2010 Opinions

2010 Site.Year2010ChargingOrderOpinions

2010 Charging Order Opinions

In re First Protection Inc. (Fursman v. Ulrich), _ B.R. __, 2010 WL 5059589 (9th Cir.BAP (Ariz.), Nov. 22, 2010).

♦ The United States Bankruptcy Appellate Panel for the Ninth Circuit affirmed a bankruptcy court's judgment avoiding a postpetition transfer of a membership interest in a limited liability company. Debtors David and Laura Fursman, who initially filed for Chapter 11 bankruptcy, were the sole owners of Redux Development, LLC. During the pendency of their case and while acting as debtors-in-possession, they transferred fifty percent of their membership interest in Redux to Gale Thompson in exchange for capital contributions and loans. Upon conversion of the case to Chapter 7, Trustee Dale Ulrich filed an adversary proceeding to avoid the transfer under Section 549 of the Bankruptcy Code. The appellate panel first determined that the debtors possessed standing to appeal despite the transfer because they were named defendants in the action and liable for costs. The panel also found that the transferee's failure to sign the notice of appeal was a non-jurisdictional defect that had been cured. Regarding the merits, the court held that the debtors' entire interest in Redux, including management and control rights, became property of the bankruptcy estate under Section 541. The court specifically rejected the debtors' contention that the LLC operating agreement was an executory contract under Section 365, noting that such an analysis is improper for single-member LLCs where there are no non-debtor parties to protect. Furthermore, the court concluded that the transfer was not authorized as a transaction in the ordinary course of business because it failed the vertical and horizontal dimension tests. Lastly, the panel ruled that the good faith purchaser defense under Section 549(c) was unavailable because that statutory exception applies only to real property, not personal property like an LLC membership interest. Accordingly, the panel affirmed the avoidance of the transfer. ♦

Olmstead v. FTC, 44 So.3d 76 (Fla., 2010).

♦ The Florida Supreme Court addressed a critical question regarding the rights of judgment creditors against owners of Florida single-member limited liability companies (LLCs). The case originated from a Federal Trade Commission (FTC) enforcement action against Shaun Olmstead and Julie Connell for operating an advance-fee credit card scam, leading to a judgment of over $10 million. To satisfy this judgment, the FTC obtained an order requiring the debtors to surrender all right, title, and interest in several single-member LLCs they owned. The debtors appealed, arguing that under section 608.433(4) of the Florida Limited Liability Company Act, a charging order was the exclusive remedy available to a judgment creditor. A charging order typically only entitles a creditor to the debtor's share of profits and distributions, not management rights or the entity's underlying assets. However, the Court rephrased the certified question and held in the affirmative, ruling that a court may indeed order a judgment debtor to surrender their full interest in a single-member LLC. The majority reasoned that the LLC Act's charging order provision did not explicitly state it was the exclusive remedy, unlike similar provisions in Florida's partnership and limited partnership statutes. Therefore, the general creditor's remedy of levy and sale under execution remained applicable. Since a sole member has the power to voluntarily transfer their entire interest, the Court concluded that a creditor could involuntarily reach that same interest. Justice Lewis issued a vigorous dissent, characterizing the majority's opinion as a judicial rewriting of the law. He argued that the statute's plain language required the charging order to apply uniformly to all LLCs regardless of membership count and cautioned that the decision undermined the legal separation between an LLC and its owners. This ruling significantly limits asset protection for single-member LLCs in Florida by allowing creditors to seize complete control of the entity. ♦

In re LaHood (LaHood v. Covey), 437 B.R. 330 (Bkrpt.C.D.Ill. 2010).

♦ The United States District Court for the Central District of Illinois reviewed appeals regarding the bankruptcy of Michael LaHood, specifically focusing on the distribution of assets from FLLZ, LLC, a company co-owned by Michael and his brother Richard. After Michael filed for Chapter 7 bankruptcy, Richard dissolved the LLC and transferred its principal real estate asset to himself and Michael without the bankruptcy court's approval, claiming first mortgage rights over the property. The District Court affirmed the Bankruptcy Court's decision that this conveyance violated the automatic stay under 11 U.S.C. Section 362(a)(6). The court reasoned that Richard's actions were an attempt to collect a pre-petition debt and that the bankruptcy estate succeeded to Michael's full interest in the LLC despite restrictive provisions in the operating agreement. Under Section 541(c) of the Bankruptcy Code, an interest of the debtor becomes property of the estate notwithstanding any agreement or non-bankruptcy law that restricts transfers upon insolvency or the commencement of a bankruptcy case. Consequently, Michael's dissociation from the LLC was not considered wrongful, and the trustee maintained the right to participate in the winding-up process. Furthermore, the court found the distribution improper because the Illinois Limited Liability Company Act and the LLC's operating agreement require that creditors be paid before assets are distributed to members. Regarding the appeal by Heartland Bank, the District Court reversed the Bankruptcy Court's finding that Heartland's lien on Michael's membership interest was invalid. While the lower court believed a charging order was the exclusive means of establishing a lien, the District Court held that service of a citation to discover assets could create a valid lien under Illinois law. The case was remanded to determine the validity of Heartland's citation and to address how the lien would be satisfied, noting that the statutory charging order remains the exclusive remedy for satisfying such a judgment. ♦

First Mid-Illinois Bank & Trust, N.A. v. Parker, 403 Ill.App.3d 784, 933 N.E.2d 1215 (2010).

♦ The Illinois Appellate Court addressed lien priority among multiple judgment creditors seeking to reach members’ distributional interests in an LLC. Mid–Illinois Bank obtained a prejudgment attachment against the defendants’ LLC distributional interests, later reduced its claim to judgment, and then secured a charging order; competing creditors later obtained their own charging orders or relied on citations to discover assets. The trial court ruled that only charging orders created liens under the Illinois Limited Liability Company Act and prioritized later-entered charging orders over Mid–Illinois Bank’s earlier attachment. On appeal, the court reversed, holding that the Act’s charging-order remedy is the exclusive postjudgment method to satisfy a judgment from an LLC distributional interest, but it does not bar prejudgment attachment under the Code of Civil Procedure to preserve that interest. When a judgment is later entered and a charging order obtained, the charging order lien relates back to the date of the prejudgment attachment for priority purposes. Applying first-in-time principles, the court concluded that Mid–Illinois Bank’s lien had priority because its attachment predated the competing charging orders, and it remanded for further proceedings consistent with that ruling. ♦

Stanley v. Reef Securities Inc., 314 S.W.3d 659 (Tex.App., 2010).

♦ The Dallas Court of Appeals clarified the critical distinction between a "partnership interest" and a "partnership distribution" under Texas law. The debtor, Robert Stanley, attempted to shield $20,000 monthly payments received from his limited partnership by arguing that the charging order is the exclusive remedy for creditors and that the payments constituted exempt "current wages." The court rejected these arguments, holding that while a charging order is indeed the exclusive means to reach a partnership interest—defined as the right to receive future distributions—it does not protect funds once they have actually been distributed and are in the debtor’s possession. At that point, the money ceases to be a "partnership interest" and becomes nonexempt personal property subject to a turnover order under Tex. Civ. Prac. & Rem. Code § 31.002. Furthermore, the court affirmed that the payments were distributions rather than wages because, as a partner, Stanley was not entitled to compensation for services absent a specific agreement. While the appellate court modified the order to remove references to other property for which no evidence of ownership was provided, it affirmed the turnover of the $20,000 monthly payments and the award of attorney’s fees. This ruling serves as a vital precedent for creditors, confirming that the "exclusivity" of the charging order remedy ends the moment the partnership's assets cross the threshold into the debtor's hands. ♦

North Valley Bank v. McGloin, Davenport, 251 P.3d 1250 (Col.App., 2010).

♦ The Colorado Court of Appeals addressed whether a statutory attorney’s charging lien on a judgment has priority over a creditor’s previously perfected UCC security interest. North Valley Bank had loaned money to a contractor and perfected a security interest in the contractor’s accounts receivable and proceeds; later, the contractor hired attorneys to collect an unpaid project bill, and the attorneys filed notice of an attorney’s lien under § 12-5-119, C.R.S. After litigation, a judgment of $51,402 was paid to the attorneys, who retained most of it for fees and a retainer and forwarded the remainder to the contractor; the bank then sued, claiming its security interest entitled it to the entire award. Affirming the trial court, the appellate court held the attorney’s lien was superior because the statute expressly makes the charging lien a “first lien,” demonstrating clear legislative intent to give it priority over earlier-perfected interests, and because Colorado’s UCC does not govern or determine the lien’s priority in this context (including that the relevant UCC priority provision concerns possessory liens on goods, whereas a charging lien is nonpossessory and attached to a judgment). ♦