BY JENNIFER LYNN PETERS, ESQ.
Often the hard work of collecting money you are owed starts after a judgment is entered. Wise collection strategies are crucial in the current real estate market where it may no longer be a practical option to record a transcript of the judgment (thus obtaining a judgment lien), wait for the judgment-debtor’s property to be refinanced or sold, and collect from the equity. Today, the creditor who pushes the hardest and uses all available legal tools often is the first and only one who gets paid. So … what is a creditor to do when a judgment debtor has hidden all of his assets in a limited liability company? Charge!
How do I get to the debtor’s interest in the company? Use a charging order.
A common chant at sporting events, “Charge!” has become the mantra of lawyers advising creditor clients trying to collect a debt from an individual who holds limited liability company (LLC) interests.
A charging order is a court order directing the charged LLC to pay all assets or distributions of the LLC due to the judgment debtor to the creditor instead. Colorado Revised Statute §7-80-703 authorizes any creditor to obtain a charging order “on application.” In 1997 when this section was first added, the statute said “upon due application”, which was interpreted by the courts to require prior notice to anyone affected by the charging order. See First Nat’l Bank of Denver v. District Court, 652 P.2d 613 (Colo. 1982). In 1998, this provision was amended to simply say “on application,” leaving open the question of whether prior notice is still required. The charging order is effective upon service to the LLC and then creates a lien on the debtor’s membership interest. Here, service means personal service pursuant to Colorado Rule of Civil Procedure 4. Such service can be accomplished several ways: by personal delivery to the LLC’s registered agent or an officer or member of the LLC, or even to a direct secretary or assistant of the registered agent, officer or member. See In re Goodman Associates, LLC v. WP Mountain Properties, LLC, 222 P.3d 310 (Colo. 2010). Service by certified mail may also suffice if the registered agent cannot easily be found; however, if serving in this manner, one should obtain a court order approving such service and setting the date of service as five days from the date of mailing. See § 7-90-704(2), C.R.S.
A creditor with a charging order may seek appointment of a receiver to oversee the profits or other money due or to become due to the judgment-debtor member. An appointed receiver can ensure that a creditor can easily and without further court orders access information such as the financial records of the LLC. Additionally, the charged membership interest can be foreclosed, or ordered sold by the court, and the proceeds paid to the charging creditor. The statute also authorizes the sale of the charged membership interest by consent of all other members. Neither scenario triggers mandatory dissolution.
Historically, if the debtor’s membership interest was not sold, the charging creditor could not step into the shoes of the judgment debtor, but instead assumed the role of an assignee or transferee of the membership interest, meaning that the creditor could not control the LLC even if the charged membership interest was the majority interest or the judgment debtor was the manager of the LLC. Absent consent, even if the only other interest remaining in the LLC was infinitesimal, the creditor had no management or governance rights in the LLC, but only a right to payment of monies owed by the LLC to the judgment debtor. See In re Albright, 291 B.R. 538 (Bankr.D.Colo. 2003), citing § 7-80-702, C.R.S.
However, in 1998, language was added to the charging order statutes allowing a court to “make all other orders, directions, accounts and inquiries that the debtor member might have made or that the circumstances of the case may require.” While there are not yet any Colorado cases interpreting this change, it appears that there may be more flexibility for courts to order additional relief to the creditor as part of the charging order, including providing for additional or greater rights than historically allowed if the circumstances justify it. One example of such flexibility has recently arisen in the context of single-member LLCs. In a single-member LLC, the purpose and benefit of the charging order, derived from the Uniform Partnership Law and intended to benefit the non-debtor partners, is not applicable. The charging order is intended to avoid forcing partners of a judgment debtor becoming business partners with, or to involuntarily share governance of their business with, a creditor. Single-member LLCs need no such protection. Additionally, in a single-member LLC the effect of a charging order would be to leave the LLC without any disinterested person to manage it. As such, courts now appear willing simply to order a judgment debtor holding an interest in a single-member LLC to forfeit or assign the interest in the LLC to the creditor, rather than requiring foreclosure of the interest. See Olmstead v. Federal Trade Commission, 44 So.3d 76 (Fla. 2010) (court could order debtor to surrender all right, title and interest in debtor’s single-member LLC to satisfy an outstanding judgment). Since the management aspect is the same in multi-member LLCs where the judgment debtor is the only manager, the courts may also, given the flexibility in the current statute, provide such relief for multi-member LLCs.
The use of a charging order in the context of LLC interests is not yet well guided by case law. Consequently, courts look to the Uniform Partnership Law for guidance on issues such as priority of competing charging orders and the availability of other means to collect a judgment by going after the judgment debtor’s interest in an entity.
So what happens if more than one creditor serves a charging order?
With competing charging orders, he who serves first is prior. See Union Colony Bank v. United Bank of Greeley NA, 832 P.2d 1112 (Colo.App. 1992). The priority of charging orders is determined by the date of service of the order upon the LLC, and not by the date judgment was obtained or a transcript of judgment was recorded. Being the first to obtain and serve a charging order is critical in achieving the first and prior lien against the judgment debtor’s membership interest.
Is a charging order my only option?
The principal difference between the LLC and partnership statutes is that the Uniform Partnership Law specifies that the charging order is the only remedy available to a creditor to enforce the judgment against a partner’s interest. See § 7-64-504(5), C.R.S. The LLC statutes do not contain such a provision. Some creditors thus argue that a charging order is not the exclusive remedy available when pursuing a judgment-debtor’s LLC interest. Although Colorado courts have not yet opined about whether a charging order is the exclusive remedy for reaching a judgment debtor’s LLC interests, recent decisions from other states indicate that it is not . See Olmstead, supra; see also F.T.C. v. Peoples First Credit, LLC, 621 F.3d 1327 (11th Cir. 2010). A recent decision by the Colorado Bankruptcy Court and an early Colorado Supreme Court decision both indicate Colorado would follow these other states. See In re Albright, supra (noting the charging order statute serves no purpose in a single-member LLC) and Collard v. Hohnster, 174 P. 396 (Colo. 1918) (remedy provided by one statute does not abolish another or common law unless specifically provided).
So what other options do I have?
With the rising use of LLCs in Colorado, the ability to collect a judgment through LLC assets can mean the difference between getting paid or not. Often the charging order is the best option for pursuing collection against a judgment debtor hiding assets in an LLC. Unlike a garnishment, which expires 180 days after service and after which a competing creditor could step in front of you, charging orders do not expire and attach to all distributions or assets due or that become due to the judgment debtor until the judgment is satisfied. However, charging orders can be avoided if an LLC doesn’t make distributions. They are also often misunderstood by LLC managers, and achieving compliance can be difficult without cooperating non-debtor members or managers. Thus, garnishments can also be an effective tool when used in conjunction with the charging order.
A creditor can also foreclose the interest, but this can be tricky, time-consuming, and expensive. Colorado law is not clear about how to foreclose an LLC membership interest, what effect the foreclosure has on the LLC, and whether the foreclosing creditor can then demand dissolution and liquidation of the LLC from which the judgment might be satisfied.
In pursuing collection of judgments against debtors with assets tied up in LLCs, a charging order can be a powerful and useful tool. It is important to be sure your charging order contains sufficiently comprehensive enforcement mechanisms and provisions allowing a creditor to obtain information about the financial status of the LLC, however, to obtain the maximum benefit. Using the charging order in conjunction with other available collection remedies will greatly increase the likelihood of recovery. If you are interested in pursuing a charging order, or have received on and have questions about it, contact Jennifer Lynn Peters, Esq. 970-330-6700.