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UCLLA 503(c) Foreclosure Of Charging Order Lien

Foreclosure Code ULLCASection503cForeclosure



503(c)

Upon a showing that distributions under a charging order will not pay the judgment debt within a reasonable time, the court may foreclose the lien and order the sale of the transferable interest. Except as otherwise provided in subsection (f), the purchaser at the foreclosure sale obtains only the transferable interest, does not thereby become a member, and is subject to Section 502.



Reporter's Comment to Subsection (c)

The phrase “that distributions under the charging order will not pay the judgment debt within a reasonable period of time” comes from case law. See, e.g., Stewart v. Lanier Park Med. Office Bldg., Ltd., 578 S.E.2d 572, 574 (Ga. Ct. App. 2003) (“Judicial sale may be appropriate where . . . it is apparent that distributions under the charging order will not pay the judgment debt within a reasonable amount of time.”); Nigri v. Lotz, 453 S.E.2d 780, 783 (Ga. Ct. App. 1995). ).
A purchaser at a foreclosure sale obtains only the very limited rights of a transferee under Section 502 and is in some ways more vulnerable and less powerful than the holder of a charging order.
After foreclosure and sale, Subsection (b) no longer applies.
More generally, the court is no longer involved in the matter.
For the vulnerability of a transferee, see Section 107(b), comment.

JayNote

Few things have caused so much consternation among planners as the foreclosure of the charging order lien, and, indeed, some states have modified their ULLCA or RULLCA to prohibit such foreclosures (which was probably a bad move for reasons beyond the discussion here). Foreclosure of the charging order lien has the effect of making the involuntary assignment permanent, i.e., the purchaser at the foreclosure sale will continue to hold the assignment of the transferable interest and receive dividends even after the judgment is fully satisfied. By contrast, if the charging order lien is not foreclosed upon, that lien will terminate when the judgment is fully paid off.
In practice, however, few creditors actually even attempt to foreclose on the lien, since there are tax hazards to the purchaser at the judicial sale, which might be the creditor. Which is to say that at ordinary judicial sales, the credit will bid a portion of the judgment against the debtor's asset (known as a "credit bid") and walk away from the auction with the asset. However, since the purchaser at the judicial sale become an involuntary assignee of the debtor's former transferable interest in the LLC, the purchaser thus goes on the hook for any tax consequences spinning off from that LLC interest, and which might include "phantom income" and no cash, also known as the "K.O. by the K-1". Brave indeed (or simply foolish) is the creditor who forecloses and takes the debtor's former interest in all but a single-member LLC.
within a reasonable time -- What constitutes a "reasonable time" is depending upon the facts of a particular case, and may range from now to never and all temporal points in between. Anecdotally, based on my own experiences, judges will not grant foreclosures of the charging order lien concurrently with the granting of the charging order, but instead (seemingly confused by the "reasonable time" language) will make the creditor wait at least a couple of months before allowing the foreclosure.
Example: Debtor owns an interest in an LLC that operates as a hedge fund, which throws off $10,000 per year in dividends. Creditor has a judgment against Debtor for $16,000 plus annual interest at 5%. Since the dividends will pay off the judgment in two years, foreclosure of the interest should be denied.
Example: Same facts, except that the LLC pays only $500 dividends per year, and Creditor holds a judgment against Debtor for $150,000 plus annual interest at 5%. Since the dividends cannot reasonably be expected to pay off the judgment, immediate foreclosure of the charging order lien should be allowed.
does not become a member -- The purchaser at the judicial sale becomes no more than a permanent involuntary assignee of the debtor's former transferable interest, and does not become a member or obtain any additional information rights, etc.

Click here for a deeper dive into foreclosure of the charging order lien

A charging order is the primary judicial remedy used by judgment creditors to reach a debtor’s interest in a partnership or limited liability company (LLC). It creates a lien on the debtor’s transferable interest, directing the entity to pay any distributions intended for the debtor to the creditor instead. Under a standard charging order, the debtor retains management rights, and the creditor cannot participate in business operations. Foreclosure of this lien is generally available when it is demonstrated that distributions will not satisfy the judgment within a reasonable timeframe. The process typically involves obtaining an initial charging order, proving its inadequacy, and filing a motion for a court-authorized judicial sale. Throughout this process, courts maintain equitable supervision to ensure the sale does not unduly disrupt the entity's business. Debtors or other entity members often maintain a right of redemption to satisfy the debt and extinguish the lien before the sale occurs. Jurisdictional rules regarding foreclosure vary significantly. States like California, Pennsylvania, Connecticut, and South Carolina permit foreclosure under statutory frameworks such as the Uniform Partnership Act (UPA) or the Revised Uniform Limited Liability Company Act (RULLCA). In these states, foreclosure is seen as a necessary secondary step for creditor relief. Conversely, Texas explicitly prohibits the foreclosure of charging order liens, establishing the charging order as the exclusive remedy available to creditors to prevent the involuntary transfer of business interests. The rights acquired by a purchaser at a foreclosure sale are strictly limited. In most cases, the purchaser only acquires "economic" or "transferable" rights—the right to receive profits and distributions. They do not become a member or partner and obtain no management, voting, or participatory rights. The only common exception is the foreclosure of a single-member LLC, which may result in the transfer of full membership and management status to the purchaser.




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