Tuesday, September 1, 2015

An Interesting (and Questionable) Decision on the Priority of Charging Orders

An Interesting (and Questionable) Decision on the Priority of Charging Orders

      A recent decision from the Colorado Court of Appeals addressed the question of which of two charging orders would first be enforced with respect to the judgment-debtor’s interest in an LLC. In this instance, ultimately it was the second awarded charging order that was given first priority with respect to distributions. McClure v. JP Morgan Chase Bank, N.A., No. 14CA1774 (Colo. Ct. App. August 13, 2015).
      In July, 2013, an Arizona court awarded Chase a judgment of approximately $20 million against Reginald Fowler. In November of that same year, that Arizona court issued charging orders in favor of Chase against Fowler’s interest in three Colorado LLCs. Those charging orders were served on three LLCs in December 2013, the same month in which the Arizona judgment was domesticated in Colorado.
      In March 2014, an Arizona court awarded a $1.5 million judgment in favor of the McClure’s against Fowler. In April, 2014, the McClure’s domesticated their Arizona judgment in Colorado.  Between May and July 2014, the Colorado District Court issued charging orders in favor of the McClures against Fowler’s interest in those same three Colorado LLCs with respect to which Chase held charging orders issued by the Arizona court.
      Finally, in August, 2014, the Colorado District Court domesticated the charging orders issued by the Arizona court in favor of Chase.
      In response to questions regarding which charging orders should first be satisfied with respect to Fowler’s distributions from the LLC, the Colorado trial court would hold that those in favor of the McClure’s had priority as they “were the first enforceable charging orders served on the [LLCs] and, hence, they have priority over [Chase’s] Arizona charging orders.” Slip op., ¶ 5.
      On appeal, the crux argument made by Chase was “that the district court erred when it ruled that Chase’s Arizona charging orders were unenforceable in Colorado until what they were domesticated in Colorado.” Slip op., ¶ 9. This argument would ultimately be rejected by the court.

      Essentially, the court looked to the Colorado enactment of the Uniform Enforcement of Foreign Judgments Act and determined that “a charging order is a judgment subject to Enforcement Act.” Slip op., ¶ 13. Hence, enforcement of the Arizona issued charging orders was conditioned on domestication in Colorado “Specifically, to enforce a foreign charging order against a Colorado LLC based on domestication, the creditor would have to domesticate the charging order and not just the judgment on which the charging order is based. This is so because the charging order - unlike the judgment which it is based - requires the Colorado LLC to take action, namely, to pay LLC distributions to the judgment creditor.” Slip op., ¶ 14.  From there, as to priority, the court would determine that:
We hold that the priority of charging orders issued against Colorado LLCs is determined by first-in-time service of charging orders enforceable in Colorado. Charging orders that are enforceable in Colorado include both those issued by Colorado courts as well as foreign charging orders that have been domesticated in Colorado courts. Slip op., ¶ 17.

      This ruling as to priority and focus upon domestication in the state in which the LLC organized is based upon the Colorado Court of Appeal’s treatment of the LLC’s interest, an intangible, as being located in Colorado irrespective of the location of the judgment debtor, the court citing in support thereof In re Blixseth, 484 B.R. 360, 369 (B.A.P. 9th Cir. 2012) and Koh v. Inno-Pacific Holdings, Ltd., 54 P.3d 1270, 1272 (Wash. Ct. App. 2002). But is that actually the case? Other courts have held that the intangible interest in an LLC (or in a partnership for that matter; they both use charging orders as a remedy) travels with the owner. It was on this basis that the Florida court, in Wells Fargo Bank, N.A. v. Barber, 2015 WL 470589 (M.D. Fla. Feb. 4, 2015), was able to undertake a conflicts analysis to determine whether Florida or the law of Nevis, the jurisdiction in which a particular LLC owned by the judgment-debtor was organized, would control. Furthermore, the court seemed to treat the charging order as a judgment against the LLC (this is a point as well addressed by Jay Adkisson in his column on this decision; HERE IS A LINK to that column). That is not, however, the case. While the LLC is obligated to comply with the terms of the order once it has notice thereof, there is no “judgment” against the LLC.  Rather, the charging order is only a lien on the distributions made as to the judgment-debtor’s interest in the LLC.  That a charging order is not a judgment against the LLC is evidenced by the fact that it need not even received notice of the hearing in which the charging order is sought. Were the LLC a party to the charging order, the absence of notice to it of that hearing would be a manifest violation of due process.
     Life would have been far simpler had Court of Appeals simply held that the charging orders will be enforced in the order in which they are granted, with the LLC afforded some protection based upon when it first has notice (if the LLC is notified of the second issued charging order first, and then diverts a distribution to that judgment-creditor before receipt of the first entered charging order, the LLC should not be criticized), but clearly life is not going to be so simple for us. Hopefully future courts will adopt the more streamlined approach based upon the acknowledgment that the charge order is not a judgment against the LLC.

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