Creditor Collection Action Against Member LLC Interest

I shy away from debtor-creditor conflicts as they are messy affairs; however, a corporate lawyer needs to have a basic understanding of collection fundamentals when creating business entities. One of the main reasons for forming an LLC is liability protection of the members from the debts of the LLC. But what about the reverse, a claim by a creditor of a member against the assets of the LLC?

The Uniform Limited Liability Company Act (upon which the LLC laws of all states are based), provides the following in Section 504 entitled "Rights of Creditors":

(a) On application by a judgment creditor of a member of a limited liability company or of a member's transferee, a court having jurisdiction may charge the distributional interest of the judgment debtor to satisfy the judgment. The court may appoint a receiver of the share of the distributions due or to become due to the judgment debtor and make all other orders, directions, accounts, and inquiries the judgment debtor might have made or which the circumstances may require to give effect to the charging order.

The comments to Section 504 further state that "A charging order is the only remedy by which a judgment creditor of a member or a member's transferee may reach the distributional interest of a member or member's transferee."

Why is this important? Two reasons: (a) it means a creditor of an LLC member cannot vote a member's LLC interest nor otherwise attempt to manage the LLC and (b) the creditor cannot force liquidation of the LLC assets to satisfy a judgment it holds against a member. Basically, once a judgment creditor seizes an LLC membership interest through a judicial charging order, the creditor is left to sit on its hands waiting for the LLC members to vote a member asset distribution. Only then does the creditor collect anything from the LLC.

A bankruptcy court in Colorado carved out an exception to the above rule in the case of single-member LLCs. In the 2003 case of In re Ashley Albright, the sole member of an LLC went into bankruptcy. The bankruptcy trustee asserted that he as trustee now controlled the LLC and could cause the LLC to liquidate its property for the benefit of the bankruptcy estate. The court held that a charging order remedy given in the state LLC statute only acts to protect other members of the LLC. With no other members to protect in this case, the court granted the bankruptcy trustee complete control of the LLC and its property. See also In re Modanlo, 2008 U.S. App. LEXIS 3685 (4th Cir.), affirming In re Modanlo, 2006 Bankr. LEXIS 4524 (Bankr. D. Md); But see In re KRSM Properties, LLC, 318 B.R. 712 (9th Cir. Bank App. 2004) rejecting the Ashley Albright holding.