Charging orders: the peculiar mechanism.
The charging order is an oddity of American law, occasionally appearing in old opinions pre-dating World War I to address odd situations in garnishment law, but is now almost exclusively found in the law of partnerships, and more recently limited liability companies ("LLCs"). Yet, in the area of LLCs, the charging order has taken on a life and aura of its own, with some states racing each other to have the "best" charging order provisions, so as to foster entity formation and registered agents business within those states. Creditors at the same time, while of course describing the "race" in less than flattering terms, have been developing their own strategies for defeating or circumventing the much-ballyhooed "exclusivity" of the charging order remedy. To understand why this unique remedy even exists, and why it has graced or cursed the area of partnership and LLC law, we must retrace the history of Anglo-American law to where a fork in the road developed in how each country would handle security interests that were created by creditor claims.
The lien was not a part of the English Common Law. Instead, it was first suggested in 1791 in the fonn of a "Mechanic's Lien" by Thomas Jefferson as a means to further the construction of the District of Columbia. After adoption by the Maryland legislature that same year, the concept quickly spread to other states. (2) The concept was not a particularly new one; the Romans had, centuries before, developed the concept of the obligare rem, by which a creditor took an interest in a pignus (the object of a security interest) to secure a debt. The Roman security interest had survived into the civil law of the continental European states, of which the Francophile attorney Jefferson was likely aware.
Now we have materialman's liens, tax liens, mortgage liens, attorney's liens, mineral liens, maritime liens, warehouser's liens, HOA liens, municipal liens, UCC liens, judgment liens (of which the charging order lien is but one), and the list goes on and on. Thanks to our third president, America has become the land of the free and the brave, and the lien.
While America went the way of the lien, the United Kingdom, instead, adopted the notion of the charging order to the same effect. That a debtor's interest in shares of stock could be "charged" was formalized in the first two Acts of Queen Victoria.
1. Judgments Act of 1838
XIV. Stock and shares in public funds and public companies belonging to the debtor, and standing in his own name, to be charged by order of a judge. And be it enacted, that if any person against whom any judgment shall have been entered up in any of her Majesty's Superior Courts at Westminster shall have any government stock, funds, or annuities, or any stock or shares of or in any public Company in England (whether incorporated or not), standing in his name in his own right, or in the name of any person in trust for him, it shall be lawful for a judge of one of the Superior Courts, on the application of any judgment creditor, to order that such stock, funds, annuities, or shares, or such of them or such part thereof respectively as he shall think fit, shall stand charged with the payment of the amount for which judgment shall have been so recovered, and interest thereon, and such order shall entitle the judgment creditor to all such remedies as he would have been entitled to if such charge had been made in his favour by the judgment debtor; provided that no proceedings shall be taken to have the benefit of such charge until after the expiration of six calendar months from the date of such order. (3)
Thus, under United Kingdom law, the method for a judgment creditor to create and maintain a legal interest on the debtor's property was through the vehicle of the charging order. When the United Kingdom codified its partnership law in 1890, the charging order was thus the natural and accepted method of achieving that end.
2. Partnership Act of 1890 c. 39 (Regnal. 53 & 54 Victoria)
23. Procedure against partnership property for a partner's separate judgment debt.
(1) After the commencement of this Act a writ of execution shall not issue against any partnership property except on a judgment against the firm.
(2) The High Court, or a judge thereof, or the Chancery Court of the county palatine of Lancaster, or a county court, may, on the application by summons of any judgment creditor of a partner, make an order charging that partner's interest in the partnership property and profits with payment of the amount of the judgment debt and interest thereon, and may by the same or a subsequent order appoint a receiver of that partner's share of profits (whether already declared or accruing), and of any other money which may be coming to him in respect of the partnership, and direct all accounts and inquiries, and give all other orders and directions which might have been directed or given if the charge had been made in favour of the judgment creditor by the partner, or which the circumstances of the case may require.
(3) The other partner or partners shall be at liberty at any time to redeem the interest charged, or in case of a sale being directed, to purchase the same.
(4) This section shall apply in the case of a cost-book company as if the company were a partnership within the meaning of this Act.
(5) This section shall not apply to Scotland. (4)
It would be incorrect to pretend that America had totally ignored the concept of the charging order. In Cross v. Brown (5) and Hunter v. Strider's. (6) we find a pair of opinions where charging orders were used to enforce writs of garnishment. By and large, however, the procedure was an oddity that was employed in unusual circumstances where no clear remedy existed, and in such a rare case to borrow the concept of the charging order from the east side of the Atlantic seemed as good an idea as any other.
The point is that the charging order was not wholly alien to American law when it came time for the United States to codify its own partnership laws. (7) The Uniform Laws Commission, which at that time had a slavish adoration for the Law Commission in England that bordered on the embarrassing, borrowed heavily from the U.K.'s Partnership Act of 1890--including the concept of the charging order--even though the rest of American law had largely chosen and had already been following, for just short of a century, the different path of the lien beginning in 1791. (8)
Thus, in the charging order, we unfortunately ended up with an English remedy to accomplish what should have been done directly and simply through an American lien. The unexplained rumblings heard by the drafters of the Uniform Partnership Act ("UPA") of 1914 was Jefferson rolling in his grave.
3. Uniform Partnership Act of 1914
[section] 28. Partner's Interest Subject to Charging Order.
(1) On due application to a competent court by any judgment creditor of a partner, the court which entered the judgment, order, or decree, or any other court, may charge the interest of the debtor partner with payment of the unsatisfied amount of such judgment debt with interest thereon; and may then or later appoint a receiver of his share of the profits, and of any other money due or to fall due to him in respect of the partnership, and make all other orders, directions, accounts and inquiries which the debtor partner might have made, or which the circumstances of the case may require.
(2) The interest charged may be redeemed at any time before foreclosure, or in case of a sale being directed by the court may be purchased without thereby causing a dissolution:
(a) With separate property, by any one or more of the partners, or
(b) With partnership property, by any one or more of the partners with the consent of all the partners whose interests are not so charged or sold.
(3) Nothing in this act shall be held to deprive a partner of his right, if any, under the exemption laws, as regards his interest in the partnership. (9)
By contrast, the limited partnership was first introduced into American law by New York's Limited Partnership Act of 1822, which was itself based on the French societe en commandite (Jefferson would have been proud). Predictably, since the charging order was an English invention, New York's innovation had no charging order provision. (10) Although the limited partnership was alien to the English partnership law upon which the UPA of 1914 was based, when the Uniform Law Commission adopted the Uniform Limited Partnership Act ("ULPA") in 1916, section 22, providing for the English remedy of the charging order, was engrafted into the ULPA, apparently to conform the two acts.
We then waited some fourteen years after the 1914 adoption of the UPA before an appellate court was finally presented with a case involving a charging order arising under the UPA; the opinion being that of Rader v. Goldoff. (11) There, the creditor of a partner had obtained an injunction that compelled a bank to freeze partnership assets until they could be executed upon by the creditor. (12) The injunction was vacated, with the Court blandly reciting that the charging order provision of New York's UPA must be followed and also awarding the debtor $10 in costs. (13)
Soon thereafter, the California Court of Appeals took up the challenge in Sherwood v. Jackson, (14) and considered the case of one partner who had sued and obtained a personal injury judgment against the other partner--and then tried to dissolve the partnership so as to enforce the judgment against the debtor-partner's share of the assets. (15) The California panel nixed this attempt, holding (based upon the New York holding in Rader) that the creditor-partner's exclusive remedy was the charging order procedure. (16)
The California experience is important to us, for in 1946 it brought us Hensley v. Popkin, (17) which appears to be the first opinion to address the effect of a charging order as creating not only a lien on the debtor-partners' interest, but a lien that was subject to priority as any other lien. (18) It also brought us Ribero v. Callaway, (19) which recognized the right of the non-debtor partners to appeal a charging order, so as to assert their defense that the debtor whose interest was charged was never actually a partner at all. (20)
For nearly fifty years following the New York decision in Rader, New York and California case law, often playing off each other's opinions, would dominate the area of charging orders; those two states producing nearly as many opinions on the topic as the rest of the states combined.
4. Tropical Interlude
Located in the South Pacific, in the vast, peaceful ocean somewhere between Hawaii and New Zealand, lies the Cook Islands. First named the Hervy Islands by the famed British explorer who would chance upon them in 1773 and then renamed the Cooks in his honor by an obscure Russian cartographer in 1820, the fifteen sparsely-populated islands would appear to be a most unlikely candidate for the massive tremor that it was to ultimately generate in the American law of charging orders. Even less likely, the tremor would be initiated by a Denver lawyer who was then about as well-known as the Russian cartographer.
The Cook Islands follow English law, as they are a protectorate of New Zealand, which itself is a Commonwealth Country, with its highest court of appeals being the Privy Council in London. In 1984, looking for sources of revenue other than the occasional National Geographic reader, the Cook Islands enacted their International Trust Law by which they sought trust business from around the globe. There were few takers.
Then, in 1989, Denver lawyer Barry S. Engel persuaded the Cook Islands' Parliament, as it was in a territory having less than 40,000 inhabitants, to amend the International Trust Law ("ITA") so as to include certain provisions that were very unfriendly to creditors. The settlor-beneficiary of a self-settled trust was given protection as to her beneficial interest, a concept which had to that point been anathema on public policy grounds throughout Anglo-American jurisprudence since at least the reign of Elizabeth. Other features were built into the ITA to deter creditors from even attempting to challenge a trust formed in the Cook Islands, and to make even the mere attempt at a challenge horrendously expensive.
Thus, the fledgling industry known today as "asset protection planning" was given birth, and a few, and then many, U.S. tax and estate planning practitioners jumped on the concept as a way of increasing practice revenues. In 1989, there was not a single practitioner nationwide who was listed in Martindale-Hubbel as practicing in the area of asset protection. Today, those lawyers hanging out that shingle as one of their practice areas number in the tens-of-thousands. Barry Engel, thus, forever cemented his legacy as the true "Father of Asset Protection," though not just a few hucksters would later take the title for themselves to try to impress their unfortunate clients.
The effect on American trust law has been similarly dramatic, with Alaska passing the first "Domestic Asset Protection Legislation" in 1997, followed closely on its heels by Delaware later that same year. As of this writing, there are now fifteen states that provide some level of protection to the settlor-beneficiary of self-settled trusts. (21) The drama would not be confined to trusts.
One of the first beneficiaries (or victim, some might lament) of the asset protection craze was the little known charging order. Ignoring that the purpose of the charging order was to protect the non-debtor partners from being forced into an involuntary partnership with somebody's creditor under the most exalted and all holy (22) "Pick-Your-Partner Principle." As that rule had characterized partnership law since the adoption of the UPA in 1914, asset protection planners quickly realized that these provisions could also be used (or misused, depending on one's point of view) by the debtor-partner to prevent creditors from accessing the debtor-partner's assets that had been contributed to the partnership.
Thus, the massive tremor, spawned in the Cook Islands, now hit partnership law as well. Partnerships would henceforth be formed not just to facilitate commercial enterprises, but would also be formed as the family piggy-bank, and thus the "Family Limited Partnership," originally conceived as an estate planning tax-shelter to take advantage of limited partnership interest discounts, gained its asset protection teeth. Meanwhile, back in the more mundane area of ordinary business planning, other changes were taking place that would bring partnership law to its current footing.
5. The Kaiser William Invades Wyoming
If the Cook Islands were an unlikely place for a sea change in trust law, then Wyoming was just as an unlikely candidate for a dramatic change in partnership or corporate law. Long known as the place one must pass through to reach Yellowstone (probably few Americans can even name the state's capital of Cheyenne), Wyoming's Devil's Tower briefly became popular for the final scenes in Steven Spielberg's 1977 film, Close Encounters of the Third Kind. (23) That year something else was happening in Wyoming; something that also had its genesis in the reign of Victoria.
Just as America borrowed heavily from the English Partnership Act of 1890, so did the fledgling German Empire of Kaiser William II. (24) Though ordinarily following the civil law, Kaiser William II borrowed heavily from his cousin Queen Victoria's Companies Act of 1862 to create the limited liability company known as the Gesellschaft mit beschrankter Haftung, or more popularly and more pronounceable as its acronym, "GmbH." The German LLC, GmbH, became, and remains, quite popular, as any owner of an auto manufactured by "BMW GmbH" might attest.
While the United States, of course, had long before adopted limited partnership ("LP") legislation, that "statutory bastard" (25) suffered from the necessity of having general partners that were generally liable for the debts of the partnership. Further, LPs carried various and sometimes undesirable baggage from their partnership heritage.
Thus, in 1977, Wyoming took the plunge and adopted the first LLC act--and then watched the new entity languish because nobody really knew how it might be treated for tax purposes. Guidance from the Internal Revenue Service ("IRS") had proclaimed that the LLC would be taxed as a partnership for tax purposes if the "four factors" test was satisfied. (26) It was not until December 18, 1996, when the IRS issued its simplified "Check-The-Box" regulations to be effective on January 1, 1997, that life was breathed into the LLC. (27)
It could not have come at a better time, as the asset protection industry that started in the Cook Islands was beginning to break into the mainstream, and Family Limited Partnerships ("FLPs") had already become a popular estate-planning tool. Now we had an entity that could be taxed as either a partnership or corporation; that did not require a general partner that was generally liable; that did not drag along most of the baggage of partnership law; and was (in theory) easy to manage--with charging order protection too.
The "Check-The-Box" regulations paved the way for the success of the LLC, and indeed, in anticipation of those regulations, the Uniform Law Commission had been working on a new Uniform Limited Liability Company Act ("ULLCA"), which was adopted in 1996. The ULLCA was revised a decade later to give us the Revised Uniform Limited Liability Company Act ("RULLCA") that we know today.
6. The Revised Uniform Limited Liability Company Act 2006
SECTION 503. CHARGING ORDER.
(a) On application by a judgment creditor of a member 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 limited liability company to pay over to the person to which the charging order was issued any distribution that would otherwise be paid to the judgment debtor.
(b) To the extent necessary to effectuate the collection of distributions pursuant to a charging order in effect under subsection (a), the court may:
(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
(2) make all other orders necessary to give effect to the charging order.
(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 member, and is subject to Section 502.
(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.
(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.
(f) This [act] does not deprive any member or transferee of the benefit of any exemption laws applicable to the member's or transferee's transferable interest.
(g) This section provides the exclusive remedy by which a person seeking to enforce a judgment against a member or transferee may, in the capacity of judgment creditor, satisfy the judgment from the judgment debtor's transferable interest. (28)
The Prefatory Note to RULLCA pays appropriate homage to its roots:
Charging Orders: The charging order mechanism: (i) dates back to the 1914 Uniform Partnership Act and the English Partnership Act of 1890, and (ii) is an essential part of the "pick your partner" approach that is fundamental to the law of unincorporated businesses. The new Act continues the charging order mechanism, but modernizes the statutory language so that the language (and its protections against outside interference in an LLC's activities) can be readily understood. (29)
For reasons largely having to do with perception from a competitive viewpoint, i.e., "We had better make our charging order provisions more attractive than those of other states, else we might lose formation business at home," various states have (often irrationally) enacted their own, unique charging order provisions. Thus, the sleepy and unusual charging order, for which historically there has been little use or controversy, has recently--with the rise of "asset protection planning" as a popular area--taken on an energetic life of its own.
II. THE PURPOSE OF THE CHARGING ORDER
To understand the charging order, we must first understand what happens when a creditor gets a judgment against a corporate shareholder. A creditor who wins a judgment against the shareholder of a corporation can enforce it by levying on the stock. This means that the local sheriff goes to the shareholder and makes the shareholder turn over the physical share certificates to him. Or, if the shareholder refuses to cough up the shares, or they have never actually been issued, the corporation can be forced to issue new shares to the sheriff. The shares are then auctioned off by the sheriff to whoever bids for them.
Sometimes, if no good cash bid has been made by a third-party buyer, the creditor will itself acquire the shares at the auction by bidding part of the creditor's judgment against the shares, also known as "credit bidding." If the shares are publicly traded, the creditor can then sell the shares at the market trading price. If the shares are privately held and the creditor acquires a majority share, the creditor can vote to wind up the company, and thus access the debtor's share of the company's value.
The benefit of corporations is that they typically have three levels of control that separate the investors from the day-to-day management of the business. First, the shareholders have a vote, and their vote can make major changes to the articles and bylaws of the corporation, and can also elect the directors. Second, the directors have a vote, and they can make significant decisions on behalf of the corporation and elect the officers. Third, the officers are empowered to run the corporation on a daily basis and make significant decisions, subject to the ratification or approval of the directors.
Importantly, the shareholders are divorced from day-to-day decisions. A change in the composition of shareholders may not immediately affect the operations of the business. The shareholders will have to wait until their meeting to elect new directors and only if new directors are elected are the officers likely to change. If the new creditor-shareholder holds less than a majority stake, then the business may not change at all. If, for instance, a creditor levies upon the debtor's one-hundred shares in Microsoft Corporation, which, at the time of this writing, had a paltry 8.26 billion issued and outstanding shares, it is unlikely that there will be many long faces in Redmond, Washington, where that company has its headquarters.
Contrast this with a partnership or LLC, where the owners of the business are usually active in the business. (30) The partners have agreed among themselves that they--and only they--will am the business, and their partnership agreement prohibits new partners without unanimous consent. A change of a partner could have a dramatic, and very negative, effect upon the chemistry of the partnership. If Microsoft were a partnership, even a partner holding a 0.01% interest could presumably come into its offices and start tinkering with its operating system.
Thus, partnerships are treated differently than corporations for judgment collection purposes. The purchaser of corporate shares at a judicial sale will not immediately be able to jump into the management of the company and disrupt its operations. Not so with a partnership, which lacks the legal separation of ownership and management.
A creditor who holds a judgment against a partner in a partnership (or a member in an LLC) is not normally allowed to take the debtor's interest. Instead, the creditor is allowed to take a lien against the debtor's interest so that any profit distributions that would have been made to the debtor will, instead, be made to the creditor. It is here that we should realize that a partner's or member's "interest" is, in fact, really a bundle of several different rights and privileges within the partnership or LLC, of which the right to distributions is just one. (31)
The legal vehicle by which the lien is placed on the debtor's distributive rights is the charging order, which exists primarily to prevent a creditor's enforcement action from disrupting the business of the partnership. The explanation given by the court in Taylor v. S & M Lamp Co. (32) is most helpful:
Lord Justice Lindley gave the following reason for the English rule forbidding execution sale of a partner's interest in the partnership to satisfy his nonpartnership debt: "When a creditor obtained a judgment against one partner and he wanted to obtain the benefit of that judgment against the share of that partner in the firm, the first thing was to issue a [fiery facias], and the sheriff went down to the partnership place of business, seized everything, stopped the business, drove the solvent partners wild, and caused the execution creditor to bring an action in Chancery in order to get an injunction to take an account and pay over that which was due the execution debtor. A more clumsy method of proceeding could hardly have grown up." It was to prevent such "hold up" of the partnership business and the consequent injustice done the other partners resulting from execution against partnership property that the [California Charging Order] code sections and their counterparts in the Uniform Partnership Act and the English Partnership Act of 1890 were adopted. As we view those code sections they are not intended to protect a debtor partner against claims of his judgment creditors where no legitimate interest of the partnership, or of the remaining or former partners is to be served. (33)
The purpose of the charging order remedy, and its exclusivity as a remedy under RULLCA section 503(g) and the other partnership acts, is to prevent disruption of the partnership's business. (34) This can be done by keeping the creditor from otherwise enforcing the judgment directly against the debtor-partner's share of the assets and to prevent a forced "business divorce." (35) It is not meant to protect the debtor-partner's interests, (36) but rather protects the non-debtor partners (37) from being forced into what amounts to an involuntary partnership with somebody's creditor. (38)
A. THE EFFECT OF THE CHARGING ORDER
In United Kingdom law, the charging order was the end in itself--the debtor's interest in the partnership was "charged" with the payment of distributions to the creditor until the debt was satisfied. But in the United States, the method is different, even if the ultimate result is nearly the same. Under American law, the issuance of a charging order has the effect of involuntarily creating a security interest in favor of the creditor by a lien on the debtor's right to distributions that requires the LLC to make all future distributions to the creditor (39) until the judgment is satisfied. (40)
One might think of a charging order as an aerosol can that sprays the lien upon the debtor-member's interest, much in the manner that a child might spray paint their bicycle a different color. In the end, it is the paint (the lien) that is important and lasting, and the charging order itself is of as little consequence as the empty can once it has accomplished its task--with one critically important exception.
The exception does not relate to the lien, but rather to ancillary provisions in the charging order that help to make it truly effective. The typical charging order will not just place the lien, but will also command that the debtor-member not take any loans, salary, fees, etc., or any other actions that would get money out of the LLC through the backdoor, thus defeating the charging order. (41)
As a matter of procedure, a creditor is not required to throw in these other provisions, but instead could bring a separate motion for an order in aid of execution or the like. It is so much easier, however, to simply bundle these provisions into the charging order. This is the (possibly sole) benefit to the creditor of the charging order procedure.
California has uniquely conformed their enforcement of judgments law to conform to charging orders. There, the filing of a motion for charging order and service upon the LLC or its members creates a temporary lien on the debtor-member's interest. Once the motion is granted, the lien then becomes permanent until the judgment is paid. (42) In all other states, a creditor must file a motion for temporary restraining order or preliminary injunction, etc., to attempt to tie up the debtor-member's distributions pending the hearing on the motion for charging order. The lien created by the charging order must be accorded priority like any other judgment lien. (43)
That the creditor who has successfully obtained a charging order ends up with a lien, and only a lien (although there may be some ancillary provisions to effectuate the lien in the text of the charging order), has certain ramifications, the most important of which is that--like any other ordinary (44) lienholder--the creditor does not gain any management rights within the LLC. (45) Some decisions have likewise held that the lien created by the charging order does not independently create any right of a creditor to demand information about the LLC's operations and affairs, although a wily creditor may be able to figure out some other method to ferret out this information. (46)
As for our poor downtrodden debtor-member, he retains, in an unfettered fashion, whatever management rights that he had before the charging order was entered, including his own rights as a member to information about the LLC's activity (and this information is usually fair game for a creditor in post-judgment examination proceedings). (47)
B. THE CHARGING ORDER PROCEDURE
To the surprise of most practitioners who do not regularly practice in the area of creditor-debtor law, most post-judgment enforcement procedures do not implicate the court directly, but instead work through the clerk acting in an almost perfunctory role, and the sheriff. For instance, most post-judgment writs, such as writs of execution, writs of attachment, writs of garnishment, etc., are normally issued by the clerk upon the request of the creditor, and often with only the slightest review to make sure that all the paperwork is in good order. Thereafter, the sheriff simply follows the instructions of whatever writ the sheriff is having to deal with that day, and takes possession of property, holds judicial sales, etc. Probably the vast bulk of garden-variety collection cases never require a judge to make anything approaching an actual decision.
The placing of a lien on the debtor's property is even easier. For real property, the creditor files an Abstract of Judgment with the local county title clerk or recorder or equivalent office, and--Voila!-- the lien is thereby instantly created upon the debtor's real property. Similarly, liens on personal property can be established variously by filing forms with the local Secretary of State, similar to a UCC-1, or by the service upon the debtor of certain writs. To create a lien on most personal property, the creditor can literally "mail it in."
The same is not true of the charging order, which requires that the creditor file a motion for charging order with the court (regarding which court, we will get to presently), serve the debtor and often either the LLC, (48) or all its members, and then have a hearing before the court where the merits of the charging order are considered. It is a time consuming and arguably needless procedure in most cases. Since it is a rare case where the debtor will have anything like a viable defense to a charging order, by and large, the hearing on the motion only provides the debtor with an opportunity to show up and annoy everybody with nonsensical arguments while whining about how unfair it all is.
When granted, the charging order, by its terms, "charges" (creates a lien (49) upon) the transferable interest of the debtor-member, i.e., the right only to distributions. (50) The effect is to divert to the creditor the payments that would otherwise have been made to the debtor, (51) and to create a liability of the LLC to make those payments. (52)
The charging order is similar in many respects to what would be a garnishment proceeding against the debtor-member's right to distributions, but a charging order is not a garnishment and is, in many ways, a more flexible remedy. (53) The charging order is also quite similar to an assignment order, which is often used to assign to creditors the interests in royalties and other income streams, and to an attachment order, which places an involuntary lien on the debtor's interest in some asset, but it is neither. It is indeed a "peculiar mechanism." (54)
As previously mentioned, the form of the charging order will routinely contain detailed ancillary provisions to keep the debtor-member from benefitting from the LLC by distributions, i.e., taking money out the back door. These provisions typically include prohibiting the LLC from making loans to the debtor-member; paying the personal debts of the debtor-member; or paying wages or salary (if they were not paid before) to the debtor-member. But even in absence of such ancillary provisions, the creditor may still have avenues for relief in such cases. (55) Failure of the LLC to abide by these provisions may subject the LLC to contempt. (56)
The RULLCA and the partnership acts only vaguely set out the availability, basic application, and exclusivity of the charging order. California, for instance, has adopted an implementing statute in its judgment enforcement laws or court rules to govern the issuance of a charging order. (57) Probably the best example is that of California, seemingly always in the forefront of charging order law, which has adopted the following in the California Code of Civil Procedure:
(a) A lien on a judgment debtor's interest in a partnership or limited liability company is created by service of a notice of motion for a charging order on the judgment debtor and on either of the following:
(1) All partners or the partnership.
(2) All members or the limited liability company.
(b) If a charging order is issued, the lien created pursuant to subdivision (a) continues under the terms of the order. If issuance of the charging order is denied, the lien is extinguished. (58)
But other states are not so lucky, causing the courts in those states when faced with a motion for charging order to deal with the "peculiar mechanism" in an ad hoc fashion. (59)
C. EFFECT OF STATE STATUTORY CREDITOR EXEMPTIONS
The Revised Uniform Limited Liability Company Act, section 503(f) specifically provides that a charging order is subject to any applicable exemptions that might exist for the benefit of the debtor-member. (60) An excellent example of this is found in the Zavodnick v. Leverfi (61) decision, where the court held that distributions from a partnership were "profits due and owing" such as to implicate the ten-percent exemption on execution or other civil process under New Jersey law. (62) The Zavodnick court noted that because no exemptions were enumerated in the New Jersey partnership act, it was necessary for the court to look elsewhere for those exemptions, and held:
Moreover, we perceive no reason why the "exemption laws" that may be invoked in response to an application for a charging order under N.J.S.A. 42:1-28 should exclude the limitation upon executions on "profits" provided by N.J.S.A. 2A: 17-56. A partner's periodic receipt of distributions from a partnership engaged in a professional practice plays substantially the same role in the partner's economic life as an employee's wages. The partner typically depends on such distributions to purchase food, shelter, and other necessities for himself and his family. If [debtor] were an associate rather than a partner in the [partnership] law firm, any wage garnishment clearly would be subject to the limitations of N.J.S.A. 2A: 17-56. Similarly, if [debtor] were a sole practitioner, the income that he derived from his practice would constitute "earnings" within the intent of N.J.S.A. 2A: 17-56. Therefore, we conclude that distributions from the partnership through which [debtor] has chosen to practice his profession are subject to the same limitation on executions under N.J.S.A. 2A: 17-56 as an employee's wages or a sole proprietor's earnings. (63)
Importantly, the Zavodnick court also held that the charging order was subject to the $10,000 personal property exemption of New Jersey law, thus indicating that a debtor may properly "stack exemptions" with a charging order, which is a quite common practice in American creditor-debtor law as to exemptions generally. (64)
Note that the Zavodnick court required the debtor-partner to prove that the distributions received from the partnership were in the nature of wages, and because the partnership was a professional practice it was not particularly difficult for the debtor-partner to do so. (65) In other cases where the role played by the debtor-partner is not so clear, consideration of the issue of whether distributions are in the nature of wages might be more difficult. This can be seen particularly in the case of a largely passive partner who may have a quite difficult time believably arguing that a part of her distributions were anything like wages.
D. EFFECT OF FEDERAL WAGE GARNISHNMENT RESTRICTIONS
One objection that a debtor-member might raise is that the distributions made to the debtor-member are in the nature of wages, and thus are protected by the Federal Wage Garnishment Law, (66) which protects from garnishment the lesser of: (1) twenty-five percent of the debtor's "disposable earnings"; or (2) thirty times the federal minimum wage amount. (67)
Section 1672(a) of that law states that the term "earnings" means "compensation paid or payable for personal services, whether denominated as wages, salary, commission, bonus, or otherwise." (68) This would appear to apply to distributions that were made to the debtor-member for his or her services rendered to the LLC.
Although the act provides protection against "garnishments," that term is defined in section 1672(c) to include "any legal or equitable procedure through which the earnings of any individual are required to be withheld for payment of any debt." (69) The charging order would seem to fit that description.
Planners might consider whether to structure an FFC so that working members are paid some level of salary, to better clarify which portion of the members' receipts will be protected by this federal protection (which of course preempts any contrary state law), and which portion will be pure distributions that will not be so protected and thus subject to the lien, as is specifically contemplated by RULLCA section 503(g). (70)
E. GIVING NOTICE OF THE ISSUED CHARGING ORDER
If the court issues the charging order, then the next step will be for the creditor to serve a "Notice of Entry of Charging Order" both on the debtor-member and on the FFC (or all its members). In the concept of the charging order, as placing a lien on the debtor-member's distributive interest, the giving of the Notice of Entry of Charging Order to the FFC has the effect of "perfecting" the lien. From the date of receipt of the notice, the LFC will itself henceforth be potentially liable to the creditor for violating the lien, and in danger of being held in contempt for violating the charging order. (71)
F. FORECLOSURE & REDEMPTION
Foreclosure of a liened interest means that the creditor can subject the interest to a judicial sale, i.e., the sheriff holds an auction at which the interest is sold to the highest bidder. (72) The creditor is not required to bid at the auction, and, in fact, hopes that some other party will pay substantial moolah for the interest, which the creditor will then cheerfully apply (less the costs of the auction) towards satisfaction of the outstanding judgment.
If the creditor does bid, then the creditor will likely make a "credit bid," whereby the creditor treats as satisfied a portion or all of the judgment, in lieu of a cash bid by the creditor. Note: the amount that the creditor applies towards the satisfaction of the outstanding judgment is the amount of the winning bid, not the value of the interest. Assume the appraised fair market value ("FMV") of the interest is $5 million, but nobody shows up at the auction, and the creditor bids only $1 as the winning bid. In that case, the $1 would be applied towards the satisfaction of the judgment, even if the creditor soon thereafter sells the interest for $5 million. This scenario is somewhat tempered by the court's mandatory review (as with all judicial sales) of the fairness of the auction, but the point is that the debtor should not blindly assume that she will get full credit towards satisfaction of the judgment based on the value of her interest which is thereby sold.
Importantly, even if the liened interest is sold at the auction, the only thing the buyer (whether the creditor or somebody else) gets is the right to distributions. That right becomes a permanent right whereby distributions will be collected after the judgment is satisfied, or even later discharged. But that does not mean the buyer obtains any other rights--such as management rights--in the LLC. That is specifically prohibited by RULLCA section 503(c). (73)
In other words, prior to foreclosure, the creditor has a temporary right to distributions only until the judgment is satisfied. After foreclosure, this right becomes permanent to the buyer regardless whether the judgment is ever satisfied. In either case, however, the creditor or buyer still does not become anything like a member or manager of the LLC--they have a right to distributions only, nothing more.
Under RULLCA section 503(c), and probably the laws of most states whether they have adopted RULLCA or not, the lien created by the charging order can be foreclosed on. (74) However, the creditor must first demonstrate to the court that the distributions from the LLC will not satisfy the judgment in some reasonable period of time. (75) This is a call entirely within the court's discretion, (76) and the court may take into account the possible disruption of the LLC and its effect (if any) on the non-debtor members. (77) However, non-debtor members are not required to consent to foreclosure. (78)
To illustrate what this means in practical terms, let's take two situations:
(A) The creditor's judgment is for $20,000 and the LLC is a hedge fund that regularly spins off $6,000 per year in distributions to the liened interest. In that case, the judgment will be satisfied in four years, even counting interest on the judgment, and so the court would be unlikely to grant foreclosure. (79)
(B) The creditor's judgment is for $5,000,000 and the LLC is a closely-held entity with few assets that irregularly spin off distributions; none of which have exceeded $20,000 in years past, and none at all during the time since the charging order was granted. In that case, it is unlikely that distributions from the liened interest will ever satisfy the judgment, and the court would likely grant foreclosure in such a case.
Note that nothing prevents the creditor from bringing a "combined motion for charging order and to foreclose" and attempting to do both at the same hearing. The case where such a combined motion might be successful is the (B) situation above, where it is clear that distributions will never satisfy the judgment, and there is little sense in making the creditor wait for a few months just to then tell the court the obvious.
G. THE MONSTER UNDER THE BED?
The mere thought of foreclosure has caused many planners to freak out and demand that their states' legislatures amend their partnership and LLC laws so as to prohibit a creditor's foreclosure of a liened interest. This is a concern primarily connected with the marketing competitiveness of partnerships and LLCs between states, as it is not a concern bom out by any widespread outbreak of creditors attempting to foreclose on the interest. To the contrary, there have been fewer than a dozen reported opinions nationwide over the entire history of partnership and LLC law where a creditor has even attempted to foreclose upon an interest subject to the charging order lien. In other words, creditors are not exactly falling over themselves to foreclose on liened interests, even in the states where such is plainly sanctioned by statute. There are several reasons for this.
First, there is often painfully little for the creditor to gain by foreclosing. The creditor already has a lien on the debtor-member's interest, and if the LLC is making significant distributions, the creditor will quite likely be satisfied to accept those distributions so long as they continue to be made. If not, i.e., the LLC is not making distributions to the liened interest, then an auction of the liened interest will not draw any serious bidders, and all the creditor will have done would be to have "thrown good money after bad" through payment of attorney's fees and expenses of the auction.
Second, where the charging order was acquired by the creditor for the strategic purpose of causing financial pain to the debtor by cutting off the debtor's access to funds from the LLC, the lien created by the charging order works just as well as a temporary lien until the judgment is satisfied, as it does if the lien were foreclosed upon and purchased either by the creditor of some third-party buyer.
Third, the creditor has a significant tax incentive to not foreclose and risk acquiring the interest. Prior to foreclosure, the creditor is simply the holder of a lien, and as such is not subject to receiving a K-1 from the LLC. (80) However, after foreclosure, the buyer (which might be the creditor who ends up with it), does then become a transferee of the transferrable interest, and is potentially liable for its distributive share of the LLC's taxes.
Finally, as discussed more fully below, the creditor has possibly better avenues to explore in attempting to get at the debtor-member's share of the assets of the LLC, instead of just seeking a judicial sale of the transferrable interest.
For all these reasons, the threat of foreclosure is the monster under the bed-much more bark than bite. The proof is, again, in the utter paucity of reported opinions where creditors have attempted to foreclose on liened interests.
H. PRE-FORECLOSURE REDEMPTION
The Revised Uniform Limited Liability Company Act section 503(d) provides that before foreclosure, the debtor-member may redeem the liened interest. (81) Section 503(e) says that the LLC or any other member may redeem the liened interest. (82)
These two paragraphs raise the specter of a situation where the creditor moves to foreclose and simultaneously: (1) the debtor-member attempts to redeem under subsection (d), and offers to pay the creditor; (2) the other members of the LLC vote to have the LLC redeem under subsection (e), and the LLC offers to pay the creditor; and (3) another member of the LLC attempts to redeem under subsection (e), and offers to pay the creditor.
Who wins? Section 503 provides no guidance, and thus we are left with a situation where, possession being nine-tenths of the law, the party whose check is first accepted by the creditor has actually redeemed, and probably wins--an unlikely "race to the creditor."
This is improbable, however, because of what is required in the way of payment. Most planners would presume that payment would be in some amount tied to the fair market value of the liened interest. Not so, according to the plain text of subsections (d) and (e), which instead require the redeeming party to pay the full amount required to satisfy the judgment. (83)
Nothing prohibits the non-debtor-members from showing up at the judicial sale and bidding on the interest themselves, (84) for which the amount of the winning bid will in most cases be much less than the full amount of the debtor's outstanding judgment. Thus, common sense dictates that where the amount of the outstanding judgment exceeds the fair market value of the interest, the non-debtors would be smarter to bid than to redeem.
Let's say that our debtor-member has suffered a $5 million judgment, and the liened interest is worth, on a good day, only $10,000. Probably nobody is going to offer to pay the full amount of the $5 million judgment, just to redeem the $10,000 foreclosed interest. This is also why planners should not rely heavily upon redemption to keep the creditor from foreclosing on the interest, not that the creditor will even want to in most cases.
III. CHOICE OF LAW ISSUES WITH CHARGING ORDERS
There is an old truism among creditors' rights counsel: "All collection law is local." This saying reflects that most judgment enforcement actions take place in the local court where the judgment was rendered, with personal jurisdiction over the debtor surviving after the judgment becomes final, or it takes place in the local court where assets are found. In ordinary judgment enforcement actions, local law will apply. As a practical matter, it is very difficult to get a court to consider that any other law might apply.
Debtors, or the LLC, often argue that the place for the bringing of a Motion for Charging Order, and the law applicable to such a proceeding, must be only in the state where the LLC was formed. So far, it has been a losing argument whenever attempted.
The first problem is that an LLC interest is personal property. (85) For collection purposes, intangible personal property is "located" either with the debtor, wherever the debtor may be found, or in the debtor's state of domicile. (86) In the vast majority of cases, these are the same since the debtor was originally sued in his place of domicile. But in either event, it is not some distant domicile where the LLC was formed.
The second problem is that for creditor-debtor purposes, an LLC interest may be analogized to a share of stock in a corporation. If a creditor is levying upon a debtor's shares in Microsoft, the creditor does not have to go to Washington state or Delaware to accomplish that result--so why should a charging order be treated much differently? It is, after all, only the debtor's rights that are being affected, and not those of the LLC (or corporation).
In several cases, the courts have held that local law applies to the issuance of a charging order, and not the law where the entity is domiciled. (87)
Debtors have attempted to change the forum for the determination of charging orders in at least two cases, New Times Media, LLC v. Bay Guardian Co. (88) and American Institutional Partners, LLC v. Fairstar Resources, Ltd. (89) In both cases, the debtors filed lawsuits for declaratory judgment in Delaware, where the LLCs were domiciled, seeking injunctions to prevent the creditor from pursuing the charging order remedy in California (Bay Guardian) and Utah (Fairstar Resources). (90) The creditors in both of those cases successfully thwarted the debtor's attempt by removing the cases to federal court, and there invoking the Federal Anti-Injunction Act which prevents a federal court from interfering with an ongoing state proceeding (the charging order motions). (91)
A. THE INTERNAL AFFAIRS DOCTRINE AND OUTSIDE CREDITORS
Some planners place a great deal of reliance upon the "Internal Affairs Doctrine" to determine which law will apply to the resolution of a charging order dispute. This doctrine is codified in RULLCA section 104:
SECTION 104. GOVERNING LAW. The law of this state governs:
(1) the internal affairs of a limited liability company; and
(2) the liability of a member as member and a manager as manager for a debt, obligation, or other liability of a limited liability company. (92)
The problem is, the Internal Affairs Doctrine has been almost consistently held to not apply to outside creditors. (93) "Internal affairs" has been consistently interpreted to mean precisely that, i.e., a dispute between members, or a member and the LLC itself. (94) The Doctrine does not extend to third-party creditors, even if the effect of the charging order would be to indirectly interfere somehow (that a member would not perform if not getting paid distribution being the most common argument) with the "internal affairs" of the LLC.
B. THE OPERATING AGREEMENT DOES NOT APPLY TO OUTSIDE CREDITORS
Similarly, the operating agreement does not bind outside creditors, for the simple reason that they are not signatories to the agreement and did not consent to be bound by its terms. Often, planners will load their operating agreements with a lot of fun, innovative, and sometimes outlandish anti-creditor provisions. While those provisions might impress their colleagues and clients, they have no practical value in an action involving outside creditors.
However, the operating agreement might be somewhat effective as to outside creditors to the extent that it narrowly defines what interest a member has, as a creditor cannot lien or foreclose upon a greater interest than the member actually owns. Here is the place that drafters should be creative, though keeping in mind that the member might not be so happy with such restrictions until a creditor actually appears.
C. THE FOREIGN COMPANY GLITCH
Article 9 of the RULLCA deals with foreign limited liability companies, but does not speak to the topic of charging orders. (95) Section 102 defines a limited liability company as: "except in the phrase 'foreign limited liability company' ... means an entity formed under this Act...." (96) Section 503 relates only to a "limited liability company," without any reference to a foreign limited liability company. (97) Bootstrapping all of this together, arguments have been made that Section 503 applies only to limited liability companies that are formed in the state, and not to foreign limited liability companies.
The argument first came up in the New Times Media litigation, where the debtor defensively argued that under California's Uniform Limited Liability Company Act ("CULLCA"), the California court lacked the authority to place a charging order on the debtor's interest in various foreign LLCs. (98) To the debtor's great surprise, the creditor gleefully accepted the argument as valid, and then offensively argued that if the charging order section of the CULLCA did not apply to foreign LLCs, then by implication the statutory restriction to the charging order remedy of that same section similarly did not apply to foreign LLCs--and thus the creditor could instead levy directly upon and sell the debtor's interests. (99) Whereupon, the debtor attempted to take back its argument, and the court simply ignored the entire issue on its way to issuing the sought charging order (without opinion) against the foreign LLC interests. (100)
Then, the Minnesota Court of Appeals took up the cudgel in Fannie Mae v. Heather Apartments LP, (101) where the creditor used the argument offensively to force a debtor to turn over his interests in a Cook Islands LLC. On this issue, the Court held in toto:
Finally, Grossman argues that Fannie Mae's only remedy is to obtain a charging order under Minn. Stat. [section] 322B.32 (2012). But this argument fails because that statute only applies to Minnesota limited liability companies. Chapter 322B defines a "limited liability company" as "a limited liability company, other than a foreign limited liability company, organized or governed by this chapter." Minn. Stat. [section] 322B.03, subd. 28 (2012). Because LSPG Shoreline was organized in, and is governed by, the laws of the Cook Islands, chapter 322B does not apply. (102)
Certainly, it was not the intent of the ULLCA or RULLCA drafters to exclude a foreign limited liability company from the ambit of the section 503 charging order procedure, or exclusive remedy limitation. Professor Carter G. Bishop of Suffolk University Law School, a member of the RULLCA Drafting Committee and an expert on American charging order law (if there is one), (103) attempted to file an Amicus Curiae brief with the Minnesota Supreme Court, to point this out, but the filing of his brief was denied. As of this writing, the appeal in Heather Apartments is still pending.
Presumably, this glitch of statutory drafting will someday be corrected in the Uniform Acts, but it may cause some interesting litigation in the meantime.
IV. CIRCUMVENTING CHARGING ORDER EXCLUSIVITY
The Revised Uniform Limited Liability Company Act section 503(h) provides: "the exclusive remedy by which a person seeking in the capacity of judgment creditor to enforce a judgment against a member or transferee may satisfy the judgment from the judgment debtor's transferable interest." (104)
They key word here is "remedy," which is a legal term-of-art that refers to a number of specific legal devices that a creditor may use to enforce a judgment-devices such as levy, attachment, garnishment, etc., that are defined in a state's remedies statutes. The word does not mean, as many planners mistakenly believe, that the outcome should be exclusively that which is set forth in the charging order procedure of RULLCA section 503 generally. Which is to say that there are a number of legal strategies that a creditor might employ that technically are not "remedies" in the sense of being an enumerated judgment enforcement device under the remedy statutes of the state. (105)
For instance, California enumerates its list of "remedies" that a creditor in a post-judgment enforcement action might employ in the Enforcement of Judgments Law ("EJL"), as execution, levy, garnishment, written interrogatories to judgment debtor, examination proceedings, creditors suit, charging orders, lien in pending action or proceeding, assignment order, and receiver to enforce judgment. (106) Everything else is not technically a "remedy" under the California EJL,
There are, in fact, other strategies of relief that creditors may pursue to get at the debtor-member's interest, if not of the actual assets of the LLC. (107) A few of those strategies are discussed below.
A. THE SOLITARY CONUNDRUM OF THE SINGLE-MEMBER LLC ("SMLLC")
Much as a computer program will terminate when an attempt is made to divide something by zero, so does the so-called charging order protection run into trouble when the LLC has but a single member, i.e., the number of other partners is likewise zero.
We have previously seen that the historical purpose of the charging order is to protect the non-debtor members, and not the debtor-member. But where there are no non-debtor members to protect, then we have a situation where the charging order is not serving its intended purpose, but is instead being misapplied to protect the assets of the single member from her creditors. This is all summarized nicely by Gerald Niesar:
When considering a charging order in the context of a SMLLC it is very important to remember why the procedure was developed. It was not to protect the debtor-partner. The procedure limiting the creditor of a partner to an economic, but not management or control, right was designed to protect the other partners and the partnership from interference by a creditor, cum partner, whom the other partners had not invited to the management and control table. Viewed in the light of its history, it is easy to see that in a SMLLC context (where there are no partners other than the debtor) the charging order procedure generally will have no raison d'etre and, in fact, it could be used unfairly by debtors to prevent creditors from having a way to collect on their judgments. In a SMLLC there is no other "partner" to protect, and it would require legerdemain to advance the notion that there is an "entity" that deserves the right to be protected from the creditor. If the judgment creditor is one who obtained a judgment based upon a tort claim, or through an enforcement action relating to the debtor's violation of a law or regulation, it is even more obvious that being limited to a charging order denies the creditor justice. For all of these reasons, the cases addressing this issue of creditors' remedies against a single member are providing scant, if any, reason for debtors to believe that a SMLLC will provide much of a shield against creditors. (108)
In at least two reported bankruptcy cases, In re Ashley Albright (109) and In re Nader Modanlo, (110) the courts held that since the purpose of charging order protection is to protect the interests of the non-debtor members, and there were no non-debtor members to protect, the application of the charging order protection was nonsensical, and the trustee was allowed to exercise management control over, and sell for the benefit of the bankruptcy estates, the assets of the subject LLCs. (111)
In a third case, the United States Bankruptcy Court for the District of Nevada, while essentially agreeing that the rationale of Albright was correct, instead embarked on a predictably (for those familiar with the Ninth Circuit) circuitous and somewhat tortured theory that involved the LLC's operating agreement as an "executory contract" under Bankruptcy Code section 365(d)(1). (112) Since there were no other parties to the operating agreement other than the debtor-members who jointly owned the single interest one-hundred percent, the debtor-members had no management or voting rights. Instead, the voting rights were vested upon their bankruptcy filing in the trustee. (113) This effectively garnered the same result as Albright, although the court had gone from Minneapolis to St. Paul by way of Miami.
Outside of bankruptcy, on a certified question from the Eleventh Circuit, the Florida Supreme Court in Olmstead v. FTC (114) answered that a charging order was not the exclusive remedy against a SMLLC under the Sunshine State's laws. (115) Although paying their respects to the logic of Albright and Modanlo, the majority in Olmstead instead focused on differences in the language between Florida's LLC statute, which did not clearly limit a creditor's remedy to a charging order, and Florida's partnership and limited partnership statutes, which did. (116) After analogizing an LLC interest to a share of corporate stock, the majority concluded that the Florida legislature must not have meant to make the charging order the exclusive remedy, at least with respect to a SMLLC. (117) Thereafter, the Florida legislature amended the LLC statute (referred to as the Olmstead patch). (118) The statute provided that the charging order was indeed the exclusive remedy in Florida--but only as to multiple-member LLCs. (119) As to SMLLCs, the Olmstead patch expressly allows a creditor to foreclose on the single-member's interest in the SMLLC, with the buyer being able to take management control of the SMLLC, but only if the creditor first shows that her judgment will not be satisfied by distributions from the LLC within a reasonable time. (120)
B. STATUTORY PROBLEMS WITH ALBRIGHT
Some states have expressly amended their partnership and LLC laws to provide charging order exclusivity for entities formed in their states, for the very purpose of making those entities an asset protection vehicle to protect the assets of the single-members who use them. (121) In such a state, where the legislative history shows that the legislature affirmatively desired charging orders to apply exclusively to single-members--an assertion of the Albright rationale to circumvent charging order exclusivity might not hold water. (122) Whether extending such exclusivity to single-member LLCs, thus turning them into asset protection vehicles with a super ability to thwart creditors, is anything like a good idea from a public policy standpoint, is another matter entirely (certainly, it helps the marketing of the LLCs from those states).
Additionally, we must recall that in Olmstead, the Florida Supreme Court indicated that the Florida partnership and limited partnership statutes did provide for charging order protection as the exclusive remedy, and thus inferred that if the Florida LLC statute had been similarly drafted, then the charging order protection might have applied in that case despite Albright, (123) Indeed, there is nothing like a single-member carve-out in RULLCA section 503, and it may be that future courts could hold that in the absence of such a carve-out, SMLLCs will benefit from charging order exclusivity just as multiple-member LLCs do. While it is the author's humble opinion that RULLCA should have its own Olmstead patch, that, of course, will be left to the wisdom of future drafting committee members.
C. LATE-ARRIVING MEMBERS
Another "fly in the ointment" goes to the issue of exactly when the status of an LLC as a single-member or multiple-member entity is tested. Theoretically, it might be possible to add a second member to an LLC so as to destroy its single-member status and thus prevent the application of Albright--the late-arriving member being the not-so-innocent party crasher who shows up with the intent of spoiling the creditor's party.
Let's consider the following timeline:
January 12 Debtor forms an LLC, contributes assets to it, and is the single-member of LLC February 13 Debtor negligently causes a car accident with multiple injuries March 14 Debtor consents to judgment in excess of his net wealth, including Debtor's 100% in the LLC April 15 Debtor's golf buddy acquires a 5% membership interest in the LLC by contributing the necessary cash May 16 Creditor files a motion for turnover order for the assets of the LLC and/or full management control of the LLC June 17 Court holds hearing on motion for turnover order
On which date do we "test" whether the LLC is single-member or multiple-member? Possibly the right answer is May 16, the date that the creditor filed the motion for turnover order. That is the date that the creditor first attempted to take enforcement action against the debtor's interest. Analogizing this to other judgment enforcement procedures, such as a writ of levy, that "hits" the value of an asset on the day the writ is served. Thus, a creditor would get whatever shares of corporate stock is owned by the debtor on the day the writ of levy is served, not the most shares of stock that were previously owned by the debtor.
However, to change the timeline slightly, let's say that the creditor first filed a motion for charging order against the debtor's LLC interest on April 14--the day before the debtor attempted to sell the interest to his golf buddy. In that case, the "temporary lien" created by the filing of the charging order motion would be created in the debtor's one-hundred percent interest, and the attempt of the golf buddy to acquire an interest might be defeated.
In addition, there may be fraudulent transfer concerns to adding a member late just to thwart collections. In the Sardis v. Frankel (124) case, the debtor owned one-hundred percent of the interest in a profitable LLC, but just days after she lost an arbitration award, she sold a ten percent interest in the LLC to her son. (125) Although the court never directly reached the issue as to whether the transfer of the ten percent interest was a fraudulent transfer, the court did negatively comment upon it as one in a number of facts that demonstrated the debtor's intent to fraudulently transfer another of her assets to her son:
Finally, the addition of Michael as a member of Applied Medicals LLC, of which Sofia was formerly the sole member, precludes plaintiffs from obtaining an order from a Florida court directing the surrender of her entire interest in the company to satisfy the award against her. (126)
Implicitly in this statement, the Sardis court was saying that even though the son acquired the ten percent interest after the debtor had lost the arbitration proceeding, that would be effective to "bust" the single-member status of the entity and require the creditor to pursue a charging order. It can be implicitly read within the overall context of the case to suggest that the transfer of the ten percent interest might be a fraudulent transfer because it had the effect of hindering the creditor.
D. WHEN IS A PEPPERCORN NOT A PEPPERCORN??
How much interest must another, non-debtor member have so as to defeat a creditor's argument based on Albright? The court addressed the issue, if only to tease us, in footnote 9 of its opinion:
The harder question would involve an LLC where one member effectively controls and dominates the membership and management of an LLC that also involves a passive member with a minimal interest. If the dominant member files bankruptcy, would a trustee obtain the right to govern the LLC? Pursuant to Colo.Rev.Stat. [section] 780-702, if the non-debtor member did not consent, even if she held only an infinitesimal interest, the answer would be no. The Trustee would only be entitled to a share of distributions, and would have no role in the voting or governance of the company. Notwithstanding this limitation, 7-80-702 does not create an asset shelter for clever debtors. To the extent a debtor intends to hinder, delay or defraud creditors through a multi-member LLC with "peppercorn" co-members, bankruptcy avoidance provisions and fraudulent transfer law would provide creditors or a bankruptcy trustee with recourse. (127)
The truth is that nobody knows, or will likely ever know, what sort of minimal interest is required to change the characterization of a single-member LLC to a multiple-member LLC for Albright purposes, since such an issue must fundamentally be resolved on a facts-and-circumstances evaluation in each particular case. Caution must be given, however, that simply putting in another member who is the de facto nominee of the debtor-member risks a court simply collapsing all the interests together and treating them as the debtor-member's interest for purposes of this analysis.
For example, it is common for planners to give their clients a ninety-nine percent non-managing interest in an LLC, and then to create a new corporation or trust (often a revocable "living" trust), directly or indirectly controlled by the client, to act as the one percent managing member. In such a case, it would not be too terribly difficult for a court to hold that the one percent (or five, ten, or even seventy percent) other member is simply the client in a different form, and trigger relief under Albright. Which is to say that planners should quit focusing on the percentage, and instead focus on the true substance of the situation--since ultimately it is the substance of what is really going on that the court will cast its focus.
E. REVERSE VEIL-PIERCING
In a traditional veil-piercing case, the LLC has a judgment against it, and the creditor seeks to disregard the LLC's separateness from its member so as to enforce the judgment directly against the member's assets. By contrast, in a reverse veil-piercing case, the creditor has a judgment against a member of the LLC, and attempts to disregard the LLC's separateness from its member, so as to enforce the judgment directly against the LLC's assets--and thereby circumvent charging order exclusivity. Veil-piercing and reverse veil-piercing are just different sides of the same coin, with the coin being to disregard the separateness for liability purposes of the LLC and its member.
I use term "member" in the singular, since the vast bulk of veil-piercing and reverse veil-piercing cases involve either one member or a dominant member. This is a result of the alter ego analysis that goes into a veil-piercing case, which-despite the multitude of factors that may be considered--usually boils down to the creditor proving two elements: (1) there exists a unity of ownership between the LLC and the member against which veil-piercing is asserted; and (2) the separateness of the LLC was used to commit some wrong.
Assuming the creditor can prove the "commit some wrong" element, which is so facts-and-circumstances dependent as to be far beyond the scope of this paper, the creditor will still have to prove the unity of ownership element. This is basically that the LLC and the member against which liability is sought, are so closely intertwined that equity demands that they be treated as one and the same.
In the law of corporations, the unity of ownership element was often met by the creditor proving that the corporate formalities of the entity were not met. This often lead to some poor first-year associate having to stay up the night before document production was due, drafting minutes "memorializing" board meetings from years past. These days, an examination of the corporate documents carries much less weight, with the court instead examining the totality of the circumstances to make this determination.
But what of the case of the LLC, of which a supposed advantage is its lack of formalities and easy-going management? Here too, the court will most likely look past the formalities, or lack thereof, and instead look to see whether the member is treating the LLC as an independent commercial enterprise, or instead as a personal appendage. If there are many more-or-less equal members in an LLC, the unity of ownership element will be more difficult for a creditor to prove. By like token, it may be much easier for a creditor to prove unity of ownership in the case of the single-member LLC.
But to get back to reverse veil-piercing, creditors in some states were able to convince a few courts that reverse veil-piercing was warranted in some cases, as discussed (but not successfully applied) by the Third Circuit in In re Blatstein, (128) However, about as quickly as the tide of reverse-piercing cases came in, it went back out. Other courts rejected the notion and pointed out that the creditor could always get at the entity's assets by enforcing the judgment against the debtor's shares, and then use the power conferred by those shares to do whatever needed to be done with the assets of the entity. (129)
Reverse veil-piercing has thus been widely neutered, but is not quite dead. In the case of a partnership or LLC where the creditor's remedy is restricted to the charging order, a creditor may be able to persuade the court in a particular case that the equitable solution of reverse-veil piercing may be warranted. The critical thing is for planners to advise clients that any protection afforded by their LLC's charging order exclusivity may only be as good as they strictly maintain separation between the operations of the LLC and their personal activities. This is particularly true with single-member entities, where proof of unity of ownership might only be a few seemingly innocuous documents away.
F. DISTRIBUTION CLAWBACKS
Assume that an LLC has several more-of-less equal members, but one of the members is a debtor, and a charging order has been entered. This places the lien on the debtor-member's interest. Further, assume that the other members decide to distribute the LLCs assets out to themselves, thus leaving the LLC with no assets available to make distributions to the debtor-member's interest.
The growing theory involving corporations is such that the creditor might be able to bring a derivative suit on behalf of the entity to make the non-debtor members return their distributions (known as the "clawback"), so that an equal distribution could be made to the debtor-member's interest for the benefit of the creditor. The theory was tested in the CML, LLC v. Sox (130) case, where the Delaware Court of Chancery held that the creditor lacked standing under Delaware's LLC statute to bring such an action. The court, however, commented that such an action was authorized under Delaware's corporate laws. (131) How the theory will be treated in other states under their LLC statutes remains to be seen. It should be noted, however, that a creditor might be able to assert a fraudulent transfer theory to obtain relief in such a case, although that theory remains to be tested as well.
G. EHMANN LIVES!
In the In re Ehmann case, the bankruptcy trustee brought an adversary action against an LLC in which the debtor-member had filed for personal bankruptcy, seeking an order that the trustee be allowed to succeed to the debtor-member's interest in the LLC, and to dissolve and liquidate the LLC, so as to prevent the waste or diversion of the LLC's assets. (132)
The LLC moved to dismiss the trustee's complaint, alleging that the trustee was restricted to the debtor-member's rights under the operating agreement, which expressly prohibited an involuntary assignee, here being the trustee, from being allowed to participate in the management of the LLC. (133) The LLC argued that Bankruptcy Code section 365(e)(2) restricts the trustee's powers to such contractual rights as are afforded by state law and contract law (i.e., the operating agreement). (134) The trustee retorted that section 365(e)(2) only applied to executory contracts, meaning contracts where something remains to be done before a party gains rights to receive the promised consideration, and that the debtor-member here was basically a passive investor who didn't have to do anything to receive distributions. (135) Instead, the trustee argued his powers came under Bankruptcy Code section 541(c)(1), which renders state and contract law restrictions invalid to the trustee in the event of a non-executory contract, which the trustee claimed was involved in that case. (136)
The court agreed with the trustee:
In the absence of any obligation on the part of the member, it is difficult to see where an executory contract lies. This is consistent with the whole purpose of Fiesta. It was created simply as a way to reduce the estate tax liabilities that might otherwise have been incurred upon the death of the parents and the distribution of their estate to their heirs. Indeed, as King Lear (137) suggests, the irrevocable transfer of the parents' assets to Fiesta and the irrevocable gift of membership interests in Fiesta to their children probably creates even less obligations on the children than the ordinary filial obligations morally felt by most expectant heirs. Moreover, not only do there not appear to be any obligations imposed upon members by the Fiesta Operating Agreement, but there are certainly none with respect to either receipt of a distribution or proper management of the company by its managers. Members do not have to do anything to be entitled to proper management of the company by the managers. The Trustee's complaint does not involve the Debtor's lone arguable obligation not to voluntarily withdraw. Because there are no obligations imposed on members that bear on the rights the Trustee seeks to assert here, the Trustee's rights are not controlled by the law of executory contracts and Bankruptcy Code [section] 365. Consequently the Trustee's rights are controlled by the more general provision governing property of the estate, which is Bankruptcy Code [section] 541. (138)
The Ehmann opinion thus sets out a roadmap for another means for creditors to circumvent charging order exclusivity, albeit restricted to situations where the debtor-member has landed in bankruptcy. (139)
As a post-script, the LLC settled the adversary action with the trustee for $85,000 but only on the condition that the court withdraw its opinion in the case. The court reluctantly did so, but felt compelled to comment:
Here, it is essentially conceded that the general manager of Defendant Fiesta Investments is particularly interested in eliminating any precedential effect this Court's December 7th Opinion might have, because his principal occupation is as a tax lawyer who frequently advises clients in the use of limited liability companies for estate planning purposes. In the balancing of the equities this counts against vacatur because it is in effect the "buy and bury" strategy that the Ninth Circuit has criticized. It also raises the Seventh Circuit's objection to the right of private parties to obtain expungement of a public act of the government. Nonetheless, in weighing the equities, the Court must be mindful of the interests of unsecured creditors in this case who are understandably much more interested in getting their debts paid than in the law of executory contracts as applied to family planning LLCs. Their interests weigh heavily in favor of the settlement and vacating the Opinion. There is little equity on the other side because a bankruptcy court opinion has essentially no precedential value beyond law of the case and the inherent logic of its analysis. And, regardless of what the Court does here, it cannot disagree with Judge Easterbrook's observation that "History cannot be rewritten." (140)
Indeed, even after the Ehmann opinion was withdrawn pursuant to the settlement, at least two more courts have picked up the Ehmann rationale and reached the same result. (141)
Ehmann lives! (142)
(1.) See 91st Street Joint Venture v. Goldstein, 691 A.2d 272, 283 (Md. Ct. Spec. App. 1997) (contrasting "standard execution procedures rather than the peculiar mechanism of the charging order which is subject both to the broad discretion of the trial court and to redemption by the debtor").
(2.) See generally Chas E. Davidson, THE MECHANICS LIEN LAW OF ILLINOIS: A LAWYER'S BRIEF UPON THE TOPIC 6 (1922).
(3.) Judgments Act 1838, 1 & 2 Viet., c. 110, [section] 23 (Eng.).
(4.) Partnership Act 1890, 53 & 54 Viet. c. 39, [section] 23 (Eng.). For those curious as to why Scotland was excluded, we find further up in the Partnership Act of 1890 that: 4. Meaning of firm.
(2) In Scotland a firm is a legal person distinct from the partners of whom it is composed, but an individual partner may be charged on a decree or diligence directed against the firm, and on payment of the debts is entitled to relief pro rata from the firm and its other members.
Id. [section] 4.
(5.) 33 A. 147 (R.I. 1895).
(6.) 23 S.E. 567 (W. Va. 1895).
(7.) But see 91st St. Joint Venture v. Goldstein, 691 A.2d 272,277 (1997) ("In the United States, . . . the 'charging order' procedure was a complete innovation. ... ").
(8.) See City of Arkansas City v. Anderson, 752 P.2d 673, 682 (Kan. 1988) ("[T]he charging order came into being as a part of the English Partnership Act of 1890 [that] was the model for section 28 of the Uniform Partnership Act, which is quite comparable to the original English version.").
(9.) UNIF. P'SHIP ACT [section] 28 (UNIF. LAW COMM'N 1914).
(10.) The author has been unable to identify how creditors of "special partners" (as limited partners were then referred to under the New York LPA and its progeny) were treated prior to the adoption of the ULPA in 1916.
(11.) 228 N.Y.S. 453 (N.Y. App. Div. 1928).
(12.) Id. at 456.
(13.) Id. at 456-57.
(14.) 8 P.2d 943 (Cal. Dist. Ct. App. 1932).
(15.) Id. at 943.
(16.) Id. at 944.
(17.) 171 P.2d 916 (Cal. Dist. Ct. App. 1946).
(18.) Id. at 917-18.
(19.) 196 P.2d 109 (Cal. Dist. Ct. App. 1948).
(20.) Id. at 111-12 (noting the partners lost on the merits of the case).
(21.) See generally DAVID G. SHAFTEL ET AL., THE AMERICAN COLLEGE OF TRUST & ESTATE COUNSEL, ACTEC COMPARISON OF THE DOMESTIC ASSET PROTECTION TRUST STATUTES (2015), http:/Avww.actec.org/assets/l/6/Shaftel-Comparison-of-the-Domestic-Asset-Protection-TrustStatutes.pdf (discussing the fifteen states with settlor-beneficiary of self-settled trusts).
(22.) As if nobody was getting together to do deals before the UPA was adopted in 1914.
(23.) CLOSE ENCOUNTERS OF THE THIRD KIND (Columbia/EMI 1977).
(24.) Father of the ill-fated Wilhelm, who would lead Germany to defeat and financial ruin in the Great War.
(25.) Green v. Bellerive Condos. Ltd. P'ship., 763 A.2d 252, 256 (Md. Ct. Spec. App. 2000) ("[W]e have characterized a charging order against a limited partnership interest as nothing more than a legislative means of providing a creditor some means of getting at a debtor s ill-defined interest in a statutory bastard, surnamed "partnership," but corporately protecting participants by limiting their liability as are corporate shareholders.'").
(26.) Comm'r v. Culbertson, 337 U.S. 733, 737-48 (1949).
(27.) 26 C.F.R. [section][section] 301.7701-2(e), 301.7701-3(c)(iii)(2015).
(28.) REV. UNIF. LTD. LIAB. CO. ACT [section] 503 (UNIF. LAW COMM'N 2006 & Supp. 2015).
(29.) Id. [section] 503, 6B U.L.A. 58, prefatory note.
(30.) See Green v. Bellerive Condos. Ltd. P'ship, 763 A.2d 252, 256 (Md. Ct. Spec. App. 2000) (stating charging orders "are purely statutory tools that judgment creditors use to reach partnership interests of indebted partners .... [W]e have characterized a charging order against a limited partnership interest as 'nothing more than a legislative means of providing a creditor some means of getting at a debtor's ill-defined interest in a statutory bastard, surnamed "partnership," but corporately protecting participants by limiting their liability as are corporate shareholders. (quoting Bank of Bethesda v. Koch, 408 A.2d 767, 770 (Md. Ct. Spec. App. 1979)).
(31.) Heilman v. Anderson, 284 Cal. Rptr. 830, 834 (Cal. Ct. App. 1991) ("[A] partner's nght in specific partnership property is different from his interest in the partnership. The property rights of a partner are (1) his rights in specific partnership property, (2) his interest in the partnership, and (3) his right to participate in the management. A partner's interest in the partnership is his share of the profits and surplus, and the same is personal property."); Madison Hills Ltd. P'ship II v. Madison Hills, Inc., 644 A.2d 363, 366 (Conn. App. Ct. 1994) ("The partner's interest in the partnership is one of three property rights the partner possesses; the others are the partner's rights in specific partnership property and the right to participate in partnership management.").
(32.) 12 Cal. Rptr. 323 (Cal. Dist. Ct. App. 1961).
(33.) Id. at 328 (citations omitted). In 91st Street Joint Venture v. Goldstein, the Maryland Court of Special Appeals declared:
A charging order is the statutory means by which a judgment creditor may reach the partnership interest of a judgment debtor. Prior to its availability, the courts would resort to common law procedures for collection that were ill-suited for reaching partnership interests. Typically, despite the fact that individual partners do not have title in partnership property, partnership property would be seized under writs of execution; the debtor partner's interest in the partnership would be sold, often to the judgment creditor, subject to the payment of partnership debts and prior claims of the partnership against the debtor partner; and the sale of the debtor partner's interest would result in compulsory dissolution and winding up of the partnership. . . . The charging order [is a] solution to this procedural nightmare ....
691 A.2d 272, 275 (Md. Ct. Spec. App. 1997) (citations omitted).
(34.) Baybank v. Catamount Constr., 693 A.2d 1163, 1165 (N.H. 1997) ("The statutory remedy of a charging order was designed to prevent the personal creditors of a limited partner from disrupting the partnership business by seizing partnership assets on execution."); Lauer Constr. Inc. v. Schrift, 716 A.2d 1096, 1098 (Md. Ct. Spec. App. 1998) ("The purpose of [a charging order] is to protect the partnership business and prevent the disruption that would result if creditors of a partner executed directly on partnership assets.").
(35.) 91st St. Joint Venture, 691 A.2d at 282 (stating purpose of charging order is not to permit court to facilitate or force upon a debtor a "business divorce"). See e.g., Baybank, 693 A.2d at 1167 ("Such an application of partnership property to pay the personal debts of a partner, however, is precisely what the charging order provisions of the ULPA and the UPA are intended to prevent."); Windom Nat'l Bank v. Klein, 254 N.W. 602, 604 (Minn. 1934) ("Plain is the purpose that all partnership property is to be kept intact for partnership purposes and creditors."); Keeler v. Acad, of Am. Franciscan Hist., Inc., 943 A.2d 630, 633 (Md. Ct. Spec. App. 2008) ("The purpose of the charging order is 'to protect the partnership business and prevent the disruption that would result if creditors of a partner executed directly on partnership assets.'").
(36.) Heilman, 233 Cal. Rptr. at 833 (stating that charging order remedy exists to prevent interference in partnership business or with partnership assets to detriment of non-debtor partners but is not meant to protect interest of debtor partner).
(37.) Union Colony Bank v. United Bank of Greeley Nat'l Ass'n, 832 P.2d 1112, 1116 (Colo. App. 1992) (stating that the charging order "remedy arose in response to the unique issues which confront partnerships, specifically the need to protect the interests of the non-debtor partners."); Christensen v. Oedekoven, 888 P.2d 228, 232 (Wyo. 1995) ("The charging order procedure protects the interests of the nondebtor partners by giving the judge wide latitude to control the creditor's actions against the partnership.").
(38.) Brant v. Krilich, 835 N.E.2d 582, 592 n.20 (Ind. Ct. App. 2005). The Court of Appeals for Indiana ruled:
[U]nless the operating agreement provides otherwise, an assignee only becomes a member of an LLC if the other members unanimously consent. There is no reason why our courts should disregard the intent of the General Assembly to protect the close-knit structure of a LLC and violate the other members' interests and rights by declaring that they must accept a judgment creditor of a member into full membership with all the rights appurtenant thereto when the judgment debtor could not transfer those rights himself.
(39.) City of Arkansas City v. Anderson, 752 P.2d 673,684 (Kan. 1988) ("[W]e hold that the issuance and service of a proper charging order is sufficient to require the partnership to pay the judgment debtor's share of distributable partnership profits to the judgment creditor or to the court to await further orders of the court."); Beach Park Assoc, v. Heron, No. H023320, 2003 WL 22000591, at *1 (Cal. Ct. App" Aug. 25, 2003). The California Court of Appeals declared:
[C]harging orders required each partnership to pay to appellant "any and all income, revenues, distributions, compensation, fees, repayment of debt, or personal property, tangible or intangible, or [sic] whatever sort or nature, that have, at any time from the date of service of the notice of motion herein on the respective partnerships or thereafter, become due, payable, or distributable to any one or more of the judgment debtors, or as to which any one or more of the judgment debtors has become entitled...."
(40.) Beach Park Assoc., 2003 WL 22000591, at *23 (finding amounts collected from charged partnership interests are credited against the underlying judgment, and in no case would holder of charging order be permitted to collect more than underlying judgment, plus interest, etc.); Anderson, 752 P.2d at 684 ("[T]he extent of [payments made pursuant to a charging order are] limited to any amounts due on the unsatisfied judgment.").
(41.) Gerry Niesar pointed out in his editing of the draft of this paper that because a charging order only applies to transferrable interests, it might not reach the salary or wages of the debtor-member at all, and the creditor would instead be required to employ the remedy of garnishment as to such compensation. The author is unaware of any case that addressed this ingenious and possibly novel argument but cannot presently conceive of an argument as to why it might be incorrect.
(42.) See CAL. CIV. PROC. CODE [section] 708.320 (West 2015).
(43.) Anderson, 752 P.2d at 684 ("[A] valid charging order does create a lien upon the debtor partner's distributive share of present and future profits as of the time of service upon the partnership. The lien or charge thus established has priority over other security interests which are not perfected prior to the date of service of the charging order."); Union Colony Bank v. United Bank of Greeley Nat'l Assoc., 832 P.2d 1112, 1115 (Colo. App. 1992) ("[T]he lien [created by the charging order] attaches at the time the order is served upon the partnership. And, upon attachment, the charging order has priority, for full satisfaction of the creditor's judgment, over any other charging order subsequently served upon the partnership, regardless of the order in which the judgments were entered and the previous efforts, if any, made by the creditor to satisfy the judgment by other means.").
(44.) Green v. Bellerive Condos. Ltd. P'ship, 763 A.2d 252, 260 n.8 (Md. Ct. Spec. App. 2000) ("Of course, we recognize that a partnership agreement may 'otherwise provide' for assignment of such management rights.").
(45.) Cadle Co. v. Ginsburg, No. CV95007681 IS, 2002 WL 725500, at *2 (Conn. Super. Ct. Mar. 3, 2002) ("[A] charging order merely gives the judgment creditor the rights of an assignee of the member's interest in the limited liability company and does not entitle the assignee to participate in the management and affairs of the limited liability company or to become or exercise any rights of a member."); Green, 763 A.2d at 262 ("In the context of a proposal to purchase partnership debt, the right to consent is essentially a right to participate in the decision regarding whether the partnership should commit its resources to pursue the partnership opportunity. Like the right to information about partnership opportunities, a partner's right to consent to another partner's pursuit of a partnership opportunity is a management right of a partner that remains with the indebted partner after his right to receive distributions in the limited partnership has been transferred via a charging order.").
(46.) Lumbermens Mut. Cas. Co. v. Luciano Enters., LLC, No. A01-309 CV JWS, 2005 WL 2340709, at *3 (D. Alaska Sept. 21, 2005) ("Neither the federal discovery rules nor the Alaska discovery rules contemplate regular, monthly disclosure such as plaintiff requests. Plaintiff is not entitled to have a regular, financial disclosure requirement included in the charging order."); Green, 763 A.2d at 261 ("Because the receiver had only the rights of an assignee, and such rights do not include the right to demand or receive information regarding partnership opportunities, the trial court was legally correct in ruling that the receiver was not entitled to separate notice of the opportunity to purchase the Note.").
(47.) Green, 763 A.2d at 264 ("[A] charging order does not prevent indebted partners from participating in partnership affairs, at least to the extent an applicable partnership agreement allows. Nor does it prohibit the indebted partner from keeping the charging creditor informed about partnership affairs."); Madison Hills Ltd. P'ship II v. Madison Hills, Inc., 644 A.2d 363, 367(Corm. App. Ct. 1994) ("Under the UPA, however, a charging creditor is entitled to more than just the rights of an assignee. The UPA provides that the charging creditor is entitled to the distributions to which the partner is entitled plus the benefit of all other orders, directions, accounts and inquiries that the partner could make. Assignees under the UPA are denied the latter benefit.") (internal citations omitted).
(48.) For the rest of this balance of this paper, unless otherwise indicated, partnerships and LLCs will be collectively referred to as LLCs, and reference will be made to the RULLCA only, although the other partnership and limited partnership Uniform Acts will often have the identical result.
(49.) Madison Hills Ltd. P'ship II, 644 A.2d at 366 ("The UPA permits a judgment creditor of a partner to place a type of lien known as a charging order on the partner's interest in the partnership."); Union Colony Bank v. United Bank of Greeley Nat'l Assoc., 832 P.2d 1112, 1115 (Colo. App. 1992) ("[C]harging order creates a lien upon a debtor partner's interest in the partnership, to wit, his distributive share of partnership's profits and surplus.")
(50.) See Cadle Co. v. Bourgeois, 821 A.2d 1001, 1009 (N.H. 2003); Brant v. Krilich, 835 N.E.2d 582, 592 (Ind. Ct. App. 2005) (Charged "interest is limited to economic interests and nothing more."); Green, 763 A.2d at 257 ("Unless otherwise provided in the partnership agreement, an assignment entitles the assignee to receive, to the extent assigned, only the distributions to which the assignor would be entitled.").
(51.) Madison Hills Ltd. P 'ship II, 644 A.2d at 366 ("The charging order leaves the partnership intact but diverts to the judgment creditor the debtor partner's share of the profits."); MacDonald v. MacDonald. 1986 WL 5480. *4 (Del. Ch. May 9, 1986) (pointing out that Delaware's charging order statute "provides a form of execution permitting a judgment creditor to divert a flow of payments from the judgment debtor to the party obtaining the charging order."); 91st St. Joint Venture v. Goldstein, 691 A.2d 272, 278 (Md. Ct. Spec. App. 1997) ("Among the cases we have found that discuss the charging order procedure in any detail, there seems to be at least implicit agreement with Professor Gose's observation that the charging order statute provides two basic collection methods: (1) the diversion of the debtor partner's profits to the judgment creditor; and (2) the ultimate transfer of the debtor partner's interest should the first collection method prove unsatisfactory.").
(52.) See Keeler v. Acad, of Am. Franciscan Hist., Inc., 943 A.2d 630, 635(Md. Ct. Spec. App. 2002) (Pre-petition charging order was a liability of the partnership and not the debtor and was not discharged in bankruptcy).
(53.) Beach Park Assoc, v. Heron, No. H023320, 2003 WL 22000591, at *21 (Cal. Ct. App. Aug. 25, 2003) (charging order "is akin to garnishment"); Banc One Capital Partners v. Russell, No. 74086, 1999 WL 435787, at *4 (Ohio Ct. App. June 24, 1999) ("[A] judgment creditor who has obtained a charging order against a member's interest in a limited liability company garnishes the financial rights that attach to the interest."); Christensen v. Oedekoven, 888 P2d 228, 232 (Wyo. 1995) ("[Cjharging orders are remedies different in character from writs of garnishment.").
(54.) Green, 763 A.2d at 256 ("A charging order is a unique tool. Although it has some characteristics of both an assignment and an attachment, it is neither."); Deutsch v. Wolff, 7 S.W.3d 460, 463 (Mo. Ct. App. 1999)("[A] charging order is not an assignment or attachment of a partnership interest."); Nigri v. Lotz, 453 S.E.2d 780, 782 (Ga. Ct. App. 1995) ("A charging order ... is not an assignment of the limited partner's interest to the creditor, nor does it confer upon the creditor the status of a substituted limited partner.").
(55.) PB Real Estate, Inc. v. DEM II Props., 719 A.2d 73, 74-76 (Conn. App. Ct. 1998) (holding that a turnover order against LLC would be granted where LLC had made payments disguised as "legal staff' expenses to debtors in violation of charging order).
(56.) Joshlin Bros. Irrigation v. Sunbelt Rental, Inc.. No. CV-13-397, 2014 WL 248104, at *2 (Ark. Ct. App. Jan. 22, 2014).
(57.) See CAL. CIV. PROC CODE [section] 708.320 (West 2015).
(59.) 91st St. Joint Venture v. Goldstein, 691 A.2d 272, 280 (Md. Ct. Spec. App. 1997)
[Section] 28 of the UPA is drafted in the most general terms and provides courts with very little guidance regarding particular procedures that should be used to further the goals of the charging order. The generality of its terms could be read to sanction the fashioning of charging order procedures on a case-by case basis and without regard to collection procedures already in place with respect to judgment debtors generally. . . . [W]e view it as just an unfortunate circumstance that [section] 28 was adopted in Maryland and most other jurisdictions without any additional elaboration of procedure.
(60.) REV. UNIF. LTD. LIAB. CO. ACT [section] 503(f)(UNIF. LAW COMM'N Supp. 2015).
(61.) 773 A.2d 1170 (N.J. Super. Ct. App. Div. 2001).
(62.) Id. at 1174-75. See also MacDonald v. MacDonald, 1986 WL 5480, at *4(Del. Ch. May 9, 1986) (stating that charging order statute "does not deprive any partner of the benefit of any exemption laws applicable to his partnership interest"); Koh v. Inno-Pacific Holdings, Ltd.. 54 P.3d 1270, 1272 (Wash. Ct. App. 2002) (stating that charging order statute "does not deprive any member of the benefit of any exemption laws applicable to the member's limited liability company interest").
(63.) Zavodnick, 111, A.2d at 1175.
(64.) Id. at 1174-75.
(66.) 15 U.S.C. [section][section] 1671-1677 (2012).
(67.) Id. [section] 1673.
(68.) Id. [section] 1672(a).
(69.) Id. [section] 1672(c).
(70.) REV. UNIF. LTD. LIAB. CO. ACT [section] 503(g) (UNIF. LAW COMM'N Supp. 2015
(71.) See Joshlin Bros. Irrigation v. Sunbelt Rental. Inc., 2014 Ark. Ct. App. 65, at 1, 2014 WL 248104, at *2-4.
(72.) 91st Street Joint Venture v. Goldstein, 691 A.2d 272, 280 (Md. Ct. Spec. App. 1997) ("[A]ny transfer of the debtor partner's interest is to take place pursuant to the rules governing judicial sales.")
(73.) See REV. UNIF. Ltd. LlAB. Co. ACT [section] 503(c) (UNIF. LAW COMM'N Supp. 2015).
(75.) Lauer Constr. Inc. v. Schrift, 716 A.2d 1096, 1098-99 (Md. Ct. Spec. App. 1998) (stating judgment creditor has the power to force a sale of the debtor's general partner's interest in a limited partnership); Nigri v. Lotz, 453 S.E.2d 780, 783 (Ga. Ct. App. 1995) ("In general, a charging order is considered the primary method of satisfying the creditor's judgment, but the further step of ordering a sale may be considered appropriate where it is apparent that distributions under the charging order will not pay the judgment debt within a reasonable period of time."); 91st Street Joint Venture, 691 A.2dat 282 ("[T]he primary means of satisfying a judgment from a partnership interest should be the receipt and distribution of any income or profits due the debtor partner, and that, ordinarily, sale of the interest should not be resorted to unless the judgment could not be satisfied in that manner within a reasonable period of time.").
(76.) Nigri, 453 S.E.2d at 783 ("[T]he trial court has discretion to determine whether or not a judicial sale of the partnership interest is an appropriate means in aid of the charging order."); Stewart v. Lanier Park Med. Office Bldg., Ltd., 578 S.E.2d 572, 574-75 (Ga. Ct. App. 2003) ("The trial court has broad discretion in deciding whether to order a foreclosure and sale of charged interests.").
(77.) Hellman v. Anderson, 284 Cal. Rptr. 830, 838 (1991):
We conclude that since the interest acquired by the purchaser of a partnership interest is limited by operation of law to the partner's share of profits and surpluses, with no acquisition of interest in partnership property or management participation, the foreclosure and sale of the partnership interest will not always unduly interfere with the partnership business to the extent of requiring consent of the nondebtor partners. In some cases, foreclosure might cause a partner with essential managerial skills to abandon the partnership. In other cases, foreclosure would appear to have no appreciable effect on the conduct of partnership business. Thus, the effect of foreclosure on the partnership should be evaluated on a case-by-case basis by the trial court in connection with its equitable power to order a foreclosure.
(78.) The non-debtor partners must be given prior notice of the foreclosure. Union Colony Bank v. United Bank of Greeley Nat'l Ass'n, 832 P.2d 1112, 1116 (Colo. 1992) (citing First Nat' 1 Bank v. District Court, 652 P.2d 613 (Colo. 1982)). Although, their consent to foreclosure is not required. Heilman, 284 Cal. Rptr. at 832 ("consent of nondebtor partners is not an inflexible requirement ....").
(79.) 91st Street Joint Venture, 691 A.2d at 283 ("Ordinarily, the trial court should consider whether the judgment can be satisfied out of the debtor partner's profits prior to resort to the more drastic method of sale of the debtor partner's interest.").
(80.) The frequently misinterpreted Revenue Rule 77-137 and IRS General Counsel Memorandum 36960 are not to the contrary. See REV. RUL. 77-137, 1977-1 C.B. 178; I.R.S. Gen. Couns. Mem. 36960 (1977) (on file with author).
(81.) REV. UNIF. LTD. LIAB. CO. ACT [section] 503(d) (UNIF. LAW COMM'N Supp. 2015).
(82.) Id. [section] 503(e); see also Union Colony Bank, 832 P.2d at 1116 ("[P]artners may, at any time before foreclosure, redeem or purchase the interest charged or subject to sale.").
(83.) REV. UNIF. LTD. LIAB. Co. Act [section] 503(d)-(e) (UNIF. LAW COMM'N Supp. 2015).
(84.) Deutsch v. Wolff, 7 S.W.3d 460, 463 (Mo. Ct. App. 1999) ("Where the court directs sale, the interest charged may be purchased by any one or more of the partners without thereby causing a dissolution.").
(85.) See, e.g., REV. UNIF. LTD. LIAB. CO. ACT [section] 501 (UNIF. LAW COMM'N Supp. 2015). See also Koh v. Inno-Pacific Holdings, Ltd.. 54 P.3d 1270, 1271 (Wash. Ct. App. 2002) ("The interest of a member in a limited liability company is personal property."); Deutsch, 7 S.W.3d at 463 (Mo. Ct. App. 1999) ("A partnership interest is an economic right to share in the profits and surpluses, most accurately characterized as intangible personal property."); Madison Hills Ltd. P'ship II v. Madison Hills. Inc., 644 A.2d 363, 366 (Conn. App. Ct. 1994) ("The charging order affects only the partner's interest in the partnership, which is personal property.") (citations omitted).
(86.) See, e.g., Waite v. Waite, 492 P.2d 13(1972):
An intangible, unlike real or tangible personal property, has no physical characteristics that would serve as a basis for assigning it to a particular locality. The location assigned to it depends on what action is to be taken with reference to it. Thus most cases that place the situs of an intangible asset at the domicile of the owner do so to enable the jurisdiction of the owner's domicile to tax that property or the income derived from it. When, however, the issue, as in this case, involves jurisdiction to compel the obligor to pay one claimant and not a competing claimant, the debt or claim is usually regarded as having a situs in any state in which personal jurisdiction of the debtor can be obtained.
Id. at 17 (citations omitted).
(87.) Rockstone Capital, LLC v. Mktg. Horizons, Ltd., No. NNHCV065006818S, 2013 WL 4046597 (Conn. Super. Ct. July 17, 2013); Am. Institutional Partners, LLC v. Fairstar Res., Ltd., C.A. No. 10-489-LPS., 2011 WL 1230074 (D. Del. Mar. 31, 2011) vacated on other grounds.
(88.) C.A. No. 10-72-GMS-LPS, 2010 WL 1909558 (D. Del. May 11,2010).
(89.) C.A. No. 10-489-LPS, 2011 WL 1230074 (D. Del. Mar. 31, 2011) vacated on other grounds.
(90.) American Institutional Partners, LLC, 2011 WL 1230074, at *8; New Times Media, LLC, 2010 WL 1909558, at *1.
(91.) American Institutional Partners, LLC, 2011 WL 1230074, at 2; New Times Media, LLC, 2010 WL 1909558, at *3.
(92.) REV. UNIF. LTD. LIAB. CO. Act [section] 104 (Unif. Law Comm'n Supp. 2015).
(93.) McDermott Inc. v. Lewis, 531 A.2d 206, 216-18 (Del. 1987); Petro v. Gold, 850 N.E.2d 1218, 1233 (Ohio Ct. App. 2006); The Heritage Org. v. Kornman (In re The Heritage Org.), 413 B.R. 438, 463 (Bankr. N.D. Tex. 2009).
(94.) The most common exception is that in alter ego cases, the law of the jurisdiction where the entity has been formed will most typically apply.
(95.) REV. UNIF. LTD. LIAB. CO. ACT ART. 9 (UNIF. LAW COMM'N Supp. 2015).
(96.) Id. [section] 102(8), 6B U.L.A. 63.
(97.) Id. [section] 503, 6B U.L.A. 145-46.
(98.) New Times Media, LLC v. Bay Guardian Co, C.A. No. 10-72-GMS-LPS, 2010 WL 1909558, at *3 (D. Del. May 11, 2010) (charging order entered January 6, 2010).
(101.) Fannie Mae v. Heather Apartments Ltd. P'ship, No. A13-0562, 2013 WL 6223564 (Minn. Ct. App. Dec. 2, 2013).
(102.) Id. at *6.
(103.) See Carter G. Bishop, Fifty State Series: LLC Charging Order Case Table, (Suffolk Univ. Law Sch., Legal Research Paper Series. Paper No. 10-15, 2015), http://ssm.com/abstractM565595.
(104.) REV. UNIF. LTD. LIAB. CO. act [section] 503(h) (UNIT. LAW COMM'N Supp. 2015); Madison Hills Ltd. P'ship II v. Madison Hills, Inc., 644 A.2d 363, 367 (Conn. App. Ct. 1994) ("Because the partner's rights in specific property of the partnership cannot be attached or made subject to execution and the partner's management rights cannot be assigned to or conferred on anyone other than a partner the charging order is the sole remedy available to a judgment creditor of a partner.") (citations omitted). Contra Nigri v. Lotz, 453 S.E.2d 780, 782 n.2 (Ga. Ct. App. 1995) ("The charging order remedy is not exclusive, and the financial interests of the limited partner may also be reached by the judgment creditor by process of garnishment."). Charging order exclusivity is likewise binding on the federal courts. Lumbermens Mut. Cas. Co. v. Luciano Enters., LLC, No. A01-309 CV JWS, 2005 WL 2340709, at *2 (D. Alaska Sept. 21, 2005) (making charging order the "exclusive remedy under Alaska law, deemed by federal court to be a situation in which a state substantive law does in fact limit the court's power to enforce its own judgments...."). It is also effective in divorce cases. Addis v. Addis, 703 S.W.2d 852, 853 (Ark. 1986) ("At divorce, in determining the rights of a husband or wife to a spouse s partnership interest, a court cannot make specific awards of partnership assets. The court must determine the value of the interest in the partnership and then award the spouse an amount equal to one-half of the value of the interest, which may be enforced by a charging order on the partnership interest.") (citing Riegler v. Riegler, 419 S.W.2d 311 (Ark. 1967)).
(105.) Some reported decisions have language to the contrary. 91st Street Joint Venture v. Goldstein, 691 A.2d 272, 276 (Md. Ct. Spec. App. 1997) ("[T]here is general agreement that the charging order is now the judgment creditor's exclusive method of reaching a partner's interest in a partnership and that the creditor may no longer execute directly on partnership property."); Dispensa v. Univ. State Bank, 951 S.W.2d 797, 800 (Tex. App. 1997) ("A charging order is the sole means by which a judgement creditor can reach an individual debtor's partnership interest.").
(106.) CAL. CIV. PROC. [section] 708-9(West 2015).
(107.) It may also be that a creditor might employ some other writ to circumvent charging order exclusivity. See, e.g., MacDonald v. MacDonald, 1986 WL 5480, at *3 (Del. Ch. 1986) (declining to address "the question whether a writ of fieri facias is effective to seize a limited partnership interest in a Delaware limited partnership").
(108.) Gerald V. Niesar, Charging Orders and the Single-Member LLC, 65 CONSUMER FIN. L. Q. REP. 278,278 (2011).
(109.) 291 B.R. 538 (Bankr. D. Colo. 2003).
(110.) 412 B.R. 715 (Bankr. D. Md. 2006).
(111.) Albright, 291 B.R. at 541; Modanlo, 412 B.R. at 728.
(112.) In re B & M Land and Livestock, 498 B.R. 262, 267 (D.Nev. 2013).
(113.) Id. at 266-67.
(114.) Olmstead v. F.T.C.. 44 So. 3d 76 (Fla. 2010).
(115.) Id. at 81-83.
(117.) Id. at 80-83.
(118.) See generally Louis T. M. Conti, The New Olmstead Patch: A Case Study in the Art of Compromise for Florida LLC Law, 85-DEC Fla. B.J. 49 (2011) (refening to the Florida statute passed after the Olmstead case as the "Olmstead Patch").
(119.) Olmstead, 44 So. 3d at 80-83.
(120.) FLA. STAT. ANN. [section] 605.0503(4) (West 2015).
(121.) See Bishop, supra note 103 (providing an exhaustive state-by-state list of jurisdictions that allow or preclude foreclosure).
(122.) See, e.g., In re Desmond, 316 B.R. 593 (Bankr. D. N.H. 2004); In re Penn, No. 09-14624-WHD, 2010 WL 9445533 (Bankr. N.D. Ga. April 2, 2010); Robucci v. C.I.R., 101 T.C.M. (CCH) 1060 (2011).
(123.) See Olmstead, 44 So. 3d at 81-83.
(124.) Sardis v. Frankel, 113 A.D.3d 135 (N.Y. App. Div. 2014).
(125.) Id. at 138-39.
(126.) Id. at 143.
(127.) In re Ashley Albright, 291 B.R. 538, n.9 (Bankr. D. Colo. 2003) (citing 11 U.S.C. [section][section] 544(b)(1), 548(a) (2015)).
(128.) In re Blatstein, 192 F.3d 88, 100-01 (3d Cir. 1999).
(129.) See, e.g., Postal Instant Press, Inc. v. KaswaCorp., 77 Cal. Rptr. 3d 96, 105 (Cal. Ct. App. 2008); Comm'r of Envtl. Prot. v. State Five Indus. Park, Inc., 37 A.3d 724, 733-34 (Conn. 2012).
(130.) 6 A.3d 238, 249-54 (Del. Ch. 2010). Contra Beach Park Assoc, v. Heron, No. H023320, 2003 WL 22000591, at *24 (Cal. Ct. App" Aug. 25, 2003) (Non-debtor partners who caused a loan from partnership, that reduced the partnership's liquidity such that it could not pay on charging order, "perpetrated a fraud on the judgment creditor" and a breach of their fiduciary duties to the partnership.).
(131.) CML, LLC, 6 A.3d at 249-54.
(132.) Ehmann v. Fiesta Invs., LLC (In re Ehmann I),319 B.R. 200, 202-03 (Bankr. D. Ariz. 2005).
(137.) A reference to Shakespeare's tragedy and not to any court opinion of that name.
(138.) In re Ehmann I, 319 B.R. at 205-06.
(139.) Ehmann v. Fiesta Invs., LLC (In re Ehmann II), 337 B.R 228, 229-30 (Bankr. D. Ariz. 2006).
(141.) In re H&W Food Mart, LLC, 461 B.R. 904, 909-10 (Bankr. N.D. Ga. 2011); Fursman v. Ulrich (In re First Protection, Inc.), 440 B.R. 821, 830-31 (B.A.P. 9th Cir. 2010).
(142.) A reference to the phenomena of the fans of late jazz musician Charlie Parker painting the graffiti "Bird Lives!" as a statement that his innovations had survived him.
JAY D. ADKISSON [(dagger)]
[(dagger)] Jay D. Adkisson, partner of Riser Adkisson LLP in Henderson, Nevada; University of Oklahoma (B.A., 1986; J.D., 1988); Admitted to practice in Arizona, California, Nevada, Oklahoma and Texas. The author thanks San Francisco attorney Gerald V. Niesar of Niesar & Vestal LLP for his very valuable contributions to this paper.
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|Title Annotation:||A Dynamic Duo: South Dakota's Trust Laws & Business Entity Statutes|
|Author:||Adkisson, Jay D.|
|Publication:||South Dakota Law Review|
|Date:||Sep 22, 2016|
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