Charging Orders Can Limit the Value of a Guarantee

By September 6, 2016Secured Transactions

Why are Charging Orders Relevant?

Usually, charging orders come up in the context of an unsecured debt.  In my practice, where I do a lot of work on loans secured by commercial real estate loans, charging orders often come up when evaluating the value of guarantees. Many times the guarantors’ main assets are membership interests in limited liability companies (“LLCs”), where the LLCs own other pieces of real estate.  Generally, the guarantors have very little in the way of liquid assets.  The question then becomes:  If the Bank has to call on the guaranty (for example, because the debtor built the extravagant building above, but couldn’t find any tenants), how can the Bank get its hands on these real estate or force the sale of the real estate and take the proceeds?  The answer is:  It can’t.  The Bank would have very little rights if the real estate assets are held by an Ohio LLC.  This is where charging orders come into play.

What are Charging Orders?

A charging order is the name used to identify the rights of an unsecured creditor (after it has obtained a judgement against a debtor) with respect to the debtor’s membership interest in an LLC.  Ohio Revised Code Section 1705.19 provides that a creditor may charge the membership interest of the debtor/member.  Charging the membership interest gives the creditor the right of an assignee.  Under Ohio Revised Code Section 1705.18, an assignee does not obtain any of the rights of the member, except the right to receive distributions and allocations of profit and loss.  Therefore, the creditor has no right to control the management of the LLC.  It cannot cause the LLC to sell the property and distribute the proceeds.  In fact, even if the LLC is profitable, the judgement creditor cannot force the LLC to make a distribution.  The member can cause the LLC to simply retain all profits so that the creditor gets nothing!

What about a Single-Member LLC?

Oddly enough, Ohio’s laws do not distinguish between a single-member LLC and a multiple-member LLC.

Ohio’s laws with respect to charging orders make perfect sense for multiple-member LLCs.  If one member has a creditor that obtains a judgement, why should that effect how the LLC is ran?  Why should that one member’s creditor (when there may be many other members) be able to force the sale of the property?

That perfect sense, though, is thrown out the window with a single-member LLC.  If the sole owner of an LLC has a creditor that it owes money too, why shouldn’t that creditor be able to force the sale of the LLC’s property?  The only difference between this scenario and one where the creditor owns the property himself/herself is that the debtor happened to form an LLC and put the property in that.

The only reason that I can think of as to why the law is this way is to get people to form their LLCs in Ohio.  It is in Ohio’s best interest to have business-favorable laws to attract businesses.

Also, Banks haven’t made a big enough stink to get the legislators to look at this law and evaluate its effects.  But, perhaps they should!

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