Adkisson's

Charging Orders

The Creditors' Primary Remedy Against A Debtor's

Interest In A Limited Liability Company Or Partnership

Caution state law variances!

UNIFORM PARTNERSHIP ACT

(1997) (Last Amended 2013)

[ARTICLE] 5

TRANSFERABLE INTERESTS AND RIGHTS

OF TRANSFEREES AND CREDITORS

For the full text of the Uniform Partnership Act click here

SECTION 501.  PARTNER NOT CO-OWNER OF PARTNERSHIP PROPERTY.

A partner is not a co-owner of partnership property and has no interest in partnership property which can be transferred, either voluntarily or involuntarily.

Reporter's Comment: This section originated in UPA (1997), followed ineluctably from the concept of a partnership as an entity, Section 201, abolished the UPA (1914) construct of “partnership in tenancy,” and was retained during the Harmonization Project as a “belt and suspenders” approach to reinforcing the entity construct. See Section 203 (providing that property transferred to or otherwise acquired by the partnership is property of the partnership and not of the partners individually).

 

SECTION 502.   NATURE OF TRANSFERABLE INTEREST.

A transferable interest is personal property.

Reporter's Comment: For the definition of transferable interest, see Section 102(23). Absent a contrary provision in the partnership agreement or the consent of the partners, a “transferable interest” is the only interest in a partnership that can be transferred to a person not already a partner. See Section 503. As to whether a partner may transfer governance rights to a fellow partner, the question is moot absent a provision in the partnership agreement changing the default rule, see Section 401(h) (allocating governance rights per capita). In the default mode, a partner’s transfer of governance rights to another partner: (i) does not increase the transferee’s governance rights; (ii) eliminates the transferor’s governance rights; (iii) and thereby changes the denominator but not the numerator in calculating governance rights.

 

EXAMPLE: LCN Company is a general partnership with three partners, Laura, Charles, and Nora. The partnership agreement does not displace this act’s default rule on the allocation of governance rights among general partners. Thus, each partner has 1/3 of those rights.  Laura transfers her entire ownership interest to Charles. The transfer does not increase Charles’s governance rights but does eliminate Laura’s. After the transfer, Laura has no governance rights (regardless of whether Charles and Nora agree to expel Laura under Section 601(4)(B)). As a result, Charles and Nora each have 1/2 of the governance rights.

 

Whether a transferable interest pledged as security is governed by Article 8 or 9 of the Uniform Commercial Code depends on the rules stated in those Articles.

 

SECTION 503. TRANSFER OF TRANSFERABLE INTEREST.

Reporter's Comment: One of the most fundamental characteristics of partnership law is its fidelity to the “pick your partner” principle. See, e.g., Bynum v. Frisby, 311 P.2d 972, 975 (Nev. 1957) (stating that (i) “the assignment of a partnership interest from one partner to a stranger does not bring that stranger into fiduciary relationship with the remaining partners”; and (ii) absent consent by the remaining partners “[t]he stranger remains a stranger” with no rights to management or even information). This section is the core of the act’s provisions reflecting and protecting that principle. A partner’s rights in a partnership are bifurcated into economic rights (the transferable interest) and governance rights (including management rights, consent rights, rights to information, rights to seek judicial intervention). Unless the partnership agreement otherwise provides, a partner acting without the consent of all other partners lacks both the power and the right to: (i) bestow partnership on a non-partner, Section 402(b)(3); or (ii) transfer to a non- partner anything other than some or all of the partner’s transferable interest, Section 503(a)(3). The rights of a mere transferee are quite limited (i.e., to receive distributions), Section 503(b), and, if the partnership dissolves and winds up, to receive specified information pertaining to the partnership from the date of dissolution, Section 503(c).

 

This section applies regardless of whether the transferor is a partner, a transferee of a partner, a transferee of a transferee, etc. See Section 102(23) (defining “transferable interest” in terms of a right “initially owned by a person in the person’s capacity as a partner” regardless of “whether or not the person remains a partner or continues to own any part of the right”).

 

This section does not directly consider whether a partner may transfer governance rights to another partner without obtaining consent from all the other partners. As noted in Section 502, comment, the question is moot under this act’s default rule for allocating governance rights.

 

However, the question can be pivotal when the partnership agreement displaces the default rule on governance rights but does not determine whether transfer restrictions (whether contractual, statutory, or both) apply to transfers of governance rights from one partner to another. Case law is scant and pertains to limited liability companies. Nonetheless, the cases suggest that this act does not protect partners from control shifts that result from transfers among partners. Blythe v. Bell, No. 11 CVS 933, 2012 WL 7807800, at ¶ 6 (N.C. Dist. Dec. 10, 2012) (holding in a case of “first impression in North Carolina” that “in the absence of articles of incorporation or an operating agreement to the contrary . . . the assignment of control [i.e., governance] interests between members is effective without unanimous member consent”); Achaian, Inc. v. Leemon Family LLC, 25 A.3d 800, 810 (Del. Ch. 2011) (Strine, Ch.) (holding that the terms of the LLC agreement did not preclude one member of a three-member LLC from transferring the member’s entire interest (including governance rights) to a second member without first having the consent of the third member; stating that the third member’s “argument relies on a very thinly sliced version of [the “pick-your-partner” principle, the strained version being] … that once one chooses his initial co-members, one continues to hold a veto over how much additional voting power they may acquire” explaining that “[t]he problem for [the third member] is that nothing in the LLC Agreement supports [that member’s] reading of it that would require an already admitted Member, like [the acquirer – i.e., the second member], to be become once, twice (or even three times) a Member each and every time that Member acquires an additional block of Interests”).

 

Other law may affect the applicability of this section. See 11 U.S.C. § 541(c)(1) (providing that, initially at least, all property of a debtor becomes part of the bankruptcy estate regardless of restrictions on transfer); UCC §§ 9-406, 9-408 (overriding specified restrictions on assignment in specified circumstances, regardless of whether state law or a contract imposes the restrictions).

In any event, this section does not apply to the transfer of ownership interests in a partner that is an entity.

 

EXAMPLE: ABC, Partnership (“ABC”) has three partners: Ralph (an individual), Alice, Inc. (“Alice”), and Norton, LLC (“Norton”). Section 502 applies to any attempt by Ralph, Alice, or Norton to transfer their respective partnership interest in ABC. Section 502 is inapplicable, however, to a change in control of Alice or Norton or even a complete change in their respective ownership.

 

(a) A transfer, in whole or in part, of a transferable interest:

Reporter's Comment: Subsection (a) - The definition of “transfer,” Section 102(22), and this subsection’s reference to “in whole or in part” combine to mean that this section encompasses not only unconditional, permanent, and complete transfers but also temporary, contingent, and partial ones. Thus, for example, a charging order under Section 504 effects a transfer of part of the judgment debtor’s transferable interest, as does the pledge of a transferable interest as collateral for a loan and the gift of a life-interest in a partner’s rights to distribution.

(1) is permissible;

(2) does not by itself cause a person’s dissociation as a partner or a dissolution and winding up of the partnership business; and

Reporter's Comment: Subsection (a)(2) - The phrase “by itself” contemplates Section 601(4)(B), which creates a risk of dissociation via expulsion when a partner transfers all of the partner’s transferable interest.

(3) subject to Section 505, does not entitle the transferee to:

Reporter's Comment: Subsection (a)(3) - Mere transferees have no right to participate in management or otherwise intrude as the partners carry on the business of the partnership and their activities as partners.

 

Because Section 102(22)(G) defines “transfer” to include “a transfer by operation of law,” this section affects the power of other law to effect transfers of a partner’s ownership interest. For example, a divorce court lacks the power to award a partner’s spouse anything beyond the partner’s transferable interest. Nor does the partner have the power to enter into a property settlement purporting to effect any greater transfer.

 

For the divorce court, the best solution is to value the partner’s complete ownership interest (i.e., the transferable interest as enhanced by the management and information rights and the standing to sue) and: (i) if possible, award the partner’s spouse marital property of equal value; or (ii) if not possible, award the partner’s spouse a money judgment and a charging order to enforce the judgment.

 

Granting the non-partner any part of a partner’s transferable interest is almost always imprudent; marital discord will almost inevitably carry over into the business relationship.

 

Granting the partner’s ex-spouse the entire transferable interest is rarely a viable alternative. If the partner is active participant in the partnership, the approach is impossible. The partner’s transferable interest will typically constitute much or all of the partner’s remuneration for the partner’s activity. Even if the partner is essentially passive, granting the transferable interest to the ex-spouse puts him or her at great risk as a “bare naked assignee.” See the comment to Section 107(b).

 

When a partner dies, subject to the partnership agreement other law may effect a transfer of the partner’s transferable interest to the partner’s estate or personal representative. However, for the reasons just stated, other law lacks the power to transfer anything more than a transferable interest. (Section 505 does provide extra information rights for the purposes of settling the estate of the deceased partner.)

 

(A) participate in the management or conduct of the partnership’s business; or

(B) except as otherwise provided in subsection (c), have access to records or other information concerning the  partnership’s  business.

Reporter's Comment: Subsection (a)(3)(B) - For a related provision, providing that that section’s information rights do not apply to transferees, see Section 408(i).

(b) A transferee has the right to:

Reporter's Comment: Subsection (b) - Amounts due under this subsection are of course subject to offset for any amount owed to the partnership by the partner or person dissociated as a partner on whose account the distribution is made. Section 405(d). As to whether a partnership may properly offset for claims against a transferor that was never a partner is matter for other law, specifically the law of contracts dealing with assignments.

(1) receive, in accordance with the transfer, distributions to which the transferor would otherwise be entitled; and

(2) seek under Section  801(5) a judicial determination that it is equitable to wind up the partnership business.

 

(c) In a dissolution and winding up of a partnership, a transferee is entitled to an account of the partnership’s transactions only from the date of dissolution.

Reporter's Comment: Subsection (c) - This very limited grant of information rights encompasses only transactions occurring at or after the date of the partnership’s dissolution. The transferee has only the right to information as to the allocation of net assets among the partnership’s creditors, partners, and transferees - and only from the date of dissolution.

 

This subsection does not prevent a transferee from contracting with a partner-transferor to require the partner-transferor to disclose further information to the transferee. Whether such an agreement would breach the partnership agreement, the implied contractual obligation of good faith and fair dealing, Section 409(d), or a fiduciary duty depends on the circumstances.

 

If a dissolved partnership rescinds its dissolution, Section 803, this subsection no longer applies.

 

(d) A partnership need not give effect to a transferee’s rights under this section until the partnership knows or has notice of the transfer.

 

(e) A transfer of a transferable interest in violation of a restriction on transfer contained in the partnership agreement is ineffective if the intended transferee has knowledge or notice of the restriction at the time of transfer.

Reporter's Comment: Subsection (e) - This provision originated as UPA (1997) § 503(e), was then consistent with Uniform Commercial Code section 9-318(3), and is now consistent with section 9-406(a) (stating that “an account debtor . . . may discharge its obligation by paying the assignor until, but not after, the account debtor receives a notification, authenticated by the assignor or the assignee, that the amount due or to become due has been assigned and that payment is to be made to the assignee”).

 

The term “notice” includes “reason to know,” Section 103(b)(1), and ordinarily a potential transferee has reason to inquire about transfer restrictions that might be contained in the partnership agreement.

 

(f) Except as otherwise provided in Section 601(4)(B), if a partner transfers a transferable interest, the transferor retains the rights of a partner other than the transferable interest transferred and retains all the duties and obligations of a partner.

Reporter's Comment: Subsection (f) - Under this subsection, a partner remains a partner (with all attendant rights and obligations) even after permanently transferring the entirety of the transferable interest, unless: (i) the other partners opt for expulsion under Section 601(4)(B); or (ii) as otherwise provided in the partnership agreement.

(g) If a partner transfers a transferable interest to a person that becomes a partner with respect to the transferred interest, the transferee is liable for the partner’s obligations under Sections 404 and 407 known to the transferee when the transferee becomes a partner.

 

SECTION 504.  CHARGING ORDER.

Reporter's Comment: 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 partner or transferee can extract value from the partner’s or transferee’s ownership interest in a partnership. See the comment to Subsection (g).

 

Under this section, the judgment creditor of a partner 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 partner 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 partnership.

 

By its terms, this section does not apply to foreign partnerships. See Section 102(11) (defining “partnership” to mean “an association of two or more persons to carry on as co-owners a business for profit formed under 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 partnership agreement has no power to alter the provisions of this section to the prejudice of third parties. Section 105(c)(17).

(a) On application by a judgment creditor of a partner or transferee, a court may enter a charging order against the transferable interest of the judgment debtor for the unsatisfied amount of the judgment. A charging order constitutes a lien on a judgment debtor’s transferable interest and requires the partnership 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: Subsection (a) - The phrase “judgment debtor” encompasses both partners 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. Ct. App. 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 partnership, 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 partnership. 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 partnership, the charging order applies only to those rights within the definition of transferable interest. See Section 102(23) (defining transferable interest).

 

(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: 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: Subsection (b)(1) - The receiver contemplated here is emphatically not a receiver for the partnership, 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).

 

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

Reporter's Comment: 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 partnership, has no claim on the partnership’s assets, and has no right to interfere in the activities, affairs, and management of the partnership.

 

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 partnership should invest less of its surplus in operations, leaving more funds for distributions. The creditor moves the court for an order directing the partnership 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 partner obtains a charging order against the partner’s transferable interest. Having been properly served with the order, the partnership nonetheless fails to comply and makes a $3000 distribution to the partner. The court has the power to order the partnership 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: Partner A of ABC, a general partnership, has for some years received distributions form the partnership. However, when a judgment creditor of Partner A obtains a charging order against Partner A’s transferable interest, the partnership ceases to make distributions to Partner A and instead provides a salary to Partner A equivalent to former distributions. A court might deem this salary a disguised distribution. (In any event, 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 partnership undergoes a merger, conversion, interest exchange, or domestication under Article 11. In the proper circumstances, such an organic change might trigger an order under Subsection (b)(2).

 

(c) Upon a showing that distributions under a charging order will not pay the judgment debt within a reasonable time, the court may foreclose the lien and order the sale of the transferable interest. The purchaser at the foreclosure sale obtains only the transferable interest, does not thereby become a partner, and is subject to Section 503.

Reporter's Comment: Subsection (c) - The phrase “that distributions under the charging order will not pay the judgment debt within a reasonable period of time” comes from case law. See, e.g., Nigri v. Lotz, 453 S.E.2d 780, 783 (Ga. Ct. App. 1995); Stewart v. Lanier Park Med. Office Bldg., Ltd., 578 S.E.2d 572, 574 (Ga. Ct. App. 2003) (“Judicial sale may be appropriate where . . . it is apparent that distributions under the charging order will not pay the judgment debt within a reasonable amount of time.”). A purchaser at a foreclosure sale obtains only the very limited rights of a transferee under Section 503 and is in some ways more vulnerable and less powerful than the holder of a charging order. After foreclosure and sale, Subsection (b) no longer applies. More generally, the court is no longer involved in the matter. For the vulnerability of a transferee, see Sections 503(a)(3) comment; 107(b), comment.

 

(d) At any time before foreclosure under subsection (c), the partner or transferee whose transferable interest is subject to a charging order under subsection (a) may extinguish the charging order by satisfying the judgment and filing a certified copy of the satisfaction with the court that issued the charging order.

Reporter's Comment: Subsection (d) - This provision allows the judgment debtor to end the charging order without need for a hearing.

(e) At any time before foreclosure under subsection (c), a partnership or one or more partners whose transferable interests are not subject to the charging order may pay to the judgment creditor the full amount due under the judgment and thereby succeed to the rights of the judgment creditor, including the charging order.

Reporter's Comment: Subsection (e) - Traditionally, charging order provisions referred to the possibility of “redeeming” an interest subject to a charging order. That usage was confusing, leaving several important questions unanswered. This act substitutes a far simpler approach, contemplating the partnership or its partners buying the underlying judgment and thereby dispensing with any interference the judgment creditor might seek to inflict on the partnership.

 

In many circumstances, buying the judgment is superior to the mechanism provided by this subsection, because: (i) this subsection requires full satisfaction of the underlying judgment; and (ii) the partnership or the other partners might be able to buy the judgment for less than face value. On the other hand, this subsection operates without need for the judgment creditor’s consent, so it remains a valuable protection in the event a judgment creditor seeks to do mischief to the partnership.

 

Whether a partnership’s decision to invoke this subsection is “ordinary course” or “outside the ordinary course,” Section 401(k), depends on the circumstances. However, the involvement of this subsection does not by itself make the decision “outside the ordinary course.”

 

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

Reporter's Comment: Subsection (f) - 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 that “it is clear that [the provision] does not create an exemption”).

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

 

Reporter's Comment: Subsection (g) - 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 partnership 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.

 

SECTION 505.  POWER OF LEGAL REPRESENTATIVE OF DECEASED PARTNER.

If a partner dies, the deceased partner’s legal representative may exercise:

(1) the rights of a transferee provided in Section 503(c); and

(2) for purposes of settling the estate, the rights the deceased partner had under Section 408.

Reporter's Comment: The estate and those claiming through the estate are transferees, and as such they have very limited rights to information. This section provides temporary, additional information rights to the legal representative of the estate. Sections 408 and 503(c) pertain only to information rights.

 

For the full text of the Uniform Partnership Act click here

 

 

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Law Review Articles By Jay D. 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

The Uniform Acts a/k/a Harmonized Acts re Charging Orders

Additional Resources

Other Websites By Jay Adkisson

© 2017, 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 http://www.chargingorder.com Contact: jay [at] jayadkisson.com or by phone to 702-953-9617 or by fax to 877-698-0678.