Charging Orders You Better Get Used To Them, 0717 SCBJ, SC Lawyer, July 2017, #39

Author:Shawn M. Flanagan, J.
 
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Charging Orders You Better Get Used To Them

Vol. 29 Issue 1 Pg. 39

South Carolina BAR Journal

July, 2017

Shawn M. Flanagan, J.

A “charging order” allows a judgment creditor to receive a debtor’s share of distributions from a limited liability company (LLC) or a partnership. With the proliferation of LLCs in the last 20 years, understanding “charging order” concepts has taken on increased importance. The focus of this article is to discuss charging orders and issues arising from charging orders in the context of LLCs.

Illustration of a charging order

Assume a creditor obtains a judgment against a person (the debtor). The creditor knows or discovers that the person owns an interest in a limited liability company (LLC) or a partnership. The creditor can obtain a “charging order” from a court and deliver the order to the debtor and the LLC/partnership.

A charging order constitutes a lien on the debtor’s distributional interest in the LLC or partnership. If the LLC or partnership makes a distribution to its owners, the share that would have been paid to the debtor will instead be paid to the creditor toward satisfaction of the judgment. A “distribution” from an LLC or partnership is akin to a “dividend” from a corporation. S.C. Code Ann. Section 33-44-504 “provides the exclusive remedy by which a judgment creditor of a member or a transferee may satisfy a judgment out of the judgment debtor’s distributional interest in a limited liability company.”[1]

History of charging orders

It is easier to understand charging orders if you understand the policy reasons behind the law.

The following synopsis from the Maryland Court of Special Appeals provides some helpful background: A charging order is the statutory means by which a judgment creditor may reach the partnership interest of a judgment debtor. Prior to its availability, the courts would resort to common law procedures for collection that were ill-suited for reaching partnership interests. Typically, despite the fact that individual partners do not have title in partnership property, partnership property would be seized under writs of execution; the debtor partner’s interest in the partnership would be sold, often to the judgment creditor …; and the sale of the debtor partner’s interest would result in compulsory dissolution and winding up of the partnership. As noted by at least one jurist, ‘[a] more clumsy method of proceeding could hardly have grown up.’ … The charging order solution to this procedural nightmare appeared first in the Partnership Act adopted in England in 1890, and then in the 1914 Uniform Partnership Act (UPA) at § 28. [2]

As noted in the Prefatory Note to the Uniform Limited Liability Company Act (2013): “The charging order mechanism … is an essential part of the “pick your partner” approach that is fundamental to the law of unincorporated businesses.”

Charging orders have been available in South Carolina for a long time. Limited research indicates that the South Carolina Uniform Partnership Act (SCUPA) has contained a charging order statute since at least 1950.[3] Having compared the current Section 33-41-750 with the SCUPA statutes in effect in 1950, 1952 and 1962, the language has remained the same for over 60 years. S.C. Code Section 33-42-1230 is the current charging order statute applicable to limited partnerships. The application of charging orders to limited partnerships in South Carolina was traced by this author back to 1960.[4]

The LLC: The most popular choice of entity

It is no longer possible for charging orders to exist in obscurity, living in the shadows. Everything changed with the adoption of the South Carolina Uniform Limited Liability Company Act of 1996 (the Act). The number of domestic legal entities formed with the South Carolina Secretary of State’s Office from July 1, 2015 to June 30, 2016 were as follows: Corporations ................... 1,784 Limited Liability

Companies .................... 31,019 Limited

Partnerships ....................... 106

Limited Liability Partnerships ...................... 190

These statistics lead to an obvious conclusion. Over the last 20 years, limited liability companies have become the legal entity of choice in this state. It is because of this fact that charging orders have become increasingly relevant to the practice of law. (Note: Charging orders only apply to LLCs and partnerships. Charging orders do not apply to corporations.) To see a sample charging order, your attention is directed to the following form: § 18:4. Charging order, 11 West’s Legal Forms, Debtor & Creditor Non-Bankruptcy Rights and Remedies, Part III. Judicial Collection, Chapter 18. Charging Orders.

Foreclosure of lien on distributional interest

Prior to a foreclosure, a creditor with a charging order is only entitled to share in distributions from the LLC in an amount equal to the judgment. If, however, the creditor purchases the distributional interest at a foreclosure sale, the creditor is entitled to share in any and all distributions from the LLC after the purchase (including distributions made in liquidation of the LLC). Where the charging order grants the creditor a lien, the purchase of a distributional interest at a fore-closure sale makes the creditor an economic owner in the LLC (albeit an owner without voting rights).

Under the Act, the equitable remedy of foreclosure is an option with respect to a charging order lien on a distributional interest in an LLC. The Act provides that a “court may order a foreclosure of a lien on a distributional interest subject to the charging order at any time.”[5]

The purchaser at the foreclosure sale has the “rights of a trans-feree.”[6] A foreclosure of a lien on a distributional interest entitles the purchaser to receive the debtor-member’s pro rata share of all distributions from the LLC. However, except for the right to receive a pro rata share of all distributions (if any), a “transferee” has almost no rights in an LLC.

Whether it is in the best interest of a judgment creditor to seek foreclosure is going to be based on the facts and circumstances of each case. If a creditor is already a “member” in the subject LLC, a purchase at a foreclosure sale is more likely to be to the advantage of the creditor. If a creditor is not already a member, foreclosing is less likely to be advantageous, unless the LLC owns valuable assets and the purchase price is not significant in comparison. Foreclosure is more likely advantageous in the case of a single-member LLC than it is in the case of a multiple member LLC.

Single-member LLCs

Foreclosing on a single-member LLC in South Carolina is likely to be different from foreclosing on an interest in a multiple-member LLC. The following is from the Comment to §503 of the Uniform Limited Liability Company Act (2013): “Subsection (f)—The charging order...

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