An Interesting Critique of the Limits of the Charging Order Remedy

An Interesting Critique of the Limits of the Charging Order Remedy

      A recent decision of a Michigan Bankruptcy Court offers some interesting commentary on the charging order remedy and some insight as to the apparent view of the powers of a Chapter 7 trustee vis-à-vis a single-member LLC.  In re: Randy K. Dzierzawski, Case No. 13-47986, 2015 WL 1612092 (Bankr. E.D. Mich. April 10, 2015)

      Dzierzawski (the “Debtor”), having some two years ago filed for Chapter 7 protection, sought to have the bankruptcy dismissed.  He owed a variety of significant debts including a judgment debt of over $1,000,000 to Vulpina.  The Debtor had transferred a 99% interest in Vinifera Wine Co., LLC to his spouse Kimberly; the opinion does not provide the debtor of the transfer vis-à-vis the entry of the judgment in favor of Vulpina.  The Bankruptcy Court had given Vulpina leave to pursue an action to have that transfer set aside under the Michigan Fraudulent Transfer Act.

      The Debtor sought to have his bankruptcy dismissed with prejudice.  In a particularly thorough analysis of the consequences of doing so, that motion was denied.

      Essentially, if Vulpina was successful in its fraudulent transfer act action, the Debtor would again be the sole member of the Vinifera LLC.  Outside of bankruptcy Vulpina would be restricted to a charging order against the Debtor’s interest therein.  Under Michigan law there is no foreclosure on the charging order remedy.  Vulpina could be left with a charging order even as the Debtor could manipulate Vinifera to insure that few if any distributions would flow to Vulpina’s benefit.

But Vulpina argues that it may be greatly prejudiced in its ability to realize any collection of its judgment from the Vinifera asset, if Vulpina must pursue its fraudulent transfer action outside of bankruptcy.  Outside of bankruptcy, Vulpina’s ability to realize any value from the Debtor’s membership interest in Vinfera may be greatly limited by Michigan’s charging-order statute that applies to limited liability companies.  Under that statute, Mich. Comp. Laws § 450.4507, a judgment creditor of a member of an LLC is limited to obtaining a charging order and lien against the membership interest of the judgment debtor.  The judgment creditor cannot foreclose on that lien, and the only thing the charging order gives the creditor is the right to receive any distributions that the member is entitled to or becomes entitled to in the future. 

      Conversely, in bankruptcy, upon a successful challenge to the transfer to Kimberly, the Bankruptcy Court could access Vinifera’s assets for the benefit of Vulpina.

By contrast, the Debtor and Vulpina appear to agree that if Vulpina is able to pursue its avoidance action within the bankruptcy case, and prevail, the resulting status of the Debtor as the 100% member of Vinifera would give the Chapter 7 Trustee the ability to cause a liquidation of the assets of that LLC, for the benefit of the creditors, including Vulpina, the largest creditor.

In their arguments, the Debtor and Vulpina both assume that if the Chapter 7 Debtor in this case is established as the sole member of this LLC, the Chapter 7 Trustee could step into the Debtor’s shoes as the sole member of the LLC, and exercise the Debtor’s rights to control the management of the LLC.  Exercising such management power, the Trustee could cause the LLC to make distributions to the bankruptcy estate, or cause the LLC to sell its assets.  Or, the parties seem to assume, the Chapter 7 Trustee could exercise the Debtor’s 100% membership rights under Mich. Comp. Laws Ann. § 450.4801 to cause the LLC to dissolve, wind down, and thereby liquidate under Michigan law.  If such a liquidation of the LLC occurred, the bankruptcy estate, as owner of the Debtor’s 100% membership in the LLC, would receive the net proceeds of the LLC’s liquidation – i.e., the proceeds that were left after the creditors of the LLC were satisfied.

      In support of this right the Court listed a series of decisions wherein a trustee was trusted as succeeding to not only the economic rights but also the management rights of a bankrupt sole member and as well similar authorities from multiple – owner structures.

      Because Vulpina would lose remedies if the bankruptcy were dismissed, the motion was denied.

      One quibble with the decision is its statement that the basis of the charging order is the rule of pick your partner.  In fact that is not the case.  Rather, the charging order protects the asset segregation effect of the business entity, a rule that has important consequences to the creditors of the venture vis-à-vis judgment-creditors of a member-partner.