One of the benefits of holding property or doing business through a limited liability company is that "entry of a charging order is the exclusive remedy by which a judgment creditor of a member or of any other owner of a membership interest may satisfy a judgment out of the judgment debtor's membership interest." Tex.Bus.Org. Code Sec. 101.112(d). But just how exclusive is that right? A recent Fifth Circuit opinion holds that a court may impose additional conditions on a judgment debtor's LLC in the name of carrying out the court's orders. Thomas v. Hughes, Case No. 20-50827 (5th Cir. 3/3/22), a copy of which can be found here.
What Happened
Lou Ann Hughes was an attorney representing Performance Products, Inc. After Performance Products, Inc. filed Chapter 7 bankruptcy, the Chapter 7 Trustee, Johnny Thomas, and another party sued her for breach of fiduciary duty and other causes of action. After a jury trial, the court rendered judgment against her for nearly $4 million.
Prior to litigation being filed, Hughes owned a piece of real estate in San Antonio, Texas. She formed M.G. & Sons, LLC as a single member LLC and transferred the real estate into it.
In September 2020, the U.S. District Court entered a charging order against Hughes's interest in M.G. & Sons stating that the Plaintiffs “have the right to receive any distribution to which Hughes would otherwise be entitled in respect of her membership interest in M. G. & Sons, LLC.” The order went on to provide that:
Hughes and M. G. & Sons, LLC must obtain leave of this court before [a)] transferring the Property to any third party; b) transferring any funds to any third party except for transactions in the ordinary course of business; or c) transferring Hughes’[s] interest (or any part thereof) in M. G. & Sons, LLC to any third party.
Opinion, p. 3.
Hughes appealed contending that the additional language exceeded the "exclusive" remedy of a charging order under Texas law.
The Ruling
The Fifth Circuit analyzed the order under an abuse of discretion standard. It wrote that:
The order at issue, in addition to charging Hughes’s distributions from M. G. & Sons, requires Hughes and M. G. & Sons to obtain leave from the district court before transferring the Property, any funds (excepting transactions in the ordinary course of business), or Hughes’s membership interest to any third party. Hughes contends that this restriction constitutes an improper “legal or equitable remed[y] with respect to[] the property of the limited liability company,” prohibited by the charging order statute. And because a charging order is the “exclusive remedy” by which Pearcy and Thomas, as judgment creditors, may satisfy their judgment out of Hughes’s interest in M. G. & Sons, Hughes asserts that the restriction on asset transfers is invalid.
We disagree with Hughes’s reading of the district court’s order. It is axiomatic that federal courts possess “inherent power to enforce [their] judgments.” Peacock v. Thomas, 516 U.S. 349, 356 (1996); see also Test Masters Educ. Servs., Inc. v. Singh, 428 F.3d 559, 577 (5th Cir. 2005) (“District courts can enter injunctions as a means to enforce prior judgments.”). Likewise, the Texas Supreme Court has held that “every court having jurisdiction to render a judgment has the inherent power to enforce its judgments” and “may employ suitable methods” to do so. Arndt v. Farris, 633 S.W.2d 497, 499 (Tex. 1982). “Those methods include, among other things, charging orders and injunctive relief.” M.W.M., 2020 WL 6054337, at *2.
In M.W.M., the trial court entered a charging order that “charged” a “[f]ather’s interest in certain entities with [his ex-wife’s] judgments and ordered those entities not to pay [the f]ather any money or expend any money for [his] personal benefit until the judgments were paid.” Id. at *1. The father argued on appeal that the order “act[ed] as an injunction” and thus exceeded the court’s authority under the charging statute. Id. at *3. But the Texas Court of Appeals rejected that argument, finding that the statute “was not the trial court’s sole means of enforcing its judgments.” Id. Instead, the court held that “[i]njunctive relief is an available means to enforce a judgment.” Id. And in doing so, it affirmed the order’s restrictions on the LLCs’ payments as a form of injunctive relief. Id.
The same reasoning applies here. The district court entered a valid charging order, requiring “any distribution to which Hughes would otherwise be entitled in respect of her membership interest in M. G. & Sons” to go to satisfy Pearcy and Thomas’s judgment. See Tex. Bus. Orgs. Code Ann. § 101.112(a)–(b). Then the district court added injunctive relief as a means of enforcing its judgment, just as in M.W.M. The district court did not abuse its discretion in fashioning relief as it did.
Opinion, pp. 5-7. The Court did find that it was an error to grant relief against the LLC, since it was not a party to the action. However, it found that it was proper to require the judgment debtor, as sole owner of the LLC, to seek court permission before alienating the assets of the LLC.
Implications for Owners of LLCs
Under the Fifth Circuit's opinion, creditors cannot directly access property owned by a limited liability company to satisfy debts of a judgment debtor. However, at the same time, those assets are not fully immunized. They remain safe while they are within the protective shield of the LLC. However, a court may prevent a judgment debtor from circumventing the charging order remedy. The injunctive language should be part of a collection lawyer's toolkit.
In one of the James Bond movies, Bond is fighting with a Russian agent over a piece of top secret equipment when it goes sailing off a cliff. Bond says words to the effect of "That's detente for you. I don't have it and you don't have it." Bond's words effectively describe the effect of a charging order on an LLC. The judgment creditor can't access the LLC assets but neither can the judgment debtor.
There are other ways that a single member LLC may be vulnerable as well. Tex.Civ.Prac. & Rem. Code Sec. 31.002(f) allows a court to appoint a receiver over the judgment debtor's non-exempt assets. Could a receiver be authorized to dissolve a single-member LLC and get at the asset that way? That is a much closer question than the one addressed here by the Fifth Circuit, but it is certainly a risk. This risk can be minimized by forming multi-member LLCs. It can be further limited by including language in the LLC's governing documents that a member subject to a charging order or under the control of a receiver, may not vote on certain critical issues, such as disposing of assets. Part of the reason that the injunctive language in this case worked was that the LLC had a single member so that enjoining the owner effectively bound the LLC. This would not be the case if the LLC had multiple members. As a caveat, this might not be true if the second member of the LLC was married to the judgment debtor since the spouse's LLC interest would likely be community property.
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