Problem: Your judgment debtor is a member of a Nevada limited liability company holding a valuable piece of real estate that is being developed and eventually will be sold for a large profit and distributed to its members. However, you do not have a judgment against the LLC but the judgment debtor and the project are located in California. How do you best proceed?
It appears that this judgment debtor has done some asset protection planning, picking a state with favorable treatment of LLCs in the hopes that the creditor will never be able to effectively execute on its judgment, become discouraged and eventually be forced to settle at highly discounted amount.
In 2011, the State of Nevada revised N.R.S. 86.401, as follows:
Rights and remedies of creditor of member
1. On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the member’s interest with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of the member’s interest.
2. This section:
(a) Provides the exclusive remedy by which a judgment creditor of a member or an assignee of a member may satisfy a judgment out of the member’s interest of the judgment debtor, whether the limited-liability company has one member or more than one member. No other remedy, including, without limitation, foreclosure on the member’s interest or a court order for directions, accounts and inquiries that the debtor or member might have made, is available to the judgment creditor attempting to satisfy the judgment out of the judgment debtor’s interest in the limited-liability company, and no other remedy may be ordered by a court.
(b) Does not deprive any member of the benefit of any exemption applicable to his or her interest.
(c) Does not supersede any written agreement between a member and a creditor if the written agreement does not conflict with the limited-liability company’s articles of organization or operating agreement.
This provision essentially limits creditors to a charging order procedure, yielding a lien on future distributions to the judgment debtor and the standing of only an assignee of the membership interests, without the right to manage or vote in the internal operations of the LLC. This situation could force the creditor to wait a long time before any payments are actually made to the member. If there are no distributions made to the judgment debtor member, the creditor is not entitled to any monies. Furthermore, depending on the provisions contained in the LLC’s operating agreement (for example, a first right of refusal or forced buyout) and/or a tiered arrangement with other LLCs, the collection situation can become increasingly dire for the creditor. See, Weddell vs. H2O, Inc., 271 P.3d 743 (2012) [Supreme Court of Nevada confirming limited creditor’s rights against Nevada LLCs, including single member entities].
Here’s how a creditor might proceed given the circumstances.
First, argue that California law applies. Since the judgment debtor is a resident of the State of California, California law should apply with respect to the collection of the judgment. And because the real estate is located in California, this increases the equities of applying California law. There is no issue concerning the internal operations of the Nevada LLC, so it appears that Nevada law is not applicable. California Corporation Code Section 17708.01. If that is the case, then the California law version of a charging order would apply, provide for the potential sale of the judgment debtor’s membership interest, allow for the appointment of a receiver and allow for supplemental orders to aid execution. California Corporation Code Section 17705.03; See,Taylor v. S & M Lamp Co.,190 CalApp 2nd 700 (1961). California law is still developing on the exclusivity of the charging order remedy involving limited liability companies.
Second, although alter ego will likely be inapplicable, a fraudulent conveyance claim may be allowed if the LLC is acting to prevent a payment to the creditor via the judgment debtor’s membership interest. Under California law, reverse piercing is not permitted, i.e., pursuing the entity’s assets in which the judgment debtor holds an equity interest. See,Postal Instant Press, Inc. vs. Kaswa Corp., 162 CalApp 4th 1510 (2008). However, if assets have been diverted away from the judgment debtor’s membership interests to avoid a distribution, there should be claim for the breach of fiduciary duty owed between the LLC members. California Practice Guide ‑‑ Enforcing Judgments and Debts (Rutter) Section 6:1475.11, p.6G-57 (2016).
Third, if there is a basis to place the judgment debtor in an involuntary bankruptcy, the judgment debtor’s membership interests would become part of the bankruptcy estate and it is likely that bankruptcy law would trump the application of state law LLC provisions. This could result in the bankruptcy trustee stepping into the shoes of the judgment debtor and not just become an assignee, but a full member with the right to vote and manage the LLC. In re First Protection, Inc., 440 BR 821, 830 (BAP 9th Cir. 2010). And as practitioners are aware, even the threat of an involuntary bankruptcy can be very useful in resolving claims.