What Is a Charging Order?
A charging order is a court-authorized lien imposed by a creditor on distributions made from a business entity, such as a limited partnership (LP) or limited liability company (LLC). The debtor, in such a case, will be a member, partner, or the owner of the business entity.
The charging order is usually limited to the dollar amount of the judgment and is similar to garnishment of wages or income. It is important to note that a charging order does not give the creditor management rights in the business entity. Nor can the creditor interfere in the management of the business to which the debtor is a partner, member, or owner.
- A charging order is a court-authorized lien placed on distributions made from a business.
- A charging order allows a creditor to garnish distributions to recoup money owed to them by a member or owner of a business entity.
- In particular, charging orders are used by claimants against limited partnerships (LPs) and limited liability companies (LLCs).
- Creditors who have been granted a charging order are not allowed to join in the LLC's management, dissolve the LLC, or sell its assets without the other LLC members' consent.
How Charging Orders Work
A charging order allows an entity to place a lien and seize money owed to them by someone who is named as a member of a limited partnership (LP) or limited liability company (LLC). Under the charging order, they may put a lien on money distributed to the debtor through the business. A charging order does not give the creditor rights of ownership of the company, but until the debt is satisfied, the creditor can legally attach distributions to the debtor from the business entity.
In many states in the U.S., personal creditors of an LLC owner are limited to using a charging order as their exclusive remedy to recoup money owed to them. States vary in the type of business entity they will allow a claim against and much will depend on whether the entity is a single- or multi-member business. Some states do not limit creditors to a charging order to satisfy their claim. These states, based on varying criteria and circumstances, allow the creditor to foreclose on the interest of the debtor in the investment-based entity. In essence, the creditor can force the liquidation of the business to satisfy the claim against the debtor.
Should one member or owner of an LLC be subject to a charging order from a personal creditor, the interests of the other LLC members are protected. Personal creditors who have been granted a charging order cannot lay claim to the distributions owed to the other LLC members nor are they allowed to join in the LLC's management, dissolve the LLC, or sell its assets without the other LLC members' consent. Charging order limitations are a good way to protect partnership assets in the states which have them, such as California.
In a single-member LLC, foreclosure on the debtor's interest may occur in addition to the grant of a charging order. The rules for single-member LLCs vary depending on the state. For those states that do allow foreclosure, the reasoning is that there are no other non-debtor members that have interests to protect. Therefore, the liquidation of the business may happen. The proceeds are used to satisfy the creditor's judgment claim.
Some states, however, have amended their LLC laws to grant single-member LLCs the same protection from creditors afforded multi-member LLCs. These laws do not allow the creditor to foreclosure and instead specify that charging orders are the creditor's exclusive remedy when seeking claims against single- or multi-member LLCs.
States that have enacted laws protecting single-member LLCs include Delaware, Wyoming, and Nevada.
Tax Ramifications of Charging Orders
Some argue that a creditor who attaches the distributions of a debtor from an LLC is responsible for paying the taxes on these distributions. However, according to the Revenue Ruling 77-137 (1997-1 C.B. 178), the creditor does not pay taxes on this distribution. Rather, the debtor is responsible for tax payment because the creditor is not a member of the LLC. In the case in which the creditor forces the liquidation of the LLC to pay the debt, the creditor at that time would be responsible for taxes on the liquidation.