is because a good asset protection plan will work in just about any jurisdiction, even if the laws of that jurisdiction tend to favor creditors. It is a sign of laziness by an asset protection planner to count on the laws of a particular jurisdiction to make up for deficiencies in an asset protection plan. Otherwise stated, if an asset protection plan will only work under the laws of one jurisdiction then it probably doesn’t work anywhere.
This is not to suggest that there are not differences in the law between jurisdictions which in particular circumstances might make a difference in dealing with creditors. This advantage is often simply being in another jurisdiction such that a creditor would have to register the judgment in that state which takes time, but as shown in this opinion, such isn’t always necessary for creditors. A good planner will discuss the benefits and disadvantages of particular jurisdictions. A bad planner will simply gloss over any issues by claiming that only the “best” jurisdiction will be used. The latter should be a red flag.
Another factor to be considered is this: If some litigation does arise that does not involve a creditor, where would you want to litigate that controversy. If the entity is local, then the dispute can be resolved locally with counsel familiar to you. If the entity is formed in another jurisdiction, you will have to hire counsel in that jurisdiction to represent you (without any familiarity with them) and you may have to travel to that state if there is a trial. Also, the states that have the laws most favorable to debtors might not have the better laws for non-creditor situations. This is also something that should be discussed with your planner.
You might be wondering at this point why the myth of the “best state” is so widespread. The answer is one word: Marketing. Many states compete for entity formation business and they ― and the company services agents in those states ― spend a great deal of time, energy and money to market their laws as the “best.” As discussed above, any advantages of these states is highly dubious if their laws will not apply anyway. Same goes for trust laws. The key is simply to not be taken in by the marketing but instead to conduct a much deeper analysis to determine if there is a tangible reason to form an entity somewhere other than the state of residence.
Until next time.