Ward on Iowa Limited Liability Company Law

Charging Orders Cannot Grant Managerial Rights in an LLC

The Nevada Supreme Court ruled in Weddell v. H2O, Inc., 128 Nev. Adv. Op. #9, (Nev. March 1, 2012) that a judgment creditor is like an assignee of a membership interest.  The creditor is entitled to only the share of the distributions the member would otherwise have received.  The managerial interest of the debtor remains with the debtor. 

This case is a good reminder that the charging order is limited to satisfaction of a judgment by petitioning a court to charge the member's interest with the amount of the judgment. In essence, a charging order is similar to a garnishment; it directs the LLC to make distributions to the creditor that it would have made to the member. It does not permit a judgment creditor of a member to affect the management of the LLC or reach its assets. 

-Marc Ward

LLC Charging Orders and Their Priority

As readers of this blog should know, a charging order is the exclusive remedy with regard to a debtor’s membership interest in an LLC.  This is true even if a creditor has a security agreement signed by the debtor that assigns all right, title and interest in a membership interest in an LLC to the creditor (courts have found that absent the consents required by the operating agreement the assignment is ineffective).

This does not mean that creditors can’t take steps to improve their position with respect to claims they have on an LLC membership interest. In First Mid-Illinois Bank & Trust v. Parker, 2010 WL 3179734 (Ill. App. 2010) Bank A argued that its charging order should take priority over Bank B’s charging order even though Bank B’s charging order was entered first because Bank A had an attachment lien entered four months earlier. The court agreed finding that because the charging order and attachment lien of Bank A related to the same claim the attachment merged with the charging order and the charging order related back to the date of the earlier attachment filing based on the “relation back” doctrine.

-Marc Ward

Charging Orders and Single Member LLCs

Applying partnership principles to single member entities can sometimes create havoc.  Enter the case of Olmsted v. FTC (SC08-1009, June 24, 2010).  The 11^th Circuit Court of Appeals certified a question of Florida law to the Florida Supreme Court asking the Florida court if the charging order provision of Florida’s LLC Act permitted a court to order a debtor to surrender all of his or her rights in a single member LLC membership interest to a judgment creditor, not just the economic rights (the right to distributions).  Applying the hoary judicial principle if you don’t like the answer change the question, the Florida Supreme Court broadened the question to ask whether Florida law permitted the surrender of the entire interest (the right to vote and manage the affairs of the LLC in addition to receiving distributions).

The Florida Supreme Court answered its own question in the affirmative, relying on the theory that LLC interests were akin to corporate stock (wrong!) and therefore subject to the general execution laws of the state.  It also relied on the fact that unlike the Florida partnership and limited partnership statutes that made charging orders the exclusive remedy for judgment creditors, the Florida LLC provision on charging orders omitted the word exclusive.

This decision will create confusion in those states that likewise do not include the word exclusive in their statutes.  Charging orders effectively preclude creditors from becoming “partners” with the other non-debtor owners of the entity.  In single member LLCs it makes sense that charging orders are not the exclusive remedy, albeit it takes some judicial jujitsu to get there.  It does not make sense in LLCs with more than one member, and in effect makes LLC interests more like corporate stock than they are intended to be.

Fortunately, this should not be an issue under Iowa’s new LLC Act because it is the exclusive remedy.  (Iowa Code Section 489.503). Iowa has its own peculiar provision, one that is straight from the Revised Uniform Limited Liability Company Act.  It says that if it can be shown that the distributions from an interest will not be sufficient within a reasonable period of time to satisfy the charging order, then the court can foreclose the lien and sell the interest.  Of course, it depends on the size of the lien, but if the interest isn’t generating enough money to pay the charging order, exactly what will be gained by selling the interest?  Presumably, only the economic interest is sold.  Right?

-Marc Ward

Charging Orders and Foreign LLCs

It may come as a surprise that the charging order remedy under Iowa Code 489.503 is only available against domestic (Iowa) LLCs (the phrase "limited liability company" is limited by definition to domestic LLCs).  Thus, if you have a judgment against a debtor who owns an interest in a Delaware LLC, that state is the proper forum to bring a charging order proceeding.  Remember that the charging order directs the company to send its distributions to the creditor, it is not an action against the debtor/member. 

 

There are some contrary opinions out there to the effect that if a state has jurisdiction over a foreign LLC it should be able to impose a charging order against it, but I don't see how you overcome the definitional challenge created by the Iowa Act.

 

This leads to some interesting asset protection planning.  Of course it is an annoyance to a creditor to have to go to Delaware to collect on an Iowa judgment.  But imagine the consternation of the creditor if the interest is in a Proprietary Limited Company in Australia. Happy New Year.

Court Affirms Charging Order as the Exclusive Remedy

It's just a hunch, but I am willing to bet the bank's lawyer in this case forgot to read the Illinois LLC Act, hence this opinion, In re Michael E. Lahood, 2009 Bankr. LEXIS 1832 (Bkrptcy. Ill. C.D. July 16, 2009).

Heartland Bank and Trust obtained a general lien on the personal property of the debtor.  It didn't, however, obtain a charging order with respect to the debtor's distributional interest in an LLC.  When it realized its mistake the bank tried a number of arguments to get its hands on the only asset with value in the debtor's estate.

First, it argued that the distributional interest in the LLC was subsumed in the general lien it had on the assets. That is, its broader more general lien included the LLC interest. The court said no, the legislature was very specific that the charging order was the exclusive remedy for an LLC distributional interest, the LLC interest was not a subpart of a general lien.

Then the bank argued that "exclusive" didn't really mean exclusive, but just one way to have a lien on an LLC distributional interest; its general lien was another (which sounds a lot like its first argument).  Nope, said the court, if the bank didn't obtain a charging order it had nothing but air in terms of the LLC interest.

-Marc Ward

Florida Charging Order Decision Expected Soon

Readers under the age of 50 might remember when I wrote about FTC v. Olmstead, et al, 2008 US App LEXIS 11393 (May 29, 2008)  back on June 2, 2008.  This is the case to decide whether under Florida law the charging order provisions of the Florida LLC Act could deflect a creditor's attempt to get voting control of a single member LLC.  The charging order provision of the Florida act is identical to the charging order provisions under Iowa Code Chapter 490A, but much different than Chapter 489.

The Florida Supreme Court heard oral arguments on the case on January 8, 2009.  Here is a link to a summary of those arguments.  http://tinyurl.com/cylz7h

-Marc Ward

A Charging Order Case to Place in Your Quiver

As Iowa lawyers know, we often lack Iowa corporate/LLC case law to support our legal positions.  This is certainly true of the law of charging orders.

Here is a case from Connecticut that confirms the statutory application of an LLC charging order law very similar to Iowa' s law.  Goldberg v. Winogradow, 2006 Conn. Super. LEXIS 3067 (2006).

-Marc Ward

Charging Orders and the Albright Decision

The charging order is an arcane legal construct that will be getting a lot more attention as the increasing popularity of LLCs meets the new economic realities.  Many judgment creditors will be surprised and disappointed to learn that their judgment entitles them to nothing more than the distributions (if any) from an LLC. That is why you see challenges to the charging order like the one I wrote about yesterday. 

One of the first cases to deal with charging orders and the single-member LLC was In re Albright, 2003 Bankr. LEXIS 291 (April 4, 2003).  Ashby Albright was the sole member of a Colorado LLC.  She was also its manager.  The LLC owned Colorado real estate.  Ashby, not the LLC, was the debtor in bankruptcy.

The bankruptcy trustee wanted to take control of the LLC and sell the real estate to satisfy Ashby's debts. Albright contended that the trustee was acting on behalf of her creditors and was entitled to nothing more than a charging order under Colorado law (the Colorado charging order provision at the time was almost identical to the current Iowa provision).  Of course, this was a case about the bankruptcy trustee's authority, not that of a judgment creditor.

The bankruptcy court rejected Albright's argument. The court concluded that (1) the LLC membership interest was personal property transferred to the bankruptcy estate when she filed for bankruptcy (including both the governance rights as well as economic rights even though Colorado law made it clear that a membership interest meant only economic rights), (2) because she was a sole member of the LLC, a transferee/assignee of an LLC membership interest could become a member without the consent of the members (as required by Colorado law), and (3) the charging order serves no useful purpose with respect to single-member LLCs.  The court granted control of the LLC to the bankruptcy trustee.

Albright is an example of a reverse piercing case.  Piercing the corporate/LLC veil is achieved by going through an entity to get to the assets of the owners to satisfy the entity's debts.  In a reverse piercing the creditor goes through an individual to get to the entity's assets to satisfy the individual's debts.

Albright also raises a lot of issues regarding the treatment of single-member LLCs in the context of charging orders and bankruptcy of the single member.  To be  continued...

-Marc Ward

Charging Orders and the Single Member LLC

Anyone who spends much time with LLCs soon realizes that some of the statutory provisions have some awkward concepts. Take the definition for example.  Under current Iowa law an LLC is defined as "an unincorporated association having one or more members."  Never mind how one person associates alone ("to join or collect in a relationship"  American Heritage Dictionary).  The new definition (actually two definitions) is not much better.  Section 489.102(9)(2009) describes an LLC as "an entity formed under this Act." (not very helpful).  Section 489.104(1)(2009) describes an LLC as "an entity distinct from its members."  This also describes corporations and the New York Mets.

Which brings me to charging orders.  The concept makes a lot of sense in the context of partnerships with multiple members.  It also makes sense with multi-member LLCs.  Things start to break down when the concept is applied to single member LLCs.  Consider the following example from Florida.

Defendants, Shaun and Julie, defrauded over 200,000 individuals in a credit card scam.  A receiver was appointed over their assets including several single-member Florida LLCs in which one or the other was the member.  The defendants objected to the order requiring them to surrender "all of their right, title and interest" in their membership interests in the single-member LLCs.

Florida's charging order provision is almost identical to Iowa's current law.  However, the new Iowa LLC law is much different (see prior post). 

Defendants claimed that the "plain language" of the Florida law makes no distinction between single and multiple-member LLCs.  Therefore, all the receiver was entitled to were distributions from the LLCs (fat chance).

The FTC (for whom the receiver was appointed) countered that a charging order makes no sense in the context of a single-member LLC and is not the exclusive remedy under Florida law.  As I explained in a prior post, the FTC argued that the point of a charging order is to protect the other partners from the uninvited guest, a purpose rendered meaningless in the single-member context.

Strict interpretation of the statute, the FTC argued, leads to absurd results.  For example, the Florida LLC Act provides that an assignee only becomes a member with the consent of the other members.  Unless single-member LLCs are treated differently than multiple-member LLCs the FTC, no assignee could ever become a member.

The FTC also made the point that under Florida law an LLC member ceases to be a member upon assignment of the member's interest.  Under the charging order provision this would leave a single-member LLC without a member to dissolve and wind up the LLC. 

Thus, according to the FTC the law must be harmonized to resolve these inconsistencies and allow a judgment creditor to step in and liquidate the assets of the LLC.  I think on this final point the FTC may be stretching the statute a bit;  having the rights of an assignee is not the same thing as being an assignee.

The 11th Circuit Court of Appeals certified this issue to the Florida Supreme Court in FTC v. Olmstead, et al, 2008 US App LEXIS 11393 (May 29, 2008).  The Florida Supreme Court's decision could have a huge impact on creditors of current Iowa LLCs through 2010, but limited applicability, if any, under the new Iowa LLC law.

I'll analyze this fact pattern in light of the new Iowa LLC Act in a future post.

-Marc Ward

Charging Orders and the New Iowa LLC Law

The charging order originates from the English Partnership Act of 1890 and the Uniform Partnership Act of 1914.  It exists in the current Iowa LLC Act (490A.904), but the new Iowa LLC Act provides more clarity and understanding to the concept.  The most important thing to know about charging orders is that they are "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."  Iowa Code Section 489.503 (2009).  (There are cases to the contrary on this point.)

The point of the charging order is to allow creditors a means to satisfy judgments (through distributions from the LLC) while protecting the LLC and the other members from having an unwanted third-party participate in the management of the LLC.

Under the new Iowa LLC law, a charging order is entered by a judge and represents a lien on a judgment debtor’s transferable interest (better, if inaccurately, known as the LLC membership interest).  It requires the LLC to pay over to the judgment creditor any distribution that would otherwise be paid to the judgment debtor. 

If necessary a court can appoint a receiver to collect the distributions.  If the distributions will not satisfy the judgment within "a reasonable time" a court can foreclose the lien and order the sale of the transferable interest.  A purchaser only obtains the transferable interest and does not become a member (i.e. has not voting or other management rights).  The court also has the authority to issue orders to the extent necessary to collect the distributions.

Satisfaction of the judgment by the debtor prior to foreclosure extinguishes the charging order.  The other members and the LLC also have the right to satisfy the judgment and step into the shoes of the judgment creditor and receive the distributions; the charging order is not extinguished in this case.

-Marc Ward