Thursday, March 28, 2013
Delaware Legislature to Consider Amendments to its Charging Order Statutes
There has been proposed for submission to the Delaware legislature amendments to the charging order provisions of the partnership, limited partnership and LLC Acts.
With respect to all of the statutes (Del. Code tit. 6 § 15-504(d); id. § 17-703(d); and id. § 18-703(d)), there would be added that:
attachment, garnishment, foreclosure or other legal or equitable remedies are not available to the judgment creditor.
It would appear the purpose of this proposal is to enhance Delaware’s “asset protection score” by precluding judgment creditors from foreclosing on the charging order lien and thereby realizing value more quickly than they might in waiting on distributions.
In the case of the charging order provision of the LLC Act there is as well to be added:
… whether the limited liability company has 1 member or more than 1 member.
I believe these amendments in general, and especially as set forth in the LLC Act, are bad policy. There is nothing special about the charging order lien that should preclude its foreclosure in the manner other liens may be foreclosed upon. Upon foreclosure the purchaser becomes only an assignee of the interest, having no right to participate in the business and affairs of the partnership/limited partnership/LLC. As such, the interest of the other partners and members are protected from interference by third-parties and in delectus personam is preserved.
Further, these limitations are especially pernicious in the case of a single-member LLC. Persons and entities may put assets into SMLLCs and when a judgment is rendered, simply allow the LLCs to accumulate income and defer making any distributions that would go to the judgment-creditor. Yes, doing so may create phantom income problems to the sole member, but maybe not. Assume Disreputable is the sole member of an LLC. The only asset of the LLC is unencumbered real property with a FMV of $1,000,000. Disreputable is the judgment-debtor of Reputable consequent to Disreputable’s intentional tort against Reputable. The LLC is not generating any income, so there are no distributions for Reputable, as the judgment-creditor, to capture pursuant to a charging order. If, however, Reputable could foreclose on the charging order the value of the property could be realized and Reputable could collect on his judgment. The amendments proposed to the Delaware LLC Act would preclude Reputable from doing so and allow Disreputable to avoid his obligation to satisfy the judgment.
Just because they do it in Delaware, it does not follow that it is a good idea.