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(c-e). FORECLOSURE OF CHARGING ORDER LIENS.

 

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(c-e). FORECLOSURE OF CHARGING ORDER LIENS.

 

(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. Except as otherwise provided in subsection (f), the purchaser at the foreclosure sale obtains only the transferable interest, does not thereby become a member, and is subject to Section 502.

 

Reporter's Comment to 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., 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.”); Nigri v. Lotz, 453 S.E.2d 780, 783 (Ga. Ct. App. 1995). ). A purchaser at a foreclosure sale obtains only the very limited rights of a transferee under Section 502 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 Section 107(b), comment.

 

JayNote: Few things have caused so much consternation among planners as the foreclosure of the charging order lien, and, indeed, some states have modified their ULLCA or RULLCA to prohibit such foreclosures (which was probably a bad move for reasons beyond the discussion here). Foreclosure of the charging order lien has the effect of making the involuntary assignment permanent, i.e., the purchaser at the foreclosure sale will continue to hold the assignment of the transferable interest and receive dividends even after the judgment is fully satisfied. By contrast, if the charging order lien is not foreclosed upon, that lien will terminate when the judgment is fully paid off.

 

In practice, however, few creditors actually even attempt to foreclose on the lien, since there are tax hazards to the purchaser at the judicial sale, which might be the creditor. Which is to say that at ordinary judicial sales, the credit will bid a portion of the judgment against the debtor's asset (known as a "credit bid") and walk away from the auction with the asset. However, since the purchaser at the judicial sale become an involuntary assignee of the debtor's former transferable interest in the LLC, the purchaser thus goes on the hook for any tax consequences spinning off from that LLC interest, and which might include "phantom income" and no cash, also known as the "K.O. by the K-1". Brave indeed (or simply foolish) is the creditor who forecloses and takes the debtor's former interest in all but a single-member LLC.

 

"within a reasonable time" -- What constitutes a "reasonable time" is depending upon the facts of a particular case, and may range from now to never and all temporal points in between. Anecdotally, based on my own experiences, judges will not grant foreclosures of the charging order lien concurrently with the granting of the charging order, but instead (seemingly confused by the "reasonable time" language) will make the creditor wait at least a couple of months before allowing the foreclosure.

 

Example: Debtor owns an interest in an LLC that operates as a hedge fund, which throws off $10,000 per year in dividends. Creditor has a judgment against Debtor for $16,000 plus annual interest at 5%. Since the dividends will pay off the judgment in two years, foreclosure of the interest should be denied.

 

Example: Same facts, except that the LLC pays only $500 dividends per year, and Creditor holds a judgment against Debtor for $150,000 plus annual interest at 5%. Since the dividends cannot reasonably be expected to pay off the judgment, immediate foreclosure of the charging order lien should be allowed.

 

"does not become a member" -- The purchaser at the judicial sale becomes no more than a permanent involuntary assignee of the debtor's former transferable interest, and does not become a member or obtain any additional information rights, etc.

 

(d) At any time before foreclosure under subsection (c), the member 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 to Subsection (d)

 

This provision allows the judgment debtor to end the charging order without need for a hearing.

 

JayNote: Paragraph (d) basically says that a debtor can avoid foreclosure of the charging order lien by paying off the judgment in full and filing with a court a certified copy of the satisfaction of judgment.

 

(e) At any time before foreclosure under subsection (c), a limited liability company or one or more members 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 to 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 limited partnership or its members 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 LLC or the other members 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 LLC.

 

Whether a member-managed LLC’s decision to invoke this subsection is “ordinary course” or “outside the ordinary course,” Section 407(b)(3) and (4)(A), depends on the circumstances. However, the involvement of this subsection does not by itself make the decision “outside the ordinary course.” For a manager-managed LLC, the distinction is irrelevant. Section 407(c)(1).

 

JayNote: Paragraph (e) sets out a "redemption mechanism" that probably nobody in their right mind will ever use, since (1) it requires that the non-debtor members pay the full amount of the judgment to redeem, which amount will usually exceed the value of the interest, but (2) the non-debtor members will very likely be able to obtain the debtor's transferable interest at a much lower price by bidding cash at the judicial sale, and the creditor will likely be happy-as-a-clam to get cash for a dubious asset.

 

(f) If a court orders foreclosure of a charging order lien against the sole member of a limited liability company:

 

Reporter's Comment to Subsection (f)

 

The charging order remedy - and, more particularly, the exclusiveness of the remedy - protect the “pick your partner” principle. That principle is inapposite when a limited liability company has only one member. The exclusivity of the charging order remedy was never intended to protect a judgment debtor, but rather only to protect the interests of the judgment debtor’s co-owners.

 

Put another way, the charging order remedy was never intended as an “asset protection” device for judgment debtors. See Olmstead v. F.T.C., 44 So. 3d 76, 83 (Fla. 2010) (recognizing “the full scope of a judgment creditor's rights with respect to a judgment debtor's freely alienable membership interest in a single-member LLC”); In re Albright, 291 B.R. 538, 540 (Bankr. D. Colo. 2003) (holding that, “[b]ecause there are no other members in the LLC, . . . the Debtor’s bankruptcy filing effectively assigned her entire membership interest in the LLC to the bankruptcy estate, and the Trustee obtained all her rights, including the right to control the management of the LLC”). Accordingly, when a charging order against an LLC’s sole member is foreclosed, the member’s entire ownership interest is sold and the buyer replaces the judgment debtor as the LLC’s sole member.

 

This subsection was added during the Harmonization Project but not for the purposes of harmonization. The subsection addresses an issue that does not exist with partnerships; neither a general nor a limited partnership can continue perpetually in existence with only one partner. See ULPA (2001) (Last Amended 2013) § 801(a)(5) (stating that dissolution is caused upon “the passage of 90 consecutive days during which the partnership has only one partner”); UPA (1997) (Last Amended 2013) § 801(6) (stating that dissolution is caused upon “the passage of 90 consecutive days during which the partnership does not have at least two partners”).

 

JayNote: Paragraph (f) is the so-called "Olmstead patch", so named after the action of the Florida legislature following the Florida Supreme Court decision by the same name. As the Reporter's Comment notes, the raison d'etre of the charging order procedure is to protect the interests of the non-debtor members, which of course is nonsensical in the context of a single-member LLC ("SMLLC").

 

Note that ¶ (f) has no analog under the corresponding charging order sections of the UPA or ULPA, since there is no such thing to begin with as a "single-partner partnership".

 

(1) the court shall confirm the sale;

 

JayNote: Subparagraph (f)(1) requires the court to do both of insure that the marketing and procedure of the judicial sale was fair to the debtor, and that the price obtained at the judicial sale was fair to the debtor (which presumably requires a valuation or appraisal of the debtor's transferable interest). There are at least two important reasons for this: first, the value of the assets in a SMLLC may greatly exceed the auction value of the debtor's interest thus resulting in an unfair windfall to the creditor, and, second, unlike a multiple-member LLC, there are no non-debtor partners who will either redeem the interest or show up to counter-bid at the judicial sale, so as to create a truly-competitive bidding environment.

 

(2) the purchaser at the sale obtains the member’s entire interest, not only the member’s transferable interest;

 

(3) the purchaser thereby becomes a member; and

 

(4) the person whose interest was subject to the foreclosed charging order is dissociated as a member.

 

JayNote: Subparagraphs (f)(2-4) basically say that the purchaser at the judicial sale (who may or may not be the creditor) ends up owning the LLC outright, and the former single-member loses all membership rights. Note, however, that if the SMLLC was manager-managed then the purchaser will probably want to immediately terminate the manager and install a new one.

 

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

 

* * * For court opinions dealing with foreclosure of the charging order lien 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