Adkisson's

Charging Orders

The Creditors' Primary Remedy Against A Debtor's

Interest In A Limited Liability Company Or Partnership

Caution state law variances!

 

The Charging Order Practice Guide: Understanding Judgment Creditor Rights Against LLC Members, by Jay D. Adkisson (2018), published by the LLCs, Partnerships and Unincorporated Entities Committee of the Business Law Section of the American Bar Association, click here for more

 

Available for purchase at https://goo.gl/faZzY6

SECTION 503. CHARGING ORDER.

 

For the full text of the Uniform Limited Liability Company Act click here

 

{ The boldface emphasis found in the Reporter's Comments were not found in the original, but was added by me because I found those particular passages to be of special importance. Note that the Reporter might disagree. }

 

SECTION 503. CHARGING ORDER.

 

Reporter's Comment to Section 503 generally

 

By its terms, this section does not apply to foreign limited liability companies. See Section 102(8) (defining “[l]imited liability company” to mean “an entity formed under this [act] or which becomes subject to this [act]”) (emphasis added); see also Fannie Mae v. Heather Apartments Ltd. P'ship, A13-0562, 2013 WL 6223564, at *6 (Minn. Ct. App. Dec. 2, 2013) (considering the remedies available to a judgment creditor with respect to the judgment debtor’s interest in a Cook Islands LLC; rejecting the debtor’s argument that the creditor’s “only remedy is to obtain a charging order under” [the Minnesota LLC statute]; explaining that “this argument fails because that statute only applies to Minnesota limited liability companies” which that statute “defines . . . as ‘a limited liability company, other than a foreign limited liability company, organized or governed by this chapter’”) (emphasis added) (statutory citations omitted).

 

The operating agreement has no power to alter the provisions of this section to the prejudice of third parties. Section 105(c)(15).

 

JayNote: Section 503 is the only section of the ULLCA that deals with charging orders. Section 503 does not, however, exist in the abstract, but must instead be carefully interpreted in accordance with its preceding § 502 which relates to transfers of transferable interests, and the definition of "distribution" found in § 102(4). Frankly, reading § 503 will make a whole lot more sense if you substantially understand those other sections first.

 

The effect of a charging order is to combine two traditional remedies (why we just don't use those remedies instead, I am not particularly sure), being (1) attachment of the interest, meaning that an involuntary lien in favor of the creditor is placed on the debtor's interest, and (2) a non-wage garnishment, or "assignment order" in some states, of any distributions made to the debtor.

 

And now, a quibble with the Reporter's Comments. The Reporter writes: "By its terms, this section does not apply to foreign limited liability companies." What the Reporter doesn't say is that this is the result of a significant drafting flaw in the ULLCA (and also in the UPA and the ULPA), since there is utterly no reason -- and certainly no good one -- why the provisions of Article V and sections 502 and 503 in particular should not apply to foreign (out-of-state) or even alien (out-of-country) LLCs just as they would to any in-state LLCs. Suffice it to say that significant efforts are in progress to fix this error.

 

(a) On application by a judgment creditor of a member or transferee, a court may enter a charging order against the transferable interest of the judgment debtor for the unsatisfied amount of the judgment. Except as otherwise provided in subsection (f), a charging order constitutes a lien on a judgment debtor’s transferable interest and requires the limited liability company to pay over to the person to which the charging order was issued any distribution that otherwise would be paid to the judgment debtor.

 

Reporter's Comment to Section 503 generally

 

Under this section, the judgment creditor of a member or transferee is entitled to a charging order against the relevant transferable interest. While in effect, that order entitles the judgment creditor to whatever distributions would otherwise be due to the member or transferee whose interest is subject to the order. However, the judgment creditor has no say in the timing or amount of those distributions. The charging order does not entitle the judgment creditor to accelerate any distributions or to otherwise interfere with the management and activities of the limited liability company.

 

Reporter's Comment to Subsection (a)

 

The phrase “judgment debtor” encompasses both members and transferees. The lien pertains only to a distribution, which excludes “amounts constituting reasonable compensation for present or past service or payments made in the ordinary course of business under a bona fide retirement plan or other bona fide benefits program.” Section 102(4)(B). A judgment creditor that wishes to levy on such amounts should use the appropriate creditor’s remedy, such as garnishment (which may be subject to exemptions or exclusions not relevant to a charging order). Cf. PB Real Estate, Inc. v. Dem II Props., 719 A.2d 73, 76 (Conn. 1998) (rejecting the contention of an LLC’s two members that “payments of $28,000 to each of them” should be treated “as expenses for wages” rather than as distributions).

 

Whether an application for a charging order must be served on the limited liability company, the judgment debtor, or both is a matter for other law, principally the law of remedies and civil procedure. The order itself must be served on the limited liability company. Whether the order must also be served on the judgment debtor is a matter for other law.

 

If a distribution consists of rights to acquire interests in a limited liability company, the charging order applies only to those rights within the definition of transferable interest. See Section 102(24) (defining transferable interest).

 

JayNote: Paragraph (a) is the meat of the charging order procedure. As mentioned, the charging order accomplishes two things, both of them through ¶ (a):

 

  • First, the charging order places an involuntary lien (forces the creation of a security interest) in favor of the creditor on the LLC interest of the debtor. This would normally be accomplished by the remedy of attachment.

 

  • Second, the charging order diverts distributions from the debtor to the creditor. This would normally be accomplished in most states by a non-wage garnishment or an assignment order.

 

Well, a reader might ask, if those existing remedies will already accomplish those things, then why do we need this charging order thingy? The short answer is: We don't. The longer answer is that the charging order remedy is the result of an error in the drafting of the original Uniform Partnership Act of 1914, where the drafters of that Act lazily copied the United Kingdom's Partnership Act on this point, without realizing that the charging order was unnecessary because of existing U.S. remedies. This error then persisted to modern times, and eventually took on a life of its own to where it may be practically impossible to get rid of the charging order and just use these other remedies instead.

 

Now, some explanations of the phraseology used in ¶ (a):

 

"On application" -- The creditor must file an "Application for Charging Order" or similar and have a hearing before the court on the application, which is probably required to satisfy procedural due process for the attachment aspect of the charging order.

 

"by a judgment creditor" -- A charging order is exclusively a post-judgment enforcement remedy, meaning that there is no such thing as a "preliminary charging order". If a creditor desires to tie up the debtor's interest prior to trial, the relief there would be in the nature of an ordinary pre-judgment attachment.

 

"of a member of transferee" -- The debtor is not necessarily a member of the LLC, but may be a transferee of the member. Example: Ted is a member of Alpha LLC, and voluntarily transfers his interest to Barbara. Later, Barbara incurs a liability and suffers a judgment. Creditor can obtain a charging order against Barbara's interest.

 

"court may enter" -- A court is not required to enter a charging order upon application, but may in its discretion decline to do so. Suffice it to say that the situations where the court chooses to exercise its discretion not to grant the charging order should be very rare. Example: State X has a statute that provides for a $10,000 "wildcard" exemption from collection. Barbara has an LLC interest worth $2,000 and which pays a dividend of only $50 per year. Barbara asserts her wildcard exemption as to her LLC interest. The court should exercise its discretion to refuse the charging order.

 

"against the transferable interest" -- The creditor can take through a charging order only what the debtor has under § 502 and no more.

 

"of the judgment debtor" -- This is shorthand for the "member of transferee" against whom the creditor holds the judgment.

 

"for the unsatisfied amount of the judgment" -- The lien created by the charging order is for the amount of the unsatisfied value of the judgment, and the redirection of distributions is likewise limited to that amount. Can the court issue the charging order for a lesser amount? Negative, according to the plain reading on the statute (which doesn't seem to think the matter through), but there may be occasions where the creditor agrees to a lesser amount, such as where the parties have partially settled, where the court should treat this more in the nature of guidance than a firm prohibition.

 

 

* * * For court opinions dealing with compliance with a charging order click here * * *

 

* * * For court opinions dealing with the charging order procedure generally click here * * *

 

(b) To the extent necessary to effectuate the collection of distributions pursuant to a charging order in effect under subsection (a), the court may:

 

Reporter's Comment to Subsection (b)

 

Paragraph (2) refers to “other orders” rather than “additional orders.” Therefore, given appropriate circumstances, a court may invoke Paragraph (1), Paragraph (2), or both.

 

(1) appoint a receiver of the distributions subject to the charging order, with the power to make all inquiries the judgment debtor might have made; and

 

Reporter's Comment to Subsection (b)(1)

 

The receiver contemplated here is emphatically not a receiver for the limited liability company, but rather a receiver for the distributions subject to the charging order. The principal advantage provided by this paragraph is an expanded right to information. However, that right goes no further than “the extent necessary to effectuate the collections of distributions pursuant to a charging order.” For a correctly narrow reading of this provision, see Wells Fargo Bank, Nat. Ass'n v. Continuous Control Solutions, Inc., No. 11-1285, 2012 WL 3195759 (Iowa Ct. App. Aug. 8, 2012).

 

JayNote: As the comment states, the receiver appointed under ¶ (b) is not, negative, a receiver for the LLC itself, but instead is only a receiver for the distributions, and the main advantage to such a receiver is for informational rights. Example: Creditor holds a judgment against debtor, who has disappeared or is recalcitrant. Normally, the creditor would obtain information about distributions from the debtor, but the court may appoint a receiver to obtain this information in the debtor's place.

 

Creditors routinely use this provision, quite appropriately, to have a "limited purpose receiver" appointed by the court with these powers only, but then work to expand the receiver's portfolio over similar matters to eventually become a general-purpose receiver.

 

* * * For court opinions discussing the role of receivers and charging orders click here * * *

 

(2) make all other orders necessary to give effect to the charging order.

 

Reporter's Comment to Subsection (b)(2)

 

This paragraph must be understood in the context of: (i) the very limited nature of the charging order; and (ii) the importance of preventing overreaching on behalf of a person that is not a judgment creditor of the LLC, has no claim on the LLC’s assets, and has no right to interfere in the activities, affairs, and management of the LLC. In particular, the court’s power to make “all other orders” is limited to “orders necessary to give effect to the charging order.”

 

EXAMPLE: A judgment creditor with a charging order believes that the limited liability company should invest less of its surplus in operations, leaving more funds for distributions. The creditor moves the court for an order directing the limited liability company to restrict re-investment. Subsection (b)(2) does not authorize the court to grant the motion.

 

EXAMPLE: A judgment creditor with a judgment for $10,000 against a member obtains a charging order against the member’s transferable interest. Having been properly served with the order, the limited liability company nonetheless fails to comply and makes a $3000 distribution to the member. The court has the power to order the limited liability company to pay $3000 to the judgment creditor to “give effect to the charging order.”

 

Under Subsection (b)(2), the court has the power to decide whether a particular payment is a distribution, because that decision determines whether the payment is part of a transferable interest subject to a charging order.

 

EXAMPLE: Member A of ABC, LLC has for some years received distributions form the LLC. However, when a judgment creditor of Member A obtains a charging order against Member A’s transferable interest, the LLC ceases to make distributions to Member A and instead provides a salary to Member A equivalent to former distributions. A court might deem this salary a disguised distribution. (In any event, however, the salary will be subject to garnishment.)

 

This act has no specific rules for determining the fate or effect of a charging order when the limited liability company undergoes a merger, conversion, interest exchange, or domestication under [Article] 10. In the proper circumstances, such an organic change might trigger an order under Subsection (b)(2).

 

JayNote:  As the Reporter's Comment notes, ¶ 2(b) gives the court wide latitude to fashion additional orders to carry out the charging order, including re-characterizing other income received by the debtor from the LLC as distributions. Example: Creditor is granted a charging order against Barbara's LLC interest. Soon thereafter, the LLC ceases to pay Barbara distributions, but she instead receives money from the LLC by way of "loans" or "management fees" or whatever. The court may re-characterize this money (known in creditor-debtor vernacular as "imputed income") as distributions. Ditto if the LLC paid Barbara's personal utility bills and credit cards, etc.

 

Note that savvy creditor rights counsel will often accompany a charging order with a Writ of Garnishment or some other remedy (or remedies) to as to pick up this other income no matter what the debtor and the LLC calls it.

 

For an excellent discussion of how a creditor may have the court include ancillary provisions in charging orders to prevent such shenanigans, see Law v. Zemp.

 

* * * For court opinions dealing with compliance with a charging order click here * * *

 

* * * For court opinions dealing with the charging order procedure generally click here * * *

 

(c-e) [Paragraphs (c) through (e) dealing with the foreclosure of charging order interests is discussed here ]

 

(f) [Paragraph (f) dealing with the foreclosure of a charging order lien against a Single-Member LLC is discussed here ]

 

(g) This [act] does not deprive any member or transferee of the benefit of any exemption law applicable to the transferable interest of the member or transferee.

 

Reporter's Comment to Subsection (g)

 

This subsection preserves otherwise applicable exemptions but does not create any. In re Foos, 405 B.R. 604, 609 (Bankr. N.D. Ohio 2009) (interpreting the comparable provision in UPA (1997) and stating, “it is clear that [the provision] does not create an exemption”).

 

JayNote: The debtor's exemptions will usually be found in one of two forms: first, some states have so-called "wildcard exemptions" for a certain amount, say $10,000 or so, that allow a debtor to protect that much in property from the creditor and which could apply to the debtor's transferable interest; and, second, there are federal (in the form of the Federal Wage Garnishment Law ("FWGL")) and state laws that have the effect of exempting portions of a debtor's wages, and which might apply to the creditor's interception of distributions by way of a charging order, see U.S. v. Alexander. As to the latter, note that there is a dispute among LLC planners and litigators as to whether the debtor's transferable interest can ever be considered to be in the nature of "wages", but that is a much longer discussion.

 

* * * For court opinions discussing the interplay of exemptions and charging orders click here ***

 

(h) This section provides the exclusive remedy by which a person seeking in the capacity of judgment creditor to enforce a judgment against a member or transferee may satisfy the judgment from the judgment debtor’s transferable interest.

 

Reporter's Comment to Section 503 generally

 

The charging order concept dates back to the English Partnership Act of 1890 and in the United States has been a fundamental part of law of unincorporated business organizations since 1914. See UPA (1914) § 28. As much a remedy limitation as a remedy, the charging order is the sole method by which a person acting as judgment creditor of a member or transferee can extract value from the member’s or transferee’s ownership interest in a limited liability company. See the comment to Subsection (h).

 

Reporter's Comment to Subsection (h)

 

This subsection does not override Uniform Commercial Code, Article 9, which may provide different remedies for a secured creditor acting in that capacity. A secured creditor with a judgment might decide to proceed under Article 9 alone, under this section alone, or under both Article 9 and this section. In the last-mentioned circumstance, the constraints of this section would apply to the charging order but not to the Article 9 remedies.

 

This subsection is not intended to prevent a court from effecting a “reverse pierce” where appropriate. In a reverse pierce, the court conflates the entity and its owner to hold the entity liable for a debt of the owner. Litchfield Asset Mgmt. Corp. v. Howell, 799 A.2d 298, 312 (Conn. App. Ct. 2002) (approving a reverse pierce where a judgment debtor had established a limited liability company in a patent attempt to frustrate the judgment creditor), overruled on other grounds by, Robinson v. Coughlin, 830 A.2d 1114 (Conn. 2003). Likewise, this subsection does not supplant fraudulent transfer law.

 

JayNote: Paragraph (h) is one of the primary reasons that LLCs and partnerships are such popular business entities, which is that the creditor's remedy is limited to a charging order. However, the enormous limitation of ¶ (h) must be realized, which is that ¶ (h) applies only and exclusively to the creditor's attempt to reach the debtor's transferable interest, which is utterly different than a creditor's attempt to access the value of the assets of the LLC. The latter may be accomplished, as the Reporter's Comment notes, through a number of theories, the most popular of which is so-called "reverse veil-piercing" (or "reverse alter ego") theories.

 

*** For court opinions discussing the exclusivity of charging orders click here.***

 

For the full text of the Uniform Limited Liability Company Act click here

 

C O M M O N      P A G E      F O O T E R

RECENT ARTICLES BY JAY ADKISSON

 

2019.06.24 ... Charging Order Protection Backfires At Judicial Sale In Preservation Holdings

2019.04.27 ... Iowa Supreme Court Serves Up A Shoddy Charging Order Opinion In Retterath

2019.03.19 ... Million Dollar Quartet Leads To Lien Priority Dispute Involving Charging Order

2019.02.18 ... Florida Order Awarding LLC Interest To Creditor Reversed In Pansky

 

More Articles On Charging Orders click here

 

THE CHARGING ORDER PRACTICE GUIDE BY JAY ADKISSON

 

The Charging Order Practice Guide: Understanding Judgment Creditor Rights Against LLC Members, by Jay D. Adkisson (2018), published by the LLCs, Partnerships and Unincorporated Entities Committee of the Business Law Section of the American Bar Association, click here for more

 

Available for purchase at https://goo.gl/faZzY6

LAW REVIEW ARTICLES BY JAY ADKISSON

 

For more on the historical background of Charging Orders and contemporary issues involving the same, see Jay Adkisson's article, Charging Orders: The Peculiar Mechanism, 61 South Dakota Law Review 440 (2016). Available at SSRN: https://ssrn.com/abstract=2928487

WEBSITE CONTENTS

 

Appeal - Issues relating to the appeal of a charging order

 

Bankruptcy - Treatment of the debtor/member's interest in bankruptcy

 

Compliance - Issues for the LLC and non-debtor members in complying with a charging order

 

Conflicts-Of-Law - Determining which state's laws apply to a charging order dispute

 

Creditor Rights Restrictions - Limitations on creditors' management and informational rights

 

Economic Rights - Limitation of charging order and foreclosure to debtor's economic rights

 

Exclusivity - The charging order as the sole remedy available to creditors and exceptions

 

Exemptions - Available state and federal protections that may apply to charging orders

 

Foreclosure - Liquidation by judicial sale of the debtor's right to distributions

 

Information Rights - Creditors' ability to access information about the LLC

 

Intra-Member Disputes - Where one member obtains a charging order against another

 

Jurisdiction - Issues relating to the court's authority over out-of-state debtors and LLCs

 

Lien - The lien effect of a charging order and priority issues

 

Procedure - The procedure for obtaining a charging order and ancillary provisions

 

Receiver - The role of the receiver in charging order proceedings

 

Single-Member LLCs - Enforcing the judgment against an LLC with a sole member

 

Taxes - Tax issues relating to charging orders for all involved parties

 

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Additional Court Opinions About Charging Orders - Unsorted

 

OTHER INFORMATIONAL WEBSITES BY JAY ADKISSON

 

  • About Jay Adkisson - More about Jay D. Adkisson, background, books, articles, speaking appearances - https://jayadkisson.com/

 

  • Captive Insurance Companies - Licensed insurance companies formed by the parent organization to handle the insurance and risk management needs of the business - https://captiveinsurancecompanies.com/

 

 

  • Collecting On A Judgment - An explanation of common creditor remedies, strategies and tactics to enforce a judgment, including a discussion of common debtor asset protection strategies - https://collectingonajudgment.com/

 

  • Voidable Transactions - Discussion of the Uniform Voidable Transactions Act (a/k/a 2014 Revision of the Uniform Fraudulent Transfers Act) and fraudulent transfer law in general - https://voidabletransactions.com/

 

  • Private Retirement Plans - An exploration of a unique creditor exemption allowed under California law which can be very beneficial but is often misused - https://privateretirementplans.com/

 

  • Protected Series LLCs - An examination of the single most complex statutory legal structure yet created, with particular reference to the Uniform Protected Series Act of 2017 - https://protectedseriesact.com/

 

  • California Enforcement of Judgments Law - Considers the topic of judgment enforcement in California, including the California Enforcement of Judgments Law and other laws related to California creditor-debtor issues - https://calejl.com/

 

 

Contact Jay Adkisson:

 

Phone: 702-953-9617     Fax: 877-698-0678     jay [at] jayad.com

 

Unless a dire emergency, please send me an e-mail first in lieu of calling to set up a telephone appointment for a date and time certain.

 

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© 2018 Jay D. Adkisson. All Rights Reserved. No claim to government works or the works of the Uniform Law Commission. The information contained in this website is for general educational purposes only, does not constitute any legal advice or opinion, and should not be relied upon in relation to particular cases. Use this information at your own peril; it is no substitute for the legal advice or opinion of an attorney licensed to practice law in the appropriate jurisdiction.  This site is https://chargingorder.com Contact: jay [at] jayad.com or by phone to 702-953-9617 or by fax to 877-698-0678.

 

Additional related sites: Voidable Transactions