I am not a lawyer, I am a judgment matchmaking specialist (Judgment Broker). This article is based on my experience in California. Laws are different in each state, and nothing in any of my articles can ever be considered legal advice. This article is my opinion on recovering judgments on debtors who are members of partnerships and LLCs in California.
In this article, when LLC is mentioned, it stands for LLCs or partnerships. What if you have a judgment debtor that makes his living, or receives assets from an LLC? How do you recover from a member of a LLC, or a LLC member?s distributions of assets?
In California, a charging order is the only method to reach a judgment debtor?s interest in a LLC. The laws concerning California charging orders are around CCP: 708.310 et seq. (et seq. means that law, and those related to it, or following it).
A LLC can pay people as employees. Wages and salary are subject to garnishments. A wage garnishment is the exclusive way of recovery against earnings. (CCP 706.020.)
LLCs may also pay non-wage income, which is called K1 income. If non-wage income comes from from LLCs, corporations, estates and trusts, the IRS tax code defines it as being K1 income. An example of K1 income is stock dividends. A charging order is required to intercept K1 distributions.
When a LLC member gets non-K1 funds, for example earnings, an Earnings Withholding Order (EWO) is required because such earnings are not the type of ?economic interests? that are attached with a charging order.
Potential problems for creditors, are that the LLC may stop paying salaries, and instead internally accrue dividends, without really distributing them to members. Or, the LLC may decide to loan money to the judgment debtor, which bypasses both charging orders and garnishments.
One way to help prevent LLC shenanigans, is to have both an assignment (charging) order and an EWO served on the LLC at the same time. It costs about $40 more to serve both, and have both hearings heard on the same date.
Many judgment debtors with an ownership interest in an entity will purposely ignore an EWO. This can be an opportunity to relax, and let your execution lien accumulate against the employer, and then sue the employer directly for the amount that should have been levied over the time you waited.
If a debtor controls the company, they could just stop paying wages to themselves. They could accrue distribution money without disbursing it. They could pay themselves in other ways ? for example as a consultant, or some other kind of other non-employment income.
A creditor might be able to get around such shenanigans, with an assignment (charging) order. The order could be broadly worded to get to whatever funds the judgment debtor is getting from the LLC. It should not be limited to employment wages. The assignment (charging) order can also capture distributions, and any other K-1 income there may be. Charging orders include civil liability, for failure to follow the court?s order to pay, similar to wage garnishments.
A charging order could be worded to charge the judgment debtor?s interests, and levy the debtor?s wages. It could include wording to request the court to prohibit the LLC from making any loans, or paying or guaranteeing any obligations of the debtor, etc.
One complication with this idea, is the ?exclusive remedy? benefit (detriment) of the charging order. See Corporations Code 17302 (e). However this applies only to the judgment debtor member?s ?transferable interest?.
The charging order is the exclusive remedy to enforce against judgment debtor?s actual interest in the LLC, however it?s not the exclusive way to go after income flowing to debtor from the LLC. Assignment (charging) orders can be written broadly to catch everything ? but only if the judge signs it.
Persuading a court judge to agree with a wide list of remedies in an assignment (charging) order is not easy. In your papers, it may be a good idea to show the judge that you tried conventional levy, garnishment, and examination procedures already, with little or no results.
Another complication is that the owners of a LLC, who manage it are usually not considered employees by the IRS. Usually, only those without any ownership of a LLC are considered employees. Also, there are asset protection strategies that may force the creditor pay taxes on LLC income without ever receiving a dime of actual income, if they force a charging order.
One idea I have heard several times from lawyers at judgment conferences, is to form a new corporation intended to own the assets and liabilities of the LLC debtor member?s interest. The new corporation would include a lawyer as an officer, and would be disposable, if things went south.
The theory is when the new corporation does a charging order, and it turns out that the assets are toxic, one could close it down and have no personal liability.
The big boys may be able to get away with this, however I doubt the average person could get away with this and also avoid big problems and liabilities. In my opinion, forming a corporation only to diffuse a liability raises red flags.
Be careful to not grab a liability when you do a charging order. A good site to learn more about this is http://www.chargingorder.com.
Source: http://articles.whatismycomputerip.com/11402/recovering-from-corporate-distributions.html
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