Recent Changes in LLC’s and Charging Orders In Nevada

Posted by: on Mon, Oct 15, 2012

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LLC’s and Charging Orders in Nevada

By G. Mark Albright, Esq.

In a long awaited and much watched decision, the Nevada Supreme Court recently addressed the rights and remedies of a judgment creditor against the member of an LLC. In Weddell v. H2O, Inc., 128 Nev. Adv. Op. No. 9, (March 1, 2012), the court analyzed NRS 86.401 and outlined the rights of a creditor against the members of an LLC. The court concluded that a judgment creditor has only the rights of an assignee of the member’s interest and receives only a share of the economic interest in a limited-liability company (LLC), including profits, losses and distributions of assets, pursuant to NRS 86.401.

The Judgment Creditors Rights under a Nevada Charging Order

The court in Weddell first reviewed the general nature of limited-liability companies under NRS Chapter 86. The court then analyzed the rights of judgment creditors under a Nevada charging order. Limited-liability companies or LLCs are business entities created to provide a corporate-style liability shield with pass-through tax benefits of a partnership. From the partnership form, the LLC borrows characteristics of informality of organization and operation, internal governance by contract, direct participation by members in the company, and no taxation at the entity level. From the corporate form, the LLC borrows the characteristics of protection of members from investor-level liability. The court explained that LLCs allow tax benefits similar to a partnership and limited liability of the investors similar to a corporation. The court noted that although LLCs were originally enacted in Wyoming in 1977, the statutorily based LLCs have now expanded to all 50 states and the District of Columbia as a result of favorable Internal Revenue Service rulings. With the hopes of attracting new businesses to move to Nevada, the Secretary of State, with the support of the Nevada Attorney General, proposed the adoption of the LLC in Nevada in 1991 as part of a comprehensive bill, AB655. Along with Colorado, Florida, Kansas and Wyoming, Nevada became the fifth state in the country to enact ground breaking corporate legislation recognizing LLCs.

In Nevada an LLC is formed by signing and filing the Articles of Organization, together with the applicable filing fees, with the Secretary of State. NRS 86.151; NRS 86.201. The court noted that an LLC may, but is not required to, adopt an operating agreement under NRS 86.286, which is defined as “Any valid written agreement of the members as to the affairs of a limited-liability company in the conduct of its business.” NRS 86.101. Unless the articles of organization or the operating agreement provide otherwise, the management of an LLC is vested in its members in proportion to their contribution to the capital of the LLC. NRS 86.291. A member of an LLC is “the owner of a member’s interest in a limited-liability company or a non-economic member”. NRS 86.081. The term “member’s interest” is defined as, “A share of the economic interest in a limited-liability company, including profits, losses and distributions of assets”. NRS 86.091.

The ability to collect against a member in an LLC is governed by NRS 86.401. This provision recognizes the charging order as the exclusive remedy by which a judgment creditor of a member can seek satisfaction of its judgment by petitioning the court to issue a charge against the member’s interest in the amount of the judgment. NRS 86.401(1). A charging order directs the LLC to make any distributions to the creditor in the same manner it would have made to the member. In other words, a charging order affects only the debtor’s interest in the LLC and does not permit the creditor to reach the assets held by the LLC.

The charging order concept was first established in the United States in the 1914 Uniform Partnership Act and has since been adopted to some degree in nearly every state in the country including Nevada. Charging orders give the judgment creditor only limited access to the partnership interest of the indebted partner or judgment debtor. Consequently, the judgment creditor does not step into the shoes of a limited-liability member by reason of its judgment. The limited access of a judgment creditor includes “only the rights of an assignee of the member’s interest”. NRS 86.401(1). In other words a judgment creditor is only entitled to the judgment debtor’s share of profits and distributions. The judgment creditor takes no interest in the LLCs assets and is not entitled to participate in the management or administration of the LLCs business.

The Nevada Supreme Court held that the judgment creditor has no right to interfere in the management of the limited partnership. After the entry of a charging order, the debtor member no longer has the right to receive future LLC distributions to the extent of the charging order, but retains all other rights that it had before the execution of the charging order, including managerial rights.

Moreover, many LLCs contain involuntary transfer provisions that specifically address the rights of the parties when a charging order is entered against one of the members of the LLC. The Nevada Supreme Court also recognized the validity of such contractual provisions outlining the steps to be taken by the parties when a judgment creditor obtains a charging order or files for bankruptcy protection. In its conclusion, the Nevada Supreme Court held as follows:

“Pursuant to NRS 86.401, a judgment creditor may obtain the rights of an assignee of the member’s interest, receiving only a share of the economic interests in a limited-liability company, including profits, losses, and distributions of assets. Thus, the charging order does not entitle the creditor to Weddell’s managerial rights in Granite.”

It’s important to note that the court in Florida, when confronted with the efforts of a creditor with a 100% ownership in a Florida LLC held that:

“Unless otherwise provided in the articles of organization or operating agreement, an assignee of a limited-liability company interest may become a member only if members other than the member assigning the interest consent.”

Olmstead v. Federal Trade Commission, WL 2518106 (July 6, 2010) The Florida Supreme Court in Olmstead held that this statute could not apply, because in the single member LLC, there are no other members who could withhold or give their consent. In what appears to have been a direct response to the Florida Supreme Court’s decision in Olmstead, the Nevada legislature amended Nevada’s governing statute to add the following highlighted clause in NRS 86.401.2(a):

“This section provides the exclusive remedy by which a judgment creditor of a member may satisfy a judgment out of the member’s interest of the judgment debtor, whether the limited-liability company has one or more than one member.”

This is important because for example in Colorado, the United States Bankruptcy Court for the District of Colorado in the Albright decision ruled that where a Colorado LLC has only one member, the Colorado charging order limitation does not apply because:

“The charging order limitation serves no purpose in a single member limited-liability company, because there are no other parties interests affected.”

In re Albright, 291 B.R. 538 (Bankr. D. Colo. 2003). However in Nevada the issue has now been settled by the amendment to NRS 86.401.2(a). Will the new Nevada statute governing charging orders on single member LLCs apply in California? Perhaps. California Corporations Code Section 17450(a) provides as follows:

“The laws of the state or foreign country under which a foreign limited-liability company is organized shall govern its organization and internal affairs in the liability and authority of its managers and members.”

Hence it is possible that a court in California may defer to the Nevada statute with respect to LLCs organized in Nevada but doing business in California.

Corporate Stock Charging Orders

One of the prior distinctions between an LLC and a corporation, at least from a judgment creditor point of view, was that a creditor of a shareholder of a corporation could seize the shareholder’s shares. If the debtor was the controlling shareholder of a corporation, then the seizure of the stock typically resulted in the creditor controlling the corporation’s assets. However in Nevada, the judgment creditor’s exclusive remedy is now a charging order for small corporations. Nevada is the first state to provide or extend a charging order limitation to the shareholders of small and/or closely held Nevada corporations. See NRS 78.746. The limitation exists only for those Nevada corporations that have no more than 75 shareholders, are not publicly held, are not subsidiaries of public companies or are a professional corporation. This 2007 Nevada statute which was amended in 2009 provides impertinent part as follows:

“On application to a court of competent jurisdiction by any judgment creditor of a stockholder, the court may charge the stockholder’s stock 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 stockholder’s stock. 2. This section…C provides the exclusive remedy by which a judgment creditor of a stockholder or an assignee of a stockholder may satisfy a judgment out of the stockholder’s stock of the corporation. 3. As used in this section, “rights of any assignee” means the right to receive the share of the distributions or dividends paid by the corporation to which the judgment debtor would otherwise be entitled. The term does not include the rights to participate in the management of the business or affairs of the corporation or to become a director of the corporation.”

Similarities between the charging order protections of an LLC are obviously recognizable and have been carried over to the shareholders of a closely held Nevada corporation. Hence, when determining whether to create an LLC or a corporation in Nevada, the client should rely strongly on tax advice from a competent tax advisor or CPA.

Additionally, the 2007 Nevada Legislature also amended NRS 21.090(aa), Nevada’s Exemption Statute, to make “stock of a corporation described in subsection 2 of NRS 78.746” exempt from execution. This means, according to some legal experts, that “an individual who files bankruptcy may now claim that his small business stock is an exempt asset.” Stephen R. Harris, Northern Nevada Business Weekly, Sept. 6, 2010. The issue has not yet been adjudicated in Nevada Bankruptcy courts.

Limited Partnerships

With respect to limited partnerships, SB 405 was codified in NRS 87A480 to apply exclusive charging order remedies to Nevada limited partnerships. Now a creditor cannot utilize other remedies, including equitable remedies, when trying to collect against the interest of a limited partner.

About the Authors: The law firm of Albright, Stoddard, Warnick & Albright is an A-V Rated Nevada-based full-service law firm having attorneys licensed in Nevada, California and Utah. Our firm’s practice includes a strong emphasis on litigation and dispute resolution, including representing clients in all forms of alternative dispute resolution and serving as mediators in private dispute resolutions for third parties.

Note: This article, and any other information you obtain at this website, is not offered as legal advice, nor should it be relied upon as such, nor is it a solicitation for legal services. Only a licensed attorney can advise you with respect to your specific legal needs. We welcome your contacting our firm to discuss such representation. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.

About the Authors: The law firm of Albright, Stoddard, Warnick & Albright is an A-V Rated Nevada-based full-service law firm having attorneys licensed in Nevada, California and Utah. Our firm’s practice includes a strong emphasis on personal injury accidents. Call us at 702-384-7111.

Note: This article, and any other information you obtain at this website, is not offered as legal advice, nor should it be relied upon as such, nor is it a solicitation for legal services. Only a licensed attorney can advise you with respect to your specific legal needs. We welcome your contacting our firm to discuss such representation. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.