Charging order protection for a single member LLC may still be illusory

published in Oklahoma Bar Journal - Volume 81, No. 7 | March 1, 2010

By Steven P. Cole

On Nov. 30, 2009, in Arrington v. Kruger,[1] the Oklahoma Court of Civil Appeals issued an opinion which, on its face, vigorously supports the use of single member limited liability companies (LLCs) for asset protection due to Oklahoma’s restrictive charging order statute.[2] The Arrington opinion is so clear and debtor friendly, it will be exceedingly tempting to take and apply the court’s analysis out of context. Estate planning counsel should exercise caution, however, before embracing Arrington as the answer to asset protection.[3]

The Arrington case arose out of a state receivership proceeding.[4] Kent Arrington, as trustee of the Paceco Financial Services Inc. Trust, had obtained a trial court judgment against Paul A. Kruger for $2.2 million. In his pursuit to collect the judgment against Kruger, Arrington obtained a charging order against Kruger’s 100 percent interest in four Oklahoma LLCs. The charging order against the LLCs did not yield a recovery, so Arrington sought the imposition of a receivership over the LLCs, asking to “step into Kruger’s shoes” and take title to the LLCs. The trial court granted Arrington’s request, appointing a receiver to take control and operate the LLCs. Kruger appealed, resulting in the debtor friendly opinion.

The Arrington court, relying on well-established rules of statutory construction, found that Oklahoma’s charging order statute, 18 O.S. Supp. 2008 §2034, was absolute and clear. According to the court, Section 2034 limits the “sole and exclusive” remedy of an LLC member’s judgment creditor to a charging order; therefore, the trial court erred in appointing a receiver over the four single member LLCs.

In reaching its decision, the court distinguished In re Albright [5] in which a federal bankruptcy court held that a debtor’s entire membership interest in a wholly owned LLC passed to the bankruptcy estate, causing the trustee to become a “substituted member,” and allowing the trustee to take over management of the LLC. According to the Arrington court, Albright relied on a Colorado charging order statute [6] which did not specify that a charging order was the “sole and exclusive” remedy of a member’s judgment creditor. Because Oklahoma’s charging order statute, Section 2034, differed from Colorado’s, the court in Arrington reasoned that Albright did not apply.

While the court’s analysis of Albright may be correct in the context of an Oklahoma receivership proceeding, any implication that Albright would have been decided differently had Oklahoma law applied instead of Colorado law is questionable at best. The difference between a state receivership proceeding and a federal bankruptcy proceeding is material, posing an uncomfortable reality for estate planning counsel.

In the federal bankruptcy case of Movitz v. Fiesta Investments LLC,[7] referred to as “In re Ehmann,” the bankruptcy trustee claimed he had acquired the status of a substitute LLC member by virtue of the debtor’s bankruptcy filing. Despite an Arizona charging order statute which specifically limited a creditor’s remedy to a charging order, the Ehmann court held that the trustee had all of the rights and powers regarding the LLC that the debtor held at the commencement of the case. According to the court, the LLC operating agreement was not executory within the meaning of Bankruptcy Code Section 365(e)(2),[8] therefore the LLC member had no binding unfulfilled obligation to the LLC, Bankruptcy Code Section 541(c)(1)[9] controlled, and the trustee stepped into the shoes of the debtor LLC member.

The Ehmann case was cited approvingly in In re Baldwin,[10] an unpublished decision of the United States Bankruptcy Appellate Panel of the 10th Circuit.[11] In Baldwin, parents created a limited partnership with their daughter owning a 99 percent limited partnership interest. Upon the filing of a Chapter 7 bankruptcy petition, the bankruptcy court declared the daughter’s limited partnership interest to be property of the bankruptcy estate. According to the 10th Circuit, although state law determines the nature of the debtor’s partnership interest, federal law determines the extent to which that partnership interest becomes a part of the estate. Consequently, the trustee in Baldwin successfully stepped into the shoes of the debtor with respect to the partnership interest.

Arrington may be correctly decided in the context of an Oklahoma receivership proceeding. To distinguish Arrington from Albright on the basis of state law, however, is half the story. Arrington is an Oklahoma receivership case, while Albright is a federal bankruptcy case. There are other cases, including Ehmann and Baldwin which suggest that a trustee in bankruptcy would not be limited to a charging order over a debtor’s membership interest in an Oklahoma single member LLC. On the contrary, it is very possible, if not likely, that in a federal bankruptcy setting a bankruptcy trustee would step into the debtor’s shoes. In other words, the trustee would own the LLC membership interest and the charging order protection would be illusory.[12]

  1. No. 106,223, 2009 OK CIV APP ___, ___ P.3d ___. The opinion of the Oklahoma Court of Civil Appeals was issued in Arrington as “Released for Publication” on Nov. 30, 2009. A Petition for Certiorari was filed with the Oklahoma Supreme Court in the case on Dec. 10, 2009, and is presently pending.
  2. A charging order statute limits a judgment creditor’s remedies against the LLC member by prohibiting the creditor from seizing or selling the LLC member’s membership interest and from seizing or selling the LLC’s assets. Historically, charging order statutes were intended to allow creditors to protect their rights in the distributions from a partnership while at the same time protecting the partnership against unwanted partners. The holder of a charging order would be treated on an assignee of the partnership interest but not succeed to a right of management of the partnership. See generally, Thomas E. Rutledge and Thomas Earl G eu, The Albright Decision, Why an SMLLC is not an Appropriate Asset Protection Vehicle, Business Entities, September/October 2003 at 16; Elizabeth M. Schurig and Amy P. Jetel, A Shocking Revelation! Fact or Fiction? A Charging Order Is the Exclusive Remedy Against a Partnership Interest, Probate & Property, November/December 2003 at 57; Daniel S. Kleinberger, Carter G . Bishop, and Thomas Earl Geu, Charging Orders and the New Uniform Limited Partnership Act, Dispelling Rumors of Disaster, Probate & Property, July/August 2004 at 30; William S. Forsberg, Asset Protection and the Limited Liability Company, Not the Panacea of Creditor Protection That You Might Think!, Probate & Property, November/December 2009 at 39; and Alan S. Gassman and Sabrina M. Moravecky, Charging Orders: The Remedy for Creditors of Debtor Partners, Estate Planning, December 2009 at 21. Oklahoma’s LLC charging order statute is found at 18 O.S. Supp 2009 § 2034 (hereinafter sometimes referred to as “Section 2034”) and provides as follows:
    On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the membership interest of the member 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 membership interest. A charging order entered by a court pursuant to this section shall in no event be convertible into a membership interest through foreclosure or other action. This act does not deprive any member of the benefit of any exemption laws applicable to his or her membership interest. This section shall be the sole and exclusive remedy of a judgment creditor with respect to the judgment debtor’s membership interest.
  3. LLCs are commonly utilized in asset protection planning to take advantage of the liability shield afforded by the LLC form of business entity, protecting a member against the liabilities of the LLC. This article addresses the use of a single member LLC to protect assets placed into the LLC against the claim of a member’s judgment creditor. While the focus of the article is upon single member LLCs, the same analysis would generally apply to multiple member LLCs.
  4. Oklahoma’s general receivership statutes appear at 12 O.S. 2001 §1551 through 1559, serving as a means to carry a judgment into effect.
  5. 291 B.R. 538 (Bank. D. Colo. 2003).
  6. Colo. Rev. Stat. §7-80-703.
  7. 319 B.R. 200 (Bankr. D. Ariz. 2005); the opinion in Ehmann was later withdrawn by order dated January 25, 2006 after the parties settled. Accordingly, the withdrawn opinion is not precedential authority. See In re Ehmann, 337 B.R. 228 (Bankr. D. Ariz. 2006).
  8. 11 U.S.C.A. §365(e)(2), which, if applicable, permits the enforcement of executory contract restrictions on the bankruptcy trustee’s powers. In an “executory” contract duties must be performed in order to receive benefits while in a non-executory contract the benefits will be received even if nothing further is done. See Steve Leimberg’s Asset Protection Planning Newsletter #59 (February 8, 2005) at www.leimbergservices. com; and Steve Leimberg’s Asset Protection Planning Newsletter #81 (April 24, 2006) at; Forsberg, supra note 2; and G assman and Moravecky, supra note 2. In order to make an LLC operating agreement executory, consideration might be given to adding ongoing obligations of the members, including a contribution obligation, the requirement that a member serve on an oversight board and adding noncompetition provisions for members.
  9. 11 U.S.C.A. §541(c)(1), which expressly provides that an interest of the debtor becomes the property of the estate notwithstanding any agreement or applicable law that would otherwise restrict or condition a transfer of such interest by the debtor.
  10.  NO. ADV.NO. 04-7126, BANKR. 04-72919, BAP.NO. EO-05-114, 2006 WL 2034217 (10th Cir. BAP, Okla., July 11, 2006) affd., 593 F.3d 1155 (10th Cir. 2010).
  11. Like Ehmann, the Baldwin opinion is non-precedential. See Steve Leimberg’s Asset Protection Planning Newsletter #89 (August 8, 2006) at On Jan. 26, 2010 the United States Court of Appeals for the 10th Circuit affirmed portions of the Bankruptcy Appellate Panel (“BAP”) decision in Baldwin; however, the BAP’s affirmation that the bankruptcy estate owned the limited partnership interest was not raised on appeal. Accordingly, the 10th Circuit’s Opinion presupposes ownership of the limited partnership interest in the bankruptcy estate. In re Baldwin, 593 F.3d 1155 (10th Cir. 2010).
  12. 11 U.S.C.A. §303. Bankruptcy Code Section 303 governs the filing of involuntary proceedings in bankruptcy. G enerally, an involuntary case may be commenced under Chapter 7 or 11 if there exists aggregate noncontingent claims against the debtor exceeding $13,475 and the requisite number of claimants. Accordingly, the threshold for forcing a debtor into involuntary bankruptcy is relatively low. In many instances, a determined creditor will easily sidestep Arrington and invoke the Bankruptcy Code, Ehmann, and Baldwin with the filing of a petition for involuntary proceedings in bankruptcy.