SFG Commercial Aircraft Leasing, Inc. won a judgment against Montgomery Equipment Company, Inc. and Dr. A. Thomas Falbo for about $1.65 million. To enforce the judgment, SFG moved in the U.S. District Court for the Southern District of West Virginia for the entry of a charging order against Dr. Falbo’s interests in five West Virginia LLCs. All this lead to what appears to be the first legal opinion in West Virginia concerning charging orders, and an interesting one at that in the case of SFG Commercial Aircraft Leasing Inc. v. Montgomery Equipment Co., 2023 WL 2447469 (S.D.W.Va., March 10, 2023).
The Court found that Dr. Falbo indeed held interests in the five LLCs, and thus granted the core of the charging order without much discussion. The charging order required each LLC to redirect to SFG’s counsel all the distributions that Dr. Falbo would have otherwise received. That part was simple, and frankly mundane.
Where the opinion gets interesting is SFG’s request for certain additional provisions to be added to the charging order. This request sought two things. First, SFG sought to enjoin the LLCs from transferring any property in which Dr. Falbo had an interest. Second, SFG wanted an accounting from the LLCs of all the distributions that were going to be made, or could have been made, by the LLCs to Dr. Falbo’s interest.
As to SFG’s request for an injunction, the Court noted that a member of LLC only holds a distributional interest (as an aside, also called an “economic interest”), meaning that the member is entitled to distribution according to the member’s ownership percentage. But the Court noted that is very different than the member having any right to the property of the LLC. Giving SFG an injunction over the five LLCs’ property, the Court continued, would interfere with those LLCs’ ability to pay its own creditors, and thus would be tantamount to giving SFG a priority lien over the LLCs’ assets to the detriment of the LLCs own creditors. Concluding that such went beyond the vehicle of the charging order, and would unfairly advantage SFG over these other creditors, the Court denied this request.
Moving on to SFG’s second request, which was for an accounting, the Court noted that creditors have often had more luck in getting financial information out of an entity whose interest has been subject to a charging order. The Court noted that other courts had approved similar requests for information about distributions that were being made to a debtor’s interest in an LLC or partnership. The Court thought that causing the LLCs to make disclosures about distributions was necessary to give teeth to the charging order, and thus required the LLCs to make quarterly accountings of all distributions that had been made to Dr. Falbo. This ruling was to distributions which the LLCs had made, past tense, but did not extend to future distributions.
As to future distributions, the Court found that SFG’s request was overly vague in terms of what SFG really wanted. The Court pointed out that with an LLC (or partnership), a distribution doesn’t come into existence until the LLC itself decides to make the distribution to the members, and so a future distribution is more of an idea than something that actually exists ― and therefore cannot be accounted until the distribution actually happens. Thus, the Court denied SFG’s request for an accounting for future distribution, albeit the denial was without prejudice in the event that SFG could fashion a better argument.
With all that, the Court issued the charging order with the additional provision regarding past distributions mentioned above.
The information rights of a creditor that holds a charging order, if indeed such a creditor has any rights at all, is a difficult area. To illustrate this difficulty, a good place to start is in § 502 of the Uniform Limited Liability Company Act (“ULLCA” or as revised “RULLCA”), which provides for the transfer of a transferable interest in an LLC. This is the section which immediately precedes the charging order section, being § 503, and one simply cannot make any sense out of § 503 unless one first understands what happens with a transferable interest under § 502.
Please note throughout that the basically the same things happen with partnerships under their analog statutes, but we’ll just stick with LLCs for now because it makes it easier to write about.
A “transferable interest” under § 502 is essentially the member’s interest in an LLC. That interest can either be voluntarily assigned, such as when the member sells an interest or makes a gift of the interest, or involuntarily assigned such as through a judicial sale. Section 502(a)(3) states that a transfer does not entitle the transferee to “have access to records or other information concerning the company’s activities and affairs.”
There are two exceptions where a transferee will have such information rights, being upon the death of the member (the member’s estate gets limited rights under § 504) and where the LLC is being wound up, under § 502(c), but neither of those concern us here.
What does concern us is that § 502(a)(3) basically says that an LLC can quite lawfully tell a transferee seeking information about the LLC and its activities to go pound sand, unless of course the other members vote to make the transferee a member. In the case of a creditor of a debtor/member, this latter is highly unlikely, and thus a non-admitted creditor does not have any rights to information under § 502(a)(3).
If you think this analysis should end the problem, you’d be wrong. Let us know turn to the charging order section (§ 503) to find out more. So, let’s look at § 503, and particularly § 503(a) which provides in relevant part that
“a charging order constitutes a lien on a judgment debtor’s transferable interest and requires the limited liability company to pay over to the person to which the charging order was issued any distribution that otherwise would be paid to the judgment debtor.”
The above passage is the muscle of the ULLCA’s charging order provision. When a court grants a charging order, the creditor gets two things: (1) a lien on the interest; and (2) an order requiring the LLC to divert to the creditor any distributions that would otherwise have been paid to the debtor/member. But what is missing here for our purposes?
What § 503(a) specially does not accomplish is to make the creditor a “transferee” of the debtor/member’s interest in the LLC such that § 502 (dealing with transferable interests) would be implicated. Instead, the creditor is essentially no more than a mere lienholder with a right to payment of the distributions, but is not a “transferee” of the interest. Note that there is a fly in the ointment of this analysis, but we’ll come back to that later.
Now, if the creditor forecloses on the lien under § 503(c), then the purchaser at the ensuing judicial sale (not necessarily the creditor) will become what amounts to an “involuntary assignee” and thus a “transferee” under § 502, and at that time then § 502 will become relevant. But at the charging order stage, the creditor is not a transferee and thus § 502 is not applicable, again subject to the fly in the ointment below.
Before the creditor forecloses, however, the creditor might be able to get the court to enter an order forcing the LLC to give information to the creditor under § 503(b)(2), which provides as follows:
“(b) To the extent necessary to effectuate the collection of distributions pursuant to a charging order in effect under subsection (a), the court may: … (2) make all other orders necessary to give effect to the charging order.”
This, of course, is sort of a “generic powers” provision frequently given to the courts in various statutes which basically says that the court can do whatever common sense requires to give teeth to an order of the court, or to a charging order specifically in this case. Indeed, this is the provision on which the court in the SFG opinion used to grant SFG information rights to past distributions.
The bottom line is that prior to a creditor foreclosing on a charging order, a court may use its generic powers under § 503(b)(2) to grant information rights to a creditor. Once the creditor has foreclosed and the purchaser has become a transferee under § 502, however, then that purchaser has no information rights under § 502(a)(3). This is yet another reason why a creditor that forecloses on a charging order lien is theoretically at least a little worse off than if the creditor never foreclosed at all.
I do want to return to the fly in the ointment of this analysis, which is found in the opening clause of § 502(a) which points to a “transfer, in whole or in part”. The problem here is that the court order requiring the debtor/member’s distributions to be re-directed to a creditor is susceptible to the interpretation of a “transfer … in part”. I am not aware of any court which has yet addressed this issue, but ultimately some court will have to decide the issue. The import is this: If a court determines that a creditor that is now receiving a distribution has received a “transfer … in part”, then § 502(a)(3) becomes operable which blocks the creditor from having any right to information. If not, then the creditor may still be able to obtain an order for the information rights under § 503(b)(2).
There are two other salient points worth discussion here.
The first point is that while a creditor might not be able to get information directly from the LLC, the creditor is entitled to get from the debtor whatever information the debtor can get from the LLC, and that is everything. So, even if a creditor cannot get a court to compel the LLC to hand over information directly to the creditor, the creditor should be able to get an order which compels the debtor to get information from the LLC and then turn that over to the creditor ― such orders are routine in post-judgment enforcement. In the vast majority of jurisdictions, creditors are also able to obtain the debtor’s tax returns, and this would include the Form K-1 given to members at the end of the year which detail the distributions made to the member. This is an example of how in post-judgment enforcement proceedings there is often another way to skin the cat.
The second point is that a charging order is not only binding upon the LLC but is also binding upon the debtor/member. So, even if a creditor cannot get information about distributions directly from the LLC, if the debtor/member receives a distribution that should have been made to the creditor, then the debtor/member must either immediately turn over that distribution to the creditor or else face the risk of contempt proceedings for violating the charging order.
All this may seem mundane to most readers, but it is often the nuances of how creditors are able to get information and tie up the debtor’s ability to get cash that dictate the timing and value of a settlement. Resolution of this issue can thus be very important in real life litigation.