LIKE SWISS CHEESE: 14 EXCEPTIONS TO CHARGING ORDER EXCLUSIVITY

Forbes

27-04-2025

Charging order exclusivity is like Swiss cheese: Full of large holes through which creditors may ... More pass.
A charging order is the American remedy by which a creditor may enforce a judgment against the interest held by a debtor in a limited liability company or partnership. A charging order has two components: First, a judicial lien is created in favor of the creditor against the debtor's interest; and, second, economic distributions to the interest are ordered to be paid to the creditor. The charging order ― which is to say the lien and order to pay ― continues to exist until the debtor has fully satisfied the judgment to the creditor. Most U.S. jurisdictions have adopted language in their LLC and partnership statutes which say that the charging order remedy is a creditor's exclusive remedy to satisfy a judgment against the debtor's interest. This is known as charging order exclusivity. But what does exclusive in this context mean really?
There is a widely-held myth in LLC and partnership law that exclusive means something like outcome determinative, i.e., the creditor is stuck with a charging order and can get no further relief against the debtor's interest. This is false for, as will be shown below, there are at least fourteen (14) identifiable exceptions to charging order exclusivity. Moreover, it has long been held that the office of the charging order is not to protect the debtor's interest from creditors, but rather to protect the non-debtor members from being forced into what amounts to an involuntary business marriage with the debtor-member's creditors. With these exceptions, we will see that so long as the interests of the non-debtor members can be protected from the forced business marriage scenario, the debtor's interest is actually quite susceptible to being lost to creditors.
For ease of analysis, this article will focus upon limited liability companies although the same analysis will usually apply to the various forms of partnerships. Also, because most U.S. jurisdictions have adopted some form of the Uniform Limited Liability Company Act ("ULLCA"), or at least a functionally-similar various of the ULLCA, we will focus upon the language of the ULLCA where applicable.
And now, on to the exceptions!
The first four exceptions are those found within the text of ULLCA 503 itself. They are thus known as the organic exceptions to charging order exclusivity.
ULLCA 503(c) provides that if the creditor can show that distributions to the debtor-member's interest will not satisfy the judgment within a "reasonable" time, the court may order a judicial sale of the interest. What the purchaser at the judicial sale gets is determined by ULLCA 502, which means that the purchaser acquires the debtor's economic interest only. See, e.g., Hellman v. Anderson, 233 Cal. App. 3d 840, 284 Cal. Rptr. 830 (Cal.App.Dist.3 1991). However, this leaves the debtor without an economic interest in the LLC and normally causes the debtor to be disassociated from the LLC.
Outcome: Debtor loses LLC interest, and the purchaser at the judicial sale becomes a mere assignee of the debtor's economic interest unless also admitted to the LLC.
ULLCA 503(e) provides that prior to the foreclosure, either the LLC or the non-debtor members may purchase the interest by paying to the creditor the the full outstanding amount of the debtor-member's judgment. Practically, however, a creditor should almost be willing to accept the fair market value of the interest (and often much less). See, e.g., Eights & Jackson Investment Group v. Kaw Valley Bank, 2013 WL 183753 (D.Kan., 2013).
Outcome: Debtor loses the LLC interest, which is acquired by the non-debtor members.
ULLCA 503(f) provides that the foreclosure of the charging order lien against the debtor-member's interest in a single-member LLC results in the purchaser at the judicial sale (usually the creditor via credit-bidding) becomes the new and only member of the LLC. The Comment to 503(f) states: "The charging order remedy—and, more particularly, the exclusiveness of the remedy—protect the 'pick your partner' principle. That principle is inapposite when a limited liability company has only one member. The exclusivity of the charging order remedy was never intended to protect a judgment debtor, but rather only to protect the interests of the judgment debtor's co-owners. Put another way, the charging order remedy was never intended as an 'asset protection' device for judgment debtors. See Olmstead v. F.T.C., 44 So. 3d 76, 83 (Fla. 2010) (recognizing 'the full scope of a judgment creditor's rights with respect to a judgment debtor's freely alienable membership interest in a single-member LLC'); In re Albright, 291 B.R. 538, 540 (Bankr. D. Colo. 2003) (holding that, '[b]
Outcome: Debtor loses the LLC interest and the purchaser at the judicial sale will take in full the debtor's former interest and also take control of the LLC's assets.
ULLCA 503(h) states that "[t]
his section provides the exclusive remedy" by which a creditor can satisfy a judgment against the debtor-member's interest in an LLC. However, "this section" includes 503(b)(2) which allows a court to "make all other orders necessary to give effect to the charging order" and to "effectuate the collection of distributions". Thus, where distributions are not being made, the court may make "other orders" that force the making of that distribution. See, e.g., Earthgrains Baking Co., v. Sycamore, 2022 WL 433486 (10th Cir., Feb. 14, 2022) ("It is wrong to use [the exclusive remedy language] to read out of the statute broad language permitting a court to 'make all other orders necessary to give effect to the charging order.' [Citation omitted]. That language is crucial to the statute's procedural design and effectiveness, as this case illustrates."). This is perhaps the biggest hole in the charging order Swiss Cheese, albeit it is typically employed only in cases where the debtor, the LLC, or the non-debtor members have acted egregiously in derogation of the creditor's rights.
Outcome: Distributions are forced to the debtor's interest subject to the charging order, including liquidation of LLC assets to accomplish this if necessary.
The next five exceptions to charging order exclusivity occur because ULLCA 503 is determined for various reasons to not apply at all. Since charging order exclusivity is a creature of ULLCA 503, it simply disappears with these exceptions. These exceptions are thus known as the inapplicability exceptions.
Comment to ULLCA 503: By its terms, this section does not apply to foreign limited liability companies. See Section 102(8) (defining "[l]imited liability company" to mean "an entity formed under this [act] or which becomes subject to this [act]") (emphasis added); see also Fannie Mae v. Heather Apartments Ltd. P'ship, A13-0562, 2013 WL 6223564, at *6 (Minn. Ct. App. Dec. 2, 2013) (considering the remedies available to a judgment creditor with respect to the judgment debtor's interest in a Cook Islands LLC; rejecting the debtor's argument that the creditor's "only remedy is to obtain a charging order under" [the Minnesota LLC statute]; explaining that "this argument fails because that statute only applies to Minnesota limited liability companies" which that statute "defines . . . as 'a limited liability company, other than a foreign limited liability company, organized or governed by this chapter'") (emphasis added) (statutory citations omitted). The operating agreement has no power to alter the provisions of this section to the prejudice of third parties. Section 105(c)(15). Note that recent changes to ULLCA, now being adopted by the states, will patch this loophole and make clear that foreign LLCs (including out-of-state LLCs) are subject to ULLCA 503.
Outcome: A creditor may choose another remedy besides the charging order to enforce the judgment against the debtor's interest.
Some states do not make the charging order the creditor's exclusive remedy. Even if the LLC is the formation state having charging order exclusivity, local judgment enforcement law may apply the law of the forum state without charging order exclusivity, thus allowing the creditor to employ another remedy. See, e.g., Bartch v. Bartch, 2024 WL 3560748 (10th Cir., July 29, 2024).
Outcome: A creditor may choose another remedy besides the charging order to enforce the judgment against the debtor's interest.
The Federal Debt Collection Practices Act (FDCPA), which controls judgment enforcement actions of the U.S. government, has been held to have supremacy as federal law over the contrary state charging order limitations. See, e.g., U.S. v. Wilhite, 2017 WL 5517410 (D.Colo., Nov. 17, 2017); Consumer Fin. Prot. Bureau v. Integrity Advance, LLC, 2024 WL 5262916 (D.Kan. Dec. 31, 2024). A similar result occurs with IRS collections. See, e.g., U.S. v. Driscoll, Case No. 18-11762 (D.N.J., Unpublished Opinion of Jan. 6, 2025).
Outcome: A creditor may choose another remedy besides the charging order to enforce the judgment against the debtor's interest.
Charging order exclusivity does not apply to a secured lender which is enforcing its security interest. The Comment to 503(h) states: "This subsection does not override Uniform Commercial Code, Article 9, which may provide different remedies for a secured creditor acting in that capacity. A secured creditor with a judgment might decide to proceed under Article 9 alone, under this section alone, or under both Article 9 and this section. In the last-mentioned circumstance, the constraints of this section would apply to the charging order but not to the Article 9 remedies." Note that charging order exclusivity should still exist where the creditor has exhausted its security interest and is only pursuing the deficiency.
Outcome: The debtor loses the interest through foreclosure, and the purchaser at the judicial sale becomes a mere assignee of the debtor's economic interest unless admitted to the LLC.
In a two-member LLC, members A & B get into a dispute and A gets a judgment against B. Since the purpose of charging order exclusivity is to protect the non-debtor member (and not the debtor member) should A's be limited to a charging order? Compare Voll v. Dunn, 2014 WL 7461644 (Conn.Super., Nov. 10, 2014) (unpublished) (no charging order exclusivity in intramember dispute), with Young v. Levy, 2014 WL 2741060 (Fla.App., June 18, 2014) (Creditor-member's remedy still limited to charging order based on wording of statute even if it doesn't make much sense). Note that this issue can likely be resolved in the drafting of the Operating Agreement, although hardly anybody does that.
Outcome: Depending upon state law, the non-debtor member/creditor may not be restricted to a charging order against the debtor/member's interest.
The final five exceptions to charging order exclusivity arise from general judgment enforcement law. While these judgment enforcement vehicles would facially seem to be subject to charging order exclusivity, the courts through decisional law have carved out these exceptions. Note that at least two of these exceptions (voidable transaction and reverse veil-piercing) are also recognized by the Comments to ULLCA 503, so these exceptions should not be particularly surprising.
This is different than the limited-purpose "informational" receiver found in 503(b)(1). Instead, the idea here is that the court may appoint a general receiver for the debtor-member which is all of (1) an officer and appendage of the court, (2) a trustee for the benefit of creditors, and, most importantly, the agent with power of attorney for the debtor. Thus, if a general receiver for the debtor-member then the receiver may exercise all rights possessed by the debtor-member, including voting to make distributions, dissolve the LLC or bring a derivative lawsuit to force distributions to be made. See, e.g., Gaggero v. Knapp, Petersen & Clarke, 2014 WL 5786609 (Cal.App., Nov. 7, 2014) (Unreported). This is another large hole in the charging order Swiss Cheese, but general receivers are typically not appointed except where a debtor has acted egregiously to defeat the creditor's rights.
Outcome: The general receiver may vote all the debtor's rights in the LLC, including to make distributions, to liquidate assets, to elect managers and new members to the LLC, and even to dissolve the LLC entirely (which would create a liquidating distribution to be paid to the debtor which would then be available to the creditor.
If money has been fraudulently transferred by the debtor to an LLC (ostensibly in exchange for LLC membership interests), the creditor can maintain a case to avoid the transfer which, if successful, would render the LLC itself a debtor on the fraudulent transfer judgment. The creditor can then enforce the judgment directly against the LLC's assets in spite of charging order exclusivity. See, e.g., Comment to 503(h): "Likewise, this subsection does not supplant fraudulent transfer law."
Outcome: LLC must pay the amount of the contribution that is avoided to the creditor which may require liquidation of some or all of the LLC's assets.
Similar to a voidable transaction theory, a constructive trust is a creditor's remedy that is used when the creditor can trace money that was procured by wrongful means. In this scenario, a constructive trust is imposed over the recipient of the money, which would be the LLC. The LLC thus becomes liable for the money that it received, even if it was received in exchange for the membership interest. The same will be true for disgorgement orders and criminal restitution orders. See, e.g., Liberation Mgt. Satellite LLC v. Green, Appeal No. D083092 (Cal.App., April 23, 2025) (criminal restitution order).
Outcome: LLC must pay the amount of the contribution that is avoided to the creditor which may require liquidation of some or all of the LLC's assets.
For creditors, the easiest and most expedient method of circumventing charging order exclusivity is by the employment of an alter ego theory, known in this context as "reverse veil piercing". Comment 503(h) states: "This subsection is not intended to prevent a court from effecting a 'reverse pierce' where appropriate. In a reverse pierce, the court conflates the entity and its owner to hold the entity liable for a debt of the owner. Litchfield Asset Mgmt. Corp. v. Howell, 799 A.2d 298, 312 (Conn. App. Ct. 2002) (approving a reverse pierce where a judgment debtor had established a limited liability company in a patent attempt to frustrate the judgment creditor), overruled on other grounds by, Robinson v. Coughlin, 830 A.2d 1114 (Conn. 2003). Likewise, this subsection does not supplant fraudulent transfer law."
Outcome: The LLC is added to the creditor's judgment and its assets become liable for execution to satisfy the judgment.
While this requires a very long explanation, suffice it here to say that there may be situations where the Bankruptcy Trustee may acquire, exercise management rights and liquidate the interests of an LLC in bankruptcy. That this is a very complex area of bankruptcy law is indicated by the fact that there have been approximately 20 court opinions relating to the issue of a debtor's LLC or partnership interest in bankruptcy ― and those opinions are all over the board. The root cause of this problem is that the current Bankruptcy Code was adopted prior to LLCs becoming popular entity planning tools and thus are required to be treated by provisions of the Bankruptcy Code (and most particularly BC § 365 relating to executory interests) which very poorly fit LLCs and partnerships.
Outcome: In the worst case, the bankruptcy trustee may vote all the debtor's rights in the LLC, including to make distributions, to liquidate assets, to elect managers and new members to the LLC, and even to dissolve the LLC entirely (which would create a liquidating distribution to be paid to the debtor which would then be available to the creditor.
The next time you hear somebody say that, "the creditor's only remedy is a charging order", you'll know that isn't true. Notwithstanding these exceptions, however, in most cases a creditor will be quite content to simply take a charging order and not seek to go further. The reason is that the charging order ties up the debtor's interest and deprives the debtor of the income stream thus helping to financially strangle the debtor. In connection with other remedies which similarly cut the debtor off from income streams, this alone can often be enough to bring the debtor to the table. Or, to alleviate the financial pain, the debtor will file for bankruptcy and the special powers of the bankruptcy court will end up cleaning the debtor out.
But if a creditor needs to go further in attacking a debtor's LLC or partnership interest, there are a lot of arrows to be found in the creditor's quiver.