All About Charging Orders – When the Judgment Debtor Is an LLC Member

ChargeGetting a judgment against an LLC member can trigger a high-anxiety response.  That’s because the normal post-judgment collection rules set out in Code Section 2-1402 and Supreme Court Rule 277  don’t cleanly apply.  

Section 30-20 of the LLC Act (805 ILCS 180/30-20) states that a creditor’s exclusive remedy is to obtain a “charging order” against the LLC member’s “distributional interest.”  Illinois cases describe  Section 30-20 as a special remedy designed to allow a creditor of an LLC member to realize the value of the debtor’s distributional interest in the LLC and also protect both the LLC’s ability to function and the other members’ LLC interests.

The LLC Act defines “distributional interest” as a “member’s interest in distributions by the limited liability company.”  A distributional interest is not salary, wages, draws or reimbursement. To reach an LLC member’s wages, for example, a creditor should still utilize a third-party citation on the LLC and seek a turnover of any wages to be paid to the debtor.

To obtain a charging order, the creditor files an application or motion with the Court (“Motion for Charging Order”) and requests a charging order on the LLC member’s interest in the LLC.  The Motion is served on the debtor by regular mail and the creditor does not have to name the LLC as a party defendant. 

The court also isn’t required to have jurisdiction over the LLC for a charging order to issue against the member-debtor.  See, Bank of America, N.A. v. Freed, 1-11-0749 et al., 2012 WL 6725894 (Ill. App. Ct. Dec. 28, 2012) (LLC is not a necessary party to creditor’s charging order application).

The charging order impresses a lien (a hold) on the debtor’s LLC interest and any distributions coming due to the debtor can be paid to the creditor.  The lien on the distribution can also be foreclosed by the creditor filing a petition to foreclose the lien.  The debtor’s LLC interest can then be sold by the Sheriff or a private property – much like with any other asset sale.  Any sale proceeds the debtor’s distributional interest garners can be applied to the judgment amount.

To summarize, then, an LLC member’s judgment creditor should follow this four-step enforcement process: (1) file a motion for a charging order against the LLC member’s distributional interest; (2) serve the charging order on the LLC’s manager and registered agent (so they know to forward the distribution to the creditor), (3) (if the debtor doesn’t redeem and the judgment isn’t satisfied after turnover of the distribution) file a motion to foreclose the charging order (appoint someone to evaluate and sell the distributional interest); and (4) schedule either a public or private sale of the debtor’s distributional interest.  I also serve a third-party citation directly on the LLC and ask for a turnover order on any wages, draws or other payments (that aren’t distributions) to the debtor.

Post-Judgment Statutory Changes

Effective January 1, 2012, several statutes that govern Illinois judgment enforcement practice took effect.  The key statutory change as it relates to enforcing judgments against LLC members is Code Section 12-112.5.  This Section speaks directly to the charging order remedy and provides:

Sec. 12-112.5. Charging orders. If a statute or case requires or permits a judgment creditor to use the remedy of a charging order, said remedy may be brought and obtained by serving any of the various enforcement procedures set forth within this Article XII or by serving a citation pursuant to Section 2-1402. If the court does not otherwise have jurisdiction of the parties, the law relating to the type of enforcement served shall be used to determine issues ancillary to the entry of a charging order such as jurisdiction, liens, and priority of liens.

The comments to revised Section 5-112.5 make it clear that while a charging order is still the exclusive remedy for a creditor to impress a lien on an LLC member’s distributional interest, the creditor can use citation/supplementary proceedings under Code Section 2-1402 and Rule 277 to obtain that charging order in the first place.

Going forward, and in light of Section 112.5 and until there are more published cases that more thoroughly examine the interplay between Section 112.5 with LLC Section 30/20, judgment creditors of an LLC member should (1) serve a citation on the debtor, (2) serve a third-party citation on the LLC (via its registered agent or manager); and (3) file a motion for a charging order against the debtor’s LLC interest.

Once the charging order enters, the creditor can either receive distributions until the judgment is satisfied or try to more quickly monetize the debtor’s LLC distribution by filing a petition to foreclose the charging order lien.  A foreclosure sale buyer of the distributional interest will have rights to future distributions but does not get to exercise voting rights or make LLC business decisions.

 

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PaulP

Litigation attorney at Fisher Kanaris, P.C. representing businesses and individuals in all types of commercial disputes.