Charging orders: the peculiar mechanism.

Author:Adkisson, Jay D.
 
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I. INTRODUCTION: HISTORY OF THE "PECULIAR MECHANISM" (1)

The charging order is an oddity of American law, occasionally appearing in old opinions pre-dating World War I to address odd situations in garnishment law, but is now almost exclusively found in the law of partnerships, and more recently limited liability companies ("LLCs"). Yet, in the area of LLCs, the charging order has taken on a life and aura of its own, with some states racing each other to have the "best" charging order provisions, so as to foster entity formation and registered agents business within those states. Creditors at the same time, while of course describing the "race" in less than flattering terms, have been developing their own strategies for defeating or circumventing the much-ballyhooed "exclusivity" of the charging order remedy. To understand why this unique remedy even exists, and why it has graced or cursed the area of partnership and LLC law, we must retrace the history of Anglo-American law to where a fork in the road developed in how each country would handle security interests that were created by creditor claims.

The lien was not a part of the English Common Law. Instead, it was first suggested in 1791 in the fonn of a "Mechanic's Lien" by Thomas Jefferson as a means to further the construction of the District of Columbia. After adoption by the Maryland legislature that same year, the concept quickly spread to other states. (2) The concept was not a particularly new one; the Romans had, centuries before, developed the concept of the obligare rem, by which a creditor took an interest in a pignus (the object of a security interest) to secure a debt. The Roman security interest had survived into the civil law of the continental European states, of which the Francophile attorney Jefferson was likely aware.

Now we have materialman's liens, tax liens, mortgage liens, attorney's liens, mineral liens, maritime liens, warehouser's liens, HOA liens, municipal liens, UCC liens, judgment liens (of which the charging order lien is but one), and the list goes on and on. Thanks to our third president, America has become the land of the free and the brave, and the lien.

While America went the way of the lien, the United Kingdom, instead, adopted the notion of the charging order to the same effect. That a debtor's interest in shares of stock could be "charged" was formalized in the first two Acts of Queen Victoria.

1. Judgments Act of 1838

XIV. Stock and shares in public funds and public companies belonging to the debtor, and standing in his own name, to be charged by order of a judge. And be it enacted, that if any person against whom any judgment shall have been entered up in any of her Majesty's Superior Courts at Westminster shall have any government stock, funds, or annuities, or any stock or shares of or in any public Company in England (whether incorporated or not), standing in his name in his own right, or in the name of any person in trust for him, it shall be lawful for a judge of one of the Superior Courts, on the application of any judgment creditor, to order that such stock, funds, annuities, or shares, or such of them or such part thereof respectively as he shall think fit, shall stand charged with the payment of the amount for which judgment shall have been so recovered, and interest thereon, and such order shall entitle the judgment creditor to all such remedies as he would have been entitled to if such charge had been made in his favour by the judgment debtor; provided that no proceedings shall be taken to have the benefit of such charge until after the expiration of six calendar months from the date of such order. (3) Thus, under United Kingdom law, the method for a judgment creditor to create and maintain a legal interest on the debtor's property was through the vehicle of the charging order. When the United Kingdom codified its partnership law in 1890, the charging order was thus the natural and accepted method of achieving that end.

2. Partnership Act of 1890 c. 39 (Regnal. 53 & 54 Victoria)

23. Procedure against partnership property for a partner's separate judgment debt.

(1) After the commencement of this Act a writ of execution shall not issue against any partnership property except on a judgment against the firm.

(2) The High Court, or a judge thereof, or the Chancery Court of the county palatine of Lancaster, or a county court, may, on the application by summons of any judgment creditor of a partner, make an order charging that partner's interest in the partnership property and profits with payment of the amount of the judgment debt and interest thereon, and may by the same or a subsequent order appoint a receiver of that partner's share of profits (whether already declared or accruing), and of any other money which may be coming to him in respect of the partnership, and direct all accounts and inquiries, and give all other orders and directions which might have been directed or given if the charge had been made in favour of the judgment creditor by the partner, or which the circumstances of the case may require.

(3) The other partner or partners shall be at liberty at any time to redeem the interest charged, or in case of a sale being directed, to purchase the same.

(4) This section shall apply in the case of a cost-book company as if the company were a partnership within the meaning of this Act.

(5) This section shall not apply to Scotland. (4)

It would be incorrect to pretend that America had totally ignored the concept of the charging order. In Cross v. Brown (5) and Hunter v. Strider's. (6) we find a pair of opinions where charging orders were used to enforce writs of garnishment. By and large, however, the procedure was an oddity that was employed in unusual circumstances where no clear remedy existed, and in such a rare case to borrow the concept of the charging order from the east side of the Atlantic seemed as good an idea as any other.

The point is that the charging order was not wholly alien to American law when it came time for the United States to codify its own partnership laws. (7) The Uniform Laws Commission, which at that time had a slavish adoration for the Law Commission in England that bordered on the embarrassing, borrowed heavily from the U.K.'s Partnership Act of 1890--including the concept of the charging order--even though the rest of American law had largely chosen and had already been following, for just short of a century, the different path of the lien beginning in 1791. (8)

Thus, in the charging order, we unfortunately ended up with an English remedy to accomplish what should have been done directly and simply through an American lien. The unexplained rumblings heard by the drafters of the Uniform Partnership Act ("UPA") of 1914 was Jefferson rolling in his grave.

3. Uniform Partnership Act of 1914

[section] 28. Partner's Interest Subject to Charging Order.

(1) On due application to a competent court by any judgment creditor of a partner, the court which entered the judgment, order, or decree, or any other court, may charge the interest of the debtor partner with payment of the unsatisfied amount of such judgment debt with interest thereon; and may then or later appoint a receiver of his share of the profits, and of any other money due or to fall due to him in respect of the partnership, and make all other orders, directions, accounts and inquiries which the debtor partner might have made, or which the circumstances of the case may require.

(2) The interest charged may be redeemed at any time before foreclosure, or in case of a sale being directed by the court may be purchased without thereby causing a dissolution:

(a) With separate property, by any one or more of the partners, or

(b) With partnership property, by any one or more of the partners with the consent of all the partners whose interests are not so charged or sold.

(3) Nothing in this act shall be held to deprive a partner of his right, if any, under the exemption laws, as regards his interest in the partnership. (9)

By contrast, the limited partnership was first introduced into American law by New York's Limited Partnership Act of 1822, which was itself based on the French societe en commandite (Jefferson would have been proud). Predictably, since the charging order was an English invention, New York's innovation had no charging order provision. (10) Although the limited partnership was alien to the English partnership law upon which the UPA of 1914 was based, when the Uniform Law Commission adopted the Uniform Limited Partnership Act ("ULPA") in 1916, section 22, providing for the English remedy of the charging order, was engrafted into the ULPA, apparently to conform the two acts.

We then waited some fourteen years after the 1914 adoption of the UPA before an appellate court was finally presented with a case involving a charging order arising under the UPA; the opinion being that of Rader v. Goldoff. (11) There, the creditor of a partner had obtained an injunction that compelled a bank to freeze partnership assets until they could be executed upon by the creditor. (12) The injunction was vacated, with the Court blandly reciting that the charging order provision of New York's UPA must be followed and also awarding the debtor $10 in costs. (13)

Soon thereafter, the California Court of Appeals took up the challenge in Sherwood v. Jackson, (14) and considered the case of one partner who had sued and obtained a personal injury judgment against the other partner--and then tried to dissolve the partnership so as to enforce the judgment against the debtor-partner's share of the assets. (15) The California panel nixed this attempt, holding (based upon the New York holding in Rader) that the creditor-partner's exclusive remedy was the charging order procedure. (16)

The California experience is important to us, for in 1946 it brought us Hensley v. Popkin, (17) which appears to be the first opinion to address the effect of a charging order as...

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