Florida Series: Charging Order that Gives Receiver Management Control over LLC Finances Too Broad – Fla Appeals Court

A creditor’s exclusive remedy against a debtor who is a member or manager of a limited liability company (LLC) is a charging order on the debtor’s distributional interest.

McClandon v. Dakem & Associates, LLC, (see here), a recent Florida appellate case, illustrates that while the charging order remedy is flexible enough to allow for some creative lawyering, it still has limits.

McClandon’s facts are straightforward: the plaintiff obtained a money judgment against an individual who had an interest in several limited liability companies.   In post-judgment proceedings, the plaintiff sought a charging order against the debtor’s LLC interests.  The court granted the charging order and appointed a receiver to take control of the LLCs’ finances.

The debtor appealed.

Partially reversing the charging order’s terms, the appeals court found the trial court exceeded its authority and encroached on the legislature by giving the receiver managerial control over the LLCs.

Section 605.0503 of the Florida LLC statute permits a court to enter a charging order as a creditor’s exclusive remedy to attach a debtor’s interest in a multi-member LLC.  The statute further provides that a court can apply broad equitable principles (i.e., alter ego, equitable lien, constructive trust, etc.) when it fashions a charging order.  Florida’s LLC act is based on the Revised Uniform Limited Liability Company Act of 2006 which specifically provides that a court can appoint a receiver to assist in collection of a debtor’s LLC distributions.  See RULLCA Section 503(b)(1).

The court had discretion to appoint a receiver to help the creditor foreclose on the charging order against the debtor’s LLC interests.  But the court exceeded its boundaries by giving the Receiver expansive management authority over the LLC’s finances.

Since there was no statutory predicate for the court to allow the Receiver to exert managerial control over the LLCs, the trial court’s charging order was overly broad.

Afterwords:

The charging order remedy lends itself to flexibility and creative lawyering.  While a creditor can have a receiver appointed to assist in collecting LLC distributions, the receiver cannot – at least in Florida and other states following the Uniform LLC Act – exert control over the LLC’s financial inner workings.  When petitioning for a receiver, creditor’s counsel should make sure the receiver does not engage in the management of the LLC’s business operations.

 

LLC Stopped From Selling Member’s Residence In Violation of Prior Charging Order – Utah Federal Court

Q: Can A Court Stop An LLC That Pays the Monthly Mortgage of One of Its Members From Selling that Member’s Home Where A Charging Order Has Issued Against the LLC to Enforce a Money Judgment Against the LLC Member?

A: Yes.

Q2: How So?

A2: By selling the member’s property and paying off the member’s mortgage with the sale proceeds, the LLC is effectively “paying the member” to the exclusion of the plaintiff judgment creditor.

Source: Earthgrains Baking Companies, Inc. v. Sycamore Family Bakery, Inc., et al, USDC Utah 2015 (https://casetext.com/case/earthgrains-baking-cos-v-sycamore-family-bakery-inc-3)

In this case, the plaintiff won a multi-million dollar money judgment against a corporate and individual defendant in a trademark dispute.  The plaintiff then secured a charging order against a LLC of which the individual defendant was a 48% member.  When the LLC failed to respond to the charging order, the plaintiff moved for an order of contempt against the LLC and sought to stop the LLC from selling the defendant’s home.

The court granted the contempt motion.  First, the court found that it had jurisdiction over the LLC.  The LLC argued that Utah lacked jurisdiction over it since the LLC was formed in Nevada.  The LLC claimed that under the “internal affairs” doctrine, the state of the LLC’s formation – Nevada – governs legal matters concerning the LLC.

Disagreeing, the court noted that a LLC’s internal affairs are limited only to “matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders.”  The internal affairs doctrine does not apply to claims of third party creditors.  Here, since the plaintiff was a creditor of the LLC’s member, this was not a dispute between LLC and member.  As a result, the internal affairs rule didn’t apply and the Utah court had jurisdiction over the LLC since a LLC member lived in Utah.  (See Cosgrove v. Bartolotta, 150 F.3d 729, 731 (7th Cir. 1998)).

The Charging Order required the LLC to pay any distribution that would normally go to the member directly to the plaintiff until the money judgment was satisfied.  The Charging Order specifically mentions transfers characterized or designated as payment for defendant’s “loans,” among other things.

The LLC was making monthly mortgage payments on the member’s home and listed the home for sale in the amount of $4M.  Plaintiff wanted to prevent the sale since there was a prior $2M mortgage on the home.

In blocking the sale, the court found that if the LLC sold the member’s home and paid off the member’s mortgage lender with the proceeds, this would violate the Charging Order since it would constitute an indirect payment to the member.  The court deemed any payoff of the member’s mortgage a “distribution” (a direct or indirect transfer of money or property from LLC to member) under the Utah’s LLC Act. (Utah Code Ann. § 48-2c-102(5)(a)).

Since the Charging Order provided that any loan payments involving the member were to be paid to the plaintiff until the judgment is satisfied, the court found that to allow the LLC to sell the property and disburse the proceeds to a third party (the lender) would harm the plaintiff in its ability to satisfy the judgment.

Afterwords:

An interesting case that discusses the intricacies of charging orders and the thorny questions that arise when trying to figure out where to sue an LLC that has contacts in several states.  The case portrays a court willing to give an expansive interpretation of what constitutes an indirect distribution from an LLC to its member. 

Earthgrains also reflects a court endeavoring to protect a creditor’s judgment rights where an LLC and its member appear to be engaging in misdirection (if not outright deception) in order to elude the creditor.

[A special thanks to attorney and Forbes contributor Jay Adkisson for alerting me to this case (http://www.forbes.com/sites/jayadkisson/)]

 

Prior Charging Order Trumps Later Divorce Court Order Involving Restaurant LLC Payouts

The Third District Appellate Court answers some important questions concerning the priority of competing creditors’ rights in the assets of a common debtor and the nature of appellate jurisdiction in FirstMerit Bank v. McEnery, 2014 IL App (3d) 130231-U.

There, a creditor obtained a $1.8M judgment against a defendant who had interests in several restaurant LLC ventures (the “LLCs”).  The creditor then moved for and received a charging order against all current and future distributions flowing from the LLCs until the judgment was satisfied.  The effect of the charging order was to place a lien or “hold” on the defendant’s distributions.  (See http://paulporvaznik.com/charging-orders-judgment-debtor-llc-member/5961).

A couple years later, defendant’s wife obtained an order in a divorce case that gave her a 50% interest in the LLCs.  About a year after that (divorce case) order, the trial court (presiding over the underlying suit) granted the plaintiff’s “turn over” motion (motion to require defendant to turn over future LLC distributions to the plaintiff/judgment-creditor.

The disputed issue: what took precedence?  The charging order against the LLCs or the later divorce court ruling giving defendant’s wife a 50% interest in the LLCs?  The trial court found that the prior charging order took priority over the defendant’s wife’s interest in the LLCs.  Defendant’s wife appealed.

Held: Affirmed.  Plaintiff’s charging order take priority over defendant’s wife’s interests in the LLCs

Reasons:

The Court first held that the trial court’s turn over order didn’t conflict with the divorce court order giving the wife a 50% share of the LLCs since that later order wasn’t “final” and appealable.

Illinois Supreme Court Rule 301 provides that every final judgment is appealable as of right;

An order is final where it either terminates the litigation between the parties on the merits or disposes of the rights of the parties – either the entire controversy, or a separate branch of the litigation;

– A notice of appeal must be filed within 30 days after the entry of a final order or within 30 days after entry of the order disposing of the last pending post-judgment motion;

– Where multiple parties and claims are involved, a party seeking an appeal must request a Rule 304(a) finding (that there is no reason to delay enforcement of or appeal from an order) from the trial judge;

– An order entered in a citation proceeding under Code Section 2-1402 is final when the citation petitioner is in a position to collect against the judgment debtor or third party or the petitioner has been foreclosed from doing so

(¶¶ 30-33)

Here, the divorce court order granting the defendant’s wife a 50% share in the LLCs – while entered before the turn over order – wasn’t final because it didn’t terminate the divorce case.  There was no order of marital dissolution and the divorce case continued for further status.  As a result, the divorce court’s 50% share order was subordinate to the trial court’s charging order and later turn over order.

Take-away:

This case rewards aggressive creditor enforcement steps.  By charging (liening) the debtor’s LLC interests, the creditor was in a position to take “first dibs” on the LLC distributions to the debtor, even though a court order later gave the debtor’s spouse a 50% share in the LLCs. 

The case also cements the proposition that a charging order impresses a lien on a debtor’s LLC distributions and that this charging lien will take primacy over any later judgment or lien filing related to the same LLC distributions.