Charging Order Protection: Business Asset Security

What is a Charging Order?

A charging order is a legal remedy that allows a creditor who has obtained a judgment against a debtor to place a lien on the debtor's interest in a business entity, such as a limited liability company (LLC) or limited partnership (LP). This lien gives the creditor the right to receive distributions that would otherwise go to the debtor, but importantly, it does not typically give the creditor management rights or the ability to force a liquidation of company assets.

Charging orders are designed to balance two competing interests: (1) allowing creditors to reach assets of debtors to satisfy legitimate debts, and (2) protecting the interests of other business owners who have not incurred such debts. This limited remedy is particularly relevant for asset protection planning, as it often represents the exclusive remedy available to personal creditors seeking to reach business assets.

How Charging Order Protection Works

Charging order protection leverages the limitations of this legal remedy to create a significant barrier between personal creditors and business assets. Here's how this protection mechanism functions:

• Limited to Economic Interest

  A creditor with a charging order can only receive distributions that would have gone to the debtor member, but cannot force distributions or liquidation of the entity.

• No Management Rights

  The creditor does not obtain voting or management rights in the company, leaving control in the hands of the remaining members or managers.

• Distribution Discretion

  In many entities, particularly manager-managed LLCs, distributions are at the discretion of the manager, who can legally choose to retain profits within the company.

• Exclusive Remedy

  In many jurisdictions, a charging order is explicitly stated as the exclusive remedy for a creditor against a member's interest in an LLC or limited partnership.

Jurisdictional Differences

The strength of charging order protection varies significantly by jurisdiction. Some jurisdictions offer stronger protections than others, making the choice of jurisdiction for entity formation a critical component of asset protection planning:

• Strong Protection Jurisdictions

  Jurisdictions like Wyoming, Nevada, and Delaware in the United States, and offshore jurisdictions like Nevis and the Cook Islands, explicitly make charging orders the exclusive remedy for creditors, with no exceptions.

• Moderate Protection Jurisdictions

  Some jurisdictions provide charging order protection but may allow exceptions in cases of fraud or for creditors to foreclose on the charged interest in certain circumstances.

• Weak Protection Jurisdictions

  In these jurisdictions, courts may permit remedies beyond charging orders, such as court-ordered foreclosure of the member's interest or even judicial dissolution of the entity.

Optimizing Charging Order Protection

To maximize the effectiveness of charging order protection as an asset protection strategy, consider implementing these best practices:

• Strategic Jurisdiction Selection

  Form your entity in a jurisdiction with strong charging order protection laws, particularly those that make it the exclusive remedy for creditors.

• Multi-Member Structures

  Establish multi-member LLCs rather than single-member LLCs, as courts in many jurisdictions afford stronger charging order protections to multi-member entities.

• Manager-Managed Entities

  Utilize manager-managed LLCs or limited partnerships where the debtor is a limited partner, providing an additional layer of separation from control over distributions.

• Operating Agreement Provisions

  Include specific provisions in operating agreements that restrict transferability of interests and reinforce the exclusive nature of charging order remedies.