Charging Orders And Debtor Exemptions

Topic Exemption TopicsExemption

While § 503(g) provides that the D/M may take advantage of any exemption, there is no guidance on how or when the D/M may assert the exemption. This should be corrected; presumably, the D/M must assert or lose the exemption at the hearing on the charging order.

Note that most judgment enforcement remedies that take something from the debtor are accompanied by statutory warnings that the debtor must assert any exemption within X days or lose the exemption.

An unsettled issue is whether a D/M may assert the Federal Wage Garnishment Law ("FWGL"), 15 U.S.C. §§ 1671, et seq., should apply to limit the charging order to 25% of the D/M's net disposable income, where the D/M can demonstrate that the distribution, or a part of the distribution, derives from the D/M's labors. For an analogous situation, see U.S. v. Alexander, 2016 WL 2893406 (D.Ariz., 2016).

In the humble opinion of your author, the way this should shake out is as follows:

  • If the debtor is receiving some compensation for services other than a distribution, such as a salary or wages, then the FWGL applies and the creditor should be limited to 25% of the debtor's net disposable income. Note, however, that bonuses are not protected by the FWGL.
  • If the debtor is receiving distributions from the LLC, then the court should examine further to see whether the distributions derive from the debtor's labors ("active income") or not ("passive income"), but which test is different from the tax test.
    • To the extent that part or all of a distribution derives directly from the debtor's own labor, then the FWGL should apply and the creditor should be limited to 25% of the debtor's net disposable income.
    • Otherwise, the distribution should not be subject to the FWGL and 100% of the distribution should be available to the creditor through the charging order lien, subject to any other exemptions that might apply.