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DTCI: He's No Creditor of Mine

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The scenario is this: Your client is one of several members in a Multi-Member Indiana Limited Liability Company. Although business is good, your client learns that one of his co-members has creditors with a judgment against him and the judgment creditor now looks to the debtor-member’s LLC interest for collection. This article is designed to briefly examine the rights of the respective parties.

The Corporate Veil

As we all know, one of the largest benefits of incorporation (in this case an LLC) is the personal asset protection provided to its members. Regardless of corporate form, this protection is widely known as the “corporate veil.” However, this corporate veil protection is not absolute. Indiana law is well established that a creditor can “pierce the corporate veil” if it can prove that, among other things, the corporation was used to promote fraud, injustice, or illegal activities and/or the corporation was merely a “shell” to avoid personal liability.

While certainly not the situation all the time, I would submit that these aspects are less likely to be found in an MMLLC than in a Single Member LLC. In the latter, there is no one to look over an owner-member’s shoulder should he improperly commingle funds, pay for personal purchases through the business, attempt to hide assets, or otherwise fail to comply with corporate formalities. Irrespective of these possible differences, a piercing count and its concomitant analysis apply where a creditor has a judgment against the LLC itself. There is a different analysis as well as statutory and case law where an individual or entity is the personal creditor of a member of an LLC.

Outsider-Reverse Veil Piercing

Even where compliance with corporate formalities is met, members of an LLC may still face threats from the creditors of its individual members. An attempt to thwart the LLC’s touted protections and collect on a creditor’s personal judgment is known by various names including “outsider-reverse veil piercing.” Under the concept of ORVP, a personal creditor of a member may disregard the corporation’s separate legal existence and attempt to reach the debtor-member’s rights in the LLC. As will be discussed immediately below, this can be accomplished – depending upon particular state law – in various ways.

I.C. 23-18-6-7 and Charging Orders

The statute under analysis herein is I.C. 23-18-6-7. That statute sets out the rights of judgment creditors vis-a-vis members of an LLC. Under I.C. 23-18-6-7, a creditor may petition a court to allow it to charge a member’s interest in the LLC for the payment of the unsatisfied amount of the judgment. The relevant section reads: “[o]n application to a court with jurisdiction by a judgment creditor of a member, the court may charge the interest of the member in the limited liability company with the payment of the unsatisfied amount of the judgment with interest.” I.C. 23-18-6-7(a). This is known as a request for a charging order.

In its simplest form, a charging order is tantamount to a garnishment order except that, given the discretionary nature of distributions, payments are not so surely guaranteed. It is the vehicle by which a lien is placed upon a member’s economic interests in an LLC. Stated differently, the judgment-creditor obtains a charging order against the debtor-member which, in turn, places a lien upon the economic interest in the LLC to collect the judgment.

An economic interest is generally described as the right to share in the income, gains and losses of the LLC as well as to receive distributions. On the other hand, a noneconomic interest of a member generally means a member’s right to vote, manage and otherwise direct the operations of the LLC. Generally, the lien of a charging order does not intrude upon the noneconomic interests of the member. The question, ultimately, is whether a charging order is the exclusive remedy for a creditor regarding an LLC. That is, under current Indiana law can a creditor seek to obtain greater leverage by levying upon the noneconomic nature of a member’s interest? The answer as Indiana law currently stands is: it depends. And what this determination usually depends upon is whether one is dealing with an MMLLC or an SMLLC.

This determination is, obviously, of extreme importance to other members of an MMLLC in that, if a charging order is not the exclusive remedy, other remedies available to a creditor of a member can wreak utter havoc upon the viability of the LLC. That is, if a charging order is not the exclusive remedy, other options available to a judgment-creditor include (1) the right to foreclose upon a debtor-member’s interest as well as (2) an order of dissolution.

Foreclosure on a Member’s LLC Interest

In short, with an order of foreclosure, a judgment-creditor can foreclose on the debtor-member’s interests of the LLC, taking the interest in full or partial satisfaction of the debt. This, of course, turns a charging order into a much more powerful remedy. The creditor would not be limited to waiting for distributions that the LLC may never make. In foreclosure, the creditor could seize a member’s interests and possibly take control of a portion of ownership and/or management. This control could cause, for example, a forced distribution to the creditor in full or partial satisfaction of the debt. What is worse is the judgment-creditor gets the money while the member is left to pay the taxes on the distribution. Foreclosure could also result in the creditor selling the member’s interest in a public or private sale. One can easily see the turmoil this would cause in the LLC, especially with regard to its ownership and management.

Order of Dissolution

A third option for a judgment creditor is an order of dissolution. This would allow the creditor to force the LLC itself to be dissolved and its assets sold and/or otherwise applied to the satisfaction of the creditor’s judgment. This is the most draconian of remedies, resulting in an extreme hardship upon other members in an MMLLC who have absolutely no personal obligation for the debt. In the event of dissolution, the business would most likely be terminated and everyone tossed out, left to pick up the pieces the best that they can. Clearly, limiting creditors to a charging order is of extreme importance to members in an MMLLC.

What I.C. 23-18-6-7 Does Not Say and Interpretive Case Law

While I.C. 23-18-6-7 states that a judgment creditor may obtain a charging order, it does not state that a charging order is the exclusive remedy. The seminal case on this topic is Brant v. Krilich, 835 N.E.2d 582 (Ind. App. 2005). In Brant, the Court of Appeals definitively stated that a charging order is the exclusive remedy. However, the Brant decision does not provide all the answers, and there are several issues to still consider. As such, Brant should be applied with caution and after a thorough analysis.

One glaring issue is that, despite the ruling in Brant, I.C. 23-18-6-7 itself simply does not state that a charging order is the exclusive remedy. Moreover, while the Brant decision does so state, the facts under Brant dealt with an MMLLC. This disparity leaves open the question as to whether a charging order is truly the exclusive remedy as far as the Legislature is concerned and, in addition, whether it is the exclusive remedy with regard to SMLLCs.

House Bill 1394

Earlier this year in the 2013 legislative session, House Bill 1394 was introduced seeking to amend I.C. 23-18-6-7 to expressly provide that a charging order be the exclusive remedy. The bill sought to add language that “[a] creditor of a member or creditor of a member’s assignee does not have a right to obtain possession of, or otherwise exercise legal or equitable remedies with respect to, the property of the limited liability company.” Proposed (13) IN 1394.1.11(d). The proposed bill sought to further limit creditor’s rights by stating that a charging order under I.C. 23-18-6-7 would provide “the exclusive remedy by which a judgment creditor of a member may satisfy a judgment from a judgment debtor’s member interest in a limited liability company. A judgment creditor has no right to foreclose upon the charging order or the judgment debtor’s member interest.” Proposed (13) IN 1394.1.11(e).

This change would have leveled the playing field between SMLLCs and MMLLCs, expressly adopted the Brant decision, and extended Brant’s reach to SMLLCs. However, under pressure from the creditor’s bar, the Legislature failed to adopt the proposed amendment and the statute remains unchanged. Thus, at the end of the day, it appears that Brant provides members in an MMLLC with some protection … for now. However, the courts are always free to revisit or distinguish Brant and reliance upon it in the formation of an MMLLC would seem somewhat speculative. Brant notwithstanding, it is open for interpretation as to what rights a creditor has against a member of an SMLLC. I would suggest that, under the totality of the circumstances, and the practicalities of the differences between an SMLLC and an MMLLC, SMLLCs are not going to be limited to a charging order and Brant has little, if any, applicability toward SMLLCs.

The Practicalities and Document Drafting

Given the gravity of the issue and the risk of a change in the law, the question is really what can an MMLLC do to more fully protect its members. As mentioned, in an SMLLC, perhaps nothing. The reasoning is that with regard to an SMLLC, there are no “innocent” members to protect. That notwithstanding, an operating agreement similar to that used for an MMLLC wherein creditor’s rights are delineated and limited, may carry the day to protect a member in an SMLLC. The practical effects of such drafting in an SMLLC remain to be seen. Another possibility – and one that makes Indiana a less desirable place to incorporate – is to form the LLC under the laws of a state that does recognize a charging order as the exclusive remedy.

However, with regard to MMLLCs, a well-drafted operating agreement clearly is of crucial importance. The operating agreement of an MMLLC can and should address this reality, despite the Brant decision. The operating agreement should delineate exactly what happens to a member’s interests in the MMLLC if a creditor seeks the remedy of a charging order or, worse, a remedy beyond a charging order. It should also address the situation where a member is forced to file for bankruptcy protection.

The means to accomplish this end are innumerable. There can be forced disassociation of the member, first rights of refusal to the other members to purchase the member’s interest, and so forth. In the end, the operating agreement must set forth a clear understanding between the parties upon formation of the LLC and close the gap between the current Indiana statute, the Brant decision, and the risk of a change in the law either by the Legislature or the courts. Furthermore, litigators need to be aware of the rights and remedies of both creditors and members when these situations arise and the arguments and tactics to best assert our client’s position, regardless of which side of the “v” we represent.•

Jason M. Massaro is the owner of The Massaro Legal Group, LLC located in Fishers, Indiana, where he focuses his practice primarily in complex civil, business, and real estate law and litigation. Mr. Massaro is a member of the DTCI Business Law Section. The opinions expressed in this article are those of the author.

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  1. I have been on this program while on parole from 2011-2013. No person should be forced mentally to share private details of their personal life with total strangers. Also giving permission for a mental therapist to report to your parole agent that your not participating in group therapy because you don't have the financial mean to be in the group therapy. I was personally singled out and sent back three times for not having money and also sent back within the six month when you aren't to be sent according to state law. I will work to het this INSOMM's removed from this state. I also had twelve or thirteen parole agents with a fifteen month period. Thanks for your time.

  2. Our nation produces very few jurists of the caliber of Justice DOUGLAS and his peers these days. Here is that great civil libertarian, who recognized government as both a blessing and, when corrupted by ideological interests, a curse: "Once the investigator has only the conscience of government as a guide, the conscience can become ‘ravenous,’ as Cromwell, bent on destroying Thomas More, said in Bolt, A Man For All Seasons (1960), p. 120. The First Amendment mirrors many episodes where men, harried and harassed by government, sought refuge in their conscience, as these lines of Thomas More show: ‘MORE: And when we stand before God, and you are sent to Paradise for doing according to your conscience, *575 and I am damned for not doing according to mine, will you come with me, for fellowship? ‘CRANMER: So those of us whose names are there are damned, Sir Thomas? ‘MORE: I don't know, Your Grace. I have no window to look into another man's conscience. I condemn no one. ‘CRANMER: Then the matter is capable of question? ‘MORE: Certainly. ‘CRANMER: But that you owe obedience to your King is not capable of question. So weigh a doubt against a certainty—and sign. ‘MORE: Some men think the Earth is round, others think it flat; it is a matter capable of question. But if it is flat, will the King's command make it round? And if it is round, will the King's command flatten it? No, I will not sign.’ Id., pp. 132—133. DOUGLAS THEN WROTE: Where government is the Big Brother,11 privacy gives way to surveillance. **909 But our commitment is otherwise. *576 By the First Amendment we have staked our security on freedom to promote a multiplicity of ideas, to associate at will with kindred spirits, and to defy governmental intrusion into these precincts" Gibson v. Florida Legislative Investigation Comm., 372 U.S. 539, 574-76, 83 S. Ct. 889, 908-09, 9 L. Ed. 2d 929 (1963) Mr. Justice DOUGLAS, concurring. I write: Happy Memorial Day to all -- God please bless our fallen who lived and died to preserve constitutional governance in our wonderful series of Republics. And God open the eyes of those government officials who denounce the constitutions of these Republics by arbitrary actions arising out capricious motives.

  3. From back in the day before secularism got a stranglehold on Hoosier jurists comes this great excerpt via Indiana federal court judge Allan Sharp, dedicated to those many Indiana government attorneys (with whom I have dealt) who count the law as a mere tool, an optional tool that is not to be used when political correctness compels a more acceptable result than merely following the path that the law directs: ALLEN SHARP, District Judge. I. In a scene following a visit by Henry VIII to the home of Sir Thomas More, playwriter Robert Bolt puts the following words into the mouths of his characters: Margaret: Father, that man's bad. MORE: There is no law against that. ROPER: There is! God's law! MORE: Then God can arrest him. ROPER: Sophistication upon sophistication! MORE: No, sheer simplicity. The law, Roper, the law. I know what's legal not what's right. And I'll stick to what's legal. ROPER: Then you set man's law above God's! MORE: No, far below; but let me draw your attention to a fact I'm not God. The currents and eddies of right and wrong, which you find such plain sailing, I can't navigate. I'm no voyager. But in the thickets of law, oh, there I'm a forester. I doubt if there's a man alive who could follow me there, thank God... ALICE: (Exasperated, pointing after Rich) While you talk, he's gone! MORE: And go he should, if he was the Devil himself, until he broke the law! ROPER: So now you'd give the Devil benefit of law! MORE: Yes. What would you do? Cut a great road through the law to get after the Devil? ROPER: I'd cut down every law in England to do that! MORE: (Roused and excited) Oh? (Advances on Roper) And when the last law was down, and the Devil turned round on you where would you hide, Roper, the laws being flat? (He leaves *1257 him) This country's planted thick with laws from coast to coast man's laws, not God's and if you cut them down and you're just the man to do it d'you really think you would stand upright in the winds that would blow then? (Quietly) Yes, I'd give the Devil benefit of law, for my own safety's sake. ROPER: I have long suspected this; this is the golden calf; the law's your god. MORE: (Wearily) Oh, Roper, you're a fool, God's my god... (Rather bitterly) But I find him rather too (Very bitterly) subtle... I don't know where he is nor what he wants. ROPER: My God wants service, to the end and unremitting; nothing else! MORE: (Dryly) Are you sure that's God! He sounds like Moloch. But indeed it may be God And whoever hunts for me, Roper, God or Devil, will find me hiding in the thickets of the law! And I'll hide my daughter with me! Not hoist her up the mainmast of your seagoing principles! They put about too nimbly! (Exit More. They all look after him). Pgs. 65-67, A MAN FOR ALL SEASONS A Play in Two Acts, Robert Bolt, Random House, New York, 1960. Linley E. Pearson, Atty. Gen. of Indiana, Indianapolis, for defendants. Childs v. Duckworth, 509 F. Supp. 1254, 1256 (N.D. Ind. 1981) aff'd, 705 F.2d 915 (7th Cir. 1983)

  4. "Meanwhile small- and mid-size firms are getting squeezed and likely will not survive unless they become a boutique firm." I've been a business attorney in small, and now mid-size firm for over 30 years, and for over 30 years legal consultants have been preaching this exact same mantra of impending doom for small and mid-sized firms -- verbatim. This claim apparently helps them gin up merger opportunities from smaller firms who become convinced that they need to become larger overnight. The claim that large corporations are interested in cost-saving and efficiency has likewise been preached for decades, and is likewise bunk. If large corporations had any real interest in saving money they wouldn't use large law firms whose rates are substantially higher than those of high-quality mid-sized firms.

  5. The family is the foundation of all human government. That is the Grand Design. Modern governments throw off this Design and make bureaucratic war against the family, as does Hollywood and cultural elitists such as third wave feminists. Since WWII we have been on a ship of fools that way, with both the elite and government and their social engineering hacks relentlessly attacking the very foundation of social order. And their success? See it in the streets of Fergusson, on the food stamp doles (mostly broken families)and in the above article. Reject the Grand Design for true social function, enter the Glorious State to manage social dysfunction. Our Brave New World will be a prison camp, and we will welcome it as the only way to manage given the anarchy without it.

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