The Charging Order as an Exclusive Remedy

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; many of these same states allow the creditor to foreclose on the ownership interest of the judgment debtor in the LLC or limited partnership if it appears that a charging order will not satisfy the judgment within a "reasonable period of time."  By comparison, in some other states, the charging order is the sole and exclusive remedy for a creditor; these states deny the creditor the right to foreclose on the judgment debtor's ownership interest in the LLC or limited partnership.

We believe that the charging order concept is an important asset protection tool. Through careful planning, we endeavor to protect a client’s ownership interest in business entities by availing ourselves of charging order protection where available.  In addition to analyzing the client's business, we consider the availability of charging order protection for LLCs and limited partnerships in those jurisdictions which limit the judgment creditor to a charging order as the sole and exclusive remedy.

The Scope of the Charging Order

Creditors holding a charging order are not allowed to interfere with the management of the business.  In particular, creditors cannot use the charging order to compel the management of the business to make a distribution in order to satisfy the creditor's claim.  Whether a distribution is to be made is entirely within the discretion of management, which has the sole authority to determine whether, when, and how much to distribute.

This limitation is another important consideration that may be used to shield a client's assets from a judgment creditor.  If you have control of, or significant influence over, the management of the business entity, this means that you get to decide if and when distributions are made.

If you know that a distribution will be going to your creditor and not you, then you are not likely to authorize payment of a distribution. Instead, you are more likely to reinvest excess funds back into the business or invest the money into new ventures. The bottom line is that, as long as the funds are not distributed to you, the creditor cannot rely on a charging order to disgorge those funds.

Keeping the Problem in Perspective

You should bear in mind that charging order protection is not a panacea. While the charging order limitation prevents the creditor from reaching into your business to grab cash, the charging order can make it difficult for you and your business partners to withdraw money from the business or obtain bank financing.

At best, charging order protection discourages the judgment creditor from wanting to pursue your ownership interest and distribution rights in a business entity, cognizant that there is no assurance of a forthcoming distribution.  At worst, charging order protection creates a legal stalemate in which neither the creditor nor you can access excess funds accumulating inside the business entity. Accordingly, the goal of your asset protection plan 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.

Charging Order Protection in Florida

In Florida, the charging order is the sole and exclusive remedy for a judgment creditor trying to collect against a debtor's interest in a multimember LLC or limited partnership. (Please note that there is no such limitation with respect to a debtor's interest in a single-member LLC.)  Accordingly, your judgment creditor must sit and wait for your business entity to authorize a distribution to you, an event which has no guarantee of happening at any time in the near future.  The creditor must not only wait to collect, but the creditor must bear the risk that your business remains free to use its excess cash in activities that carry significant risk of loss.

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 upon 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 upon). 

In those states that permit foreclosure on a member's LLC or LP interest, the creditor may seize your ownership interest in your business entity to meet their claim.  However, if the business entity is properly structured, the creditor does not gain admission as a new member or partner by virtue of foreclosing on your ownership interest.  Therefore, even in those states that permit the foreclosure, the creditor may be locked out of management, such that the foreclosure remedy does not yield a significantly different result from the outcome in a state in which the charging order is the sole and exclusive remedy.  In other words, even with foreclosure, the creditor may still be compelled to come to a settlement.  Therefore, the level of asset protection needed for your business 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 an LLC in a more debtor-friendly state.  You do not have to form your asset protection entity in your home state, even if that is where you live or do business.  However, 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.  Given the complexity surrounding "conflict of laws" principles involving business entities, the use of an out-of-state jurisdiction for asset protection planning should not be undertaken without experienced legal counsel.