subject: Charging Orders Against Partnerships [print this page] I am not an attorney, I am a judgment referral specialist (Judgment Broker). This article is based on my experience in California. Laws are different in every state, and nothing in any of my articles can ever be considered legal advice. This article is my opinion on recovering judgments from debtors who are members of partnerships and LLCs in California.
In this article, when LLC is mentioned, it means LLCs or partnerships. What if you get a judgment debtor that makes their living, or receives assets from an LLC? How does one go after a member of a LLC, or a LLC member's distributions of assets?
In California, a charging order is the exclusive method of reaching a judgment debtor's benefits from an LLC. The laws concerning California charging orders are around CCP: 708.310 et seq. (et seq. means that law, and those related to it, or following it).
A LLC can pay people as employees. Wages and salary are subject to garnishment. A wage garnishment is the exclusive way of recovery against earnings. (CCP 706.020.)
LLCs may also pay non-wage income, that is named K1 income. If non-wage income originates from LLCs, corporations, estates and trusts, the IRS tax code defines it as being K1 income. One example of K1 income is stock dividends. A charging order is needed to intercept K1 distributions.
When a LLC member receives non-K1 funds, for example earnings, an Earnings Withholding Order (EWO) is required because such earnings are not the kind of "economic interests" which are attached with a charging order.
Potential problems for judgment owners, are that the LLC might stop paying salaries, and instead internally accrue dividends, without actually distributing them to members. Or, the LLC may decide to make loans to the judgment debtor, which circumvents both charging orders and garnishments.
One way to help prevent LLC games, is to have both an assignment (charging) order and an EWO served on the LLC at the same time. It costs about $40 additional to serve both, and have both hearings heard on the same date.
Many judgment debtors with an ownership interest in the entity will purposely ignore an EWO. This is an opportunity to relax, and let your execution lien accumulate against the employer. Then you can sue the employer directly for the amount that should have been levied over the time you waited.
If a judgment debtor is in control of the company, they could just stop paying wages to themselves. They could accrue distribution money without disbursing it. They could pay themselves in other ways - for example as a consultant, or some other kind of other non-employment income.
A judgment owner may be able to get around these kind of shenanigans, with an assignment (charging) order. Such an order could be broadly worded to get to whatever income the debtor is getting from the LLC. It should not be confined to employment wages. The assignment (charging) order can also capture distributions, and any other K-1 income there might be. Charging orders include civil liability, for failure to obey the court's order to pay, similar to wage garnishments.
A charging order could be worded to charge the judgment debtor's interests, and levy the debtor's wages. It could include wording to ask the court to prohibit the LLC from making any loans, or paying or guaranteeing any obligations of the judgment debtor, etc.
One complication of a broadly worded charging order, is the "exclusive remedy" benefit (detriment) of the charging order. See Corporations Code 17302 (e). However this applies only to the judgment debtor member's "transferable interest".
A charging order is the exclusive remedy to enforce against judgment debtor's actual interest in the LLC, but it is not the exclusive remedy for going after income flowing to debtor from the LLC. Assignment (charging) orders can be broadly written to catch everything - but only if a judge signs it.
Convincing a court judge to agree to a wide list of remedies in an assignment (charging) order is not easy. In your papers, it is a good idea to prove to the judge that you tried conventional levy, garnishment, and examination procedures already, with little or no results.
Another complication is that the owners of a LLC, who manage it are usually not considered employees by the IRS. Usually, only those without any ownership of a LLC are considered employees. Also, there are asset protection strategies that can make the creditor pay taxes on LLC income without ever receiving a dollar of actual income, if they force a charging order.
One idea I have heard several times from lawyers at judgment conferences, is to form a new corporation intended to own the assets and liabilities of the LLC debtor member's interest. The new corporation would include a lawyer as an officer, and would be disposable, if things went south.
The theory is when the new corporation does a charging order, and it turns out that the assets are toxic, one could close it down and have no personal liability.
The big boys may be able to get away with this, but I doubt the average person could get away with this and also avoid big problems and liabilities. In my opinion, forming a corporation only to avoid a liability raises red flags.
Be careful to not grab a liability when you perform a charging order. A good site to learn more about this is http://www.chargingorder.com.
