Tuesday, July 11, 2017

Charging Orders, Olmstead, and RULLCA (2013)

     Most LLC statutes provide an exclusive charging order remedy that creditors can use against a member's interest.  A charging order is effectively a lien on the member's transferable interest (i.e., the member's financial rights) in the LLC.  If a court imposes a charging order, the judgment creditor is entitled to any distributions made by the LLC that would otherwise have gone to the debtor-member.  The entitlement to distributions continues until the judgment creditor has received enough proceeds to pay off the judgment.  The creditor is not permitted, however, to execute on a member's interest in the same way that a creditor could normally execute on the debtor-member's non-exempt personal property.  If the LLC does not make sufficient distributions, some statutes allow a court to order foreclosure of the charging lien, which effectively results in a sale of the debtor-member's transferable interest.  Significantly, even with foreclosure, the purchaser at the foreclosure sale will only become a transferee and will not have the status of a member (nor the rights of a member).  This charging order scheme protects the rights of the non-debtor members to control the admission of new members to the LLC.

     In Olmstead v. Federal Trade Commission, 44 So. 3d 76 (Fla. 2010), the Supreme Court of Florida held that, in a single-member LLC, the statutory charging order procedure did not preclude a creditor from executing on an ownership interest.  The court acknowledged that a charging order provision is generally designed to preserve a non-debtor member’s right to block the admission of a new member (and the exercise of accompanying management rights), but it implied that this right was not implicated when the debtor was the sole member of the LLC.  The court was particularly influenced by the fact that the Florida LLC statute at the time did not indicate that a charging order was a creditor’s exclusive remedy, while the Florida general partnership and limited partnership statutes did so provide.  Although the court appeared to limit its holding to disputes involving a single-member LLC, the dissent noted that the court’s emphasis on the lack of exclusivity language in the statute would seem to extend its holding to multiple-member LLCs. 

     In response to Olmstead, the Florida legislature amended its charging order statute to make it clear that multiple-member LLCs were not affected by the decision.  With respect to single-member LLCs, however, the Florida statute provides that a court may order a foreclosure sale of the member’s interest.  The purchaser at the sale “obtains the member’s entire [LLC] interest, not merely the rights of a transferee”; consequently, “[t]he purchaser at the sale becomes the member of the [LLC].” Fla. Stat. § 605.0503.

     The 2013 Revised Uniform LLC Act also provides that a charging order (with the possibility of foreclosure) is a creditor’s exclusive remedy, see RULLCA (2013) § 503(h), but it carves out a separate Olmstead-like treatment for single-member LLCs.  If a court orders foreclosure of a charging order in a single-member LLC, “the purchaser at the sale obtains the member’s entire interest, not only the member’s transferable interest,” and “the purchaser thereby becomes a member.”  Id. § 503(f).  In discussing this procedure, the comment to § 503 states the following:

The charging order remedy—and, more particularly, the exclusiveness of the remedy—protect the “pick your partner” principle. That principle is inapposite when a limited liability company has only one member. The exclusivity of the charging order remedy was never intended to protect a judgment debtor, but rather only to protect the interests of the judgment debtor’s co-owners.

Put another way, the charging order remedy was never intended as an “asset protection” device for judgment debtors.  Accordingly, when a charging order against an LLC’s sole member is foreclosed, the member’s entire ownership interest is sold and the buyer replaces the judgment debtor as the LLC’s sole member.

     What do you think?  Did the Revised Uniform LLC Act make the right decision in following Olmstead for single-member LLCs?

http://lawprofessors.typepad.com/business_law/2017/07/most-llc-statutes-provide-an-exclusive-charging-order-remedy-that-creditors-can-use-against-a-members-interest-a-charging.html

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Comments

FWIW, there are a couple of articles on this, including one by me at 66 Bus. Law. 339 (2011). Bill

Posted by: Bill Callison | Jul 11, 2017 8:36:56 AM

Also, I think there is a larger question re when pick your partner (grounded in liability, agency, etc rules) should play in LLC land. I think it has been assumed (sort of a mantra), but I am not sure there is a strong theoretical basis for the assumption.

Posted by: Bill Callison | Jul 11, 2017 8:40:50 AM

Section 503(h) is another instance where, under the guise of “harmonization,” ULC took the opportunity to modify its 2006 uniform LLC statute. The change in § 503(h) (perhaps better described as an addition) has little to do with harmonizing the LLC statute with ULC’s other uniform statutes. Indeed, the official comments to § 503(h) concede this: “This subsection was added during the Harmonization Project but not for the purposes of harmonization.” I would have preferred that ULC be more transparent about what it was actually doing in its so-called “harmonization” project. Robert Keatinge has a nice chapter about this problem in the recent Hillman and Loewenstein handbook.

Posted by: Mohsen Manesh | Jul 12, 2017 11:22:54 AM

Hi Doug,

My thoughts on the topic are contained in my chapter in Hillman & Loewenstein's book.

Posted by: Franklin Gevurtz | Jul 13, 2017 8:40:19 PM

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