- Using Charging Orders to Collect from Members of an LLC
- November 16, 2017 | Author: James T. Hart
- Law Firm: Weltman, Weinberg & Reis Co., L.P.A. - Cincinnati Office
Commercial collection cases often present unique challenges to judgment creditors. For instance, a judgment debtor in a commercial case may be more sophisticated than the average debtor in a consumer matter, as they are more likely to have the ability to protect assets from routine execution methods. However, such relative sophistication with various asset holdings may also afford the judgment creditor with the opportunity to use otherwise underutilized tools for recovery.
Charging orders are one such tool that is often overlooked as a device for a creditor. A charging order is "a lien on and the right to receive distributions made with respect to the judgment debtor's limited liability company interest."1 Kentucky allows for charging orders against members of a limited liability company (LLC), corporation or limited cooperative association, against partners in a partnership or limited partnership, or even against beneficiaries under a trust.2 Because LLCs have become the most popular means of business formation, this article focuses on charging orders in the context of an LLC.
Essentially, a charging order provides the judgment creditor with the right to receive monies generated from the interest that a member has in an LLC on a continual basis until the debt is paid. For example, if Acme Bank has a judgment against Joe Debtor, and Joe Debtor is a member of Company, LLC, Acme can seek a charging order requiring Company to pay over to Acme any distributions that would otherwise be paid to Joe until the judgment debt is satisfied. Although the charging order confers this "economic interest," it does not actually assign or convey the member's interest in the LLC to the creditor.3 Moreover, the charging order does not give the judgment creditor the right to participate in the management of the LLC or a right to dissolve the LLC.4
Further, the statute provides that this is the judgment creditor's "exclusive remedy" in seeking to satisfy a judgment from a member's interest in an LLC.5 This language prevents a judgment creditor from using any other execution method (i.e., garnishment, personal property execution, corporate veil piercing, assignment orders, fraudulent transfer actions, etc.) to otherwise obtain disbursements from a member's interest in the LLC.6
So how does a charging order work?
First, the judgment creditor must identify an LLC for which the judgment debtor may have an interest. This determination can be made through a judgment debtor exam, post-judgment written interrogatories, or through a search of the Secretary of State's online service portal where a search can be conducted either by the LLC's name or by a member's name.7 Under the Kentucky statute, the judgment creditor must make an "application to the court of competent jurisdiction" requesting that a member (or its assignee's) interest in a limited liability company be subject to a charging order.8 While presumably this can be done as an original action, the application is most commonly made as a post-judgment motion in the case where the judgment was rendered. Also, the LLC (or LLCs) to be charged does not need to be added as a party to the case when submitting the application or filing the motion.9
Once the application is made and the charging order entered, the court may appoint a receiver to collect the distributions.10 The receiver can be appointed for disbursements from a single LLC or from multiple LLCs depending on how many LLCs the judgment debtor identified as ones in which it has an interest.11 The court is also broadly empowered to "make all other orders, directions, accounts, and inquiries the judgment debtor might have made or which the circumstances of the case may require to give effect to the charging order."12 A common example of such additional orders would be a periodic accounting to the court.
The statute also allows a court to order foreclosure of the member's interest in the LLC "at any time."13 Under the foreclosure provision, the judgment creditor can petition the court for a sale of the member's interest. If granted, the purchaser at the sale becomes an assignee of the member’s interest with all of the rights that result from an assignment.14 Foreclosure is a remedy that is generally used if the LLC is not producing distributions so that a charging order would essentially be useless. Unlike some jurisdictions, Kentucky does not specifically require that the judgment creditor demonstrate prior to seeking foreclosure that distributions under the charging order would not pay the judgment debt in a "reasonable time."15 However, before the sale, the judgment debtor member, one or more of the other members of the LLC, or the LLC itself may redeem the interest subject to foreclosure.16
It is also important to be aware of a recent amendment to Kentucky’s LLC Act that specifically disallows a charging order to be used by an LLC against its own member.17 Thus, if a member of an LLC were to become indebted to that same LLC, and the LLC were to obtain a judgment against the member, the LLC would not be able to use the charging order remedy against that member concerning its interest in that same LLC.
Finally, bankruptcy, insolvency, incompetency and death of a member each have an effect on the validity of a charging order. Once a member files a bankruptcy petition or is adjudicated a bankrupt, he or she "shall disassociate from and cease to be a member" of an LLC.18 In the event that the member dies or is adjudicated incompetent by a court (ex. guardianship), the judgment debtor can no longer be a member of the LLC and the charging order will be of no further consequence.
For more information, please contact James T. Hart, Esq. Mr. Hart is an attorney based in the Cincinnati office of Weltman, Weinberg & Reis Co., LPA. He practices in Consumer and Commercial Collections, with a focus on legal action recovery, healthcare collections, student loan recovery, subrogation, and complex commercial collections.
1 KRS § 275.260(3)
2 See e.g. KRS §§ 272A.6-050, 275.260, 362.285, 362.481, 362.1-504, 362.2-703, 362.2-933, and 386A.6-060.
3 KRS § 275.260(3)
4 KRS § 275.260(2)
5 KRS §275.260(1)
6 The Kentucky Limited Liability Company Act joins of 35 other states in containing such exclusivity language, while the 14 states that have adopted similar LLC Acts do not. Meredith Cipriano, Limited Liability Company Charging Orders Part II: Charging Order Protections: Exclusivity, Foreclosure and Single Member LLCs, MSBA Business Law Section Newsletter, published April 2, 2015, http://msbabusinesslawnewsletter.com/2015/04/02/llc-charging-ii/.
7 CR 69.03; Kentucky Secretary of State website: https://app.sos.ky.gov/ftsearch/.
8 KRS § 275.260(2).
9 KRS § 275.260(6); see also, Vance v. Spring Hill Signs, LLC, No. 2013-CA-001264-MR, 2015 Ky. App. Unpub. LEXIS 251, *11 (rendered April 10, 2015)
10 KRS § 275.260(2).
11 There is no conceivable limit to how many LLCs the court can make subject to a single charging order. In Vance v. Spring Hill Signs, LLC, supra, the charging order concerned eight separate LLCs.
12 KRS § 275.260(2).
13 KRS § 275.260(4).
14 As an assignee, the purchaser can gain the ability to participate in the management or dissolution of the LLC, which would otherwise disallowed by KRS § 275.260(2). However, as an assignee, the purchaser at the foreclosure sale must still be aware of the provisions of KRS § 275.265, which include a requirement that it obtain the consent of other members, and any limitations that may be set out in the LCC’s articles or operating agreement.
15 See Cal. Corp. Code § 17705.03. For a good overview of how certain states treat foreclosure in the context of charging orders, see Meredith Cipriano, Limited Liability Company Charging Orders Part II: Charging Order Protections: Exclusivity, Foreclosure and Single Member LLCs, MSBA Business Law Section Newsletter, published April 2, 2015, http://msbabusinesslawnewsletter.com/2015/04/02/llc-charging-ii/.
16 KRS § 275.260(4). Notice that under subsection (b) if a member(s), other than the judgment debtor, is seeking to redeem, the member(s) cannot use any property owned by the LLC to do so. However, under subsection (c), the LLC itself can use its own property to redeem so long as all the members who are not subject to the charging order consent.
17 KRS § 275.260 (7); see KY SB 235 (BR 1471).
18 KRS § 275.280(1)(d); see Hubbard v. Talbott Tavern, Inc., Nos. 2003-CA-001468-MR, 2003-CA-001543-MR and 2004-CA-002184-MR, consolidated, 2006 Ky. App. Unpub. LEXIS 1 (rendered July 28, 2006)
19 KRS 275.280(1)(f).