Real Estate Investor Magazine South Africa Real Estate Investor Magazine - Dec/Jan 2018 | Page 59

US INVESTMENTS
Using LLCs and Charging
Order Protection
Charging order protection arises from
each state’s law and is a key strategy for
shielding your assets from attack. As
with anything in the law, the charging
order is subject to change and inter-
pretation by the courts. Some states
view the statute differently than others,
which is why it is important to choose
the right state when forming a limit-
ed partnership (LP) or limited liability
company (LLC). It is also important
to keep up on the new court cases and
trends in this area to keep yourself bet-
ter protected.
Remember, the LLC has only been
widely used in the USA in the last 25
years or so. We are just now starting to
see court cases defining their scope and
use.
Going back to the original statute
(the rule passed by each state’s legis-
lature) we consider section 703 of the
Uniform Limited Partnership Act. It
states that if a partner of an LP owes
money to a judgement creditor (one
who has gone to court and won) the
court may order a ‘charge’ against the
partner’s interest to pay the judgement
creditor. Thus the term ‘charging order.’
This rule also applies to LLCs.
For example, if John owns a 50%
membership interest in XYZ, LLC
and John owes money to Mary after
losing to her in court, Mary can seek
a charging order to receive John’s 50%
share in the distributions from XYZ,
LLC. Of course, John’s other part-
ner Carlos is not as keen to this, but
any disruption is minimized with the
charging order. Mary does not step
into John’s shoes as a substituted part-
ner. She can’t vote and tell Carlos how
to run the business. Instead, she is only
assigned the distributions that would
have been made to John.
Again, the charging order is a court
order providing a judgement creditor
(someone who has already won in court
and is now trying to collect) a lien on
distributions.
In our example, John was in a car
wreck which injured Mary, the oth-
er driver. Mary does not have a claim
against XYZ, LLC itself. The wreck
had nothing to do with the duplex.
Instead, Mary wants to collect against
John’s main asset, which is a 50% inter-
est in XYZ, LLC. Courts have said it is
not fair to Carlos, theother 50% own-
er of XYZ, to let Mary come crashing
into the LLC as a new partner. Instead,
the courts give Mary a charging order,
meaning if any distributions (think
profits) flow from XYZ, LLC to John
then Mary is charged with receiving
them.
Mary is not a partner, can’t make
decisions or demands and has to wait
until John gets paid. If John never gets
paid, neither does Mary. The charging
order not only protects Carlos, but it is
a useful deterrent to frivolous litigation
brought against John. Attorneys don’t
like to wait around to get paid.
But what if there is only a single
owner?
Consider the illustration on this
page.
In this example, there is no Carlos
to protect. It’s just John. Is it fair to
Mary to only offer the charging order
remedy? Or should other remedies be
allowed?
The Difficulties of Single
Member LLC Owners
A key issue is whether the charging
order applies to a single member (one
owner) LLCs. There is a nationwide
trend against protecting single member
LLCs with the charging order. Courts
are starting to deny single owner LLCs
the same protection as multiple mem-
ber LLCs. The reason has to do with
the unique nature of the charging order.
In June of 2010, the Florida Su-
preme Court decided the Olmstead
vs. FTC on these grounds. In a single
owner LLC there are no other mem-
bers to protect. The court allowed the
FTC to seize Mr. Olmstead’s member-
ship interests in order to collect. Other
states have followed the trend.
See part 2 in our February edition
SA Real Estate Investor Magazine DECEMBER 2017/JANUARY 2018
57