What is a Charging Order
A charging order is a court-authorized right granted to a judgment creditor to attach distributions made from a business entity, such as a limited partnership (LP) or limited liability company (LLC). The debtor 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 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.
BREAKING DOWN Charging Order
A charging order allows an entity to place a lien and seize money owed them by someone who is a named portion of a limited partnership or limited liability company. 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.
Since a creditor may not directly claim against the property of an LP or LLC, in most states, they may file for a charging order. States vary in the severity of business property which they will allow a claim against and much will depend on if the entity is a single 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.
In a single-member LLC, foreclosure on the debtor's interest may occur in addition to the grant of a charging order. The reasoning is that there are no other non-debtor members whose interests to protect. Therefore, liquidation of the business can happen, and the proceeds used to satisfy the creditor's judgment claim.
Charging order limitations, in the states which have them, such as California, are a good way to protect partnership assets. Order limitations are also common in the U.K.
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 Revenue Ruling 77-137, which specifies that since the creditor is not a member of the LLC, the creditor does not pay taxes on this distribution, but rather the debtor does. 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.