Can a Debtor Reach an LLC Member's Interest to Satisfy a Personal Debt?

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A limited liability company (LLC) is an attractive business form in Maryland that gives members benefits such as limited liability from company debts.  However, there are unique circumstances under which a creditor of an individual member may reach the member’s interest in the LLC to satisfy a personal debt.  Under Section 4A-607 of the Maryland Limited Liability Company Act, a creditor may apply for a charging order against a debtor who holds an economic interest in an LLC.  A charging order constitutes a lien on the economic interest of the debtor in the LLC and requires the LLC to pay directly to the creditor any distributions that would otherwise be payable to the debtor.  However, the law does not stop there.  If the debtor holding the charging order can show that the distributions will not pay the amount owed to the creditor within a reasonable time, the court may order foreclosure of the economic interest and order the sale of the economic interest of the debtor. 

What happens after the sale?  The purchaser of the economic interest is an assignee.  Sections 4A-603 and 604 of the Act govern the interests and rights and obligations of the assignee.  Notably, under certain circumstances an assignee may become a member of the LLC and the debtor member may no longer be a member.

Changes to the law are relatively new and therefore much of the language has yet to be tested in the courts.  For example what is considered “within a reasonable time” before a court will foreclose on a member’s economic interest?  In addition, there is language in Section 4A-607 of the Act that may prohibit the foreclosure of the economic interest of the debtor member and the ultimate sale of their economic interest if the LLC’s operating agreement contains protective language stating that a member’s economic interest cannot be foreclosed and sold in accordance with a charging order. 

While it is not certain a court would uphold the language as a means of prohibiting the foreclosure and sale option for a creditor, as a best practice, if you are a member of an LLC that was formed before or after October 1, 2012, it is recommended that the operating agreement be reviewed and the protective language be added. 

Topics:  Business Formation, Choice of Entity, LLC

Published In: Business Organization Updates, General Business Updates, Finance & Banking Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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