The Creditor's Remedy Against A Debtor's Interest In An LLC Or Partnership
2020 - Texas - Thomas - Charging Order Form And Terms
Thomas v. Hughes, 2020 WL 5015441 (August 24, 2020).
United States District Court, W.D. Texas, San Antonio Division.
Johnny THOMAS, AS Bankruptcy TRUSTEE OF PERFORMANCE PRODUCTS, INC.; James Pearcy, Carolyn Pearcy, in Her Capacity as Trustee of the Pearcy Family Trust, Trustee of the Pearcy Marital Trust, and Executor of the Estate of James Pearcy, Plaintiffs,
Lou Ann HUGHES, Advanced Probiotics, LLC, Performance Probiotics, LLC, Defendants.
Attorneys and Law Firms
Clark Willis Richards, Daniel R. Richards, Daniel J. Riegel, Richards, Rodriguez & Skeith LPP, Austin, TX, for Plaintiffs.
Eric A. Pullen, Leslie Sara Hyman, Matthew J. McGowan, Thomas Rice, Pulman, Cappuccio, Pullen, Benson & Jones, LLP, Sarah A. Sweet, Elder Bray & Bankler PC, San Antonio, TX, for Defendants.
REPORT AND RECOMMENDATION OF UNITED STATES MAGISTRATE JUDGE
ELIZABETH S. (“BETSY”) CHESTNEY, UNITED STATES MAGISTRATE JUDGE
*1 To the Honorable United States District Judge David A. Ezra:
This Report and Recommendatio§n concerns Plaintiffs’ Application for Charging Order [#225]. The motion was referred to the undersigned for disposition pursuant to Western District of Texas Local Rule CV-72 and Appendix C. The undersigned has authority to enter this recommendation pursuant to 28 U.S.C. § 636(b)(1)(B). For the reasons set forth below, it is recommended that Plaintiffs’ motion be GRANTED.
I. Procedural Background
The record in this case reflects that on March 4, 2020, the Court awarded judgment in favor of Plaintiffs Johnny Thomas, as Bankruptcy Trustee of Performance Products, Inc., and Carolyn Pearcy, in her capacities as Trustee of the Pearcy Marital Trust and Executor of the Estate of James Pearcy, following a jury trial. The judgment ordered that (a) Plaintiff Carolyn Pearcy shall recover from Defendants Performance Probiotics, LLC and Lou Ann Hughes, jointly and severally, the amount of $1,442,580.06 in damages and $1,200,000.00 in punitive damages plus post-judgment interest and (b) Plaintiff Johnny Thomas shall recover from Hughes the amount of $859,490.00 plus post-judgment interest. (Final J. [#189].) On July 17, 2020, the Court adopted the undersigned’s report and recommendation regarding attorney’s fees awarding Plaintiffs $409,182.74 in attorney’s fees and expenses. (R&R [#212]; Order [#224].) On July 17, 2020, the Court denied Defendants’ Renewed Motion for Judgment as a Matter of Law and Motion for New Trial, meaning the Court’s Final Judgment dated March 4, 2020 is final. (Order [#223].) The total amount of the final judgment against Hughes, including attorney’s fees, but excluding post-judgment interest, is $3,911,252.80. The judgment remains unpaid, and Defendants have appealed the final judgment to the Fifth Circuit.
Plaintiffs’ motion currently before the Court asks the Court to enter a charging order with respect to Hughes’s membership in the Texas limited liability company M. G. & Sons, LLC to satisfy the final judgment against her pursuant to Section 101.112 of the Texas Business Organizations Code. Section 101.112 provides the following:
(a) On application by a judgment creditor of a member of a limited liability company or of any other owner of a membership interest in a limited liability company, a court having jurisdiction may charge the membership interest of the judgment debtor to satisfy the judgment.
(b) If a court charges a membership interest with payment of a judgment as provided by Subsection (a), the judgment creditor has only the right to receive any distribution to which the judgment debtor would otherwise be entitled in respect of the membership interest.
(c) A charging order constitutes a lien on the judgment debtor’s membership interest. The charging order lien may not be foreclosed on under this code or any other law.
Tex. Bus. Orgs. Code Ann. § 101.112. A charging order is the “exclusive remedy by which a judgment creditor of a member or of any other owner of a membership interest may satisfy a judgment out of the judgment debtor’s membership interest.” Id. at § 101.112(d). A judgment creditor “does not have the right to obtain possession of, or otherwise exercise legal or equitable remedies with respect to, the property of the limited liability company.” Id. at § 101.112(f).
*2 Attached to Plaintiffs’ motion is a copy of the Certificate of Formation and 2018 Public Information Report for M. G. & Sons, LLC, demonstrating that Hughes is the sole member of M. G. & Sons. (LLC Docs. [#225-1].) Plaintiffs argue that as a judgment debtor Hughes’s membership interest in M. G. & Sons is subject to a charging order under Section 101.112, which constitutes a lien on the membership interest of Hughes in M. G. & Sons. Plaintiffs contend they have the right to receive any distribution to which Hughes would otherwise be entitled with respect to her membership interest in M. G. & Sons and that any membership distributions, profits, cash, assets, or other monies due or that shall become due by Hughes by virtue of that membership shall be paid by Hughes, M. G. & Sons, and/or any third party to Plaintiffs through their counsel of record. Furthermore, Plaintiffs ask the Court to order that Hughes and M. G. & Sons be required to obtain leave of court before transferring any asset of M. G. & Sons to any third party, transferring any funds to any third party except for transactions in the ordinary course of business, or transferring Hughes’s interest in M. G. & Sons to any third party. According to Plaintiffs, the sole current asset of M. G. & Sons is real estate located at 727 Isom Road, San Antonio, Texas.
Defendants’ response acknowledges that Plaintiffs have received a judgment that has not been superseded or otherwise stayed pending appeal and that Texas law allows for a charging order on application by judgment creditors of a member of a limited liability company like Hughes. Defendants argue, however, that Plaintiffs’ motion seeks to go beyond what Section 101.112 allows in two respects. First, Hughes takes issue with the language used by Plaintiffs in their motion that the charging order “direct[ ] that M. G. & Sons, LLC pay to Plaintiffs all funds and assets whatsoever, which by virtue of Hughes’s membership interest would have been distributed to Hughes.” (Mtn. [#225] at ¶ 4.) Hughes argues that this language does not track Section 101.112(b) and that a proper charging order would simply state that Hughes’s interest in M. G. & Sons is directed to pay the judgment creditors “any distribution to which the judgment debtor would otherwise be entitled in respect of the membership interest.”
Second, Hughes opposes Plaintiffs’ request for language in the charging order requiring Hughes to obtain leave of court before transferring real property, funds, or her interest in M. G. & Sons to a third party. Hughes argues that this language would violate Section 101.112(f) because it is an attempt to “exercise legal or equitable remedies with respect to the property of the limited liability company.”
Plaintiffs respond to these arguments by maintaining that the language in their proposed charging order is not overbroad in light of the jury’s finding that Hughes engaged in fraudulent transfers to frustrate Pearcy’s attempts to collect his judgment. Plaintiffs argue that they have well-founded concerns that Hughes may again attempt to circumvent the charging order by transferring something other than “distributions” to herself from M. G. & Sons and then claim the transfer was not subject to the charging order. As to the argument that the charging order application requests improper legal or equitable remedies over the property of M. G. & Sons, Plaintiffs respond that the proposed requirement that Hughes seek leave of court before transferring assets of or interests in M. G. & Sons simply provides security against any attempts at future fraudulent transfers.
The undersigned agrees with Plaintiffs that their proposed charging order language is not overbroad. The language “directing” M. G. & Sons, LLC to pay to “Plaintiffs all funds and assets whatsoever, which by virtue of Hughes’s membership interest would have been distributed to Hughes” that is challenged by Defendants appears in Plaintiffs’ motion and not the proposed charging order. The proposed charging order states the following:
Plaintiffs have the right to receive any distribution to which Hughes would otherwise be entitled in respect of her membership interest in M. G. & Sons, LLC. Any membership distributions, profits, cash, assets, or other monies due or that shall become due to Hughes by virtue of her membership in M. G. & Sons, LLC shall be paid by Hughes, M. G. & Sons, LLC, and/or any third party to the Plaintiffs through their counsel of record.
*3 (Proposed Order [#225-2] at 2.) Section 101.112(b) entitles the judgment creditor to the “right to receive any distribution to which the judgment debtor would otherwise be entitled in respect of that membership interest.” Plaintiffs direct the Court to the charging order language used in Pajooh v. Royal W. Investments LLC, Series E, 518 S.W.3d 557 (Tex. App.—Houston [1st Dist. 2017, no pet.), which ordered U.S. Capital Investments to pay to Royal West Investment LLC, Series E “all funds and assets whatsoever, which by virtue of the membership interest ... would have been distributed” to Pajooh. Id. at 560. Given Hughes’s history evading the payment of monetary judgments and the jury finding that Hughes engaged in fraudulent transfers of assets, the specificity included in Plaintiffs’ proposed charging order language is not overbroad. Defendants fail to direct the Court to any authority prohibiting the inclusion of the words “profits, cash, assets, or other monies” to clarify the scope of possible “distributions” by virtue of Hughes’s membership interest in M. G. & Sons, LLC.
Regarding the proposed language requiring Hughes to seek leave of court before transferring real property, assets, or her membership interest, the undersigned also finds this language does not run afoul of the parameters of Section 101.112. Again, the Texas Business Organizations Code prohibits Plaintiffs from obtaining possession of or otherwise exercising legal or equitable remedies with respect to the property of the M. G. & Sons, LLC. Tex. Bus. Orgs. Code § 101.112(f). Plaintiffs do not seek to obtain possession of the real property located at 727 Isom Road, San Antonio, Texas. As Plaintiffs point out in their reply, “[t]he charging order was developed to prevent disruption of a partnership’s business by a judgment creditor seeking to force an execution sale of a partner’s interest to satisfy a nonpartnership debt.” Pajooh, 518 S.W.3d at 562 (citing Stanley v. Reef Secs., Inc., 314 S.W.3d 659, 664 (Tex. App.—Dallas 2010, no pet.)). Accordingly, a charging order entitles a judgment creditor to receive a partner’s share of profits directly from a partnership “when and if those profits are distributed,” but does not entitle a creditor to participate in the partnership or compel distribution of profits. Id. at 562–63. Nothing in Plaintiffs’ proposed charging order disrupts M. G. & Sons’ business, forces the sale of Hughes’s interest, or compels distribution of profits. The requirement that Hughes seek leave of court prior to transferring assets of or her interest in M. G. & Sons is not prohibited by Section 101.112(f) and is justified in light of Hughes’s history of fraudulent transfers to avoid payment of a judgment.
III. Conclusion and Recommendation
Having considered Plaintiffs’ motion, the response and reply thereto, the record in this case, and governing law, the undersigned recommends that Plaintiffs’ Application for Charging Order [#225] be GRANTED and the Charging Order attached to Plaintiffs’ motion [#225-2] be entered.
IV. Instructions for Service and Notice of Right to Object/Appeal
The United States District Clerk shall serve a copy of this report and recommendation on all parties by either (1) electronic transmittal to all parties represented by attorneys registered as a “filing user” with the clerk of court, or (2) by mailing a copy to those not registered by certified mail, return receipt requested. Written objections to this report and recommendation must be filed within fourteen (14) days after being served with a copy of same, unless this time period is modified by the district court. 28 U.S.C. § 636(b)(1); Fed. R. Civ. P. 72(b). The party shall file the objections with the Clerk of Court and serve the objections on all other parties. A party filing objections must specifically identify those findings, conclusions or recommendations to which objections are being made and the basis for such objections; the district court need not consider frivolous, conclusive or general objections. A party’s failure to file written objections to the proposed findings, conclusions and recommendations contained in this report shall bar the party from a de novo determination by the district court. Thomas v. Arn, 474 U.S. 140, 149–52 (1985); Acuña v. Brown & Root, Inc., 200 F.3d 335, 340 (5th Cir. 2000). Additionally, failure to file timely written objections to the proposed findings, conclusions and recommendations contained in this report and recommendation shall bar the aggrieved party, except upon grounds of plain error, from attacking on appeal the un-objected-to proposed factual findings and legal conclusions accepted by the district court. Douglass v. United Servs. Auto. Ass’n, 79 F.3d 1415, 1428–29 (5th Cir. 1996) (en banc).
by Jay Adkisson
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More Articles On Charging Orders click here
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
Analysis of Uniform Limited Liability Company Act Sections re Charging Orders
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
NATURE OF REMEDY
Distributions/Economic Rights - Creditors rights to distributional interests/economic rights
Prejudgment Relief - Freezing the interest and distributions pending judgment
Procedure - The procedure for obtaining a charging order and ancillary provisions
Unknown Interest - Where the debtor's interest, if any, has not been ascertained
Order Form Generally - Most issues to the form of the charging order
Order Form Future Interests - How the charging order affects subsequently-acquired interests
Exemptions - Available state and federal protections that may apply to charging orders
Conflicts-Of-Law - Determining which state's laws apply to a charging order dispute
Jurisdiction - Issues relating to the court's authority over out-of-state debtors and LLCs
Foreign Entities - Charging orders against out-of-state entities
Creditor Rights Restrictions - Limitations on creditors' management and informational rights
Information Rights - Creditors' ability to access information about the LLC
Management & Voting Rights - Rights of creditor after charging order issued
LIEN EFFECT AND PRIORITY
Lien - The lien effect of a charging order and priority issues
Compliance - Issues for the LLC and non-debtor members in complying with a charging order
Receiver - The role of the receiver in charging order proceedings
SINGLE MEMBER LLC
Single-Member LLCs - Enforcing the judgment against an LLC with a sole member
Foreclosure - Liquidation by judicial sale of the debtor's right to distributions
REPURCHASE AND REDEMPTION RIGHTS
Repurchase/Redemption Rights - Third-parties' ability to purchase the charged interest
Appeal - Issues relating to the appeal of a charging order
RELATION TO OTHER REMEDIES
Exclusivity - The charging order as the sole remedy available to creditors and exceptions
Voidable Transactions/Fraudulent Transfers - Issues relating to avoidable transfers of interests
Abstention - Attempts to collaterally attack the charging order in federal court
Bankruptcy - Treatment of the debtor/member's interest in bankruptcy
Intra-Member Disputes - Where one member obtains a charging order against another
Taxes - Tax issues relating to charging orders for all involved parties
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Additional Court Opinions About charging orders (unsorted)
THE CHARGING ORDERS PRACTICE GUIDE
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
OTHER INFORMATIONAL WEBSITES
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