Shanghai Real Estate Ltd., obtained a judgment in Connecticut against Mark and Linda Greenberg. To enforce the judgment, Shanghai sought to collect against the personal assets of the Greenbergs, including their investment assets, which seem to mostly consist in their ownership of numerous limited liability company (LLC) interests.
This is as good as any place to digress for a moment and talk about collecting against investments. Where a debtor owns stock, the creditor can levy upon the stock, sell it on the courthouse steps at a sheriff's sale, and pocket the sale proceeds less expenses. Not so with LLC and partnership interests; the only thing the creditor can do against those assets is get a "charging order" which has the effect of placing a lien upon those assets, and re-directing any distributions made by the LLC or partnership interests that would have gone to the debtor, instead to the creditor until the judgment is paid. (By the way, and contrary to prevailing asset protection mythology, the debtor still pays the taxes on the distributions received by the creditor, i.e., the creditor gets the money and the debtor gets the taxes).
Shanghai asked the Court to enter charging orders against 34 -- yes, 34 -- limited liability companies in which the Greenbergs had various interests.
Of these companies, 21 were registered with the Connecticut Secretary of State, and were obviously subject to jurisdiction in Connecticut. The interests in these LLCs were owned by Mark Greenberg, and he stipulated to an Order charging the interests of these 21 companies.
However, nine more LLCs were owned by Mark Greenberg, and three more LLCs were owned by Linda Greenberg, and these 12 other LLCs were not registered in Connecticut but were instead out-of-state ("foreign") LLCs. The couple objected to the Connecticut Court issuing charging orders against the interests of these out-of-state LLCs on the basis that the Court had no jurisdiction over them. But the Court rejected this argument:
The proposed order which the plaintiff submitted to the court with its brief does not order the foreign companies to do anything. The proposed order is directed to the defendants only. It orders the defendants to:
(1) provide the plaintiff's attorney with the name and address of each of the managers and managing members of each of the foreign companies;
(2) charge the defendants' interests in the foreign companies to pay all present and future distributions, credits, drawings, or payments due to the defendants to be paid to the plaintiffs until the judgment is satisfied in full, including, interest and costs;
(3) take no loans, directly or indirectly, from the foreign companies until the judgment is satisfied in full, including interest and costs;
(4) not undertake, enter into or consummate any sale, encumbrance, hypothecation or modification of the defendants' membership interest in any of the foreign companies except in the context of a bona fide sale to an unrelated third party and the defendants shall provide ten business days' notice of any such sale to the plaintiff's attorney.
The language of the order being sought by the plaintiff is unobjectionable. It is directed to the defendants only. The court has jurisdiction over the defendants. So, even if the defendants would have standing to object to an order directed to foreign companies, the plaintiff is not currently seeking such an order. Accordingly, the defendants' objection to the application for a charging order is overruled.
And with that, the Connecticut Court entered the charging order against the dozen out-of-state LLCs that were not registered in Connecticut.
ANALYSIS
This is the same result that I won in the Bay Guardian Co. v. New Times Media LLC case, where a California court entered charging orders against a bunch of mostly-Delaware limited liability companies and limited partnerships, and which has been repeated in a few cases since. The debtor in that case ran off to Delaware to try to get the Delaware courts to protect them, but the case was removed to federal court which refused to block the California action under the Federal Anti-Injunction Act, which prohibits a federal court from interfering with an on-going state proceeding. The bottom line is that the Court that issued the judgment (or wherever the judgment is domesticated under the Full Faith & Credit clause) can issue a charging order against a debtor/member's interest in an out-of-state LLC and there is not much the debtor or LLC can do about it.
As the Connecticut Court points out, the most important thing is that the Court have jurisdiction over the Debtor, and at the very least the Charging Order is valid as to the Debtor, which means that the Debtor cannot receive distributions from an LLC without violating the Charging Order and risking contempt.
Where the LLC is being used as an asset protection device, this has the effect of freezing the assets of the LLC so that the debtor/member cannot access those assets. The creditor cannot access those assets either, at least directly through the vehicle of the charging order, but this may buy time for the creditor to access the assets some other way. At least, the debtor/member may be put into further financial distress if they needed the cash-flow from the LLC for other purposes, such as to live on or to fund the debtor's legal defense.
In other words, standing alone LLCs make for mediocre asset protection tools. They may provide some short-term relief against certain assets being frozen or immediately seized, but in the long run they will not offer much protection unless the LLC membership interests are themselves creditor-protected.
What is illustrated in this case is that the fact that the LLC is formed in another state does not prevent the local court from entering a charging order against the debtor/member's interests in the LLC. There is an old truism in creditor-debtor law that "All collection law is local", and that certainly seems to hold true here as well.
It also makes sense that local law should apply. Obtaining a Charging Order against a debtor/member's interest in an LLC for this purpose is fundamentally no different that levying on a debtor's shares in some stock company, i.e., if a debtor held shares in Microsoft, the creditor would not have to go to the state where Microsoft is incorporated to perform the levy. There is utterly no reason why the result should be any different with a charging order placed against an LLC or LP interest.
Importantly, note that a Charging Order only creates a lien against the debtor/member's "economic right to distributions", i.e., the debtor/member's right to receive profit distributions from the LLC if any are made. The effect of a Charging Order on the LLC is little more than causing it to change the address to where the distribution check is sent. The impact on the business of the LLC is de minimis.
Even if a creditor were to foreclose on its charging order lien (and be successful at purchasing the interest at the foreclosure sale), the creditor would only take ownership of the debtor/member's economic right to distribution -- and still would not get any actual assets. However, as the creditor in this case would be in the nature of an assignee of the debtor/member's interest, then the creditor would potentially become liable for any taxes spun off from the LLC to its members. Thus, as a practical matter, most creditors will not even attempt to foreclose (I didn't even try in the Bay Guardian litigation even though I easily could have done so), but instead are quite content to let their liens just sit in place, and financially starve the debtor while they explore other avenues of collection.
Because of cases like this one, folks that form LLCs and LPs in other states thinking that those state's "better Charging Order law" will assist them, are probably fooling themselves. As shown in this case, that the LLCs were formed out-of-state didn't stop the issuance of the Charging Orders.
To the contrary, the best state to create an LLC might very well be the one you are in, since for purposes of third-party creditors at least, local laws are most likely to apply anyhow, and forming an out-of-state entity thus may have the sole effect of simply increasing annual costs to keep the entity in compliance.
But you're not likely to hear that marketed anytime soon.
CITE AS
Shanghai Real Estate Ltd. v. Greenberg, 2014 WL 660624 (Conn.Super., Jan. 28, 2014). Full Opinion at https://chargingorder.com/opinion-2014-connecticut-shanghai-charging-order.html
This article at http://onforb.es/N9KRKl and http://goo.gl/ZFwoM8
