¶ 1601
Overview
Scope of the chapter. Chapter 15 examined the protection an entity gives its owners from the entity's creditors. This chapter examines the reverse: the protection an entity gives its assets from the owners' personal creditors. The principal device is the charging order, a court order that gives the owner's creditor a lien on distributions from the entity without any right to manage it, vote, compel distributions or reach its assets. The chapter traces the charging order from its origins in partnership law, examines the statutes that make it the exclusive remedy, considers the special problems of single-member LLCs and series LLCs, and addresses the treatment of LLC interests in bankruptcy, the family limited partnership and the drafting of operating agreements that preserve the protection.
Why the charging order matters. For many families, the charging order is the protection on which their holding entities rest. A family that holds its investments, real estate or business through an LLC with several members can expect that a creditor of one member will receive, at most, a right to that member's share of whatever distributions the managers decide to make. If the managers make none, the creditor receives nothing, while the creditor may bear tax on income allocated to the charged interest. The creditor's leverage is correspondingly reduced, and claims against members of well-structured family entities often settle for modest amounts.
The limits of the charging order. The protection is narrower than its reputation. It depends on the law of the state that governs the entity and, often, on the law of the forum where the creditor sues. It is weaker for single-member entities, which many courts and some statutes treat differently. It does not survive the member's bankruptcy in the same form, because the trustee succeeds to the member's interest. It does not prevent the creditor from attacking the transfer of assets into the entity as a voidable transfer, or the entity itself as an alter ego (see supra ¶ 1550). And it gives no protection against creditors, such as the IRS and a divorcing spouse, whose remedies are not limited by the charging-order statutes.
Charging-order protection in the Threat Matrix. The charging order is strongest against C1 and C2 creditors of a member of a multi-member entity formed at T0 under a statute that makes it the exclusive remedy. It is weaker against C6, the bankruptcy trustee, and weak against C3 spouses, whose claims are resolved by dividing the marital estate, including the member's interest, and against C5 sovereign creditors, who may levy on the interest and pursue nominee and alter-ego theories. The ratings are summarized in ¶ 1690.
How to read the chapter. Paragraph 1610 explains the charging order and its history. Paragraph 1620 examines exclusivity and choice of law, and ¶ 1630 single-member LLCs. Paragraph 1640 addresses foreclosure, receivers and the other remedies a creditor may pursue. Paragraph 1650 treats series LLCs. Paragraph 1660 examines LLC and partnership interests in bankruptcy, and ¶ 1670 family limited partnerships and LLCs. Paragraph 1680 sets out drafting points for operating agreements, and ¶ 1690 places the charging order in the Threat Matrix.