Rights of Secured and Judgment Creditors

Secured creditors. A security interest in or other encumbrance against a member’s interest without any related amendment of the operating agreement does not provide the secured creditor with the ability to exercise any rights or powers of a member or to receive distributions. Corp C §17705.02(b). The secured creditor obtains rights only with respect to the transferable interest of the member. In SP Inv. Fund I LLC v Cattell (2017) 18 CA5th 898, the court held that a limited partner could contract to transfer the right to receive distributions with respect to his limited partnership interest even though the transferee had not been approved as a new limited partner.

Judgment creditors; charging orders. A lien by a judgment creditor against a member’s interest is created by service of a notice of motion for a charging order on the member and all other members of the LLC and continues unless the order is denied. CCP §708.320. A judgment creditor of a member may charge the “assignable” membership interest of a member without becoming a member. Corp C §17705.03. The purpose of the right established by a charging order is to permit the creditor to “realize on his judgment” by “appropriate supplementary proceedings or orders” against the debtor’s membership interest. See Taylor v S & M Lamp Co. (1961) 190 CA2d 700, 711.

Receivers. A court may appoint a receiver for the share of a member’s distributions from the LLC that are “subject to the charging order” and may “make all other orders necessary to give effect to the charging order.” Corp C §17705.03(b). In addition, under CCP §187, a court can apply other “practical means for enforcing” the right of the creditor. In Phillips v Fotouhi (2011) 197 CA4th 1132, 1143, a judgment debtor was found liable for breaching the partnership agreement when he started a new partnership and took clients with him. Shortly thereafter, the new partnership began doing business as a corporation, which took over the partnership’s office lease and continued to operate in the same location. In granting the charging order, the superior court applied principles of successor liability and found that the corporation was a continuation of the partnership.

Foreclosure. To obtain the remaining benefits of the transferable interest, the creditor must establish a right to foreclose on the membership interest. The court may order a foreclosure on the membership interest at any time if the court determines that foreclosure is appropriate in light of the relevant equities. See Hellman v Anderson (1991) 233 CA3d 840, 853. The purchaser at the foreclosure sale will obtain the rights of a “transferee.” Corp C §17705.03(b)(3). The judgment debtor and the other members of the LLC retain the right to redeem the membership interest at any time before foreclosure. Corp C §17705.03(c).

Other remedies, including fraudulent conveyance. The charging order provisions of Corp C §17705.03 are stated to be the exclusive remedy for a judgment creditor to satisfy a judgment out of a membership or transferable interest in an LLC. Corp C §17705.03(f). However, given the associated rights of a creditor under the California Code of Civil Procedure to seek foreclosure, a receiver, or other practical means for enforcing the creditor’s rights, along with the potential to “reverse veil pierce” the liability limitations and impose liability on the LLC for a member’s obligations, the charging order provisions in RULLCA may not be exclusive in practice. A California creditor also may seek to avoid the charging order limitations by asserting a fraudulent conveyance or claiming a breach of the fiduciary duty obligations of the members to each other. Tiering of LLCs may be helpful in providing additional protection for the LLC and other members against a member’s creditors.

Reverse veil piercing. For a case allowing potential alter ego liability with respect to an LLC for the obligations of a member (“reverse veil piercing”), see Curci Invs., LLC v Baldwin (2017) 14 CA5th 214. In contrast, reverse veil piercing was not allowed in Phillips, Spallas & Angstadt, LLP v Fotouhi (2011) 197 CA4th 1132 or Postal Instant Press, Inc. v Kaswa Corp. (2008) 162 CA4th 1510, but neither Phillips nor Postal Instant Press involved LLCs.