Articles Tagged with charging order

share-certificateWe counsel many owners of limited liability companies that the filing of a Certificate of Formation does note automatically protect the owners from person liabilities.  There are a number of business practices, often referred to as the “corporate formalities” that should be followed.

A case from Iowa’s Court of Appeals illustrates this principle, in which the court affirmed the finding of a trial court that the owners of a limited liability company were personally liabile for $235,000 owed to a supplier.  Keith Smith Co. v. Bushman, 873 N.W.2d 776(Table), 2015 WL 8364910(Table) (Iowa App., 2015).

The supplier claimed that the defendant was essentially a shell company with inadequate capitalization.  The trial court agreed and the appeals court affirmed.

Asset Protection, Charging Order
LLCs Can Protect Individual Assets From Judgement Creditors

One of the principal reasons for forming a business entity is to protect the owners from personal liability for the debts of the corporation. At the same time, business owners may use the business, most often a limited liability company, as a way to protect their business interests from being at risk for personal liabilities.

Understanding how a charging order could ultimately be applied is particularly important for individuals in high-risk professions.  This includes not just the professionals like doctors or engineers, but also anyone who routinely deals with intellectual property, including patents, copyrights, trademarks and trade secrets. In all of these areas, the insurance coverage is poor and the risk is high. For that reason, many individuals will seek to hold assets inside of other vehicles, including a limited liability company.


Agent Fails to Dislcose Principal Exists, Avoids Liability

Was the limited liability company statute supposed to eliminate basic principles of agency law?  That seemsto be the import of a decision by the Appellate Division of Superior Court in Castro v. Giacchi, Docket No. A-6220-12T2 (N.J. Super. App. Div. agent3December 5, 2014)(Opinion Below) that reversed a judgment against an individual who failed to disclose that he was acting on behalf of a limited liability company.

Perhaps just as important as our first question: does it really matter?  Here the answer is pretty easy.  Absolutely.  Understanding agency law – that is the law that governs when one person acts on behalf of another – is critical to understanding how business entities function.  The reason is that even though a business entity is a legal person, but it can an only act through its agents.  The business entity is distinct from its principals.

Contractor’s Handshake Deal with Sub

The decision arose out of a contruction contract.  Castro was subcontracted to do carpentry work on a new home under construction in Southhamptom by Defendants.  It was a handshake deal.  Plaintiff contended that he never knew Giacchi was acting on behalf of anyone other than himself, but he received two progress payments John & Sons ANG, LLC.  The final bill was sent to ANG.

Ordinarily, an agent who fails to disclose he is entering into a contract on behalf of a principal is individually liable on the contract, unless the other party knows or had reason to know the agent was acting on behalf of a principal.

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But N.J.S.A. 42:2B-23 shielded a member or agent of a limited liability company from all of its debts. The statute did not limit the circumstances under which a member or agent was immune from liability, including those where a member or agent of a limited liability company entered into a contract without disclosing the identity of its principal. Being clear and unambiguous, our sole function is to enforce the statute according to its terms.

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A recent dispute involving the owners of a medical office building demonstrates, once again, how unexpected business governance issues can threaten an ongoing business.LLC-interest-over-tenants-233x300

This opinion from the Appellate Division, in New Jersey Realty Concepts, LLC v. Mavroudis, Docket No. A-2013-12T1 (App. Div. March 18, 2014)(opinion here), demonstrates how the failure to put a business enterprise into a business form with limited liability, be it a corporation, limited liability company or limited liability partnership, can make it impossible for the business to continue.


The case itself turned on the scope of authority of a special fiscal agent, which is a court appointee typically found in shareholder or limited liability company litigation. We’ll discuss this in more detail below.

Judgment Creditor Attaches LLC Interest in Rents

The real issue, however, is buried at the end of the opinion in which the Appellate Court held that a debtor could directly attach rents paid by the building tenants because the owners’ interest was itself assignable. And that is the big difference as far as asset protection goes – a joint tenancy offers no real protection to creditors.

Had the owners of the building placed it in some type of holding company, then the remedy against a debt owed by of one of the principals would have been much more limited — and would not have threatened the viability of the enterprise. Here, as a result of the form of the enterprise, a judgment creditor of one of the participants was able to levy against 60 percent of the rent roll, leaving the building itself apparently insolvent.

Had the building been held as a limited liability company, the best the judgment creditor could have done was a charging order against the individual interest of the member that was a judgment creditor. Similarly, in a corporation, the remedy would have been limited to the individual shareholder’s interest – assuming no buy-sell agreement restricted transfer.

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A recent amendment to New Jersey’s limited liability company law changes the rights of creditors seeking to collect a judgment from a member of a limited liability company, eliminating the creditor’s right to foreclose the member’s interest.

Foreclosure of LLC Member Interests Eliminated

This particular aspect of the Revised Uniform Limited Liability Company Act (RULLC) is one of the more controversial provisions of the newly enacted statute because it eliminated a key asset protection aspect of LLCs.  Under the prior statute, a creditor’s right was limited to a “charging order.”  The amendment to the statute simply restores the prior law.

Under most state limited liability company statutes, a creditor has the right obtain a charging order that provides that when an LLC distributes money to its members, the debtors share goes to the party holding the charging order.  It only works if any money is actually distributed to the members.

The RULLC was based on a model act devised by the Uniform Law Commission and contained a provision that allowed judgment debtors to foreclose an interest under certain circumstances.  What that meant was that if the judgment creditor was being paid, it had a right to seek a foreclosure of the interest, meaning that it would be sold at a judicial auction.

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Court Issues Writ of Execution on Minority LLC Interest of Ex-Spouse

One of the perceived benefits of the limited liability form of doing business is the limited remedy that a creditor has when attempting to use the LLC member’s interest as a source to satisfy a judgment.  The majority position has been that the judgment creditor may be able to secure a charging order, but can neither foreclose on the interest (that is a force a judicial sale) or  divest the debtor of their management rights.

minorityA decision by a Chancery judge in Ocean County involving a New Jersey limited liability company affirms that the “sole remedy” is the charging order – something that is about to change under recent amendments to the LLC statute – but finds that a court may issue a writ of execution. Leonard v. Leonard, Docket No. FM:15-450-05 (App. Div. June 13, 2012)(approved for publication).

Charging Order Sole Remedy under LLC Act

Under the current law, a judgment creditor that receives a charging order is entitled to receive the distributions that the the debtor-LLC member would otherwise receive, if anything.  However, beginning with limited liability companies organized after March 2013, and the following year with all New Jersey LLCs, judgment creditors will be able in some circumstances foreclose the interest of the LLC member.

The issue in this case was the ability of a judgment creditor — in this case a custodial parent seeking to enforce a child support award – to levy against the interest of a minority member of a New Jersey limited liability company.  The plaintiff and defendant divorced in 2004, with the plaintiff agreeing to pay alimony and child support.  The plaintiff, however, alleged that as of 2012, the defendant had unpaid support totaling $110,000.  Plaintiff moved to secure a judgment and a writ of execution against the defendant’s 10% interest in a real estate limited liability company, Blydan Okay Group, LLC.

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