The Company They Keep: Charging Orders Under The New LLC Act – Feb 2015
Terry Jessop & Bitner Newsletter
Issue 18, February 2015
One way to collect from a debtor who owns an interest in a Utah limited liability company is to “charge” the debtor’s interest. A charging order is basically a lien on the debtor-member’s LLC interest. Under Section 48-3a-503 of Utah’s new LLC Act (“the Act”), after a creditor obtains a judgment against a debtor the creditor may, by application to the court, obtain a charging order against the debtor’s transferable interest in the LLC. Once the LLC has been served with the order, the LLC must pay the creditor any distribution that would otherwise be made to the debtor-member. While this sounds easy you’ll need help from a qualified attorney to navigate around pitfalls which lie in wait.
Pressure on the Debtor
A charging order applies pressure to the debtor and his company, but it does not give the creditor legal authority to force the LLC to make distributions. A charging order does not make a creditor a member of the LLC. Thus, the creditor has no vote on distribution decisions. To enforce the charging order the creditor may ask the court to appoint a receiver or subpoena records to verify information related to the distributions that are subject to the charging order. However, doing so does not guaranty that the LLC will make a distribution.
Will Foreclosure Help?
If the creditor can show that distributions from the LLC will not pay the debt within a reasonable time, the creditor can ask the court to foreclose the lien and order the sale of the debtor-member’s interest. This pressure may motivate the debtor or other members of the LLC to pay the creditor to satisfy the judgment before the foreclosure order. But if the sale occurs, the purchaser of the interest only gets the rights of a transferee of that interest and does not become a member of the LLC. At a foreclosure sale the value of the interest may be highly discounted because a transferee has no rights to manage the LLC and generally is not allowed any access to the LLC’s records. They essentially become a super-silent non-partner.
Single Member LLC’s
When a member’s creditor comes into play the purpose of the Act is to shield the other members of the LLC from the creditor. But in a single member LLC, there are no other members. If a creditor convinces the court to foreclose the lien and order the sale of the interest, the purchaser obtains the debtor-member’s entire interest and thereby becomes the sole member of the LLC. There is no discount in value of the interest because the purchaser is the member; she is not hamstrung by the limited rights of a transferee as is the case with a multiple-member LLC. The debtor-member then becomes a dissociated member and loses his right to participate in the management and conduct of the company’s affairs.
Again, this may seem to be a great result for the purchaser because she now has control over the LLC. However, the purchaser not only obtains control over the assets of the LLC, but also becomes responsible for the obligations that come with being a member, including fiduciary duties to transferee non-members and dissociated members. A creditor needs to be careful about taking on these responsibilities even if she gets control over the assets.
A creditor should review all the issues before charging head-first into collecting from a debtor’s LLC. Seek competent counsel. Please contact us if you need help determining if a charging order is a good idea in your case.
© Terry Jessop & Bitner February 2015