A Tale of Two Charging Orders

Many practitioners think limiting creditors of an LLC member to a “charging order” is a panacea. Other practitioners think the benefits of charging orders are overblown. Who is correct? Can a member’s judgment creditor access LLC property? In addition to a recent case from the Alabama Supreme Court[1], two other recent cases illustrate how charging orders operate in practice. First, the Tenth Circuit Court of Appeals recently affirmed a trial court’s decision to force the sale of LLC property to be distributed to the debtor-member’s creditor.[2] Next, a U.S. District Court in Georgia required a member’s judgment creditor to return funds to an LLC that it garnished[3]. Although these cases may appear to reach opposite results, there is good reason for the difference in outcome.

EarthGrains

In the Earthgrains case, a charging order was entered against the debtor’s interests in a family LLC. The terms of the charging order were as follows:

Sycamore Family LLC … is ordered to pay directly to [EarthGrains] all assets, profits, proceeds, distributions, advances, draws, and any other remuneration due to [Leland] Sycamore as a result of his ownership interest in Sycamore Family LLC, including without limitation any transfers characterized or designated as payment for [Leland’s] tax liabilities, salary, wages, reimbursements, or loans, until the [judgment against Leland] is satisfied in full.

Notwithstanding this order by the court, years passed without any payment being made to Earthgrains, the creditor. Earthgrains successfully sought the appointment of a receiver to account for any wrongfully withheld distributions. The receiver submitted an accounting of distributions the LLC made, both actual and constructive, without rendering any payment to Earthgrains as required by the charging order. The receiver also recommended that the court compel the LLC to pay all of its cash to Earthgrains and to liquidate its real estate holdings to satisfy the distributions which previously should have been paid to Earthgrains.

The court noted that a charging order “constitutes a lien on a judgment debtor’s transferable interest”[4] and that “after the limited liability company has been served with the charging order” it “requires the limited liability  company to pay over to the person to which the charging order was issued any distributions that otherwise would be paid to the judgment debtor.”[5] Having agreed with the receiver that distributions were made in violation of these requirements, the court cited the statutory power to “make all other orders necessary to give effect to the charging order”[6] in agreeing with the receiver’s recommendations. The Tenth Circuit Court of Appeals found this to be permissible notwithstanding Utah’s statute stating that a charging order is the “exclusive remedy” for a judgment creditor seeing to satisfy their judgment against LLC interests.[7]

McLeod

Similar to Earthgrains¸ the relevant story here in McLeod begins with the creditor’s request for the issuance of a charging order against a member’s LLC interest. The relevant Georgia statute in this case states as follows:

a judgment creditor of a member of a limited liability company has a statutory right to collect a judgment debt from the member’s distributional interests in a limited liability company by obtaining a charging order and diverting payments to the creditor which would otherwise have been made to the member.[8]

Without the court having ruled on the charging order, the creditor, McLeod, began a garnishment action against the LLC’s bank account. The LLC’s bank, raising certain procedural objections to the garnishment, deposited the LLC’s funds with the registry of the court.

The LLC moved to quash and/or dismiss the garnishment. The court, finding that McLeod failed to comply with Georgia’s garnishment statute, ordered the funds returned to the LLC’s bank account. The court refused to grant the LLC’s request for temporary restraining order prohibiting McLeod from collecting against the LLC. However, the court issued “a strong warning against continuing to attempt to circumvent the law on his mission to collect the default judgment entered in this case.”

LLC as a Party to Charging Order Proceedings

An interesting note in both Earthgrains and McLeod is how the courts handled whether the LLC should be a party to proceedings related to application of the charging order. In Earthgrains, the LLC filed the appeal to the Tenth Circuit. The court noted that “it is a ‘well settled’ general rule that ‘only parties to a lawsuit, or those that properly become parties, may appeal an adverse judgment’.”[9] However, in spite of this general rule, the U.S. Supreme Court has affirmed the right of a nonparty to appeal when bound by the nature of the “adjudication upon the interested nonparty.”[10] Ultimately, the court allowed the appeal to proceed notwithstanding the appeal by a nonparty who never sought to intervene in the underlying action due to the LLC’s “unique interest” in the outcome. The outcome directly affects the LLC’s interests and the LLC actively participated in proceedings prior to the appeal rather than taking a wait-and-see approach.

In McLeod, the LLC moved to intervene in the proceedings under Fed. R. Civ. P. 24(a)(2) which allows intervention by a party who “claims an interest relating to the property…that is the subject of the action.” The court allowed the LLC to intervene but noted this was required particularly because McLeod sought to garnish the LLC’s accounts prior to the issuance of the charging order. Had the charging order been issued, the LLC is not a necessary party “because the limited liability company has no right or direct interest that is affected by the charging order.”[11]

Discussion

These cases illustrate, as we often see, that administration of charging orders can be messy. Parties and courts are commonly dealing with confusing issues and unwinding misadministration. Ultimately, however, although these cases reached different outcomes, there is a very reasonable explanation for why that occurred.

In Earthgrains, the LLC failed to comply with the terms of the charging order. It made distributions to members, actually and constructively, without accounting to the judgment creditor in whose favor a charging order had been issued. At that point, the charging order creditor converted from merely having a lien on the debtor-member’s LLC interests to having a claim against the LLC itself for failing to comply with the charging order.[12] This case illustrates that LLCs which seek to circumvent a charging order can find themselves the target of enforced collections. Once distributions are made to other members, but not the judgment creditor, the judgment creditor has a direct claim on the LLC for its unpaid portion of the distribution. At that point, courts, as in Earthgrains and SE Property Holdings, LLC[13], have found that LLC assets are placed directly in the crosshairs of a creditor.

On the other hand, until the LLC has violated any of the requirements of a charging order, there is no right of a creditor to proceed against LLC assets. This was illustrated in McLeod. Of course, in that case, the charging order had yet to even be issued. However, even had it been, until the LLC failed to comply with the requirements of the charging order, neither would the LLC have any direct interest in the charging order nor would the creditor have any right to proceed against LLC assets. As stated above, the McLeod court noted that “when a charging order is issued, it is not necessary for the limited liability company to be made a party to the proceeding ‘[b]ecause the limited liability company has no right or direct interest that is affected by the charging order.'”[14]

These cases also support the outcome of what occurred with respect to the LLC as a party to proceedings relating to the charging order. The LLC ordinarily has no interest in the charging order. Rather, the LLC merely makes distributions otherwise attributable to the debtor-member pursuant to the terms of the charging order (whether directly to the creditor or to the court). There is no need for the LLC to participate in litigation involving the charging order. However, once the creditor seeks to proceed directly against LLC assets, the LLC becomes a proper party as its own assets are directly affected by the litigation.

Conclusion

While Earthgrains and McLeod appeared to reach opposite conclusions, that is not necessarily the case. Rather, each of these cases support the notion that LLC’s subject to charging orders have no direct interest in the matter other than to comply with the terms of the charging order. However, once the charging order is in effect, any LLC which fails to comply with the terms of the charging order, risks becoming the subject of enforced collection action by the judgment creditor.

At the end of the day, practitioners who talk about the benefits of charging order protections are neither selling a panacea nor snake oil. Rather, they are discussing the legitimate benefits of charging order protections. Those protections are real and can serve to keep LLCs and non-debtor members of those LLCs from experiencing negative effects of a debtor-member’s judgment. That protection has limits. Those who believe an LLC subject to a charging order can simply refuse to make distributions to the judgment debtor while allowing the members to live out of the LLC, use LLC assets for no consideration, or otherwise benefit from LLC assets, would be well served to look at these cases. While the protections are real and valuable, when they are abused, the plan can backfire.

 

[1] Ex Parte SE Property Holdings, LLC, 2021 WL 5145446 (Ala. 2021). See also, Edmondson, Gray, “Charging Orders – SE Property Holdings, LLC,” Jan. 25, 2022, https://esapllc.com/charging-orders-se-property-holdings-llc-2022/#_edn10.

[2] Earthgrains Baking Companies, Inc. v. Sycamore, 2022 WL 433486 (10th Cir. 2022).

[3] McLeod v. Bruce, 2022 WL 731517 (M.D. Georgia 2022).

[4] Utah Code Ann. § 48-3a-503(1).

[5] Id.

[6] Utah Code Ann. § 48-3a-503(2)(b).

[7] Utah Code Ann. § 48-3a-503(8).

[8] O.C.G.A. § 14-11-504.

[9] Citing Marino v. Ortiz, 484 U.S. 301, 304 (1988).

[10] Devlin v. Scardelletti, 536 U.S. 1, 8 (2002).

[11] Citing Mahalo Inv. III, LLC v. First Citizens Bank & Trust Co., Inc. 330 Ga. App. 737, 743 (2015).

[12] See, e.g., § 404(d) Uniform Limited Liability Company Act (2006), as amended in 2013, stating that “If a member or transferee becomes entitled to receive a distribution, the member or transferee has the status of, and is entitled to all remedies available to, a creditor of the limited liability company with respect to the distribution.”

[13] See supra Note 1.

[14] See supra note 11.