Charging Orders: The Key to Reaching a Judgment Debtor’s LLC Interest

(NOTE: This is Part 1 of a 2-part Series.  In this Part, we examine the Charging Order itself.  Part 2 deals with potentialarguments against a Charging Order.)

  No one enters into a financial transaction believing that the transaction will fail.  If that were the belief, the transaction would never take flight.  Unfortunately, oftentimes defaults do happen, and the aggrieved party is forced to embark on an expensive and time-consuming process known as “litigation.”    While litigation is only one of the many remedies available to redress these wrongs, it is perhaps the most widely used.The typical lawsuit consists of several phases: the pleading phase, the discovery phase, the dispositive motion phase, the trial phase, and, if judgment is entered in favor of the plaintiff, the post-judgment or collection phase.  Though all phases can be expensive and frustrating, the most challenging one is often the collection phase.To the uninitiated, this phase can be the most frustrating experience.  Here’s the typical scenario: Creditor has just received a judgment against Debtor finding that Debtor breached the terms of the deal and monetary damages have been awarded to Creditor.  Creditor has received vindication, which has been reduced to several sheets of paper, but is still without financial recompense.   The question most asked at this point is, “What now?”  What that question really asks is “How do we convert this judgment into money?”  The typical course of action is to try and garnish wages, levy on bank accounts, and sell, through judicial processes, other assets of the judgment debtor.More often than not there are insufficient liquid assets to satisfy the judgment.  One asset that could be reached to aid in satisfying the judgment is a debtor’s ownership interest in a limited liability company or corporation.  As with most states, Tennessee has promulgated rules regarding a creditor’s rights to recover a judgment against a debtor’s financial rights in a corporate entity.  This article will briefly examine the use of a charging order as a creditor’s tool for recovery, and the potential problem that exists in balancing a creditor’s right to recovery against the corporate insulation that members seek through the creation of a limited liability company.I.          The Charging OrderIn Tennessee, the sole and exclusive remedy of a judgment creditor seeking to recover a judgment against a judgment debtor’s financial interest in a corporate entity is a charging order.  See T.C.A. § 48-218-105 and § 48-249-509.  These two statutes largely mirror each other but are not duplicative since each represents two separate acts passed by the Tennessee Legislature for limited liability companies.In 1994, Tennessee passed the “Tennessee Limited Liability Company Act” (the “Act”), which is codified at Tenn. Code Ann. § 48-28-101.  Some twelve years later, the Tennessee Legislature amended and revised the Act (the “Revised Act”), which is codified at Tenn. Code Ann. § 48-249-101.  Those limited liability companies in existence prior to the effective date of the Revised Act can elect to remain bound under the terms of the Act or can, by approval of their members, formally vote to be bound under the provisions of the Revised Act.  Since no formal election notice is required to be filed with the Secretary of State, it is often difficult to determine which statutes govern these “pre-existing” entities.Both the Act and the Revised Act trace their roots to model acts proposed by the American Bar Association and the National Conference of Commissioners on Uniform State Laws.  See Susan Kalinka, Eighth Annual Corporate Law Symposium: Limited Liability Companies: Assignment of an Interest in a Limited Liability Company and the Assignment of Income, 64 U. Cin. L. Rev. 443 (1996); National Conference of Commissioners on Uniform State Laws, Revised Uniform Limited Liability Company Act, Annual Conference, Hilton Head, SC, July 2006.  Along with most other states, Tennessee has included provisions providing for the method and manner that judgment creditors may exercise their rights against limited liability company assets, but unlike many of those states, Tennessee has specifically limited the available remedy to a charging order.  Id., Endnote 203 (listing all states with similar statutes).  Other states, including Florida, permit a charging order, a foreclosure of the judgment debtor’s membership interest, or other equitable relief.T.C.A. § 48-218-105 states as follows:

On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge such person’s financial rights with payment of the unsatisfied amount of the judgment with interest.  To the extent so charged the judgment creditor has only the rights of an assignee of such person’s financial rights under § 48-218-101.  This section does not deprive any member or assignee of financial rights of the benefit of any exemption laws applicable to the membership interest.  This section is the sole and exclusive remedy of a judgment creditor with respect to the judgment debtor’s membership interest.

T.C.A. §48-249-509 mirrors § 48-218-105, and states:

On application to a court of competent jurisdiction by any judgment creditor of a member or holder of financial rights, the court may charge such person’s financial rights with payment of the unsatisfied amount of the judgment with interest.  To the extent so charged, the judgment creditor has only the rights of a transferee of such person’s financial rights under § 48-249-507.  This section does not deprive any member, holder or transferee of financial rights of the benefit of any exemption laws applicable to the membership interest or financial rights.  This section is the sole and exclusive remedy of a judgment creditor with respect to the judgment debtor’s membership interest or financial rights.

There is no set format or procedure for obtaining a charging order.  The judgment creditor simply needs to move the court for the entry of an order charging the judgment debtor’s financial interest in the limited liability company.  Obviously the motion should include evidence of the judgment and the relevant supporting statutes.  The judgment creditor should also include the subject limited liability company in the motion, and make sure that service of the motion is also made upon the subject limited liability company.  Often this will bring about an objection predicated upon a lack of due process but such argument is flawed.In the same way that a garnishment brings a non-litigant under the power of the court to aid in the satisfaction of a judgment, so this procedure provides a mechanism to permit a judgment creditor to charge a non-litigant entity with the responsibility to account for the financial interests of the judgment debtor.  The judgment creditor would be wise to seek not only an order that charges the judgment debtor’s financial interests, but directs the limited liability company to pay over all sums, distributions, financial entitlements, draws, or such other financial interests of the judgment debtor to the judgment creditor.  A request for an accounting of all such interests of the judgment debtor from the date of the judgment through and including the date of the entry of the charging order should also be included.NEXT UP: Potential Arguments Against Issuance of a Charging Order.For more information or for help in collecting on a judgment, please do not hesitate in contacting Ronn Steen.  He can be reached at (615) 465-6010 or ronn.steen@thompsonburton.com.  Thompson Burton is a full-service law firm committed to innovative and practical legal solutions for clients.