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Conflicts-Of-Laws And Charging Orders

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♦ Introduction

Charging orders present significant conflict of law challenges across federal and state jurisdictions due to the absence of uniform federal legislation and substantial variations in state laws governing creditor remedies against LLC membership interests. The primary conflicts arise in four key areas: (1) determining the proper situs of LLC membership interests for jurisdictional purposes, (2) enforcing foreign charging orders across state lines, (3) applying choice of law provisions in multi-jurisdictional entities, and (4) reconciling varying state remedies ranging from exclusive charging order protection to foreclosure rights. Federal courts apply state law under Federal Rule of Civil Procedure 69(a) and the Klaxon doctrine, while states differ markedly on domestication requirements, with some requiring full re-litigation in the LLC's state of formation and others applying more liberal recognition principles.

Federal Framework and Jurisdictional Foundations

Federal courts lack independent statutory authority to issue charging orders and must rely on state law procedures under Federal Rule of Civil Procedure 69(a)(1), which provides that "a money judgment is enforced by a writ of execution, unless the court directs otherwise" and that enforcement procedures "must accord with the procedure of the state where the court is located." FRCP Rule 69 As noted in Arvest Bank v. Byrd, a Western District of Tennessee case, "no federal statute governs enforcement of a judgment against a member's interest in a limited liability company."

Legal commentary has identified three potential jurisdictional bases for charging order enforcement: (1) personal jurisdiction over the debtor member, (2) in rem jurisdiction over the LLC membership interest to be charged, or (3) personal jurisdiction over the LLC itself. 12 No. 3 BUSENT 14. Federal Rule of Civil Procedure 4(n)(2) permits courts to assert in rem jurisdiction over a defendant's assets found in the district if the court cannot obtain personal jurisdiction over the defendant. FRCP Rule 4 However, the effectiveness of each jurisdictional theory depends on how courts characterize and locate LLC membership interests.

Under Section 544(a)(1) of the Bankruptcy Code, Chapter 7 trustees may assert the rights and powers of a hypothetical judicial lien creditor, including the right to obtain charging orders under applicable state law. Pettine v. Direct Biologics, LLC (In re Pettine), 2023 WL 7648619 (BAP 10th Cir., Nov. 15, 2023).. The Tenth Circuit Bankruptcy Appellate Panel confirmed that charging orders constitute judicial liens under federal bankruptcy law and that trustees may invoke state charging order remedies without creating conflicts between federal and state law. Pettine v. Direct Biologics, LLC (In re Pettine), 2023 WL 7648619 (BAP 10th Cir., Nov. 15, 2023)..

State Law Variations and Conflicting Remedies

State charging order statutes reveal fundamental disagreements about the appropriate balance between creditor rights and debtor protection. Delaware provides that "the entry of a charging order is the exclusive remedy by which a judgment creditor of a member or a member's assignee may satisfy a judgment out of the judgment debtor's limited liability company interest." DE ST TI 6 § 18-. This exclusive remedy approach prevents creditors from pursuing foreclosure, garnishment, or other attachment procedures against LLC interests.

In contrast, Florida law permits both charging orders and foreclosure, but foreclosure is available only for single-member LLCs and only when a judgment creditor establishes that distributions under a charging order will not satisfy the judgment within a reasonable time. For multi-member LLCs, charging orders remain the sole and exclusive remedy. FL ST § 605.0503. Florida Statutes Section 605.0503(4) authorizes courts to order a foreclosure sale of a judgment debtor's interest in a single-member LLC, but only if the judgment creditor establishes that distributions under a charging order will not satisfy the judgment within a reasonable time. Section 605.0503(5)(a) provides that when such foreclosure is ordered, "the purchaser at the court-ordered foreclosure sale obtains the member's entire limited liability company interest, not merely the rights of a transferee." FL ST § 605.0503.

Texas represents a middle approach, providing that charging orders "may not be construed to deprive a member of a limited liability company or any other owner of a membership interest in a limited liability company of the benefit of any exemption laws applicable to the membership interest." TX BUS ORG § 101.112. California's current LLC statutes provide procedures for charging orders and related remedies applicable to limited liability companies.

Situs Determination and Choice of Law Conflicts

Courts fundamentally disagree on where LLC membership interests are located for conflict of laws purposes, creating a circuit split with significant practical consequences. The Colorado Supreme Court in JPMorgan Chase Bank, N.A. v. McClure held that "for purposes of determining the enforceability of a charging order, a member's membership interest is located where the LLC was formed." JPMorgan Chase Bank v. McClure, 2017 CO 22, 2017 WL 1321334 (Colo., April 10, 2017).. The court reasoned that "given that a charging order is a mechanism by which a judgment creditor may enforce its judgment by requiring an LLC to redirect the debtor-member's distributions to the creditor, as a practical matter, the charging order is directed to the LLC." JPMorgan Chase Bank v. McClure, 2017 CO 22, 2017 WL 1321334 (Colo., April 10, 2017)..

Conversely, the Middle District of Florida in Wells Fargo Bank, N.A. v. Barber applied the traditional situs rule that "Unlike stock certificates in a corporation, a membership interest in a limited liability company is intangible personal property, which 'accompanies the person of the owner.'" and concluded that "because Barber resides in Florida, Barber's membership interest in Blaker is located with her in Florida." Wells Fargo Bank v. Barber, 2015 WL 470589 (M.D.Fla., Feb. 4, 2015).. This approach permits Florida courts to apply Florida law even to foreign LLCs when the member resides in Florida.

Federal courts honor contractual choice of law provisions in LLC operating agreements when they meet established validation standards. The Western District of Tennessee applied Tennessee's choice of law framework, which the court articulated as requiring: "The choice of law provision must be executed in good faith. The jurisdiction whose law is chosen must bear a material connection to the transaction. The basis for the choice of another jurisdiction's law must be reasonable and not merely a sham or subterfuge. Finally, the parties' choice of another jurisdiction's law must not be "contrary to 'a fundamental policy' of a state having [a] 'materially greater interest'" and whose law would otherwise govern." Peach REO, LLC v. Rice, 2017 WL 2963511 (W.D.Tenn., July 11, 2017)..

Foreign Order Recognition and Domestication Requirements

The enforcement of foreign charging orders presents complex full faith and credit issues, with states adopting markedly different approaches. Colorado requires strict domestication procedures before foreign charging orders become effective against in-state LLCs. The Colorado Court of Appeals held that "to enforce a foreign charging order against a Colorado limited liability company (LLC) based on domestication, the creditor has to domesticate the charging order and not just the judgment on which the charging order is based, because the charging order—unlike the judgment on which it is based—requires the LLC to take action." JPMorgan Chase Bank v. McClure, 2017 CO 22, 2017 WL 1321334 (Colo., April 10, 2017)..

The Colorado Supreme Court emphasized that "to be enforceable and effective, a charging order that compels an LLC to act must bind the LLC such that ignoring the order would subject the LLC to remedial action." JPMorgan Chase Bank v. McClure, 2017 CO 22, 2017 WL 1321334 (Colo., April 10, 2017).. The court cited authority suggesting that when an LLC is not subject to personal jurisdiction in the state where the judgment was entered, creditors may need to engage in a two-step process to obtain an effective charging order: first domesticating the money judgment in the LLC's state of formation, and then seeking a charging order from a competent court in that state. 12 No. 3 BUSENT 14

Other jurisdictions apply more liberal recognition principles. Florida courts have applied Florida law to foreign LLC interests based on situs determinations favoring the member's residence, effectively bypassing foreign law protections. Wells Fargo Bank v. Barber, 2015 WL 470589 (M.D.Fla., Feb. 4, 2015).. The Middle District of Florida concluded that where Florida and Nevis law conflict regarding available creditor remedies, "the situs of the property at issue in this case is Florida and Florida law applies." Wells Fargo Bank v. Barber, 2015 WL 470589 (M.D.Fla., Feb. 4, 2015)..

International Comity and Offshore Entity Challenges

Charging orders against offshore LLCs implicate international comity principles when foreign jurisdictions provide enhanced debtor protection. U.S. courts generally override foreign law restrictions when they determine that LLC interests are located within U.S. jurisdiction based on the member's residence or other connecting factors.

The Bankruptcy Court for the Southern District of New York has recognized Cayman Islands liquidation proceedings under Chapter 15, noting that such proceedings are "foreign proceedings" under the Bankruptcy Code when hedge funds incorporated in the Cayman Islands are being wound up subject to Cayman court supervision. In re SPhinX, Ltd., 351 B.R. 103 (2006). This recognition facilitates coordination between U.S. and foreign insolvency proceedings while preserving U.S. creditor rights.

Arguments and Rebuttals

Arguments Supporting Liberal Cross-Border Enforcement

Full Faith and Credit Mandate
  • The Constitution's Full Faith and Credit Clause and 28 U.S.C. § 1738 require states to recognize valid foreign judgments with limited procedural exceptions.
  • Charging orders are judgments entitled to interstate recognition under established principles governing judgment enforcement.
  • Anticipated Rebuttals: Opponents argue that charging orders are fundamentally different from money judgments because they compel ongoing conduct by third parties (LLCs) and therefore require separate jurisdictional analysis.
Judicial Economy and Efficiency
  • Requiring separate proceedings in each jurisdiction wastes judicial resources and creates potential for conflicting orders affecting the same LLC interests.
  • Modern business entities operate across state lines, making restrictive domestication requirements impractical and economically inefficient.
  • Anticipated Rebuttals: Defenders of domestication requirements contend that efficiency concerns cannot override due process rights of LLCs and that separate proceedings ensure proper application of governing state law.
Anti-Fraud and Creditor Protection Policies
  • Allowing debtors to escape legitimate obligations through strategic LLC formation in protective jurisdictions undermines fundamental collection policies.
  • Liberal enforcement prevents abuse of corporate forms designed primarily for asset protection rather than legitimate business purposes.
  • Anticipated Rebuttals: Proponents of domestication argue that states have legitimate sovereignty interests in controlling remedies available against entities formed under their laws and that creditor protection must be balanced against debtor rights.

Arguments Supporting Restrictive Enforcement and Domestication Requirements

State Sovereignty and Legislative Intent
  • Each state's LLC statute reflects specific policy choices about the appropriate balance between creditor rights and member protection.
  • Foreign enforcement of charging orders effectively nullifies the protective provisions that state legislatures specifically enacted.
  • Anticipated Rebuttals: Liberal enforcement advocates argue that states cannot use their corporate laws to defeat valid judgments from other jurisdictions and that full faith and credit principles override local policy preferences.
Due Process and Fair Notice Requirements
  • LLCs must receive fair notice and opportunity to be heard before being compelled to act under foreign court orders.
  • Domestication procedures ensure that LLCs can challenge the validity and scope of charging orders under applicable procedural safeguards.
  • Anticipated Rebuttals: Supporters of liberal enforcement contend that LLCs receive adequate due process through service of foreign orders and that domestication requirements create unnecessary procedural barriers.
Jurisdictional Integrity and Legal Certainty
  • Clear domestication requirements provide predictable rules for determining when charging orders become effective against LLCs.
  • Restrictive approaches prevent forum shopping and ensure that charging order disputes are resolved under the law governing the target entity.
  • Anticipated Rebuttals: Critics argue that jurisdictional certainty is undermined rather than enhanced when different states apply conflicting situs rules and that forum shopping is more likely when debtors can strategically choose protective jurisdictions for entity formation.

Cases on Both Sides

Cases Supporting Strict Domestication Requirements

Cases Supporting Liberal Cross-Border Recognition

  • Peach REO, LLC v. Rice, 2017 WL 2963511 (W.D.Tenn., July 11, 2017). — The Western District of Tennessee honored choice of law provisions in multiple LLC operating agreements, applying Tennessee, Mississippi, and Delaware law to different entities based on contractual designations rather than requiring uniform application of forum law.

Practical Implications

The conflicting approaches to charging order enforcement create significant strategic considerations for both creditors and debtors in multi-jurisdictional disputes. Creditors must carefully analyze the situs of LLC interests under different jurisdictional approaches before pursuing enforcement actions, as the wrong choice of forum can result in years of delay and additional costs. The Colorado approach favoring the state of formation encourages debtors to form LLCs in protective jurisdictions like Delaware or Nevada, while the Florida approach based on member residence provides creditors with potential alternatives when members reside in pro-creditor states.

Asset protection planning has become increasingly sophisticated in response to these jurisdictional variations, with practitioners forming complex structures involving multiple entities in different jurisdictions to maximize charging order protection. However, the trend toward requiring domestication in some states has reduced the effectiveness of these strategies by forcing creditors to pursue enforcement in the most protective available jurisdiction.

Choice of law clauses in operating agreements provide some certainty but require careful drafting to meet validation standards across different jurisdictions. The Tennessee federal court's willingness to apply multiple state laws to different LLCs in the same case demonstrates both the potential utility and complexity of contractual choice of law provisions in multi-entity structures.

Recent Developments

Courts in various states have adopted stricter domestication requirements, reflecting growing recognition that charging orders implicate different jurisdictional concerns than traditional money judgments. This trend represents a shift away from the more liberal recognition approaches that some federal courts applied in earlier decisions.

The Tenth Circuit Bankruptcy Appellate Panel's 2023 decision in In re Pettine clarified that federal bankruptcy law incorporates rather than conflicts with state charging order protections, eliminating concerns that Section 544(a) strong-arm powers might circumvent state LLC protections. Pettine v. Direct Biologics, LLC (In re Pettine), 2023 WL 7648619 (BAP 10th Cir., Nov. 15, 2023). This development provides greater certainty for both debtors and trustees in bankruptcy proceedings involving LLC interests.

Several state legislatures have amended their LLC statutes to provide clearer guidance on charging order procedures and interstate enforcement, though significant variations remain. The trend toward single-member LLC statutes with enhanced foreclosure rights reflects ongoing policy debates about the appropriate level of asset protection available through LLC formation.

Conclusion

Charging orders generally serve as the exclusive remedy for judgment creditors seeking to satisfy debts from a member’s interest in an LLC or partnership, providing a lien on the debtor's distributional interest without conferring ownership or management rights. However, the application and enforceability of charging orders raise significant conflict of law issues, especially when the LLC or partnership is organized in one jurisdiction, the judgment debtor is domiciled in a second jurisdiction, and judgment enforcement occurs in a third. The situs of the membership or partnership interest, often the state of formation of the entity, frequently governs the applicable law on charging order enforcement, though some courts apply the lex fori or the law of the forum where enforcement is sought. Courts have recognized the need for domestication of foreign charging orders to enforce them and determine their priority among competing creditors. Foreign charging orders lacking jurisdiction over the entity typically lack binding effect, and enforcement may require a multi-step process including judgment domestication and reissuance of charging orders in the entity's state of formation. The internal affairs doctrine applies primarily to intra-entity relations and not to third-party creditor rights, complicating governing law determinations. Conflicts may arise as some states permit foreclosure on charged interests while others restrict creditors solely to the charging order lien remedy, leading to divergent remedies and creditor priorities across jurisdictions.

Priority disputes among multiple creditors also present conflict challenges, with some courts ruling priority based on order and service of charging orders or related attachments, which may relate back in time for priority purposes. Persons served with charging orders can trigger liability for LLC managers or risk contempt if distributions violate such orders. In cross-jurisdictional contexts, courts often adopt pragmatic approaches weighing the situs of the interest, jurisdictional authority, and the policies underlying charging order protections, including preserving LLC management control and limiting creditor rights to distributional proceeds. ♦

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