What is charging order protection in the context of an LLC?
A charging order is a legal remedy through which the creditor of an LLC member may collect the debt owed to him/her by seizing any distributions made to other members in the absence of an agreement to the contrary.
Charging order protection limits this remedy by only allowing the LLC member/debtor (the “Chargor”) to be subject to one charge; generally, shareholders are not subject to this remedy outside of bankruptcy proceedings, and thus do not benefit from CFP.
CFP also protects shareholders who are acting in their role as managers by preventing them from having distributions seized for debts incurred while performing managerial duties. Only Chargors can benefit from charging order protection under section 18-305; there is no provision for protecting distributions made to managers within section 18-305.
In order to have any effect, section 18-305 must be specifically invoked through a written operating agreement provision. If not otherwise stated in the LLC’s operating agreement, the Chargor/debtor is entitled to an award of one-third of distributions received by other members during the period of his/her management or control.
Charging order protection does not affect creditors’ rights outside of charging orders, for example a creditor may still pursue fraud claims against a nonmanager member who has fraudulently transferred property from the LLC. Creditors also have significant rights under federal bankruptcy law; however, only shareholders can capitalize on these protections as managers are excluded from filing under Chapter 11 and 12 unless they resign their status as a Chargor.
Charging order protection affects a creditor’s rights to seize distributions by incorporating section 18-305’s charging order provision, but it does not affect the creditor’s ability to take recourse against other LLC property. For this reason CFP must be paired with asset protection planning in order to fully protect LLC members from creditors’ claims for debt repayment. In addition, an operating agreement may allow creditors to call a special meeting of members and seek dissolution of the company through a supermajority vote under certain conditions.
In both cases, the member/debtor loses his/her status as Chargor when bringing suit or dissolving the company. However, if he/she is still a member at the time of legal action or dissolution, then he/she is entitled to one-third of the distributions received by other members.
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