COMMENTARIES Posted May 31, 2022
What Are Charging Orders and How Do They Affect My Limited Liability Company?

A Brief and Simple Summmary

Article At-A-Glance

  • A charging order is a court-authorized lien placed on distributions made from a business.
  • Charging orders may be used by creditors against limited partnerships (LPs) and limited liability companies (LLCs).
  • In most cases, a Charging order does not permit a creditor to join in the LLC's management, dissolve the LLC, or sell its assets without the other LLC members' consent.
  • However, while a charging order does not give the creditor rights of ownership of the company until the debt is satisfied it does allow the creditor to legally attach distributions to the debtor from the business entity.
  • Bankruptcy may affect the rights of creditors to the LLC, and may also jeopardize the intended operation of the LLC itself.
  • Given the above, all LLC owners need to draft and implement an operating agreement that takes into account the impact of a member filing bankruptcy or having a court judgment entered against him or her.
A charging order is a court-authorized lien imposed by a creditor on distributions made from a business entity, such as a limited partnership (LP) or limited liability company (LLC). The debtor, in such a case, 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 the garnishment of wages or income. It is important to note that a charging order does not give 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.

Charging Orders: Overview

A charging order allows a creditor to place a lien and seize money owed to it by someone who is named as a member of a limited partnership (LP) or limited liability company (LLC). Under the charging order, the creditor may put a lien on money distributed to the debtor through the business. While a charging order does not give the creditor rights of ownership of the company, until the debt is satisfied, the creditor can legally attach distributions to the debtor from the business entity.
In Arizona and in other states a charging order exists as the exclusive remedy of a creditor of an LLC member to recoup money owed to them. States vary in the type of business entity they will allow a claim against and a lot will depend on whether the entity is a single- or multi-member business.
Some states do not limit creditors to a charging order to satisfy their claims. 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.
Should one member or owner of an LLC be subject to a charging order from a creditor, the interests of the other LLC members remain protected. That is, creditors that have been granted a charging order cannot claim the distributions owed to other LLC members. Nor are they allowed to join in the LLC's management, dissolve the LLC, or sell LLC assets without the consent of the other LLC members.

State Law Remedies

Creditors of an LLC owner/member are limited to one or more of the following remedies:
  • getting a court to order that the LLC pay to the creditor all the money due to the LLC owner/debtor from the LLC (this is called a charging order)
  • foreclosing on the owner/debtor's LLC ownership interest, or
  • getting a court to order the LLC to be dissolved.
In most states, obtaining a charging order is a creditor's exclusive remedy. Statutes in these states provide the greatest protection for LLC owners against creditors. These protections extend both to the debtor/LLC member and to any co-owners who might otherwise be at risk of having creditors take more aggressive action against the LLC, including possibly forcing a dissolution of their LLC.
Other states permit a charging order as one of several remedies allowed for creditors. For example, these other remedies might include foreclosure of the LLC. Some states, by statute or case law, have special rules for single-member LLCs. The liability protection members receive with an LLC is an important issue, particularly because the rules can vary from state to state.

Single-Member LLCs

The protections are generally less in a single-member LLC. In a single-member LLC, foreclosure on the debtor's interest may occur in addition to the grant of a charging order. That being said, the laws pertaining to single-member LLCs vary depending on the state. For those states that do allow foreclosure, the reasoning is that there are no other non-debtor members that have interests to protect. Therefore, the liquidation of the business is permitted, and the proceeds are used to satisfy the creditor's judgment claim.
Some states, however, have amended their LLC laws to grant single-member LLCs the same protection from creditors afforded multi-member LLCs. These laws do not allow the creditor to foreclosure and instead specify that charging orders are the creditor's exclusive remedy when seeking claims against single- or multi-member LLCs. So it is important to know the law in your state before commencing an action to obtain a charging order.

Importance of an LLC Operating Agreement

LLC owners must draft and implement an operating agreement that takes into account the possibility and the impact that a member might file bankruptcy or that a member might have a court judgment entered against him or her.
For example, the LLC members may wish to include a provision in their operating agreement allowing for the expulsion of any member who files for bankruptcy, or allowing them to purchase the interest of any member who becomes subject to a charging order. A comprehensive operating agreement is particularly important for multi-member LLCs, if only because disputes sometimes develop among the members.

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 (1997-1 C.B. 178), the creditor does not pay taxes on this distribution. Rather, the debtor is responsible for tax payments because the creditor is not a member of the LLC. 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.[1]

Impact of Bankruptcy

Finally, bankruptcy, insolvency, incompetency, and death of a member each have an effect on the validity of a charging order. Once a member files a bankruptcy petition or is adjudicated bankrupt, he or she "shall disassociate from and cease to be a member" of an LLC. If the member dies or is adjudicated incompetent by a court (ex. guardianship), the judgment debtor can no longer be a member of the LLC, and the charging order will be of no further consequence.
This includes the right to manage the LLC and sell its assets (such as real estate) to pay off creditors. The protection afforded by the LLC form can simply be ignored by the bankruptcy court where there is only one LLC owner. It's possible that other bankruptcy courts would reach a different conclusion, but no one knows for sure.
Perhaps the ownership interest of a member of a multi-member LLC could be taken over by a bankruptcy trustee. This is a rapidly evolving and unclear area of the law.


Additional Resources


LLCs, Charging Orders, Creditor Rights, Business Planning, Business Litigation

Press Resources

Office at Wright Law Firm