Before we get into definitions and explanations, let us propose a few questions. These complicated questions face the courts when remedying a judgment.
· What happens if a judgment is obtained against a partner, but not the partnership?
· What happens if the judgment closes the company down?
· What if there is another remedy besides the remedy to close the company?
· Is it fair to punish the non-debtor partners who have no judgment against them?
A Charging Order is an order obtained from a court or judge by a judgment creditor, by which the property of the judgment debtor is held against the partner’s right to distributions from the entity. The Uniform Partnership Act and LLC Act describe the charging order as “in the nature of a garnishment” from a business. A Charging Order may be analogous to a garnishment because it is an assignment of the partner’s economic right to distributions from the partnership.
The rationale for charging orders came as a reaction to historical remedies for punishing debtors. A simple way was to have a law enforcement agency of the church or the town simply close the company down, even if one partner was at fault and the others had no judgment. Eventually the non-debtor partners got wise and began to protect themselves with legal remedies against the liability of their partners and file in court for remedies against the violation of their rights. It may sound confusing or unreal, but this is a natural cycle in law.
To protect the non-debtor partners from the creditor of the debtor-partner it was necessary to keep the creditor from seizing partnership assets (which was also in line with the developing perception of partnerships as legal entities and not simple aggregates of partners) and to keep the creditor out of partnership affairs.
Before the Charging Order, a creditor was able to treat the company as a single entity instead of an aggregate of interests or partners. In almost all states, LLC statutes are based on the Uniform Code Acts UCC, such as the Revised Uniform Partnership Act of 1994 “RUPA”, the Uniform Limited Partnership Act of 2001 (“ULPA”) or the Uniform Limited Liability Company Act of 1996 (“ULLCA”), or the earlier versions of these acts.
These acts set precedence for the following important parameters.
The RUPA, at Section 504, and the ULLCA, at Section 504, introduced the following new concepts.
1) The charging order constitutes a lien on the judgment debtor’s transferable interest.
2) The purchaser at a foreclosure sale has the rights of a transferee.
3) The charging order is the exclusive means by which the creditor could pursue the partnership interest.
The ULPA (the last act, chronologically), in addition to the new language in the RUPA and the ULLCA provides, further, at Section 703, that,
1) The judgment creditor has only the rights of a transferee, and
2) The court may order a foreclosure only on the transferable interest.
In general, these are the points that have evolved.
1) The charging order is a lien on the judgment debtor’s transferable/distributional interest; it is not a levy.
2) The creditor can never exercise any management or voting rights because the creditor has only the rights of an assignee/transferee and not the rights of the manager.
3) The foreclosure of the charged interest does not harm the debtor because the buyer at the foreclosure sale receives no greater right than was possessed by the original creditor.
4) The creditor, expressly, has no other remedies except for the charging order (and foreclosure on the charging order).
The acts also provide that the charging order does not charge the entire partnership or membership interest of the debtor, but only the “transferable” (RUPA) or “distributional” (ULLCA) interest. However, the language providing that the creditor has the rights of an assignee was dropped.
Because the charging order creates a lien and not a levy, and because the creditor has only the rights of a transferee, the creditor does not become the owner of the charged interest unless there is foreclosure. This means the creditor has no management capabilities.
The creditor’s inability to vote the charged interest or participate in the management of the entity is at the heart of asset protection efficiency. If the partnership, or the LLC, halts all distributions, the creditor has no ability to force the distributions.
This is only an introduction to Charging Orders and a basic understanding of what they entail. If you would like to know more, call us at TrustMakers.
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