Collecting Judgments From LLC Member Debtors
I am not a lawyer, I am a judgment referral expert (Judgment Broker). This article is only my opinion, about the laws I have read, and what I have learned. Nothing in any of my articles should 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 used, it means LLCs or partnerships. What if you have a judgment debtor that makes their living, or receives income from an LLC? How do you recover from a member of a LLC, or a LLC member’s distributions of income?
In California, a charging order is the exclusive method of reaching a judgment debtor’s interest in an LLC. The laws concerning California charging orders are near CCP: 708.310 et seq. (et seq. means that law, and any related to it, or following it.)
A LLC can pay people as employees. Wages Samoa and salary are subject to garnishments. A wage garnishment is the exclusive method of enforcement against earnings. (CCP 706.020.)
LLCs can also pay non-wage income, which is called K1 income. When non-wage income originates 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.
If a LLC member receives non-K1 funds, for example earnings, an Earnings Withholding Order (EWO) is required because such earnings are not the kind of “economic interests” which are attached with a charging order.
Potential problems for creditors, are that the LLC may stop paying salaries, and instead internally accrue dividends, without actually distributing them to members. Or, the LLC may decide to make loans to the debtor, which circumvents both charging orders and garnishments.
One way to help prevent LLC shenanigans, is to serve 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 debtors with an ownership interest in an entity will intentionally 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 is in control of 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 overcome such shenanigans, with an assignment (charging) order. Such an order could be broadly worded to reach whatever income the debtor is getting from the LLC. It should not be confined to employment income. The assignment (charging) order can also capture distributions, and whatever other K-1 income there might 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 written to charge the debtor’s interests, and garnish the debtor’s wages. It could include wording to ask the court to prohibit the LLC from making any loans, or paying or guaranteeing any obligations of the debtor, etc.
One complication of a broadly worded charging order, is the “exclusive remedy” benefit (detriment) of the charging order. See Corporations Code 17302 (e). However this applies only to the debtor member’s “transferable interest”.
A charging order is the exclusive remedy to enforce against debtor’s actual interest in the LLC, however it is not the exclusive remedy for going after income flowing to debtor from the LLC. Assignment (charging) orders can be broadly written 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 prove to 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 often not considered employees by the IRS. Usually, only those with no ownership of a LLC are considered employees. Also, there are asset protection strategies that can make 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 have a lawyer as an officer, and would be disposable, if things went sour.