Charging Orders: A Wake-Up Call in Pennsylvania

Many lawyers tend to think of ‘corporate separateness’ as a line dividing the business owner and the business itself. In this context, creditors of the business may reach assets of the business, but not the owner. However, owners may have creditors too. In this context, personal creditors of the owners may attempt to reach the monetary equivalent of their interest in their business. In the case of an LLC, the creditor will seek an order from the court, charging the business owner’s membership interest in the LLC with payment of the creditor’s judgment; this is known as a “Charging Order”. While most statutes generally define a membership interest to include both economic and governance rights, this does not mean that a transferred interest will include such rights. In Pennsylvania, the statute which limits the transferred interest to include only economic rights without the unanimous consent of the other members, was intended to restrict creditors from collecting more than they were entitled to, and also prevent business owners from being forced to accept unwanted partners. However, the statute says nothing in the context of single member LLC’s. If unanimous consent is required from the other members, and there are none, does this give the transferee both economic and governance rights? There is no case law on the matter in Pennsylvania. However, in 2010 the Florida Supreme Court rendered a landmark decision, Olmstead v. FTC. The Olmstead case drew nationwide attention and has become a call to legislators across the country to re-examine their related statutes.

In Olmstead, the Florida Supreme Court held that a judgment creditor who obtained a charging order on the membership interest of the debtor in a single-member LLC obtained both economic rights (rights to distribution) and management rights (self explanatory) on the debtor’s membership interest. As a result, since the decision came out in 2010, business lawyers have scoured the statutes of their respective states. Not surprisingly, the relevant statutes in many states reveal gross inconsistencies and lack of clarity. Despite the nationwide frenzy, nearly two years have passed since Olmstead and there appears to be little discussion on this issue in Pennsylvania. For a state that borders the Delaware ‘corporate mecca’, it is crucial that the Pennsylvania legal community (and perhaps legislature) re-examine potential issues in light of Olmstead. In a Pennsylvania case involving a multi-member LLC, the court interpreted 15 Pa.C.S.A. §8924 to prohibit the right of a transferee to participate in the management of the business absent the consent of all members. Frank R. Zokaites v. Pittsburgh Irish Pubs , LLC. Like the statute, the case was silent on what rights are transferred in the context of a single-member LLC. However, the court provided some value in its discussion of the purpose behind the restriction, which in turn, implies that the same may not apply to single member LLC’s:

Pennsylvania Limited Liability Company Law prohibits transferring or assigning a member’s interest without the unanimous approval of other members of the company. When such approval is not forthcoming, a judgment creditor is still entitled to the debtormember’s economic rights (which are transferable) to satisfy the member’s indebtedness…….When Appellant attempts to expand his recoupment efforts from one of just securing economic rights to also obtaining governance rights, we find this approach proscribed when viewed against the backdrop of Pennsylvania’s Limited Liability Company Law…

It is important to note that Zokaites was decided in 2008, two years before Olmstead. Since the Olmstead decision, there appears to be no case law or statutory guidance in Pennsylvania on the application of §8924 to singlemember LLC’s. In addition to the inconsistencies surrounding Section 8924, many business lawyers in Pennsylvania are admittedly unclear on the function, use and scope of a Charging Order, let alone its equivalent function within the context of a Partnership or Corporation. As implied in Zokaites, the answer to these questions depends on the entity classification. However, the accuracy of these answers depends on clear and consistent statutes and more case law. Because these issues can have a serious impact on both clients and attorneys, there should be an increased awareness of these issues in the Pennsylvania legal community. Even more, perhaps there should be a call to the legislature for a statutory amendment.

Given the court’s reasoning in Zokaites, the Pennsylvania legislature may wish to amend §8924, such that it reflects the fact that a creditor should therefore be able to obtain economic and governance rights in a transferred interest, given that there are no other members to unanimously approve the transfer.

-Luke W. Sampson
(This article originally published in The Philadelphia Law Insider; April 2012)

by Robert M. Bovarnick

Rob Bovarnick is a graduate of the University of Miami School of Law. Prior to starting his firm, he was Vice Chair of the Bankruptcy Group at a 170 lawyer firm and head of the Creditor’s Rights practice at a 20 lawyer firm. He is the former Chair of the Eastern District of Pennsylvania Bankruptcy Conference.