Charging Orders: The Key to Reaching a Judgment Debtor’s LLC Interest (Part II)


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money_scalesII.        Reconciling Unintended Statutory Conflicts

This is the second part of the two-part series examining Tennessee’s sole remedy for creditors seeking to exercise post-judgment rights against a debtor’s interests in limited liability companies.  In this part, we examine some of the issues arising with the interpretation and interplay of the Limited Liability Act and the Revised Limited Liability Act.

One potential argument against issuing a charging order against a judgment debtor’s interest in a limited liability company is an apparent statutory conflict in the provisions of the Act and the Revised Act.  As previously stated, §§ 48-218-105 and 48-249-509 both provide that the sole remedy of a judgment creditor seeking to enforce a judgment against the membership interests of a judgment creditor is a charging order but this remedy is tempered by limiting the available rights to an assignee (the Act) or a transferee (New Act).

Of interest, and in relevant part, § 48-218-105 states that “the judgment creditor has only the rights of an assignee of such person’s financial rights under       § 48-218-101,” and § 48-249-509 states that a “judgment creditor has only the rights of a transferee of such person’s financial rights under § 48-249-507.”  By incorporating these two sections by reference, i.e., § 48-218-101 and § 48-249-507, the door is left open for a judgment debtor to argue that no charging order can be levied against the judgment debtor’s interest in a limited liability company.  For ease of reference, these two sections will be collectively referred to as the “Transfer Sections.”

The Transfer Sections detail whether and to what degree a member and/or a holder of financial rights in a limited liability company can transfer or assign those financial rights. Section 48-218-101 states:

48-218-101.  Assignment of financial rights. 

(a) Assignment of Financial Rights Permitted. Except as provided in subsection (c), a member’s financial rights are transferable in whole or in part.

(b) Effect of Assignment of Financial Rights. An assignment of a member’s financial rights entitles the assignee to receive, to the extent assigned, only the share of profits and losses and the distributions to which the assignor would otherwise be entitled. An assignment of a member’s financial rights does not dissolve the LLC and does not entitle or empower the assignee to become a member, to cause a dissolution, to exercise any governance rights, or, except as specifically provided by chapters 201-248 of this title, to receive any notices from the LLC, or to cause dissolution. The assignment may not allow the assignee to control the member’s exercise of governance rights, and any attempt to do so shall be null and void.

(c) Restrictions on Assignment of Financial Rights.  (1) A restriction on the assignment of financial rights may be imposed in the articles, in the operating agreement, by a written resolution adopted by the members, or by a written agreement among, or other written action by, members, or among them and the LLC.

(2) A restriction on the assignment of financial rights referenced in subdivision (c)(1) that is not manifestly unreasonable under the circumstances is enforceable against the owner of the restricted financial rights. A written restriction on the assignment of financial rights that is not manifestly unreasonable under the circumstances and is noted in the articles or operating agreement may be enforced against a successor or transferee of the owner of the restricted financial rights, including a pledgee or a legal representative, whether or not such successor or transferee of the owner had actual notice thereof. Unless noted in the articles or operating agreement, a restriction, even though permitted by this section, is ineffective against a person without knowledge of the restriction.

Similarly, § 48-249-107 states:

48-249-507.  Transfer of financial rights. 

(a) Transferability of financial rights. Except as provided in subsection (c) the financial rights of a member or a holder of financial rights are transferable in whole or in part.

(b) Effect of transfer of financial rights. A transfer of the financial rights of a member or a holder of financial rights entitles the transferee to receive, to the extent transferred, only the share of profits and losses and the distributions to which the transferor would otherwise be entitled, together with the right to transfer further the financial rights so transferred. A transfer of the financial rights of a member or a holder of financial rights does not dissolve the LLC and does not entitle or empower the transferee to become a member, to cause a dissolution, or to exercise any governance rights. Any attempt by the transferee to become a member, cause a dissolution or exercise any governance rights shall be null and void.

(c) Restrictions on transfer of financial rights.  (1) A restriction on the transfer of financial rights may be imposed in the LLC documents, by a written resolution adopted by all the members, or by a written agreement among, or other written action by, all the members, and, if so provided in the LLC documents, holders of financial rights.

(2) A restriction on the transfer of financial rights referenced in subdivision (c)(1) is enforceable against the owner of the restricted financial rights. A written restriction on the transfer of financial rights that is set forth in the LLC documents may be enforced against a successor or transferee of the owner of the restricted financial rights, including a pledgee or a personal representative, whether or not such successor or transferee of the owner had actual notice of the restricted financial rights. Except for a written restriction in the LLC documents, a restriction, even though permitted by this section, is ineffective against a person without knowledge of the restriction.

(d) Effective date of transfer. Any permissible transfer of financial rights under this section shall be effective as to and binding on the LLC, only when the transferee’s name, address, taxpayer identification number and the nature and extent of the transfer are reflected in the LLC documents or the records of the LLC.

Subsection (c) of the Transfer Sections creates the problem.  Since both §§ 48-19-105 and 48-249-509 incorporate by reference the Transfer Sections generally, the argument is that the Transfer Sections prevent the issuance of a charging order against a judgment debtor’s interest when the members of a limited liability company elect to restrict the transfer or assignment of members’ financial rights.  By interpreting these two statutes in such a manner, it effectively guts the sole remedy afforded to judgment creditors by enabling a judgment debtor, through subsections (c) of the Transfer Sections, with the ability to shield membership interests from creditors so long as the limited liability company membership votes to restrict transfers and assignments of membership interests.

It is well settled that interpretation of statutory provisions shall be undertaken so as to give meaning to all portions of the statute and companion or related statutes.  When interpreting provisions of an act, the provisions should be interpreted “as a whole, giving effect to each word and making every effort not to interpret a provision in a manner that renders other provisions of the same statute inconsistent, meaningless or superfluous.”  Lake Cumberland Trust, Inc. v. EPA, 954 F.2d1218, 1222 (6th Cir. 1992).  Additionally, when interpreting the Tennessee Code Annotated, the “provisions [should be read] in pari material and [presume] that the legislature intended for each word in the statute to have meaning … endeavor[ing] to effectuate the intent of the legislature by avoiding an interpretation that would render the statute’s language meaningless, redundant or superfluous.” In re Estate of Paul Harris Nelson, 2007 Tenn. App. LEXIS 147, 33-34 (Tenn. Ct. App. 2007)(citing, Faust v. Metro Gov’t of Nashville, 206 S.W.3d 473, 489-90 (Tenn. Ct. App. 2006); Eastman Chem. Co. v. Johnson, 151 S.W.3d 503, 507 (Tenn. 2004)(quoting Tidwell v. Collins, 522 S.W.2d 674, 676-77 (Tenn. 1975))).

There is a dearth of case law on this issue, not just within Tennessee but nationwide.  A helpful case in construing these potential statutory conflicts between §§ 48-19-105 and 48-249-509 and the Transfer Sections is Meyer v. Christie, 2011 WL 4857905 (D. Kan. Oct. 13, 2011).  In Meyer, the court addressed whether it could grant a charging order against the judgment debtor’s limited liability interest where the operating agreement prohibited the transfer or assignment of such interests.  Id. At *9.  Kansas has statutes mirroring § 48-218-105 and § 48-249-509 and the Transfer Sections. The Meyer court held that notwithstanding any assignment or transfer restrictions in the operating agreement, the judgment creditor was entitled to a charging order against the judgment debtor’s limited liability interest, stating, “although an operating agreement may absolutely prohibit transfers or assignments, such prohibition cannot prevail over applicable law.”  Id.  As cogently explained in Meyer:

The charging order remedy originated in the Uniform Partnership Act in 1914 (“UPA”).  Under UPA § 28 and interpreting case law, a charging order affects only the debtor’s partnership interest and does not permit the creditor to reach partnership assets.  After obtaining a charging order, the creditor is entitled only to the partner’s share of distributions and the partner’s share of assets on liquidation after all partnership debts have been paid.  After the entry of a charging order, the debtor partner continues to be a partner and retains all rights and obligations of a partner except the right to receive partnership distributions until the creditor has been paid its judgment and interest thereon.  The creditor is not entitled to participate in the management of the partnership.

Id. At *10 (citations omitted).

Employing the Meyer court’s reasoning, § 48-218-105 and § 48-249-509 would be preserved otherwise the interpretation of these statutes would lead to a perverse result. Since both § 48-218-105 and § 48-249-509 state that the judgment creditor is already a valid assignee/transferee, concerns about further assignments or transfers are relieved because under the provisions of § 48-218-101 and § 48-249-507, subsections (b) and (c), respectfully, a judgment creditor is limited as to further assignments or transfers once the charging order is entered.  By treating the judgment creditor as an existing assignee or transferee, the ability of the limited liability company to subsequently enforce the limits and restrictions on assigning and transferring company interests is preserved but still permits the judgment creditor to exercise its collection rights and remedies.

The judgment creditor is limited to receiving only the profits, losses, and distributions that the judgment debtor would receive.  It has no power, governance rights or further assignment or transfer rights.  In this sense, the charging order functionally acts as a “garnishment” of the judgment debtor’s financial rights in the limited liability company.  See 64 UCINLR at 452 (stating that a charging order “garnishes” the financial rights attaching to a member’s interest in a limited liability company).  Furthermore, the judgment creditor must wait until such time as the limited liability company makes a distribution or payment to the judgment debtor in accordance with the judgment debtor’s interest.

Despite the fact that these statutes seemingly create a problem for judgment creditors, the only logical interpretation is that there is no general anti-assignment/transfer right that will thwart a judgment creditor’s right to obtain a charging order.  The easiest solution to avoid this statutory interpretation problem would be for the Tennessee Legislature to amend § 48-218-105 and § 48-249-509 by limiting the inclusion of § 48-218-105 and § 48-249-507 to subsections (b), respectively, which merely provide for what rights an assignee or transferee have once the assignment/transfer is made but until that happens, the above-stated argument should be sufficient.

Recently, the United States District Court for the Middle District of Tennessee issued an unpublished opinion on this issue, which can be found in Fifth Third Bank v. Monet, et al., Case No. 3:12-cv-01074, Document No. 73, filed February 25, 2014.  In that case, the court agreed with the above-stated reasoning, and held that general anti-assignment/transfer provisions in a limited liability company’s operating agreement could not prevent the issuance of a charging order in favor of a judgment creditor. 

Conclusion

Judgment enforcement and collection is a complicated, difficult, and expensive process.  Oftentimes, the achievement of receiving a judgment is short-lived once the judgment creditor realizes that it must now undertake the process of converting the judgment into actual money.  Knowing and implementing all available post-judgment remedies is crucial to this process.  Charging orders are an important weapon in a judgment creditor’s arsenal, and knowing how and when to obtain one will aid the judgment creditor in reaching its final goal: realization of the damages it has incurred as evidenced by the judgment.

 

For more information or for help in collecting on a judgment, please do not hesitate to contact Ronn Steen.  He can be reached at (615) 465-6010 or [email protected].  Thompson Burton is a full-service law firm committed to innovative and practical legal solutions for clients.

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