Limited Liability Company Charging Orders Part II Charging Order Protections: Exclusivity, Foreclosure and Single Member LLCs

Limited Liability Company Charging Orders Part II
Charging Order Protections:
Exclusivity, Foreclosure and Single Member LLCs
By
Meredith Cipriano
With input from Clerkship Fellows
Under the auspices of John Orrick, Jr., Carmen Fonda and Marshall Paul

 

Introduction

Charging orders have deep roots in English law and early American partnership laws. Despite the long established presence of charging orders in partnership law, such provisions have recently generated significant discussion in the context of the Limited Liability Company (LLC) framework. With the rise of the LLC in the 1990’s, states passed LLC Acts that incorporated the charging order into these statutes. While state LLC laws are uniform in providing this creditor remedy, this is where much of the similarity ends. The most significant and noteworthy variances between states are provisions regarding the exclusivity of a charging order as the creditor’s sole remedy, the ability of a creditor to foreclose on the charging order, and the application of charging order law to single-member LLCs. This article provides a survey of state LLC laws and the varying treatment of these three provisions of charging order protections.

 

Charging Order Purpose and Statutory Mechanism

Reflective of its roots in partnership law, the charging order is a statutory mechanism for judgment-creditors to reach the judgment-debtor’s membership interest in an LLC. Charging orders allow the judgment-creditor to receive the judgment-debtor’s distributions from the LLC until the judgment is satisfied. However, charging orders only convey the economic interest of the judgment-debtor to the judgment-creditor. The judgment-creditor has no management rights to the LLC and cannot force the LLC to make any distributions. Therefore, charging orders balance the competing interests of the judgment-creditor to collect on a judgment and the non-debtor members to choose with whom they will co-manage the business.

Generally, charging order statutes in most states provide that: 1) a court of competent jurisdiction, on application, may charge the debtor’s transferable interest; 2) the court may appoint a receiver of the distributions due; 3) the creditor retains only the economic rights of the debtor’s interest in the LLC, and not managerial rights;[1] and 4) the charging order does not accelerate any distributions or otherwise interfere with the management of the entity.[2] Although statutory language varies from state-to-state, these elements generally provide for the operation of this creditor remedy. Beyond these commonalities, state statutes vary in the rights of a creditor to foreclose on a charging order and whether the charging order serves as the exclusive remedy for the creditor. Whether or not and if so, the way these two elements are memorialized in the various statutes greatly impacts the judgment-creditor’s ability to access any distributions to satisfy the judgment, and the judgment-debtor’s ability to retain his economic interest in the LLC. Significantly, however, the treatment of these provisions as applied to Single Member LLCs (SMLLCs) are ambiguous as to their impact in light of recent court decisions.

 

Variances in State Statutes

Exclusivity or Sole Remedy

Thirty-six states explicitly declare the charging order to be the exclusive remedy of a judgment-creditor.[3] Fourteen states do not incorporate exclusivity language.[4] As case law has indicated, however, the silence of these fourteen states does not necessarily mean that the charging order is a non-exclusive remedy. This silence may create uncertainty, particularly in light of the relatively sparse case law on charging orders. Furthermore, some courts have determined that a charging order is not the exclusive remedy when applied against a debtor’s interest in a SMLLC, as the policy rationale of charging orders is lost in the SMLLC context.[5] Absent statutory language regarding the exclusivity of the remedy, judgment-creditors may be entitled to foreclosure on the order or utilize other equitable remedies generally available to creditors under other provisions of law, such as fraudulent transfer and reverse veil piercing.

 

Foreclosure

            The ability to foreclose on a charging order provides an enhanced remedy for the judgment-creditor. If the LLC fails to make any distributions, then the charging order attached to the judgment-debtor’s interest in the LLC is essentially worthless. Thus, some states explicitly allow a judgment-creditor to foreclose on a charging order if the judgment is unlikely to be satisfied. For example, California’s LLC Act provides that “[u]pon 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.[6] Select states permit foreclosure of a charging order, but give members the ability to prohibit foreclosure through the operating agreement (as Maryland does.)[7] In contrast, some states affirmatively preclude the right of a judgment-creditor to foreclose on a charging order. Many of these states (including Delaware) reject the foreclosure remedy because they are attempting to be more “business friendly” or aligned with Delaware law.[8]

State LLC laws are quite varied regarding the foreclosure of a charging order lien. Fifteen states explicitly authorize the foreclosure of a charging order.[9] Alaska, Delaware, Florida, Georgia, Maine, Michigan, New Hampshire, New Jersey, Oklahoma, South Dakota, Texas, and Wyoming explicitly preclude foreclosure.[10] Twenty-one state LLC laws are silent as to the right of foreclosure.[11] However, out of these states the statutory silence in the laws of Virginia, and Nevada are distinguishable as each state recently amended its LLC statutes by deleting the right to foreclosure, whereas the other silent states never addressed the right to foreclosure in their LLC acts.

State legislatures are actively reviewing and reforming charging order protections under their LLC Acts. The status of laws in Minnesota and Alabama are changing over the next few years. Effective in 2018, Minnesota’s LLC act will explicitly permit the right of a judgment-creditor to foreclose on a charging order, whereas in 2018, Alabama’s law will expressly preclude this remedy.[12] In addition, Washington’s legislature recently repealed proposed changes to their statute which would have allowed for foreclosure and made the charging order the exclusive remedy.[13]

 

Single-Member LLC

Charging orders developed in the context of the general partnerships, which require at least two partners.  The policy rationale of charging orders was to protect both the partnership as an entity and the individual partners from interference by another partner’s personal judgment-creditor. The SMLLC, however, creates significant challenges to the underlying rationale for the charging order because there is no potential that the charging order would affect the managing or economic interests of another member. Recently, courts have neglected to support the exclusivity of the charging order provisions in favor of allowing a judgment creditor to reach the partnership assets (including membership interests) of a SMLLC.

For example, the U.S. District Court in Kansas examined the scope of a charging order against a single-member LLC in Meyer v. Christie.[14] While the Kansas LLC Act provides that a charging order against a member’s interest is the creditor’s exclusive remedy,[15] the court found that, in the case of a SMLLC, the creditor could assert management rights and take control of the LLC. The court looked beyond the charging order statute and instead referenced a section of the Kansas LLC Act dealing with the assignments of LLC interests. From this section, the court held that “the assignee/creditor shall have the right to participate in the management of the business and affairs of the LLC as a member.”[16] Consequently, the holder of a charging order against a sole member has managerial rights, enabling the holder to take over the LLC, make distributions to itself, or even liquidate the LLC.

Likewise, in Olmstead v. FTC, the Florida Supreme Court had to decide whether a charging order would be the sole remedy available to the creditor of a member of a Florida LLC.[17] At the time of the case, Florida LLC law governing charging orders was silent as to whether the charging order was the exclusive remedy of a judgment creditor.[18] After comparing Florida’s limited liability company statute with the state’s partnership act and limited partnership act, the Florida Supreme Court decided that the charging order was not the creditor’s sole remedy.[19] That decision opened the door for the creditor to take possession of the member’s LLC interest in his single-member LLC, and the possibility of a similar outcome in the context of multi-member LLCs.[20]

Currently, only Alaska, Delaware, Wyoming, Nevada, and South Dakota LLC laws specifically acknowledge the similar treatment of multiple-member LLCs and SMLLCs under their charging order provisions.[21] Florida and New Hampshire have statutes that enhance the right of creditors solely when holding an order against a SMLLC debtor’s interest. In these states, while foreclosure is not a right available to the judgment-creditor of a debtor’s interest in a multiple-member LLC, foreclosure is an affirmative remedy afforded to the judgment-creditors of debtor’s interest in a SMLLC.[22] The silence of all other jurisdictions may present an ambiguous question as to whether the courts will favor of judgment-creditors attempting to reach a SMLLC, even when the charging order provisions include an exclusivity provision.

 

Maryland Law

The Maryland LLC Act was revised in 2011-2012 adding to the law that charging orders and foreclosure rights constitute the exclusive remedies by which a creditor can satisfy the debt of a debtor-member through the debtor-member’s interest LLC.[23] It is important to note that though the recent amendments to the Maryland LLC Act afford creditors a right to foreclose on a charging order, Maryland law also permits members of an LLC to prohibit foreclosure by explicitly disallowing it in the LLC’s operating agreement.[24] The Maryland statute does not address whether the charging order provisions apply uniformly to multiple-member LLCs and SMLLCs.

 

Conclusion

            Although charging order protections have been a feature of American partnership law since the 1900’s, there remains sparse authority on the application of charging orders in the LLC context. As examined, state statutes vary considerably in the extent of protection a charging order may provide to an LLC, a judgment-debtor, and a judgment-creditor. Moreover, they vary as well in whether the state treats the creditors of debtor member of a SMLLC the same as a debtor member of a multiple member LLCs. The varying statutory language combined with the sparse case law in this area creates many ambiguities of law. Most significantly, the application of charging order protections in the SMLCC context presents an area of uncertainty that state legislators and the judiciaries are just now beginning to interpret.

[1] Some state laws explicitly allow the purchaser of a charging order at a foreclosure sale to obtain the full membership interest rights, not just the economic interest, when the charging order is against a debtor who is the sole member of an LLC. E.g., Fla. Stat. Ann. § 608.426(6)(a)­–(c) (West 2015); Utah Code Ann. § 48-2C-1103(2)(d) (West 2015).

[2] See generally Bishop, Carter G., Fifty State Series: LLC Charging Order Statute Table, Suffolk Univ. Law Sch., Research Paper No. 10-03 (Aug. 2014), available at http://ssrn.com/abstract=1542244.

[3] The thirty-six states that explicitly declare that charging orders are the exclusive remedies are as follows: Ala. Code § 10-A-5-6.05(a) (West 2015); Alaska Stat. § 10.50.380(c) (West 2015); Ariz. Rev. Stat. Ann. § 29-655(c) (West 2015); Cal. Corp. Code § 17705.03(f) (West 2015); Del. Code Ann. tit. 6, § 18-703(d) (West 2015); D.C. Code Ann. § 29-805.03(h) (West 2015); Fla. Stat. Ann. § 608.433(c)(5) (West 2015); Haw. Rev. Stat. Ann. § 428-504(e) (West 2015); Idaho Code Ann. § 30-6-503(7) (West 2015); 805 Ill. Comp. Stat. Ann. § 180/30-20(e) (West 2015); Iowa Code Ann. § 489.503(7) (West 2015); Kan. Stat. Ann. § 17-76, 113 (West 2015); Ky. Rev. Stat. Ann. § 275.260(1) (West 2015); Me. Rev. Stat. Ann. tit. 31 § 1573(7) (West 2015); Md. Code Ann., Corps. & Ass’ns § 4A-607(f) (West 2015); Mich. Comp. Laws § 450.4507(6) (West 2015); Minn. Stat. Ann. § 322B.32 (West 2015); Miss. Code Ann. § 79-29-705(3) (West 2015); Mont. Code Ann. § 35-8-705(5) (West 2015); Neb. Rev. Stat. § 21-142(g) (West 2015); Nev. Rev. Stat Ann. § 86.401(2)(a) (West 2015); N.H. Rev. Stat. § 304-C : 126(IV) (West 2015); N.J.S.A. 42:2B-45 (West 2014); N.C. Gen. Stat. § 57D-5-03(d) (West 2015); N.D. Cent. Code § 10-32-34(3) (West 2015); Ohio Rev. Code Ann. § 1705.19(B) (West 2015); Okla. Stat. tit. 18 § 2034 (West 2015); S.C. Code Ann. § 33-44-504(e) (West 2015); S.D. Codified Laws § 47-34A-504(e) (West 2015); T.C.A. § 48-249-509 (West 2015); Texas Bus. Orgs. Code Ann. § 101.112(d) (West 2015); Utah Code Ann. § 48-2c-1103(2)(5) (West 2015); Vt. Stat. Ann. tit, 11 § 3074(e) (West 2015); Va. Code Ann. § 13.1-1041.1(d) (West 2015); W. Va. Code Ann. § 31-B-5-504(e) (West 2015); Wyo. Stat. Ann. § 17-29-503(g) (West 2015).

[4] Ark. Code Ann. § 4-32-705 (West 2015); Colo. Rev. Stat. § 7-80-703 (West 2015); Conn. Gen. Stat. Ann. § 34-171 (West 2015); Ga. Code Ann. § 14-11-504 (West 2015) ; Ind. Code Ann. § 23-18-6-7 (West 2015); La. Rev. Stat. Ann. § 12:1331 (West 2015); Mass. Gen. Laws Ann. ch. 156C, § 40 (West 2015); Mo. Ann. Stat. § 347.119 (West 2015); N.M. Stat. § 53-19-35 (West 2015); N.Y. Ltd. Liab. Co. Law § 607 (West 2015); Or. Rev. Stat. § 63.259 (West 2015); R.I. Gen. Laws § 7-16-37 (West 2015); Wash. Rev. Code Ann. § 25.15.255 (West 2015); Wis. Stat. Ann. § 183.0705 (West 2015).

[5] In re Albright, 291 B.R. 538, 541 (Bankr. D. Colo. 2003).

 

However, the charging order, as set forth in Section 703 of the Colorado Limited

Liability Company Act, exists to protect other members of an LLC from having

involuntarily to share governance responsibilities with someone they did not choose,

or from having to accept a creditor of another member as a co-manager. A charging

order protects the autonomy of the original members, and their ability to manage their

own enterprise. In a single-member entity, there are no non-debtor members to protect.

The charging order limitation serves no purpose in a single member limited liability

company, because there are no other parties’ interests affected.”

 

[6] Cal. Corp. Code § 17705.03.

[7] See Md. Code Ann., Corps. & Ass’ns § 4A-607(c)(3)(i) (“Unless otherwise agreed, on a showing that the distributions under a charging order will not pay the amount owed to the creditor within a reasonable time, the court may order foreclosure of the economic interest subject to the charging order and order the sale of the economic interest of the debtor.”).

[8] “The intent is to update Nevada’s charging order protection laws that affect corporations, limited liabilities, and limited partnerships to make our laws as good as other states’ laws including South Dakota, Wyoming, and Delaware . . . .” Minutes of the Meeting of the Assembly Committee on the Judiciary May 12, 2011, 76th Session, available at http://www.leg.state.nv.us/Session/76th2011/Minutes/Assembly/JUD/Final/1189.pdf.

[9] Cal. Corp. Code § 17705.03(b)(3); Colo. Rev. Stat. § 7-80-703; D.C. Code Ann. § 29-805.03(b)(c); Haw. Rev. Stat. Ann. § 428-504(b); Idaho Code Ann. § 30-6-503(3); 805 Ill. Comp. Stat. Ann § 180/30-20(b); Iowa Code Ann. § 489.503(3); Ky. Rev. Stat. Ann. § 275.260(4); Md. Code Ann., Corps. & Ass’ns § 4A-607(a)(3)(i)); Mont. Code Ann. § 35-8-705(3) ; Neb. Rev. Stat. § 21-142(c);S.C. Code Ann. § 33-44-504(b); Utah Code Ann. § 48-2c-1103(2)(b); Vt. Stat. Ann. tit, 11 § 3074(b); W. Va. Code Ann. § 31-B-5-504(b).

[10] Alaska Stat. § 10.50.380(c); Del. Code Ann. tit. 6, § 18-703(d); Fla. Stat. Ann. § 608.433(c)(8); Ga. Code Ann. § 14-11-504(b); Me. Rev. Stat. Ann. tit. 31 § 1573(3); Mich. Comp. Laws § 450.4507(5); N.H. Rev. Stat. § 304-C : 126(v)(a); N.J.S.A. 42:2B-45;Okla. Stat. tit. 18 § 2034; S.D. Codified Laws § 47-34A-504(e); Texas Bus. Orgs. Code Ann. § 101.112(c); Wyo. Stat. Ann. § 17-29-503 (2014).

[11] Ala. Code § 10-A-5-6.05; Ariz. Rev. Stat. Ann. § 29-655; Ark. Code Ann. § 4-32-705; Conn. Gen. Stat. Ann. § 34-171; Ind. Code Ann. § 23-18-6-7; Kan. Stat. Ann. § 17-76, 113; La. Rev. Stat. Ann. § 12:1331; Mass. Gen. Laws Ann. ch. 156C, § 40; Minn. Stat. Ann. § 322B.32; Mo. Ann. Stat. § 347.119; N.M. Stat. § 53-19-35; N.Y. Ltd. Liab. Co. Law § 607; N.C. Gen. Stat. § 57D-5-03; Ohio Rev. Code Ann. § 1705.19; R.I. Gen. Laws § 7-16-37;T.C.A. § 48-249-509; Wash. Rev. Code Ann. § 25.15.255; Miss. Code Ann. § 79-29-705; N.D. Cent. Code § 10-32-34; Or. Rev. Stat. § 63.259; Wis. Stat. Ann. § 183.0705.

[12] H.F. 977, 88th Leg., (MN 2014); HB 2, Act No. 2014-144 (Ala. 2014).

[13] 2015 Washington Senate Bill No. 5030.

[14] Meyer v. Christie, No. 07-2230-CM, 2011 WL 4857905 (D. Kan. Oct. 13, 2011).,

[15] “The KRLLCA makes clear that the charging order is the only remedy by which a judgment creditor of a member can reach the member’s interest in the LLC.” Id. at 3.

[16] Id.

[17] Olmstead v. FTC, 44 So. 3d 76 (2010).

[18] Id. at 82.

[19] “The Legislature has shown—in both the partnership statute and the limited partnership statute—that it knows how to make clear that a charging order remedy is an exclusive remedy. The existence of the express exclusive-remedy provisions in the partnership and limited partnership statutes therefore decisively undermines the appellants’ argument that the charging order provision of the LLC Act—which does not contain such an exclusive remedy provision—should be read to displace the remedy available under section 56.061.” Id.

[20] The dissent strongly criticized the majority for unnecessarily re-writing the LLC charging order statute and consequently creating a hostile environment for LLCs in Florida.

 

An adequate remedy is available without the extreme step taken by the majority

in rewriting the plain and unambiguous language of a statute. This is extremely important

and has far-reaching impact because the principles used to ignore the LLC statutory language

under the current factual circumstances apply with equal force to multimember LLC entities

and, in essence, today’s decision crushes a very important element for all LLCs in Florida.

If the remedies available under the LLC Act do not apply here because the phrase “exclusive

remedy” is not present, the same theories apply to multimember LLCs and render the assets

of all LLCs vulnerable.

Id. at 84 (Lewis, J., dissenting).

[21] Alaska Stat. § 10.50.380 (West 2015); Del. Code Ann. tit. 6, § 18-703 (West 2015); Nev. Rev. Stat. § 86.401(2)(a) (West 2015); S.D. Codified Laws § 47-34A-504 (West 2015); Wyo. Stat. Ann. § 17-29-503(g) (West 2015).

[22] Fla. Stat. Ann. § 608.433(5)–(6) (West 2015); N.H. Rev. Stat. Ann § 304-C : 126(IV)–(VI)(a) (West 2015).

[23] Md. Code Ann., Corps. & Ass’ns § 4A-607 (West 2015)

[24] § 4A-607(c)(3).