Wednesday, October 14, 2015

California Court Adds Unnecessary Complexity to Issuance of Charging Order

California Court Adds Unnecessary Complexity to Issuance of Charging Order

      In a recent decision from a US District Court in California, a charging order was denied on the basis that the judgment-creditor had not proved that the judgment-debtor was in fact a member of the LLCs to whom the charging orders would be delivered.  Textron Financial Corp. v Gallegos, Case No. 15cv1678-LAB (DHB), 2015 U.S. Dist. LEXIS 137133, 2015 WL _______ (S.D. Ca. Oct. 7, 2015).
      Textron held a judgment for almost $22 million against Gallegos.  In furtherance of collection on that judgment, it sought a charging order against Gallegos’ interest in two LLCs, Pacific Pearl Hotels, LLC and Pacific Pearl Hotel Management, LLC.  The records of the California Secretary of State indicated the Gallegos was the manager of each of these LLCs.  He challenged the motion for a charging order based upon the fact that Textron had not proven that he is a member of each LLC.  As noted by the court .“Nor does he deny that he's a member of the LLCs.  He just argues that [Textron] hasn't proved it.”
      After finding that the records of the Secretary of State are admissible and that the service of the motion for the charging order was sufficient, the court denied the motion on the basis that it's entry requires “substantial evidence” that the judgment-debtor is a member in the entity, and they had not demonstrated that to be the case.  For that reason, the motion for the charging order was denied even as Textron was given leave to engage in post-judgment discovery to determine whether Gallegos is in fact a member of either or both of the LLC.

      Simply put, this decision is not well reasoned and should not be followed by other courts.  Any LLC, on receipt of a charging order, will check its records to determine whether the judgment-debtor is a member thereof.  If they are a member, the charging order attaches to all future distributions unless and until lifted by the court.  If, however, the judgment-debtor is not a member, the charging is without effect.  Simply put, the lien attaches to nothing if the judgment-debtor is not a member of the LLC, the judgment-creditor gets nothing they would not have otherwise received, and any suggestion of inconvenience to the LLC is below de minimus.  At the same time, definitive information as to who is or is not a member of an LLC (or a partner, general or limited, in a partnership) is not publicly available.  Judgment-creditors, who seldom if ever received much cooperation from the judgment-debtor, need to be able to pursue collection without affording the judgment-debtor much if any notice of what is being done; elsewise the judgment-debtor simply moves the assets or engages in improper conduct such as fraudulent transfers.  Having to prove membership/partnership prior to the entry of a charging order is an unjustified (and oft insurmountable barrier).

(thanks to Jay Adkisson for the lead on this case).

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