In Wright v. Shenandoah Investors, LLC, 2023 NY Slip Op. 31392(U), a New York trial court considered the situation where a creditor held a judgment against Cavan Properties, Inc., a New York Corporation. The assets of Cavan included interests in two LLCs, one of which was formed in Virginia and the other in South Carolina. To enforce the judgment against Cavan, the creditor moved for the issuance of a charging order against Cavan’s interests in the two out-of-state LLCs. Cavan and the two LLCs defended against the motion for charging ordere on the grounds that the two LLCs were not party to the litigation, and thus the New York court did not have the jurisdiction necessary to issue the charging orders against them.
As an aside, this issue comes up frequently in post-judgment enforcement litigation, i.e., an in-state debtor holds membership interests in out-of-state LLCs. The New York trial court here correctly describes how the issue should be handled.
First, the court noted that under both Virginia and South Carolina law, an interest in an LLC is considered to be the intangible personal property of the debtor. Such intangible personal property of the debtor is deemed to exist in the jurisdiction where the debtor is found, or at the very least in the jurisdiction of the debtor’s residence. Thus, since Cavan was a New York corporation, its interests in the two LLCs were found in New York.
The Court then noted that a charging order is not an order directed at the companies themselves, but rather at Cavan’s interests in the companies, which is entirely different:
“Therefore, a charging order against Cavan’s membership interest in either LLC does not frustrate the property right of either company, thus the court is not asserting in rem jurisdiction over the property outside New York. Whether the court has personal jurisdiction over the LLC has no bearing on the issue in dispute here. Since the debtor Cavan is a New York State corporation and is subject to the personal jurisdiction of the court, the court has jurisdiction over its personal property in consequence. See Hotel 71 Mezz Lender LLC v Falor, 14 N.Y.3d 303, 307 (A court with personal jurisdiction over a nondomiciliary present in New York has jurisdiction over that individual’s tangible or intangible property, even if the situs of the property is outside New York). Accordingly, respondents did not state a meritorious defense to both claims here.”
The New York trial court thus overruled the objections of Cavan and the two LLCs.
Unstated in the opinion is how the creditor might enforce the charging order against the two out-of-state LLCs. There are two answers to this question:
First, the creditor can register it judgment and the charging order in Virginia and South Carolina under the Full Faith & Credit clause of the U.S. Constitution, and the judgment and charging order would thereupon be binding upon the two LLCs, which would violate it only under penalty of contempt.
Second, and this is something that is frequently overlooked in charging order discussion, the charging order also acts as an order against the debtor, such that if Cavan were to receive any distributions from these LLCs then Cavan would be required ― also under penalty of contempt ― to turn those distributions over to the judgment creditor. This would be true even if the judgment creditor does not register the judgment and charging order in Virginia or South Carolina.
The lesson of all this is that having an interest in an out-of-state LLC (or partnership, to which all of this equally applies) does not protect one from having a charging order entered in-state against that interest. Yet, folks read something on the internet about Nevada or Delaware or Wyoming, etc., having “better law” when it comes to charging orders, and so they form LLCs in those states thinking that they are gaining some sort of asset protection advantage, when in fact they are not. It’s all illusory, since the in-state court can quite correctly enter a charging order against a debtor’s interest in an out-of-state LLC just like the New York court did here. There might be other reasons to form an LLC out-of-state, but better charging order protection isn’t one.
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