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.

 

 

 

 

 

 

 

Land Trust Beneficial Interest is Personal Property; Related Realty Can’t Be Liened by Creditor (IL Law)

It’s easy to robotically parrot the “beneficial interest in a land trust is personal property” rule but First Clover Leaf Bank v. Bank of Edwarsville, 2014 WL 6612947 (5th Dist. 2014) actually examines the rule’s impact against the factual backdrop of a judgment creditor trying to lien a debtor’s residence.

The creditor plaintiff obtained a $400,000-plus judgment against a husband and wife (the “Shareholders”) on various commercial guaranties they signed.  A corporation that the Shareholders each held a 50% stake in was the beneficiary of a land trust that held title to the Shareholders’ home (the “Property”).

When plaintiff learned that the Shareholders were trying to sell the Property for over $700,000, it recorded a lis pendens based on its earlier breach of guaranty judgment.  The lis pendens filing dissuaded the Property’s contract purchaser from closing and a lender later sued to foreclose on the Property.

The plaintiff then filed suit against the land trust, the corporate beneficiary (the Shareholders’ company) and the Shareholders to impose a constructive trust over the foreclosure sale proceeds.  The trial court granted plaintiff’s summary judgment motion and imposed a constructive trust on the proceeds.  The court also held that the corporate beneficiary was the alter ego of the Shareholders and so plaintiff was entitled to a constructive trust on each Shareholder’s equitable interest in the foreclosure sale proceeds.  The land trust appealed.

Held: reversed.  Land trust beneficial interest is personal property; not real property.  As a result, the lis pendens recording didn’t affect the corporate beneficiary’s interest in the Property.

Rules/reasoning:

A beneficiary’s interest in a land trust is personal property and is not considered real estate;

– To create a security interest in personal property, a creditor must look to Article 9 of the UCC;

– Assignment of a beneficial interest in an Illinois land trust transfers an interest in personal property and does not give the assignee a direct interest in the real estate subject to the trust;

– A lien on a beneficial interest is not a lien on the real estate itself;

– A corporation will be deemed an alter ego of a controlling shareholder where the corporation is inadequately capitalized, doesn’t issue stock or observe corporate formalities, fails to pay dividends, is insolvent, has no records and nonfunctioning officers;

– Illinois has a general reluctance to pierce the corporate veil and a party seeking to pierce must make a substantial showing on all these factors;

– A lis pendens notice can only be filed when real estate is involved (735 ILCS 5/2-1901); it is not proper to file in connection with a personal judgment against someone

(¶¶ 15-18)

Here, the Shareholders had no legal interest in the Property.  They were shareholders in a corporation that was a beneficiary of the land trust that held title to the Property.  The corporate beneficiary’s interest in the land trust was personal property.  Because of this, the Shareholders interest in that corporate beneficiary was also personal property.

The net effect: plaintiff could not impress a lien against the Property in efforts to enforce its guaranty judgments against the Shareholders. Instead, Plaintiff should have filed a UCC financing statement (in the Secretary of State’s office) to lien the beneficial interest in the land trust.  Since the shareholders had no definable legal interest in the Property (it was owned by the land trust), plaintiff couldn’t assert a constructive trust against the Property foreclosure sale proceeds.

Take-away:  A factually convoluted and tortured case that illustrates the challenges creditors face trying to untangle complex webs of corporate protection to reach a controlling individual’s assets.  If in the creditor’s position, in addition to filing a UCC statement, I think I would issue third-party citations on the land trust entity and the corporate beneficiary.  Then, I would try to impress a lien or seek a turnover order as to any of the Shareholders interests in either the land trust or the corporate beneficiary.