Ancillary Provisions in Charging Orders Illuminated in Law v. Zemp

9 Min Read By: Jay D. Adkisson

IN BRIEF

  • The ancillary provisions that may be inserted by a creditor into a proposed charging order and approved by the court has long bedeviled practitioners.
  • Drafting a charging order was very much a task of making it up as one goes, and there was no good guidance as to which ancillary provisions were acceptable and which were not.
  • Now we know the answer thanks to the Oregon Supreme Court in Law v. Zemp.

In Law vs. Zemp, 362 Or. 302 (Jan. 11, 2018), the creditor Robert Law held an Oregon judgment against the debtor Ronald Zemp. The creditor moved for the entry of a charging order against Zemp’s interests in four limited partnerships and a limited liability company (the companies) in which Zemp was the general partner of the partnerships and manager of the LLC.

The form of the charging order proposed by the creditor contained, in addition to the typical language of such orders that placed liens on Zemp’s interests, five additional provisions as follows:

  1. The companies were to make no loans.
  2. The companies were to make no capital acquisitions without the approval of the creditor or the court.
  3. The companies were not to sell or modify any interests without the approval of the creditor or the court.
  4. The companies were to provide lots of information to the creditor, including their partnership or operating agreements, federal and state income tax returns, balance sheets, etc.
  5. The companies were to provide financials to the creditor within 30 days of the close of each accounting period.

None of these was expressly authorized by Oregon partnership and LLC law, which merely provides—as nearly all such statutes do—that the court may charge (lien) a debtor’s interest in such companies until the judgment has been paid in full, and until that time the creditor is only to be considered a voluntary assignee of the interests, which carries almost no other rights than the lien rights.

Zemp didn’t defend against the creditor’s motion, but the companies appeared and asserted various objections. First, the companies claimed that Zemp held no interest in the companies. Second, the companies claimed that the five ancillary provisions mentioned above were not authorized by Oregon law and would adversely affect the companies’ operations.

The creditor made various arguments of his own, including that Zemp in fact controlled the companies and was operating them as a “class asset protection program” rather than as bona fide commercial enterprises.

The trial court overruled the companies’ first objection that Zemp had no interest, and then granted the charging order with four of the ancillary provisions, leaving out only the one that required the companies to provide various information and tax returns to the creditor.

Making its way up to the Oregon Court of Appeals, the issue in the case was whether the ancillary provisions allowed by the trial court were proper. The higher court noted that although the ancillary provisions were not provided by Oregon’s partnership and LLC laws, there existed a general statute that allows a court to “make all other orders, directions, accounts and inquiries the judgment debtor might have made or that the circumstances of the case might require.”

Under this general statute, the Oregon Court of Appeals held as to the four partnerships that the trial court had the power to order the companies to disclose financial information because Zemp himself (as general partner or manager) had that power. Given that Zemp did not have the unilateral power to make loans, capital acquisitions, or change the interests, however, those provisions were improper. Even as to the last point, the court remanded the case back to the trial court to determine whether those provisions were necessary to ensure the companies’ compliance with the charging order.

As to the LLC, the court held that relying upon the general statute was not permissible because the Oregon LLC Act did not have a provision that incorporated it by reference (unlike the Oregon Limited Partnership Act). Therefore, all the ancillary provisions were improper as to the LLC.

The court’s ruling satisfied neither the creditor nor the companies, so everybody appealed the decision to the Oregon Supreme Court.

Oregon’s highest court first set out a lengthy review of the history of Oregon’s partnership and LLC acts, particularly as they related to charging orders. The court noted that charging orders exist to prevent “an obvious invasion of the rights and interests of nondebtor partners and resulted in disruption of the partnership business and, often, a forced dissolution of the partnership,” which would occur if the creditor simply levied on a debtor’s interest, as happens with corporate shares.

Against this historical backdrop, the court then looked at the particular issues in this case, beginning with the ancillary provisions as directed to Zemp’s four partnerships.

The companies argued that ancillary provisions should not be allowed at all with the partnerships because (their argument distilled to its essence) the general statute allowing courts to make additional provisions to effectuate their orders had been superseded by the specific charging order provisions of the Limited Partnership Act, i.e., they argued the “General Rule,” which is that “general rules are generally inapplicable.”

The court didn’t buy the argument that the Oregon legislature intended to cut out the general statute when it enacted Oregon’s partnership laws. To the contrary, the drafters of Oregon’s ULPA anticipated that supporting law could come from other provisions of Oregon law. That the charging order remedy is supposed to be the “exclusive remedy” under Oregon’s statute didn’t change that.

Yet, even the general statute had its limitations, and as applied here it meant that ancillary provisions could be included so long as they did not unduly interfere with the business of the partnerships. The key here is balancing the rights of the creditor, the partnership, and the nondebtor partners. Thus:

What that standard means, as a practical matter, is that, if a court has reason to believe that the charging order by itself cannot effectively convey to the judgment creditor the debtor-partner’s right to distributions and profits—as might happen, for example, if the limited partnership exists only to shelter assets from creditors and has no business that will generate distributions or profits in the ordinary sense of the words, or has been structured in or operated in such a way as to allow money to be transferred to the debtor-partner or his or her agents through a mechanism other than formal distribution or profit sharing—the court may issue ancillary orders that will ensure that the charge on the judgment creditor’s share is not evaded. And while the court would be expected to craft its orders, if possible, to avoid interference in the partnership’s management, there may be circumstances in which it is not possible to effectuate the goal of charging the judgment creditor’s share of distributions and profits without some degree of interference in the business. As long as the order effectuates a reasonable balance between the two objectives, it would be authorized.

This brought the court to Zemp’s LLC. The court noted the difference identified by the Oregon Court of Appeals, which was that Oregon’s partnership law made a reference to the general statute, but the Oregon LLC Act did not. Here, the creditor made the quite rational argument that courts have inherent powers to do certain things to effectuate their orders. The Oregon Supreme Court agreed, noting the necessity of such powers to balance the interests of the creditor, the LLC, and the nondebtor members.

Having recognized the power of the courts to issue ancillary provisions to effectuate a charging order through a very long and well-researched discussion, the court then turned to whether the particular ancillary provisions in this case were appropriate.

The court thought not, largely because there was no record evidence that the provisions were necessary—the only proof the creditor offered was that Zemp owned the interests without providing further evidence that these ancillary provisions were necessary:

The court could not determine, on the basis of that evidence alone, that the ancillary orders were so crucial to the effectiveness of the remedy that the court sought to provide (i.e., access to the debtor-partner’s or debtor-member’s distributional interest in the partnership or limited liability company) and their effect on the companies’ management was so that incidental that, on balance, the orders were justified. It follows that none of the challenged ancillary orders were authorized.

Thus, the decision of the Oregon Court of Appeals was reversed and the case remanded back to the trial court for “further proceedings,” presumably to allow the parties to come forward with evidence as to whether the ancillary provisions were justified by the evidence.

Analysis

The issue of what ancillary provisions may be inserted by a creditor into a proposed charging order and approved by the court has long bedeviled practitioners. There is no express guidance on the issue in the so-called harmonized acts (UPA, ULPA, ULLCA, and their revisions), which has caused the courts to address the issue ad hoc and therefore has led to problems. The laws and procedural rules of not one state requires a particular form of charging order, and there is nothing like an “official form” for a charging order such as those which are appended to the Federal Rules of Civil Procedure. Very simply, drafting a charging order is very much a task of making it up as one goes, and there was no good guidance as to which ancillary provisions were acceptable and which were not.

Now we know the answer: A particular ancillary provisions is allowable so long as (1) the need for the provision is well-supported by record evidence; and (2) the provision strikes an appropriate balance between the competing needs of the creditor, the company, and the nondebtor partners or members. Simply filing a bare motion for a charging order accompanied by an elaborate proposed charging order will no longer suffice; instead, if a creditor wants the charging order to say much more than that a lien is created upon the debtor's distributional interest, the creditor must prove up the need for those provisions.

Note that information rights, i.e., ordinarily financial information about the company, should almost never be permitted. The reason here is that if the debtor has access to the financial information, then the creditor can compel that information from the debtor without having to bother the company about it. This should be particularly true in a case like this where the debtor is a general partner or managing member. Only if there is relevant information that the debtor is not entitled to it should the court consider whether the compel the company to provide the information.

Otherwise, there is not much more to say simply because the Oregon Supreme Court has just said it.

ABOUT THE AUTHOR

Las Vegas, NV

Jay D. Adkisson

Jay Adkisson is an attorney who practices in the areas of creditor-debtor litigation, asset protection and wealth preservation, and captive insurance companies and insurance/reinsurance litigation.…

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