Delaware Chancery Court Rejects Effort to Avoid Charging Order Based Upon Lease Covenants. But Should They Matter At All?

Delaware Chancery Court Rejects Effort to Avoid Charging Order Based Upon Lease Covenants. But Should They Matter At All?

      In a recent decision from the Delaware Chancery Court, there were considered and rejected defenses to the issuance of a charging order in favor of a judgment-creditor based upon certain lender covenants. Ultimately, they were found to not be violated. But the question still remains whether they need to be considered. GMF ELCM Fund L.P. v. ELCM HCRE GP, No. 2018-0840-SG, 2020 WL 2518000 (Del. Ch. May 18, 2020).

     Andrew White was the judgment-debtor in an amount exceeding $350,000. In the course of discovery, the plaintiffs identified two LLCs, EL FW Leasing LLC and EL FW Intermediary I LLC, both wholly-owned by White. In furtherance of collecting upon the judgment against White, a charging order was sought with respect to certain distributions made to White. White alleged that issuance of the charging order would cause the default of a Master Lease to which EL FW Intermediary I, LLC was a party, thereby jeopardizing the stream of payments against which the charging order was sought.  In response to that argument, the court ordered White to produce certain documents and allowed the parties to submit additional pleadings, all leading to this decision.

With respect to the argument that the charging order would constitute a prohibited lien, the Master Lease provided that the FW Intermediary LLC could not allow to be created a lien on the subject property. Holding that a charging order does not constitute a lien on the property of the LLC, that argument was rejected: “Because the charging order attaches to distributions from FW Intermediary to White, it is not a lien on ‘the Facilities and all rights related to the use and operation of the,’ Facilities or ‘rights to payment arising from the Facilities,’ which are rights that belong to FW Intermediary as the ‘Tenant.’ Therefore, a charging order on White’s interest in FW Intermediary would not constitute a prohibited lien under the Master Lease.” 

      Another event of default under the Master Lease was a change of control of the FW Intermediary LLC, being a “‘a transfer, assignment, or other event that results in [FW Intermediary] no longer being directly or indirectly controlled by Andrew White.’” In light of the fact that the Delaware LLC Act’s charging order provision expressly provides that a creditor holding a charging order shall not have the right to exercise legal or equitable remedies with respect to the LLC’s property, this argument was rejected: “In other words, the charging order would not affect White’s ability to control FW Intermediary, nor does it grant the plaintiffs any interest in FW Intermediary’s rights under the Master Lease. The charging order gives ‘only the right to receive any distribution’ that would otherwise go to White.”

      But should it matter what the contracts provided? The charging order exists to balance the asset partitioning function of a business entity against the rights of a judgment-creditor to collect on a judgment (sorry, the charging order is not part of the pick-your-partner analysis). Assume that “change in control” had been defined as including the entry of a charging order against White’s distributional interest in the LLC. We can even go so far as to assume that White might request that in order to, in effect, shield his distributional rights from the LLC from creditors and in so doing significantly increase the cost of collection.  The opportunities for abusive asset protection are all too obvious.