Wednesday, May 20, 2015

Confusion Over Charging Orders – Distributions of Contributed Capital

Confusion Over Charging Orders – Distributions of Contributed Capital


            A recent decision from the Ohio Court of Appeals held, inter alia, that a charging order did not extend to distributions from the LLC of contributed capital, saying those amounts are not “distributions.”  Knollman-Wade Holdings, LLC v. Platinum Ridge Properties, LLC, No. 14AP-595, 2015 WL 1913565 (Ohio Ct. App. 10th Dist. April 28, 2015).  With due respect, this decision is incorrect.

            Knollman-Wade Holdings (“KWH”) held a judgment against against Platinum Ridge Properties (“PRP”) for some $288,330.07.  Seeking to collect thereon, KWH sought a charging order against PRP’s interest in Platinum Polaris partners, LLC (“PPI”).  PRP objected to the tendered charging order, asserting that it went beyond the scope of the statute to include withdrawals of contributed capital.  The trial court entered the requested order, and this appeal followed.

            The Ohio Court of Appeals wrote:

Pursuant to R.C. 1705.19(A), a judgment creditor of a member of a limited liability company may apply to the court of common pleas to charge the membership interest of the member with payment of the unsatisfied amount of the judgment with interest. A charging order is a judgment creditor’s sole and exclusive remedy to satisfy a judgment against the membership interest of a limited liability company member. R.C. 1705.19(B). A membership interest is defined by R.C. 1705.01(H) as a “member’s share of the profits and losses of a limited liability company and the right to receive distributions from that company.” Id. at *2

After discussing rules of statutory construction, the Court determined:

The charging order issued by the trial court impermissibly expands the scope of R.C. 1705.18(A). The plain language of the statute does not include either “withdrawals of capital” or payments made “through” a judgment debtor as items subject to a charging order. Rather, R.C. 1705.18(A) expressly provides that an assignee such as KWH is entitled only to receive “the distributions of cash and other property and the allocations of profits, losses, income, gains, deductions, credits, or similar items” to which PRP would be entitled. Had the General Assembly intended what KWH contends, it could have employed language to that effect. Because it did not, we conclude the trial court erred in inserting these phrases into the charging order. Id. at *4.

For that reason the portion of the charging order which extended its reach to “withdrawals of capital” was set aside.

            Again, with due respect, the Court of Appeals got it wrong. 

            While the language from *2 of the decision quoted above is correct, the Court of Appeals failed to analyze whether a return of contributed capital is a “distribution.”  In fact it is.

            Under the Ohio LLC Act, capital contributed to an LLC is property of the LLC – a member will typically receive a limited liability company interest, which is personal property, in consideration of the contribution.  See Ohio Code  § 1705.09(A) (“The contributions of a member may be made in cash, property, services rendered, a promissory note, or any other binding obligation to contribute cash or property or to perform services; by providing any other benefit to the limited liability company; or by any combination of these.”); id. § 1705.17 (“A membership interest in a limited liability company is personal property.”); id. § 1705.34 (“Real and personal property owned or purchased by a limited liability company shall be held and owned in the name of the company.”)
     Consider ABC, LLC, to which Amy contributes unimproved real property, Whiteacre.  Once she makes that contribution Amy has not ownership interest, direct or indirect, in Whiteacre.  Rather, Whiteacre belongs to ABC, LLC.  Amy’s contribution to ABC, LLC, is valued as the members agree among themselves, and that value is utilized in determining the shareing ratio in distributions made by the LLC.  See, e.g., Ohio Code § 1705.11(A) (“A [LLC] from time to time may distribute cash or other property to its members. Unless otherwise provided in the operating agreement, distributions that are made shall be made to the members in proportion to the value as stated in the records of the company required to be kept under section  1705.28 of the Revised Code of the contributions made by each member to the extent the contributions have been received by the company and have not been returned.”)

            Upon liquidation, the statute makes clear that there will be “distributed” to the members a traunch determined by reference to their respective capital contributions. See id. §1705.46:

(A) Upon the winding up of a limited liability company and the liquidation of its assets, the assets shall be distributed in the following order:

(1) To the extent permitted by law, to members who are creditors and other creditors in satisfaction of liabilities of the company other than liabilities for distributions to members;

(2) Except as otherwise provided in the operating agreement, to members and former members in satisfaction of liabilities for distributions to members;

(3) Except as otherwise provided in the operating agreement, to members as follows:

(a) First, for the return of their contributions;

(b) Second, with respect to their membership interests. (emphasis added).

      Simply put, a “distribution” is the means by which the assets of the LLC are converted into the property of the members – until the declaration of a distribution the LLC’s assets are its as a legal entity.  The only means by which an LLC’s member may receive either the positive fruits of the venture or the assets contributed to the LLC (either in kind or in cash) is for the LLC to declare a “distribution.”

            A charging order that by the terms of the statute extends to the distributions made by the LLC encompasses withdrawals and returns of contributed capital.

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