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Charging Orders on LLCs in Kentucky
The organization of any business as a limited liability company ("LLC") brings with it attendant protections for the members from the liabilities that arise in the course of the business as well as beneficial tax treatment. This protection is not a two-way street, however: the member's financial interest in the LLC does not receive complete protection from the member's personal liabilities. Judgment creditors of LLC members have at their disposal a unique remedy to collect distributions and more from the judgment debtor's membership or partnership interests; that remedy is the charging order.
The charging order is the exclusive remedy for creditors to attach any benefit from the debtor's ownership interest in the LLC. While one of the more useful benefits of the LLC structure, as opposed to, say, an S corporation, is that creditors cannot directly levy on the debtor member's interest in the company, the charging order acts a lien on any distributions that might be made to the debtor member, allowing the judgment creditor to obtain the debtor's financial rights to income from the LLC. It does not, however, allow the creditor to participate in management of the LLC, so it cannot force the LLC to make distributions.
As stated in KRS § 275.260(3), a charging order in and of itself is only a lien on a member's interest with the right to receive distributions, not an assignment of that member's interest. The net effect of this is to render the charging order as a rather inefficient remedy for judgment creditors, as the LLC is not required to make distributions to the debtor/member thus making satisfaction of the judgment from said distributions impossible. This protects the LLC from having its management interfered with by outside creditors of its individual members.
However, though rarely if ever implemented by Kentucky Courts, KRS § 275.260(4) allows a court to order a foreclosure on that interest, forcing a sale of the individual debtor/member's membership interest in the LLC on the Courthouse steps. Should an individual debtor/member's membership interest in the LLC be foreclosed upon, the purchase of said membership interest does not act as an assignment of the interest as, in Kentucky, foreclosure does not entirely dissociate the debtor member; the member will only be removed with the written consent of the majority-in-interest of the members who have not assigned their interests. KRS § 275.280(1)(c)2. However, in the case of single-member LLCs, the single member will be dissociated upon the assignment of his or her entire interest, and the purchaser/assignee of the interest may then elect her or himself as the sole member of the single-member LLC. Still, the judgment creditor cannot, in a multi-member LLC, directly force the distribution of LLC assets or act to dissolve the LLC, even under foreclosure.
Charging orders can prove difficult for creditors and LLC members alike, and the tax implications of such an order can prove tricky. For more information or assistance with charging orders, contact the attorneys at McBrayer.
We take a team approach to deliver effective counsel to all our clients, so other attorneys in the firm may perform these services as well.
This article does not constitute legal advice.