What are Charging Order Protections, and what States are the best?

WHAT IS A CHARGING ORDER?

A charging order is the way in which Limited Liability Company (LLC) or a Limited Partnership (LP) protects assets. Specifically, it provides that a creditor who has obtained a judgment against a member or partner of an LLC or LP cannot seize the member's interest in the entity to satisfy the judgment or force a foreclosure of the entity and seize any of the underlying assets. Instead, the creditor is limited to a "charging order" against the member's interest in the case of an LLC or in a partner's interest in an LP.

A charging order is essentially a court order that directs the entity to pay any distributions that would otherwise be paid to the member/partner to the creditor instead. The creditor does not have any ownership rights in the entity or the ability to make decisions regarding its operations. The creditor is only entitled to receive distributions which would otherwise be paid to the member/partner.

LIMITATIONS OF CHARGING ORDER PROTECTION

Charging orders protections are governed by state law, and therefore the states differ in how they are applied.  In some states, the Charging Order is just one of many remedies. For example in California the statute allows for the following:

California Code, Corporations Code - CORP § 17705.03

To the extent necessary to effectuate the collection of distributions pursuant to a charging order in effect under subdivision (a), the court may do any of the following:

1. Appoint a receiver of the distributions subject to the charging order, with the power to make all inquiries the judgment debtor might have made.
2. Make all other orders necessary to give effect to the charging order.
3. Upon a showing that distributions under a charging order will not pay the judgment debt within a reasonable time, foreclose the lien and order the sale of the transferable interest. 

You can see that in California the court has several options including a foreclosure of the members interest itself. This is why California is not considered a good charging order protection state for LLCs and LPs.  To be a good state, it is critical that the jurisdiction statutorily states that the Charging Order is the exclusive remedy.   The key is the the "Exclusive" part.  What this means is that a charging order is the ONLY remedy the creditor can get.  

Some states provide for a charging order protection as one of the remedies, like California, but not the exclusive. Other states use the language in the statute which has EXCLUSIVE.  Many have heard that Nevada, Arizona, Wyoming and Delaware are good states, specifically due to charging order exclusivity.  This is correct.  Specifically lets take a look at an Arizona for both the Limited Partnership and the Limited Liability Company.

ARIZONA LIMITED PARTNERSHIPS

A.R.S. § 29-341. Charging order

1. On application to a court of competent jurisdiction by any judgment creditor of a partner, the court may charge the partnership interest of the partner with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of the partner's partnership interest. This chapter does not deprive any partner of the benefit of any exemption laws applicable to his partnership interest. This section provides the exclusive remedy by which a judgment creditor of a partner may satisfy a judgment out of the judgment debtor's interest in the partnership.  

ARIZONA LIMITED LIABILITY COMPANIES

A.R.S. § 29-3503. Charging Order

1. On application by a judgment creditor of a member or transferee, a court may enter a charging order against the transferable interest of the judgment debtor for the unsatisfied amount of the judgment. A charging order requires the limited liability company to pay over to the person to which the charging order was issued any distribution that otherwise would be paid to the judgment debtor....
2. This section provides the exclusive remedy by which a person seeking in the capacity of judgment creditor to enforce a judgment against a member or transferee may satisfy the judgment from the judgment debtor's transferable interest.

THE BOTTOM LINE

If you have a choice of jurisdiction, then it is important to choose one in which the Charging Order is the Exclusive Remedy for a judgement creditor.  We have found that Arizona meets this criteria and also has other benefits, which make it our top choice for use as a holding company for our clients.

To understand why we prefer AZ over the other good states, see:

Why I prefer an Arizona Limited Partnership as the Holding Company