Charging Order Protection

Charging Orders are an important legal issue that must be navigated by the client and their attorney in order to create a successful asset protection plan.  Technically, a charging order is a creditor remedy.  It is a court order that allows a creditor to intercept any distributions of income or profits that are paid out by an LLC or a Limited Partnership to a member who owes money to a judgment creditor (hyperlink to online dictionary).  All states allow for charging orders.  But the law on charging orders is not uniform throughout the country.  The laws of some states say that charging orders are merely one remedy available to a creditor to collect on a judgment, and allow the creditor to foreclose the ownership interest of the judgment debtor (hyperlink to online dictionary) in the LLC or Limited Partnership if it appears that a charging order will not satisfy the judgment “in a reasonable period of time.”  In other states, the law makes charging orders the sole and exclusive remedy of a creditor and denies that creditor the right to foreclose.  This is a key difference in the law, and allows the creative asset protection attorney, through careful planning, to protect a client’s ownership interest an LLC or Limited Partnership.

In most states, creditors holding a charging order will not be allowed to interfere with the management of the company.  This limitation in the law of certain states is another important legal strategy that can be used to protect a client from a charging order when creating an asset protection plan.  If the asset protection plan is structured correctly, it is up to the management of the LLC or LP (i.e., you) to decide if, and when, a distribution will be paid to the members.  This is a key concept.  

If you know that a distribution will be going to your creditor and not you, then why authorize payment of distribution, right? Instead, you can reinvest these monies in the company, or pay distributions only to those members who do not have charging orders issued against them (this requires a carefully crafted operating agreement) or use a multilayered asset protection plan to make distributions into new companies and other investments.  The bottom line is, so long as the distribution does not get paid to YOU, your creditor can’t seize it.

Again, it bears repeating, if the governing documents of the business entity are properly structured, a creditor cannot order the LLC or LP to make a distribution that would be subject to its charging order.  Frequently, creditors who obtain charging orders often end up with nothing because they can’t force the LLC to make any distributions.

The fact that a charging order may not result in a payment to a judgment creditor does not, however, mean that it is not going to be a problem for the debtor and his company.  The existence of a charging order can make it difficult for the debtor/member and the other partners to take money out of the company and/or to obtain bank financing.  It certainly complicates things.

Accordingly, the goal of your asset protection structure should be to facilitate a favorable settlement.  If the creditor knows that you will never authorize a distribution that will wind up in their pocket, you can often settle the matter for pennies on the dollar.

In Florida, a creditor’s collection rights against a multimember LLC or an LP are limited to obtaining a charging order (single member LLCs are treated differently).  Therefore, effecting a favorable settlement is realistic goal.   

If you own assets outside of Florida, however, things become more complicated.  As mentioned above, many states do not limit creditors to a charging order.  They also allow a creditor to foreclose a debtor’s ownership interest in an LLC or LP if a charging order will not result in the payment of the judgment within a reasonable period of time.  The same is also true here in Florida if your LLC is a single-member LLC (i.e., your interest can be foreclosed).  

This means that creditors in states that permit foreclosure also have the right to take you ownership interest in your LLC, LP, corporation, etc. to pay their claim.  So, as you can see, the level of your asset protection will depend upon the type of business entity you’ve chosen and where it is located. 

Should You Form Your LLC Outside Your Home State?

If your home state does not provide all the creditor protection you want, you can form your LLC in a more debtor-friendly state.  You do not have to form your business entity in your home state, even if that is where you live or do business.  Which state’s law will apply, however, can become quite complicated should litigation arise.  There is no guarantee that the courts in your home state or the courts in the state where you formed your entity will apply the law you want.  This is a complex legal area so, the use of foreign jurisdictions for asset protection purposes should not be undertaken without competent legal counsel.