Clients ask us whether a charging order can help them collect on a debt from a debtor’s LLC. The answer is: sometimes.
When starting a business, people form limited liability companies (“LLC’s”) to protect their personal assets from their business debts. What happens, however, if there is personal debt? Can the creditor on the personal debt recover assets or money from an LLC in which the debtor owns an interest?
In California, creditors of an individual cannot take away the money or property of an LLC to pay off the individual’s debts. However, a creditor can obtain a charging order. A charging order requires the LLC to pay any money due to the LLC member debtor directly to the creditor. The creditor, however, does not have any control over the LLC. So the creditor cannot order the LLC to disburse money. If no distributions are made, the creditor can end up collecting nothing on their debt.
Some asset protection specialists claim that the debtor can still get money out of the LLC without having to pay the creditor by way of salary or loans. However, when charging orders are issued by the courts, courts will often order that no salaries or loans be paid to the individual debtor or that such salaries or loans be paid to the creditor.
So, the charging order can, in effect, create a standoff between an LLC member and a creditor. Neither has access to the money or assets of the LLC. The more patient party — or the one less in need of money — wins. So, for example, a real estate LLC formed to hold investment property and for which the individual member has no need for immediate cash may be less likely to settle with the creditor. On the other hand, an LLC formed for an existing business for which several members depend on disbursements or salary to support themselves may, in fact, have an incentive to get rid of the creditor by satisfying the debt.
The law of charging orders and LLCs are necessarily complex and fact specific. If you are owed money from a member of an LLC, you should consult with a lawyer with experience with LLCs and charging orders.