Cunningham on LLCs: Charging orders
How LLCs work to help protect your personal assets
Note: If you are a member or manager of a New Hampshire LLC, or if you plan to form one, you and your business advisers need to have a solid basic knowledge of LLC law and tax in order for your LLC to succeed. This is the second in a series of columns that will give you this knowledge.
If you want to understand your LLC, you need to know when your LLC statutory liability shield will protect your personal assets and when it won’t. But Section 126 of the Revised New Hampshire Limited Liability Company Act also provides LLC members with a second major type of statutory asset protection, called “charging order protection.” Few people, including LLC lawyers, are aware of these protections, and fewer yet understand them in any detail. However, for many LLC members, they are likely to have significantly greater practical value than their LLC liability shields.
Charging orders, like liability shields, are best understood by an example:
Mary Jones is a member of a successful New Hampshire multi-member LLC. She has very little cash. However, securities that she owns are worth $300,000 and her LLC membership is worth $200,000.
In 2022, Mary incurs a $500,000 debt for uninsured medical bills — a debt she can’t pay. Her creditor, XYZ Hospital, obtains a court order transferring her securities to the hospital in partial payment for her debt. In addition, the hospital seeks an order transferring to it her LLC membership.
However, under Section 126 of the New Hampshire LLC Act, the hospital cannot obtain the second order transferring Mary’s LLC membership; it can only obtain a charging order. Under this order, all it gets is the right to “charge” the LLC with making distributions to the hospital that would otherwise go to Mary.
In other words, the charging order is like a lien on these profits. Further, if Mary’s LLC has not been making regular distributions to her, she can make a good argument that the hospital, too, has no right to LLC distributions.
Why does the LLC Act provide for charging orders, whereas the New Hampshire Business Corporation Act does not? The reason is that multi-member LLCs have always been regarded by the courts and by legislators as, in essence, partnerships. And for centuries, both English and American courts have believed that an indispensable need of partnerships if they are to succeed is a need for partnership compatibility — i.e., a need for mutual respect and cooperation among their partners.
This traditional judicial view is reflected in the statutory provisions of general and limited partnerships, but also in LLC acts, including New Hampshire’s. Obviously, a court’s transfer of Mary’s LLC membership to the hospital could destroy the compatibility among the remaining members of the LLC.
By contract, with a few exceptions, the courts have never viewed corporate shareholders as partners with one another. Rather, they have viewed them as mere investors in their corporations. This is why corporate statutes, unlike LLC statutes, don’t protect corporate owners’ interests in their corporations from Indeed, many New Hampshire corporations have converted to LLCs specifically in order to obtain charging order protections.
It may occur to you that since the theory underlying statutory charging orders is partnership compatibility, charging order protections should not be available to the members of single-member LLCs, and you’d be right. However, anomalously, the New Hampshire LLC Act, and, to my knowledge, all other LLC acts, do provide charging order protections to the members of single-member LLCs. But under most or all of these LLC acts, the scope of charging order protections single-member LLCs is much narrower than for members of multi-member LLCs.
Thus, for example, under the New Hampshire LLC Act, if a court awards to a creditor a charging order against the member of a single-member LLC and if the creditor can prove to a court that under that order the repayment of the member’s debt on the basis of distributions from that LLC will take unduly long, the court can transfer the member’s LLC membership to the creditor.
So if you’re a member of a New Hampshire single-member LLC and you want charging order protections, find yourself a second member.
A final note for New Hampshire lawyers: The world’s expert on charging orders is Jay D. Adkisson, who has written an excellent book, “The Charging Orders Practice Guide,” published by the American Bar Association. If you want to become a charging order expert, Jay’s book is the place to start.
John Cunningham, a lawyer licensed to practice law in New Hampshire and Massachusetts, is of counsel to the law firm of McLane Middleton. He can be contacted at 603-856-7172, firstname.lastname@example.org or llc199a.com.