Creditors And LLCs – Charging Orders
Posted Oct 14, 2020
By Washington State Business and Real Estate Lawyer David C. Tingstad
Collecting a judgment is always a challenge, especially when the judgment debtor holds an interest in an LLC. This article delves into the exclusive remedy available to creditors against judgment debtors with interests in a limited liability company: the charging order.
The charging order is a statutory remedy established by RCW 25.15.256 and available to creditors when the debtor holds a membership interest in an LLC. The statute provides that a court may “charge” a member-debtor’s transferable interest. RCW 25.15.256(1). The charging order constitutes a lien on the debtor’s transferable interest, which may be foreclosed at any time. RCW 25.15.256(2). If the transferable interest is foreclosed, the purchaser at the foreclosure sale has only rights of a transferee. Id.
There are also certain redemption rights under RCW 25.15.256(3). Specifically, any time prior to foreclosure, the transferable interest “charged” may be redeemed by 1) the debtor; 2) by one or more of the other members; or 3) by the LLC with consent of all members whose interests are not so charged.
It is also significant to note that the charging order is the exclusive remedy by which a creditor of a member of an LLC may satisfy a judgment out of the member’s transferable interest. RCW 25.15.256(5).
Interest Foreclosure and Dissociation
When a creditor obtains a charging order and forecloses, the debtor does, in fact, lose their interest and are effectively dissociated from the LLC. This issue was squarely addressed in the 2018 decision, Timberland Bank v. Mesaros, No. 50207–1–II, 2018 WL 2215463 (Wn. App. May 15, 2018).
In Timberland, the plaintiff Bank obtained a judgment against defendant Mesaros. Despite the Bank’s execution on Mesaros’ real property, the judgment remained unsatisfied, so the Bank moved for a charging order against Mesaros’s transferable interest in Pamria, LLC. Mesaros was the sole member of the LLC. Additionally, the Bank requested that Mesaros be restrained from taking any action on behalf of the LLC out of concern that Mesaros would attempt to hide LLC assets. The trial court ultimately granted the Bank’s charging order, restrained Mesaros, ordered a foreclosure of Mesaros’s interest, and ordered the county sheriff to sell Mesaros’s interest. Mesaros’s interest was then sold to a third party. Mesaros appealed the charging order, not the sale, which would ultimately prove fatal to his claims.
On appeal, Mesaros argued that the trial court exceeded its statutory authority by restraining Mesaros from acting on behalf of the LLC after issuing the charging order. This argument, however, was readily dismissed by the appellate court because they could not provide Mesaros any effective relief as he was dissociated as a member of the LLC under RCW 25.15.131. This interesting argument from the appellate court is as follows:
Mesaros does not argue that the trial court erred in entering the charging order and ordering the foreclosure. Nor has he appealed from the foreclosure sale of his transferrable interest in the LLC. Thus, the sale of all of Mesaros’s transferrable interest dissociated him from the LLC, and he no longer has the right to participate in the management and conduct of the LLC’s activities. RCW 25.15.131(1)(b), (3)(a). So, even assuming without deciding that the trial court could not have restricted Mesaros’s management of the LLC activities prior to the sale, restoration of his management rights would no longer have any effect because of the foreclosure of all of his transferrable interest in the LLC and his resulting dissociation.
Timberland Bank, 2018 WL 2215463 at *4. It is unclear whether Mesaros’ claims would have been dismissed if he contested the foreclosure sale of his interest. Nevertheless, the point still stands: when a judgment creditor obtains a charging order on a transferable interest, forecloses and sells the interest, the debtor is, in fact, dissociated.
The charging order is a useful tool for creditors looking to collect judgments against those with LLC interests. It also appears from the case law discussed that trial courts have significant authority available when issuing charging orders.
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