Let’s say that a debtor holds an interest in First LLC, and First LLC itself (but not the debtor) holds an interest in Second LLC. There is no doubt that a creditor can obtain a charging order against the debtor’s interest in First LLC. Can the creditor also obtain a charging order against Second LLC as well? Certainly, whatever percentage of interest in First LLC held by the debtor would include at least a portion of Second LLC. That by itself does not answer the question, but it does illustrate why a creditor might seek a cascading charging order which places a lien not only on the LLC interest directly held by the debtor, but also an LLC interest indirectly held by the debtor through the LLC in which the debtor does hold directly. The answer is below.
In Bran v. Spectrum MH, LLC, 2023 WL 5487421 (Tex.App., 14th Distr., August 24, 2023), a Texas District Court in Houston confirmed an arbitrator award of almost $1.5 million in favor of Spectrum Parties and against the Bran Parties. The judgment also ordered the Bran Parties to restore about the same amount of money from a bank account (called the “MMM3 Bank Account”) owned by a company called Montrose Multifamily Member III, LLC (“MMM3”).
The Spectrum Parties filed an application for the appointment of a receiver and a turnover order, which was granted by the District Court. The receiver very aggressively emptied out the accounts of some of the Bran Parties, but collected only about $50,000. The receiver then also emptied accounts not belonging to the Bran Parties but instead belonging to seven other entities. These seven other entities filed for Chapter 11 bankruptcy protection, and the Bankruptcy Court ordered the receiver to deposit the moneys for these seven entities into the Court fund, which the receiver did. In the meantime, the Bran Parties filed an emergency appeal, which lead to the opinion and order that follows.
The first issue before the Texas Court of Appeals was whether the receiver could force the turnover of money in non-party LLCs that were owned by the Bran Parties, or whether instead the receiver was limited to a charging order against the Bran Parties’s interests in those LLC. Here, the Texas LLC Act (like pretty much every other LLC Act nationwide) states that a charging order is the “exclusive remedy” by which a judgment creditor may enforce the judgment against a debtor’s interest in an LLC. While the receiver argued that the Texas statutes give the receiver very broad powers to recover money from debtors (and it does), the Court of Appeals agreed — for the same reasons that I have written about many dozens of times and do not feel a particular need here to write about yet again — that a charging order is indeed the “exclusive remedy” and that includes the remedy of a receiver as well.
The second issue related to the Bran Parties’s claim that the Spectrum Parties had failed to prove that they had any ownership interest in some of the entities whose bank accounts were tapped by the receiver. The Court of Appeals ordered that part of the case remanded back to the District Court to make further findings, but with instructions that the District Court should only allow the receiver to hit the accounts of the Bran Parties themselves, but not those of any LLCs in which the Bran Parties held an interest.
The third issue was whether the receiver could access the funds of LLCs that were not owned by the Bran Parties, but were owned by LLCs in which the LLCs held an interest. Because a creditor could only get a charging order against the LLCs in which the Bran Parties held an interest, and not tap the bank accounts of those entities, it stood to follow that a creditor could not assert any remedies of any kind against the LLCs in which the Bran Parties did not hold an interest, even if they were owned in part by LLCS in which the Bran Parties did hold an interest.
So, the answer to the question posed above is this: A creditor cannot get a charging order (or any other remedy) against an LLC in which the debtor does not hold any interest. The so-called cascading charging order is thus impermissible.
ANALYSIS
A charging order is in many ways a lousy remedy for creditors, insofar as it allows the creditor to take a lien against the debtor/member’s interest in an LLC and get any distributions due to the debtor, but that’s about it. This is illustrated in spades by this case. A creditor who gets a charging order cannot tap bank accounts, cannot get any property of the LLC, cannot take over management of the LLC, or — as shown here — even get another charging order in LLCs interests owned by the LLC subject to the charging order.
That doesn’t mean that creditors are always out of luck in these cases. Where a debtor has structured many layers of LLCs, all owned and controlled directly or indirectly by the debtor, a creditor can attempt to assert an alter ego theory against all the entities, which is a cascading alter ego claim. These sorts of claims are difficult, but certainly not impossible, to bring: I’ve had success with them, but they take a great deal of effort to properly set up through discovery.
This case also demonstrates the limits of a receiver where the debtor holds an interest in an LLC. Like a bankruptcy trustee, a receiver is an odd duck as simultaneously the agent of the court, the agent of creditors, and the agent of debtor. As to the latter, a receiver who “steps into the shoes” of a debtor has no more rights in an LLC that the debtor/member herself had, and those rights are limited by the local LLC Act and sometimes also the LLC’s operating agreement. The most important of these limitations is so-called charging order exclusivity, i.e., the restriction of the remedy to a charging order lien as opposed to all other remedies. If the debtor/member has no rights to the assets of the LLC, including that LLC’s interests in other LLCs, then neither will a receiver. Here, the receiver clearly overstepped his powers, and the Court of Appeals put him on a much tighter leash on remand.
Yet to be resolved is whether a receiver can vote the rights of the debtor/member, but that is for another day.
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