Charging Order Against Out-Of-State LLCs Allowed In AVT

A company called AVT VT -New York, LP, obtained an approximately $3.5 million judgment in the U.S. District Court for the District of Utah against Olivet University. The latter held interests in four limited liability companies: Two of the LLCs were formed in New York, and the other two were formed in Delaware. Seeking payment on its judgment, AVT applied for a charging order in Utah against Olivet’s interests in the four LLCs. In defense, Olivet argued that the court could not issue a charging order against its interests in the four LLCs because the court did not have personal jurisdiction over those LLCs.

The court overruled Olivet’s objections. First, the court noted that Olivet did not have standing to raise an objection to personal jurisdiction on behalf of the four LLCs. Second, the court held that the court has jurisdiction to adjudicate a debtor’s interest in intangible personal property (which an LLC interest is) even if that property is located in another state. Thus, the court granted AVT’s request for a charging order against Olivet’s interests in the four LLCs, for the amount of the judgment plus appropriate interest.

ANALYSIS

This is simple and common fact pattern: Judgment is rendered against the debtor in State A, and debtor holds interests in LLCs that are formed outside of State A and have no minimum contacts with State A such as that the LLCs would be subject to personal jurisdiction in State A. In such a case, including the one we are now discussing, is it appropriate for a court in State A to issue a charging order against the out-of-state LLC interests?

Yes, it is, and while the court here reached the correct result, albeit by way of a very abbreviated opinion that cuts a lot of corners, let me explain how all this works.

The most important thing to know is that a charging order is really just a vehicle that places a lien on the debtor’s economic interest (or distributive interest if you prefer) in an LLC up to the amount of the judgment, including interest as it accrues. At the end of the day, what the creditor gets is a lien. For a court to place a lien on the debtor’s LLC does not require that the court have personal jurisdiction over the LLC, any more than a court that places a lien on a debtor’s interest in Microsoft MSFT stock would require the court to have personal jurisdiction over Microsoft. So, the Utah court’s order in granting a charging order to AVT for Olivet’s interests in the two New York LLCs and the two Delaware LLCs was completely proper and not at all out of the ordinary.

Okay, so now AVT has a lien against Olivet’s interests in the LLCs. The problem is that the LLCs were not a party to the Utah proceeding, and thus have no formal notice that there is any lien on Olivet’s interests. Thus, the next thing that AVT will need to do is to make service of the charging order on the four LLCs in New York and Delaware respectively. Thus, being advised of the existence of the lien, the four LLCs will then have to deal with the lien like they would any other.

But what if Olivet has other creditors who may themselves seek charging orders against the LLCs interests subject to the Utah charging order? Here, there is a split of authority on what happens, with some courts holding that whoever gives notice of the charging order lien first receiving the higher priority (which I think is the correct result), and other courts holding that the first creditor to register its charging order as a sister-state order and then giving notice would have priority. So, if AVT is concerned about other creditors of Olivet, then AVT had better register its charging orders in New York and Delaware and serve (or re-serve) the LLCs with the charging order.

Another possible situation is this: Assume that one of the LLCs decides to ignore the charging order and continues to make distributions to Olivet? There are two things that happen in this situation.

The first is that although the Utah court can place a lien on the debtor’s interest in an out-of-state LLC, the court doesn’t have the power to enforce that charging order by way of contempt unless the out-of-state LLC was also a party to the Utah litigation, which it wasn’t. Thus, to enforce the charging order, AVT would have to register the charging order in whatever state the LLC was located, and then seek a contempt remedy in that state. Which is another way of saying that if you are a creditor and you want your charging order lien to be good and the charging order itself enforceable, then you’d better register it in the state where the LLC is located.

The second thing that happens in this situation is that even if the LLC whose interest is the subject of the charging order is out-of-state, the debtor is still within the personal jurisdiction of the court (personal jurisdiction does not cease simply because a judgment is issued but continues post-judgment), and therefore the debtor is bound by the charging order as well. Thus, if the debtor receives a distribution in violation of the charging order, the debtor must immediately turn that distribution over to the creditor or be subject to contempt — and this is true even if the court doesn’t have personal jurisdiction over the LLC which made the distribution.

One lesson to take from all this is that a debtor’s objection to a charging order on the grounds that the LLC is out-of-state and not subject to jurisdiction in-state will not prevent the charging order from being appropriately granted. Another lesson is that where the interest of an out-of-state LLC is being charged, that may just be the start of the creditor’s process to make the charging order enforceable against the LLC. The final lesson is that none of this helps a debtor who receives such a distribution, since the debtor must pay it over to the creditor anyway or risk contempt.

Notably, it is not a difficult thing to register a judgment and charging order in another state, and the LLCs in those states have no viable objection to the registration. At the end of the day, the out-of-state LLCs have no cognizable interest in preventing the charging order from being entered or registered as a sister-state order, since an LLC is not itself affected by a charging order other than to whom the distribution is addressed. In the vast majority of cases, the involved out-of-state LLCs will not want to make the debtor’s problems their problems, and simply being served with a copy of the charging order will be more than enough for them to fully comply with it. However, as mentioned, where this can get interesting is where the debtor has other creditors and there are other charging orders out there competing for priority.

But that is for another day.

CITE AS

AVT – New York, L.P. v. Olivet University, 2022 WL 951754 (D.Utah., March 30, 2022). https://chargingorder.com/index.php?n=Site.2022UtahAvtJurisdictionForeignEntities

Source: Forbes