Orders in Furtherance of a Charging Order

Orders in Furtherance of a Charging Order

           A continuing tension is the degree to which the judgment-creditor, holding a charging order, is entitled to information as to the internal activities of the LLC in order to determine whether the charging order is being satisfied. For example, what have been the actual distributions made to the judgment-debtor, and have the LLC and the judgment-debtor, in cooperation with the other members, made payments to or on behalf of the judgment-debtor that should properly be characterized as distributions paid to the account of the judgment-creditor. In a recent decision from Alabama, the court enforced the ability to subpoena LLC records to make those determinations. SC Property Holdings, LLC v. United Recovery Group, LLC, Misc. No. 14-0008-KD-MU, 2020 WL 3579210 (S.D. Ala. May 29, 2020).

         Holding the LLC and its managing member in contempt for failure to produce certain records, the court wrote that “And without access to the subpoenaed documents, neither SCPH nor this Court, for instance, it can determine whether Green & Sons, LLC is in violation of the charging orders, a definitive harm to both SCPH and this Court’s authority.”

Charging Order Denied

                                                             Charging Order Denied

            In an April decision from California, the charging order was denied a judgment-creditor when that judgment-creditor failed to demonstrate that the judgment-debtor was in fact a member of the LLC against which the charging order was sought. Perez v. Dhillon, No. 2:19-mc-00071 KJM AC, 2020 WL 1900447 (E.D. Ca. April 17, 2020.

            In this case, when the judgment-creditor sought a charging order against the judgment-debtor’s alleged interest in Hiway Farm LLC, both it and the judgment-debtor challenge that he, in fact, had an interest in that LLC. Finding that the judgment-creditor had not carried its burden of showing that the judgment-debtor was a member of the LLC, the court wrote, “Plaintiff’s motion to enforce the judgment against the defendant’s debtor interest in the Hiway Farm, LLC necessarily fails, because plaintiff has not established that defendant has any such interest.” 2020 WL 1900447, *3.

            As I and others, including Jay Adkisson, have suggested, this and similar decisions are of questionable merit.  The cost of an LLC of complying with a charging order where the judgment-debtor is not a member is nothing; there is no distribution to be diverted to the judgment-creditor.  In contrast, there can be high transaction costs in requiring the judgment-creditor to prove the judgment-debtor is in fact a member of the LLC.  Believe it or not judgment-debtors are sometimes (often) less than forthcoming in identifying their assets against which a judgment may be collected, and while it may be possible under local law to require the LLC in which the judgment-debtor may be a member to respond to discovery, that imposes additional cost upon the judgment-creditor and the LLC.  This latter class of costs is imposed irrespective of whether the judgment-debtor is or is not a member.   

A Pair of Decisions (One Recent) on Foreclosure of the Charging Order

 A Pair of Decisions (One Recent) on Foreclosure of the Charging Order

            As has otherwise been noted, a charging order is a lien issued in favor of a judgment-creditor against a judgment-debtor’s distributional interest in an LLC. As distributions are made by the LLC, pursuant to the charging order they are paid not to the judgment debtor, but rather are diverted to the judgment creditor with the aim of reducing the outstanding judgment indebtedness. Being a lien, the possibility of foreclosure exists. There are relatively few decisions on the foreclosure of a charging order; last year I reviewed the Illinois decision Preservation Holdings,LLC v. Norberg. Here are two more decisions to consider.

          The first decision, Professionals Real Estate Partnership v. Linn, No. 1970-MDA 2019, 2020 WL 3887995 (Pa. Super. July 10, 2020), involved a general partnership. In this instance, and as is seldom seen, the judgment-creditor was the partnership itself; the charging order was issued in order to enforce a judgment in favor of the partnership against one of the partners. In this instance, the partnership held certain office buildings that were occupied by the partner’s respective businesses; the judgment-debtor in this case had failed to satisfy certain obligations to the partnership. The partnership itself generated no net distributable income. On that basis, it argued that it should be able to foreclose upon the charging order in that it would not generate funds sufficient to satisfy the judgment in any reasonable period of time. The judgment-debtor asserted that foreclosure was not justified in that, once the property was sold, the judgment could be collected from his portion of the sale proceeds. This assertion was rejected by the court in that it was the judgment-debtor partner who had repeatedly interfered with the sale of the partnership’s property.

         In the second decision, the Missouri Court of Appeals was called upon to consider whether foreclosure the charging order can even take place.  DiSalvo Properties, LLC v. BluffView Commercial, LLC, No. ED 101977, 2015 WL 3795402 (Mo. App. June 16, 2015), the question presented was whether the charging order lien could be foreclosed upon. In this case, the court held that foreclosure was not possible in that the statute did not affirmatively provide for foreclosure.

Scope of Charging Order Upheld

Scope of Charging Order Upheld

        A charging order is a lien on the distributions made to a member who is a judgment-debtor.  Essentially a garnishment, it directs the LLC to pay the distributions not to the judgment-debtor, but rather to the judgment-creditor.  Those distributions are then applied against and reduce the judgment.  It is not uncommon for judgment-debtors to argue that the scope of the charging order, i.e, what will be treated as a distribution is overly broad.  In this recent decision, the court rejected that assertion.  In Johnny Thomas, Trustee of Performance Products, Inc. v. Hughes, SA-16-CV-00951-DAE, 2020 WL 5015441 (W.D. Tex. Aug. 8, 2020).

            The court wrote:

 “Plaintiffs contend they have the right to receive any distribution to which Hughes would otherwise be entitled with respect to her membership interest in M. G. & Sons and that any membership distributions, profits, cash, assets, or other monies due or that shall become due by Hughes by virtue of that membership shall be paid by Hughes, M. G. & Sons, and/or any third party to Plaintiffs through their counsel of record. Furthermore, Plaintiffs ask the Court to order that Hughes and M. G. & Sons be required to obtain leave of court before transferring any asset of M. G. & Sons to any third party, transferring any funds to any third party except for transactions in the ordinary course of business, or transferring Hughes’s interest in M. G. & Sons to any third party.”

         Implicitly the court approved of the limitations on the transfer of company assets that were not identified as distributions and the transfer of the judgment-debtors interest in the LLC, neither of which would strictly be subject to the charging order.  The court noted, in approving the language, the judgment-debtor’s “history of fraudulent transfers to avoid payment of a judgment.” Id. at *3.

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.

Charging Orders Affirmed

Charging Orders Affirmed

In this third appeal of a family dispute, the Washington Court of Appeals affirmed the issuance of a charging order in support of certain judgments graned to one sibling against another. Bangasser. v. Bangasser, 2019 WL 5112459 (Wash. Ct. App. Oct. 14, 2019).

As the court noted, this is the third appeal in this case. Thomas Bangasser served as the general partner of Midtown Limited Partnership, a partnership that held certain commercial real estate in Seattle. The limited partners in that partnership were Thomas’ siblings or entities owned by those siblings. Various of the siblings had made personal loans to Thomas, which loans were never repaid. Ultimately, the limited partners removed Thomas as the general partner, and he brought suit alleging that his removal was in violation of the partnership agreement. Roughly coincident in time, the siblings who had loaned money to Thomas, brought suit to enforce the promissory notes and to collect thereon.

Ultimately, Midtown would sell its real estate for a total of some $23,300,000. In support of the judgments enforcing the promissory notes, the court issued charging orders against Thomas’ distributions. The limited partnership deposited approximately one half of his anticipated proceeds from the sale in court against a potential claim of a purported transferee of a portion of Thomas’ interest in the limited partnership.

The decision affirmed the validity of the charging orders, including that they could be used to collect attorney’s fees pursuant to the promissory notes Thomas had executed.

Bigfoot, Unicorns and Foreclosure Sales of Charging Orders

Bigfoot, Unicorns and Foreclosure Sales of Charging Orders

      The evidence for Bigfoot seems to be restricted to some blurry black and white film footage, while evidence for unicorns seems to be restricted to some medieval tapestries and the Ark Encounters Theme Park in Northern Kentucky. Sightings of the foreclosure sale of a charging order are it seems only slightly less rare. Still, in a recent case from Illinois, a number of issues relating to a charging order foreclosure sale were addressed. Preservation Holdings, LLC V. Norberg, 2019 Il. App. (1^st) 181136, 2019 WL 2510260 (June 14, 2019).

       Norberg was one of several defendants against whom judgments had been entered in Maine; another of the defendants was Gleichman. That Maine court had also entered charging orders against Gleichman’s interest in 51 LLCs and limited partnerships. The Maine judgment was domesticated in Illinois pursuant to the Uniform Enforcement of Foreign Judgments Act, and an Illinois court issued additional charging orders against the 51 LLCs and limited partnerships. The judgment-debtor then moved for a foreclosure sale of those interests. At that time, the plaintiff Preservation Holdings held a judgment against Gleichman for about $800,000; another judgment-creditor, Promenade Trust, held a trio of judgments of some $36,440,000.00.

       At the judicial sale conducted by the Cook County Sheriff, Gleichman’s interest in 46 limited partnerships were sold to Promenade Trust for $4.8 million, an amount significantly below the total judgments against Gleichman in favor of Promenade. Promenade moved to have the sale confirmed, to which Gleichman objected on bases including that “the sale price was unconscionably low.” In support of that argument, she submitted an affidavit from a Sean Hamilton, who opined that the price was too low. The Circuit Court found that the Hamilton affidavit was unpersuasive for having valued the wrong assets, namely the real estate held by the various LLCs and limited partnerships, rather than only Gleichman’s distribution interests in the partnerships. This appeal followed.

      In the course of the appeal, after determining that the law governing post-mortgage foreclosure sales would serve as a useful guidepost in the absence of a deep body of law on charging order foreclosure sales, it was noted that:

Of course, in a forced judicial sale, the price will be lower than the arm’s-length ideal because the marketplace is constricted. In the forced sale setting, the seller is under judicial compulsion to sell, and the buyers may not have the ability to learn all the relevant facts regarding the asset for sale.  So as the NAB Bank [v. LaSalle Bank, N.A. (2013 Il. App. 1^st) 121147, 98410 N.E.2d 154 (Il. App. 1^st 2013)] court observed, property sold at a for sale does not generate a true fair market value price.

2019 WL 2510260, *4.

      The court then rejected Gleichman’s suggestion that the Circuit Court should have sua sponte undertaken its own analysis of the interests sold at the sale, explaining rather that “the sale is presumptively valid, and it is the debtor’s burden to show why the price is unconscionably low.” Id.

     Rejecting the Hamilton affidavit as a basis for setting aside the sale, it was observed:

As the Circuit Court correctly found, Hamilton opined as to the fair market value of the real estate owned by the LLCs and limited partnerships, not the value of Gleichman’s distributional interests in them. This is a distinction with a significant difference. A bidder who acquires a distributional partnership interest at a judicial sale does not step into the shoes of his predecessor because the bidder acquires no management role and no right to receive or inspect the books and records of the partnership.

Id.

      Gleichman then objected that, notwithstanding the fact that the order for the judicial sale had indicated that the various interests should be sold seriatim, in fact the sale had been accomplished as a single group. This argument was rejected on the basis that Gleichman had not raised this objection in the court below as part of the objection to confirmation of the sale and it was thereby deemed waived. Further, she could have attended the sale and there objected:

At the Circuit Court hearing on the motion to confirm sale, counsel for Promenade stated that, besides the sheriff’s staff, only he and counsel for Preservation Holdings attended the sale. The sale was open to the public, nothing prevented Gleichman from monitoring it to ensure that the sheriff conducted at in punctilious conformity with the court's order. We therefore find the point forfeited and will not disturb the confirmation of the sale on this basis.

Id, *5.

Service of Petition for Charging Order Upon LLC

Service of Petition for Charging Order Upon LLC

      In a recent decision from a federal district court in Georgia, it was held that, under the Georgia LLC Act, a petition for a charging order need not be served on the LLC itself. First Southwestern Financial Services, LLC v. Dennis Waters Construction, LLC, Civil Action No.: 4:13-CV-260, 2019 WL 1782123 (S.D. Ga. April 23, 2019).

      In this instance, First Southwestern sought a charging order against the interest of Dennis Waters in numerous LLCs. Although it is not entirely clear as to why the question arose (the defendant never responded to the request for a charging order), the court considered whether it was necessary to serve the application for the charging order upon the subject LLC. Comparing the Georgia LLC Act’s charging order statute (O.C.G.A. § 14-11-504) to those of other states including with the equivalent provision of the Kentucky Uniform Partnership Act (Ky. Rev. Stat. Ann. § 362.481), in the absence of a provision in the Georgia statute requiring that service of the charging order be made as well upon the LLC, as well as a limited rights afforded one to whom a charging order is granted, it was held the service on the LLC is not required.

Court Issues Charging Order, Avoids Question of Priority

Court Issues Charging Order, Avoids Question of Priority

      In a recent decision from a federal district court sitting in New Jersey, it both entered a charging order and determined it would not address the question of that charging order’s priority over an already existing lien. Government Employees Insurance Co. v. Hamilton Healthcare Center, P.C., Civ. No. 17-674, 2019 WL 251740 (D. N.J. Jan. 17, 2019).

      Various persons affiliated with the Hamilton Healthcare Center were found to have engaged in insurance fraud. A judgment exceeding $2.3 million was entered against them. One of those judgment debtors, Kahn, had ownership interests in Pennsauken Diagnostic Center, LLC and Professional Medical Resource Management, LLC. The judgment creditor sought a charging order against Kahn’s interest in each of those companies. In accordance with New Jersey law on charging orders, that charging order was awarded the judgment creditor.

      Apparently as a defense to the issuance of the charging order, it was asserted that the law firm Stark and Stark had a lien on Kahn’s interest in each of these LLCs, and those liens should have priority over the charging order addressed in this opinion. The court noted, however, that Stark and Stark is not a party to this case, and on that basis declined to address the priority of its lien over this charging order.

California Court Addresses Priority of Unperfected Security Interest and Charging Order

California Court Addresses Priority of Unperfected Security Interest and Charging Order

      In a decision rendered last Wednesday by the California Court of Appeals, it addressed the question of whether an unperfected security interest would have priority over a subsequently entered charging order. On the facts of this case, it was held that the charging order had priority. MDQ, LLC v. Gilbert, Kelly, Crowley & Jennett LLP, B283025, 2019 WL948726, ___ Cal. Rptr. 3d __ (Feb. 27, 2019).

       To secure payment for certain legal fees, Gilbert Kelly took a security interest in certain expected distributions to its client. In that same litigation, the client from whom Gilbert Kelly took the security interest was held liable for almost $1 million. For reasons not explained in the decision, Gilbert Kelly never filed a UCC-1 in order to perfect its interest in the to be distributed funds. This case would turn upon the question of whether the unperfected security interest, created first in time, would have precedence over the subsequent charging order.

      A charging order creates a lien on the distributions made from an LLC. A charging order is not a voluntary lien subject to Article 9 of the Uniform Commercial Code. In consequence, a charging order is not subject to Article 9’s “perfection” requirements. In contrast, the court determined that the interest held by the law firm was indeed a security interest covered by the UCC. As such, its priority with respect to other liens would be determined based upon the date of perfection.

      In that the security interest held by Gilbert Kelly was never perfected before the entry of the charging order, it being deemed perfected, the charging order took precedence. As such, until such time as the distributions from the LLC or other funds satisfy the judgment entered, Gilbert Kelly will have to await payment.

        Jay Adkisson has published a review of this decision; HERE IS A LINK to that review.

Nobody Comes Out Looking Good in this Charging Order Dispute

Nobody Comes Out Looking Good in this Charging Order Dispute

      In a recent decision from Arizona, everybody, they being the law firm that held a charging order against a former client and that former client, came out looking good. Campbell Law Group Chartered v. Jagelski, No. 1 CA-CV 17-0032, 2018 WL 3853518 (Ariz. Ct. App. August 14, 2018).

      Campbell Law Group Chartered (“CLG”) held a judgment of some $454,000 against its former client Monica Jagelski for failure to pay attorney fees. CLG sought a charging order against Jagelski’s interest in Empire Vista, LLC. Jagelski was the sole member of that LLC. It in turn owned a one-third interest in real property worth in excess of half a million dollars. Having been awarded a charging order against Jagelski’s interest in Empire Vista, CLG filed with the Arizona Corporation Commission articles of amendment to the LLC’s articles, identifying CLG as the 100% member therein. Then, CLG contacted the other co-owners of the property, claiming to be Empire Vista’s new sole member. CLG as well advised those co-owners that all proceeds from a pending sale of the property should be conveyed to CLG “In its capacity as the new sole member and manager of Empire Vista, LLC.”

      Shortly after CLG obtained the charging order with respect to Empire Vista, Jagelski caused there to be formed a new LLC, Northern Mancore LLC, it owned by her children. By a mechanism not explained in the decision, Empire Vista “Then transferred the real property” to that newly owned LLC; how and what was done is unclear in that the opinion earlier says that Empire was a one third, not a 100%  owner in the property. Regardless, Northern Mancore then transferred the property back to Empire Vista, whereupon Empire Vista transferred it to another LLC, Southwest Mancore, “In exchange for a promissory note in the amount of $550,000 and a deed of trust.” It is recited that “Jagelski admits the purpose of the transfer from Empire Vista to Southwest Mancore was to ‘protect the assets of Empire Vista’ from CLG.” Thereafter, CLG obtained a charging order against Jagelski’s interest in Southwest Mancore and as well sought a court ruling that CLG was in consequence the member in Southwest Mancore.

      The decision would then focus upon three points, namely: (i) is the holder of a charging order a substitute member for the judgment-debtor, (ii) did Jagelski’s efforts to transfer the property from Empire Vista constitute a fraudulent conveyance; and (iii) did the property transfers violate the terms of the charging order?

The Holder of a Charging Order is a Not a Substitute Member

      The court began by rejecting the assertion that the person holding a charging order is a substitute member, even for a sole member. Rather, under the statute, the holder of the charging order has only the rights of an assignee.

      The court did not address the penalty to be suffered by CLG for, without authority, amending the articles of Empire Vista.

Transfers Done to Avoid Creditor Claims are Fraudulent

      With respect to the various transfers of property amongst the LLCs, the court found that they did constitute a fraudulent conveyance in that they were undertaken for the purpose of thwarting the claims of CLG. Balancing the equities, the court wrote:

Though arguably undertaken as a practical means of thwarting CLG’s own unlawful efforts to take over control of the LLCs, the transfers were no less fraudulent. The fraudulent transfer statutes contain no exceptions for debtors faced with malfeasant creditors. Debtors faced with unlawful attempts at collection may seek emergency relief from the court - they may not violate the law in the name of self-help.

The Property Transfers Did Not Violate the Charging Orders

      The court rejected the suggestion that the transfers of property amongst the various LLCs, beginning with Empire Vista, violated the charging order CLG had been awarded with respect to Jagelski’s interest therein. While fraudulent, the transfers did not result in any distribution to Jagelski that was not properly diverted to CLG pursuant to the charging order.

Be Careful of Other Rules When Enforcing a Charging Order

Be Careful of Other Rules When Enforcing a Charging Order

      A recent decision from Mississippi is a helpful reminder that, when seeking to enforce a charging order, it is necessary to pay attention to other rules. PNC Bank, National Association v. Walnut Grove Office Gardens, LLC. No. 3:17-MC-17-DMB, 2018 WL 4855212 (N.D. Miss. October 5, 2018).

      PNC had made a series of loans to various LLCs, all personally guaranteed by Walter D. Wills, III. All of the loans went into default. Judgment was entered in favor of PNC against each of the borrower LLCs and Wills in his capacity as guarantor. That happened on September 28, 2017. Then, on October 4, 2017, the court entered an amended judgment. That all happened in the Western District of Tennessee. On November 2, 2017, PNC registered the amended judgment in the Northern District from Mississippi and then, some seven months later, filed an application for a charging order. It was whether that charging order could be issued that is the subject of this decision.

      Under 28 U.S.C. § 1963, a judgment from one court (in this instance, the Western District of Tennessee) may be registered in another court (in this instance, the Northern District of Mississippi) “when the judgment has become final by appeal or expiration of the time for appeal.” Wills never appealed the judgment holding him and the various LLCs liable to PNC Bank. In consequence, the question was whether there had occurred the “expiration of the time for appeal”? As to this point, the court relied upon Federal Rule of Appellate Procedure 4(a)(1)(A), which provides that a notice of appeal “must be filed with the district clerk within thirty (30) days after entry of the judgment or order appealed from.” The amended decision in this case was issued on October 4, 2017. It was registered in Mississippi on November 2, 2017. In consequence, less than 30 days had passed from the date of the amended order of the Tennessee court and its registration in Mississippi.

      On that basis, the Mississippi court refused to issue the requested charging order, writing:

Accordingly, the registration was premature and may not form the basis for the enforcement PNC Bank seeks here.

      PNC was granted leave to reregister the amended judgment from the Tennessee court.

More Fun and Games and Charging Orders;If It Is Yours It Can Be Reached With a Charging Order

More Fun and Games and Charging Orders;
If It Is Yours It Can Be Reached With a Charging Order

      A recent decision from Illinois is yet another illustration of the steps that judgment-debtors will undertake in order to avoid satisfying a judgement. In this instance, an individual sought to use a dissolved LLC as, effectively, his personal piggy bank. Golfwood Square LLC v. O’Malley, No. 1-17-2220, 2018 IL App. (1^st) 172220-U, 2018 WL 4370875 (Sept. 11, 2018).

      Golfwood Square LLC held a judgment exceeding $900,000 against O’Malley and another individual. O’Malley was the 90% owner of SSG, LLC, which he acknowledged “doesn’t do anything.” In turn, SSG was the sole member of 3 Squared, an LLC that had owned a condo. After judgment had been entered against O’Malley, 3 Square sold the condo, and after satisfaction of the related mortgage retained some $224,000. The operating agreement of 3 Square provided that upon the sale of its assets, the company would be dissolved and, after satisfaction of claims of creditors, the net proceeds would be distributed to the members.

      O’Malley, who admitted that he had “unfettered access” to the account in which those proceeds were deposited, use substantial portions to pay both personal debts and as well the obligations of other companies with which he was affiliated.

      In order to enforce a charging order that had previously been injured, Golfwood sought an order from the court requiring O’Malley to turn over the remaining 3 Square funds.

      In addition to applying several portions of the Illinois law governing supplemental proceedings and collection on judgments, the trial court found that “according to the clear language of 3 Square’s operating agreement, upon selling the Garlands Condo, 3 Square should have dissolved and distributed the sale proceeds to SSG. From there, per the charging order, any distributions that SSG would otherwise have made to O’Malley would instead go to Golfwood. But O’Malley circumvented the charging order by keeping the funds normally under 3 Square’s control while he retained “unfettered access” to the accounts - essentially making a direct distribution to himself in all but name.”

      On that basis, the court of appeals affirmed the turnover order, finding it to be necessary both to enforce the charging order and on otherwise applicable provisions of collection law.

      O’Malley sought to avoid the charging order, by arguing that, in effect, it effected an improper piercing of the veils of each of 3 Square and SSG. This was rejected on the basis that the assets being held (and dispersed from) 3 Square were already O’Malley's.

On Charging Orders, Bankruptcy, and the Scope of the Automatic Stay

On Charging Orders, Bankruptcy, and the Scope of the Automatic Stay

      In a recent decision out of Louisiana, the Federal District Court, sitting as the appellate court from a Bankruptcy Court, pointed out some important issues to be considered in connection with the bankruptcy of an individual member of an LLC and the scope of the automatic stay. In this instance, certain of those important matters had not been fully considered by the Bankruptcy Court. For that reason, remand was ordered. In the Matter of: Thomas Mack and Mary Susan Mack, Civ. Act. No. 17-3587, 2018 WL 1532979 (E.D. LA. March 29, 2018).

 

Consequent to some financial setbacks, Thomas Mack, along with certain others, was held liable to First Bank for some $400,000 plus attorneys’ fees and additional collection costs. Mack, in turn, was a member in two LLCs, but the only one relevant to the opinion was Matrix Hospitality Group, L.L.C. Therein, he held a 60% membership interest, and apparently it was only through Matrix that Mack had any income, specifically:

Mack is paid by Matrix in three ways: (1) a monthly salary as a 1099 employee; (2) a periodic disbursement of profits as a part-owner; and (3) a performance bonus paid in April by particular clients if Matrix is able to meet client-set goals.

Seeking to collect on the judgment debt of approximately $400,000, First Bank sought a charging order against Mack’s interest in Matrix. The charging order was awarded and served on the company, but it failed to respond in accordance with Louisiana procedure. In addition, Matrix made distributions to Mack after the charging order was served. When legal action was then initiated against Matrix, Mack (both Thomas and Mary Susan) filed for Chapter 11 bankruptcy. At that point, the value of First Bank’s judgment had increased to $789,212.85.

From there the chronology of what happened gets somewhat confusing. What is known is that, on January 31, 2017, First Bank moved for relief from the automatic stay. Ultimately that relief was denied.

The reason this is confusing is that when a member files for bankruptcy, and the LLC is not itself in bankruptcy, and activities of the LLC are not automatically subject to the automatic stay there is an exception to this rule when, in the presence of “unusual circumstances,” “there is such identity between the debtor and the third-party defendant at the debtor may be said to be the real party defendant and that a judgment against the third-party defendant will in effect be a judgment or finding against the debtor.” 2018 WL 1532979, *3. In those circumstances, the automatic stay may extend to a non-debtor, in this instance Matrix. In this instance, however,:

The Court is unable to evaluate the Bankruptcy Court’s decision in denying the modification of the scope [of the automatic stay] because the Bankruptcy Court never made a finding on whether the scope of the stay included Matrix. Although it is arguably implied that the Bankruptcy Court determined that it did because it denied First Bank’s motion for relief, neither party raised the issue and the Bankruptcy Court did not state on the record whether the automatic stay applies to Matrix. Further, the Bankruptcy Court held that First Bank had the burden to modify the automatic stay, but the appellees [i.e., Mack], the parties seeking to maintain the stay, actually had the burden. The Bankruptcy Court failed to apply the appropriate standard to determine if modifying the stay was appropriate. Because the Bankruptcy Court did not require the appellees to meet their burden, the factual record is not sufficiently developed for this Court to determine whether the circumstances justify the rare finding that the stay applies to non-debtors [i.e. Matrix].

Id. (bracketed language added).

So the matter will go back to the Bankruptcy Court to determine whether Matrix and Mack are of such unitary interests that First Bank cannot, outside of the bankruptcy proceedings, seek to enforce its judgment by means of a charging order.

Enforcement of Foreign Charging Order Fails for Failure to Domesticate

Enforcement of Foreign Charging Order Fails for Failure to Domesticate

      An Alabama court entered a judgment in favor of Bentley for $1,350,000 against Byrd. When Bentley asked a Tennessee court to assist in collecting on this judgment by issuing a charging order against Byrd’s interest in Hisbach, LLC, a Tennessee LLC, things broke down. Estate of Mark Bentley v. Byrd, No. W2017-00446-COA-R3-CV, 2018 WL 930921 (Tenn. App. Feb. 15, 2018).

      Under Tennessee law, before the court would have jurisdiction, it needed to make service of the request for a charging order on Byrd, the judgment debtor. Tenn. Code Ann. § 26-6-105(c). Bisbach argued that “because Mr. Byrd had never been served with process, Mr. Bentley’s requested relief could not be granted.” 2018 WL 930921, *1. Still, the trial court issued the charging order, finding that Byrd was on notice, “both ‘actually and constructively’” as:

Plaintiff has made a good faith effort to serve actual notice upon Defendant at two separate residences in Alabama, a third residence in New Mexico listed for Defendant in a separate legal proceeding here in Madison County, and actual service upon Hisbach Partners. 

Legal counsel for Byrd participated in at least one telephone conference with the court.

      Under the Tennessee Uniform Enforcement of Foreign Judgments Act, the clerk of the court issues a summons to the judgment debtor and, if after being served, the judgment debtor makes no response, the judgment debtor may enforce the judgment. The Bentley court noted that:

As is clear, service on the judgment debtor plays a key role in the statutory requirements. The statute unequivocally provides that no execution whether enforcement action is allowed until thirty days after summons has been served on the judgment debtor. This requirement is important because it allows the judgment debtor to ‘appear and show why enforcement of the judgment should be stayed.’

2018 WL 930921, *4. The court also found that the participation by Byrd’s out-of-state counsel in one telephone conference with the court was not sufficient to waive lack of service.

      Ultimately, because Byrd was never served in Tennessee in connection with the effort to enforce the Alabama judgment, the charging order issued against him “was void.” Id. *5.

      This decision is rather troubling with respect to the ability to use a charging order to collect upon a judgment. Consider, for example, judgment entered by a court in Alabama with respect to a defendant resident in New York. That New York resident is a member in a Utah LLC. That New York resident, however, has absolutely no other connections to Utah. In fact, the investment in the Utah LLC was made by means of a wire transfer. In order to enforce the Alabama judgment against the New York resident with respect to his membership interest in the Utah LLC, (here assuming Utah law is the same as that of Tennessee discussed in the decision above), when application is made to the Utah court for a charging order, that Utah court must have personal jurisdiction over the New York resident. Absent a statute giving rise to special jurisdiction by reason of being a member of a Utah LLC (see, e.g. KRS § 275.335(6)), the Utah court will lack the capacity to enter the charging order.  In effect, by being a member in LLCs organized in states in which the member does not otherwise have contacts, it may be possible to avoid service and therefor the issuance of a charging order.

Delaware Jurisdiction to Issue Charging Order

Delaware Jurisdiction to Issue Charging Order

      In a recent decision from Delaware, the primary question was whether it is the Chancery Court, the Superior Court, or both that has the capacity to issue a charging order. Bridev One, LLC v. Regency Centers, L.P., 2018 WL 824976 (S. Ct. Del. Feb. 9, 2018).

      Essentially, the defendant who was subject to the sought charging order asserted that only the Chancery Court could issue a charging order. After parsing the statute and various changes made in the jurisdictional authority of the various courts, it was held that the Superior Court, coincident with the Chancery Court, has the authority to issue a charging order.

      In addition, the defendant asserted that the information relied upon to determine that he was at least likely a member of the LLC was “stale.” The court found the relied upon information was sufficient. The court went on to observe that “Either way, discovery in aid of execution would be appropriate.”

Florida Court Addresses Priority of Charging Orders

Florida Court Addresses Priority of Charging Orders

      In a pair of recent decisions, the Court of Appeals for the First District in the State of Florida has provided guidance with respect to the priority of the lien created by a charging order.  This being a point seldom addressed, the prior guidance largely being restricted to the McClure decision from Colorado, these new decisions provide important guidance.  Capstone Bank v. WinSouth Credit Union, Case No. 01D-16-1484 (Nov. 30, 2017); Capstone Bank v. Perry-Clifton Enterprises, LLC, Case No. 01D-16-1094 (Nov. 30, 2017).

      In the WinSouth Credit Union case, while the facts recited in the opinion are rather sparse, WinSouth applied for a charging order against the interest of John Richards and Christopher Richards, each in an unnamed Florida limited liability company.  Likewise, Capstone Bank had applied for a charging order against the same interest, the question was the priority of the orders.  The charging order issued in favor of WinSouth was based upon a judgment entered by an Alabama court.  Over a dissent, it was determined that the Alabama judgment had not been properly domesticated in Florida before the charging order was issued.  On scanty analysis, the court went on to determine that the WinSouth charging order should not have been issued, leaving that of Capstone with priority.

      While the dissent would challenge the determination that the judgments against John Richards and Christopher Richards were not sufficiently domesticated in Florida, it explained why Capstone would still prevail, that based upon the timing of the application for and receipt of the charging order. 

      In the Perry-Clifton case the dispute again began with an Alabama judgment, this being a divorce decree.  The question was whether a Alabama divorce judgment in favor of Christy Richards constituted a charging order in favor of Christopher Richards’ interest in Perry-Clifton Enterprises, LLC.  The divorce decree awarded to her all of Christopher’s interest in Perry-Clifton Enterprises.  While the divorce decree was filed in Florida, no charging order was at that time requested.

      Thereafter, Capstone requested and received from a Florida court a charging order against Christopher Richards’ interest in Perry-Clifton.  Christy Richards, some six weeks later, sought to intervene in that action and filed a motion to stay the issued charging order.  The trial court determined that the Alabama divorce decree “itself constituted a charging order” and had priority over that issued to Capstone Bank.  That determination would, in this appeal, be reversed.

      On the basis that a charging order, issued by a court on motion, is the “sole and exclusive remedy” against an interest in a Florida LLC, the court concluded that the charging order issued in favor of Capstone Bank would have priority. 

Charging Orders and Choice of Law

Charging Orders and Choice of Law

      In a recent decision from Maryland, the court held that it would apply Maryland law, to the issuance of a charging order against the judgment-debtor’s interest in a Georgia LLC. German American Capital Corp. v. Morehouse, Case No.: GJH-13-296, 2017 WL 3411941 (D. Md. Aug. 4, 2017).

      Morehouse owed German American Capital Corp. (“GACC”) in excess of $11 million on a judgment rendered in the District of Columbia.  Having domesticated the judgment in Maryland, GACC sought a charging order against Morehouse’s interest in Residences at Savannah Harbor, LLC (“Residences”), a Georgia LLC.  In a belated argument, Morehouse alleged that Georgia, and not Maryland, law should control.  The court found that the Maryland LLC Act’s charging order provision is broad enough to reach an interest in a foreign LLC, reasoning that:

In Maryland, a creditor of a debtor who “hold[s] an economic interest in a limited liability company” may request that a court “charge the economic interest of the debtor in the limited liability company for the unsatisfied amount of the debt.” Md. Code. Corps. & Ass’ns § 4A-607(b)(1). Because it was formed under the laws of Georgia. ECF No. 40-2. Savannah Harbor is a foreign limited liability company. See Md. Code. Corps. & Ass’ns § 4A-101(j) (defining “foreign limited liability” [sic – should read “foreign limited liability company”] as a company formed under the laws of a state other than Maryland.). Notably, the charging statute that GACC relies on does not reference foreign limited liability companies and the term, “limited liability company.” is defined as an unincorporated business “organized and existing under [the Mary land Limited Liability Company Act].” See id. § 4A-101(k). However, the charging statute also references a debtor’s “economic interest.” which is defined in the Act’s definitional section as the right of a “member.” of either a limited liability company or a foreign limited liability company, to receive distributions from a limited liability company, or a member’s share of the profits and losses of such a company. See id. §§ 4A-101(i), (m). Thus, reading the charging statue in conjunction with the definition section, and in the absence of any language specifically barring the entry of charging orders against foreign limited liability companies, the Court concludes that the charging statue does provide for the enforcement of a charging order against a foreign limited liability corporation [sic- should read “company”] like Savannah Harbor. Vision Mktg. Res., Inc. v. McMillin Grp., LLC. No. CIV.A. 10-2252-KHV, 2015 WL 4390071, at *6 (D. Kan. July 15, 2015) (reaching same conclusion after interpreting similar Kansas statute).

Charging Order Receiver Could Not Exercise Control Over LLCs

Charging Order Receiver Could Not Exercise Control Over LLCs

      In a recent decision from Florida, the court held that a receiver appointed pursuant to the charging order statute could not exercise managerial control over the LLCs. McClendon v. Dakem & Associates, LLC, 42 Fla. L. Weekly D1189, 2017 WL 2298443 (Fla. 5^th Dist. Ct. App. May 26, 2017).

      Dakem was successful in receiving charging orders against McClendon’s interest in numerous LLCs, those charging orders in furtherance of judgments in favor of Dakem. In four instances, with respect to LLCs controlled by McClendon, the receiver was charged to exercise managerial control over the companies. McClendon challenged the receiver’s exercise of those rights, asserting they were outside the scope of the statute. The Court agreed with that determination, writing:

[T]he charging order should only have divested [McClendon] of her economic opportunity to obtain profits and distributions from the LLC, charging only her membership interest, not her managerial rights. To the extent that the order appointing the receiver authorized the receiver to exercise managerial control over the LLCs, it exceeded the permissible scope and is reversed. In sum, the order granting the charging order and appointing a receiver is affirmed; however, the portions of the order permitting the receiver to be the financial officer of the LLC and exercise managerial control is reversed.

Courts Disagree as to the Standard for Issuing a Charging Order; Is the Judgment-Debtor a Member?

Courts Disagree as to the Standard for Issuing a Charging Order;
Is the Judgment-Debtor a Member?

      As a vehicle for collecting on a judgment, a charging order may be issued against a judgment-debtor’s interest in a partnership, limited partnership or LLC, functioning essentially as a garnishment of whatever distributions that company would otherwise make to the judgment-debtor. Pursuant to the charging order, those amounts are paid to the judgment-creditor. In a pair of recent decisions, courts disagreed as to what level of showing must be made that the judgment-debtor is indeed a member/partner in the LLC/partnership that would be subject to the charging order.

      In the first of these decisions, the court held, in effect, that there is a very low threshold for the issuance of a charging order.  Seufret v. Temple Management, LLC, 2017 WL 2622347 (Conn. Sup. Ct. May 25, 2017). In this instance, the judgment-creditor asserted that the judgment-debtor, Bergman, was a member in 660 Sherman, LLC, and that his interest therein should be subject to a charging order. An objection thereto was filed on the basis that the plaintiff had not made a showing that of the judgment-debtor held an interest therein. The court overruled that objection, writing:

If 660 Sherman, LLC is served with the charging order and owes no debt to the defendant, 660 Sherman, LLC is under no jeopardy. If a dispute arises about whether Bergman is owed a debt by 660 Sherman, LLC, that dispute can be presented to this court for resolution at a future date with notice to all relevant parties.

      In contrast, in a decision out of Missouri, the judgment-creditor seeking a charging order was held to a much higher standard. St. Louis Bank First v. Kohn, 517 S.W.3d 666 (Mo. Ct. App. 2017). Therein, the court of appeals reversed a lower decision granting charging orders with respect to the judgment-debtor’s alleged interest in certain partnerships and LLCs. On the basis that there had not been a sufficient showing that in fact the judgment-debtor was a member/partner in those ventures, the award of the charging orders was reversed.

      IMHO, the Seufret decision is the better of the two. Vis-a-vie the LLC, the charging order is a passive obligation to direct to the judgment-creditor what would otherwise be paid to the judgment-debtor. For that reason, little proof of the judgment-debtor’s interest in the LLC need be shown. Rather, even as the statute is silent as to the point, the judgment-creditor should be awarded a charging order on “information and belief” that the judgment-debtor is a member/assignee. If in fact the judgment-debtor is not in fact a member/assignee of the LLC, it is not obligated to do anything as there are no payments to divert to the judgment-creditor.