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 directly from the ABA at https://goo.gl/faZzY6

 

Also available from Amazon at https://www.amazon.com/Charging-Orders-Practice-Guide-Understanding/dp/1641052643

SECTION 102(4). DEFINITION OF DISTRIBUTION

 

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. }

 

(4) “Distribution” means a transfer of money or other property from a limited liability company to a person on account of a transferable interest or in the person’s capacity as a member. The term:

JayNote: The "general rule"* is that anything, whether cash or other assets, that is transferred to a member will be considered to be in the nature of a distribution, but with the caveat that whatever is received must be "on account of a transferable interest or in the person's capacity as a member", i.e., the member would receive that amount of money simply because of the member's equity ownership in the LLC and nothing more.

 

The language used here gives rise to myriad unanswered questions, such as whether management fees or or other compensation in the nature of salary or wages would be considered "on account of a transferable interest or in the person's capacity as a member." Look down to ¶ (B) below, and you will see that the answer is "no, negative." Although LLC planners naturally detest analogies to stock corporations, the analogy here to distributions from an LLC as being very similar to a stock distribution seems appropriate. Thus, Jim can own shares in Microsoft and earn dividends from those shares, while also acting as an employee of Microsoft and earning a salary that has utterly nothing to do with his distributions.

 

It is for this reason that the "best practice" for creditor rights attorneys is to serve, concurrently with a charging order, a garnishment, wage levy, assignment order (and/or whatever else is appropriate in a given jurisdiction) so as to pick up any non-distribution income received by the debtor/member.

 

* Thus, once again illustrating the legal cynicism that "general rules are generally inapplicable".

 

(A) includes:

 

JayNote: The use of the term "includes" of course denotes that the following two items are not the only things that would be considered distributions, but instead are exemplary.

 

(i) a redemption or other purchase by a limited liability company of a transferable interest; and

 

JayNote: If the member is bought out, the buy out (at least to the extent that value is given by the company for the member's interest) would be a distribution as to the member. Likewise, if the LLC were wound up, the value paid by the member for her share of the assets in the LLC would likewise be considered a distribution.

 

(ii) a transfer to a member in return for the member’s relinquishment of any right to participate as a member in the management or conduct of the company’s activities and affairs or to have access to records or other information concerning the company’s activities and affairs; and

 

Reporter's Comment

 

“Distribution” [(4)(A)—redemptions included]—This provision specifically refers to transactions between a limited liability company and one of its members, which in the corporate context would be labeled a “redemption.” The paragraph has subparts because ownership interests in an LLC are conceptually bifurcated into economic rights (“transferable interest”) and governance and information rights.

 

Under Section 404(a), “[a]ny distribution made by a limited liability company before its dissolution and winding up must be in equal shares among members and persons dissociated as members . . . .” Since a redemption is a distribution, absent authorization in the operating agreement an LLC may not redeem the interest of one member or transferee without redeeming (or at least offering to redeem) the interests of all other members and transferees to a comparable extent.

 

The law of close corporations has flirted with a similar notion. See, e.g., Donahue v. Rodd Electrotype Co. of New England, Inc., 367 Mass. 578, 598, 328 N.E.2d 505, 518 (1975) (stating, with regard to closely held corporations, “if the stockholder whose shares were purchased was a member of the controlling group, the controlling stockholders must cause the corporation to offer each stockholder an equal opportunity to sell a ratable number of his shares to the corporation at an identical price”); Toner v. Baltimore Envelope Co., 304 Md. 256, 273, 498 A.2d 642, 650 (1985) (rejecting the “per se breach of duty” approach); Wilkes v. Springside Nursing Home, Inc., 370 Mass. 842, 850, 353 N.E.2d 657, 663 (1976) (stating that “untempered application of the strict good faith standard enunciated in Donahue to . . . will result in the imposition of limitations on legitimate action by the controlling group in a close corporation which will unduly hamper its effectiveness in managing the corporation in the best interests of all concerned”).

 

An operating agreement can override Section 404(a)’s equal treatment requirement without specifically mentioning redemptions.

 

EXAMPLE: Ryan, LLC is a manager-managed limited liability company whose operating agreement: (i) includes a list (the “protected list”) of decisions or actions that may be taken only with the consent of all members; and (ii) provides that all other decisions and acts may be taken as the manager determines. The protected list does not include redemptions. The operating agreement overrides the Section 404(a)’s equal treatment requirement.

 

JayNote: If the member gives up some right under the operating agreement in return for payment, such would be considered to be in the nature of a partial redemption of the member's interest, and thus a distribution.

 

(B) does not include 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.

 

Reporter's Comment

 

[(4)(B)—exclusion]—This exclusion affects the reach of: (i) the charging order remedy under Section 503; and (ii) Section 405’s clawback provision. The effect on the clawback provision reflects the law in several states, see, e.g., DEL. CODE ANN., tit. 6, § 18-607(b) (2012) and VA. CODE ANN. § 13.1-1036 (2012), and makes sense conceptually and as a matter of policy. See In re Tri-River Trading, LLC, 329 B.R. 252, 266 (B.A.P. 8th Cir. 2005), aff’d, 452 F.3d 756 (8th Cir. 2006) (“We know of no principle of law which suggests that a manager of a company is required to give up agreed upon salary to pay creditors when business turns bad.”).

 

JayNote: Broken down, ¶ (B) states that the term "distribution" does not include:

 

(1) Compensation for present services;

 

(2) Compensation for past services; or

 

(3) Normal payments make pursuant to a retirement plan or program.

 

See also, comment to (4) above.

 

 

 

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 directly from the ABA at https://goo.gl/faZzY6

 

Also available from Amazon at https://www.amazon.com/Charging-Orders-Practice-Guide-Understanding/dp/1641052643

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

 

General Information

 

Analysis of Uniform Limited Liability Company Act Sections re Charging Orders

  • Charging Orders (Section 503) contains the general charging order provisions.
  • Transfers of Transferable Interests (Section 502) includes definitions of "transfer" (102(23)), "transferable interests" (102(24)), and "transferees" (102(25)) defines to what the charging order attaches.
  • Definition of Distribution (Section 102(4)) specifies the economic right obtained through a charging order lien and/or foreclosure.

 

The Uniform Acts re Charging Orders and Transferable Interests (without Jay's comments):

 

Effect of Bankruptcy On The Debtor-Member's LLC Interest here

 

 

Collected Court Opinions On Charging Orders here and below

 

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.

 

Las Vegas Office: 6671 S. Las Vegas Blvd., Suite 210, Las Vegas, NV 89119, Ph: 702-953-9617, Fax: 877-698-0678. By appointment only.

 

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Admitted to practice law in Arizona, California, Nevada, Oklahoma and Texas.

 

© 2019 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.