Taxation & Estate Planning

CHARGING ORDERS AS EXCLUSIVE REMEDIES IN LLC?S ? PART ONE

By Charles Rubin

A recent Florida Supreme Court case addressing whether a charging order is an exclusive remedy for a creditor of a member of an LLC as to the LLC interest is creating a stir. This posting addresses the case. A future posting will address the question of whether the exclusive remedy of charging orders issue should be garnering so much attention.

First, some background. Assume that Owner O is a member of an LLC, and owes $1 million to judgment Creditor C. O has no assets other than his LLC interest. The LLC owns substantial assets, so that O?s share of the LLC exceeds $1 million in the underlying assets.

C can obtain a ?charging order? against O. This requires that if and when the LLC makes distributions to its members, the amount due to O has to be paid to C instead to the extent of its $1 million judgment. C does not become a member of the LLC and obtains no voting or other rights as to the LLC. O remains the member. Once C is fully paid, O can then begin again to receive member distributions from the LLC.  Thus, a charging order does not provide a lot of leverage to C ? it cannot force a distribution so it has to wait around until the members decide to vote a distribution. This could involve a very long wait for C.

In most states, in the absence of a specific statutory provision that a charging order is an exclusive remedy for a creditor, a creditor could alternatively judicially foreclose on a debtor?s interest. This would require the sale of O?s member interest either to third parties or to C. If this happens, then C loses his member interest permanently. 

If C can only obtain a charging order as his sole remedy, this is generally perceived to be favorable to debtors like O.

The purpose of the charging order remedy is to protect the other members of the LLC. This avoids innocent co-members from having their entity hijacked or interfered with by a third party creditor of a debtor member that succeed to the ownership interest of a debtor member. Instead, the creditor has to stand by on the outside of the entity awaiting distributions and cannot interfere with LLC operations.

So what happens if the LLC is only owned by one person? Since there are no other members of the LLC to protect, the question arises whether a creditor should be limited to charging order remedies only. This was the question raised in the recent Florida case.

The Florida Supreme Court held that even though Florida law provides for a charging order as a remedy as to LLC interests, a charging order is not the exclusive remedy for a creditor. When one considers that the purpose of the charging order remedy is to protect other members, it is not surprising that a creditor was not limited to a charging order as its sole remedy in the single member LLC situation.

However, the way that the Court went about this is questionable. Instead of simply addressing the situation of a single member LLC, the Court ruled with a broad stroke, seemingly interpreting that the Florida Statutes do not support a reading that charging orders are an exclusive remedy for LLC interests. The problem is that the case may stand for the proposition that charging orders are not an exclusive remedy, even in the case of multiple member LLC?s.

In the end, this may not be that big a deal, at least in Florida. There is a strong likelihood that a legislative fix will be enacted to clarify that charging orders are an exclusive remedy, at least for multiple member LLC?s (as many commentators thought was already presently the case).

As noted, in a future posting, I?ll address the question whether having charging orders being an exclusive remedy is really that big a deal ? as you may be speculating, I don?t think it is.

Shaun Olmstead, et. al., vs. The Federal Trade Commission,  Supreme Court of Florida. Case No. SC08-1009 (June 24, 2010).

Full post as published by Rubin on Tax on July 08, 2010 (boomark / email).