South Carolina’s LLC Act authorizes courts, on request of a judgment creditor, to issue charging orders and to foreclose an LLC member’s interest. Last month South Carolina’s Supreme Court considered for the first time the standards for foreclosure and the relationship between foreclosure and charging orders. The court held that the primary factor in determining whether to order foreclosure of an LLC member’s interest is whether the charging order is likely to result in payment of the debt in a reasonable amount of time. Kriti Ripley, LLC v. Emerald Invs., LLC, No. 27277, 2013 WL 3200596 (S.C. June 26, 2013).
Background. In 2003 Kriti Ripley, LLC and Emerald Investments, LLC formed Ashley River Properties II, LLC. The plan was to develop condominiums and a marina on a piece of property in Charleston, South Carolina. Emerald contributed the property and its permits to Ashley River for its 70% member interest, and Kriti contributed $1.25 million for its 30%. Id. at *1.
Unfortunately, Emerald immediately diverted and misappropriated the funds contributed by Kriti to Ashley River. When Kriti learned of Emerald’s wrongdoing it initiated arbitration pursuant to Ashley River’s operating agreement. That began a long and complex series of legal proceedings between Kriti and Emerald, consisting of two separate arbitrations and five different lawsuits. Id. at *2-3.
Kriti eventually obtained an award of $706,000 against Emerald in arbitration in New York, confirmed the arbitration award in a New York court, and registered the New York judgment in South Carolina. Kriti then filed suit in South Carolina and in 2008 obtained a charging order on Emerald’s interest in Ashley River, in the amount of Kriti’s judgment against Emerald.
By 2011, Kriti’s charging order had yielded no funds towards satisfaction of its judgment, and Kriti filed a motion to foreclose on Emerald’s interest in Ashley River. The trial court viewed foreclosure as a drastic remedy, found that the charging order was sufficient protection for Kriti’s interests, and denied Kriti’s motion to foreclose on Emerald’s interest in Ashley River. Id. at *4-6.
Court’s Analysis. The Supreme Court first examined South Carolina’s statute on LLC charging orders and foreclosures:
(a) On application by a judgment creditor of a member of a limited liability company or of a member’s transferee, a court having jurisdiction may charge the distributional interest of the judgment debtor to satisfy the judgment. The court may appoint a receiver of the share of the distributions due or to become due to the judgment debtor and make all other orders, directions, accounts, and inquiries the judgment debtor might have made or which the circumstances may require to give effect to the charging order.
(b) A charging order constitutes a lien on the judgment debtor’s distributional interest. The court may order a foreclosure of a lien on a distributional interest subject to the charging order at any time. A purchaser at the foreclosure sale has the rights of a transferee.
S.C. Code Ann. § 33-44-504(b). The court noted that foreclosures are actions in equity, and therefore the decision to grant or deny foreclosure under Section 504 is equitable. Kriti Ripley, LLC, 2013 WL 3200596, at *7.
In denying Kriti’s motion for foreclosure of the charging order, the trial court had viewed other provisions of the LLC Act as providing alternative remedies, including dissolution and the forced purchase of a member’s interest. The Supreme Court rejected that as a factor in the decision whether to order foreclosure, pointing out that Kriti sought foreclosure as a judgment creditor, not as a member, and that Section 504 provides that charging orders and foreclosure are the exclusive remedies of a judgment creditor. Id.
The Supreme Court also rejected the trial court’s characterization of foreclosure as a drastic remedy. “It is a remedy commonly used around the country when a charging order on a debtor’s interest in an entity alone will not result in payment of a judgment. . . . Moreover, the statute provides no indication that a foreclosure is ‘drastic’ or only to be used in extreme circumstances.” Id. at *8.
The trial court had also considered foreclosure to be a form of forfeiture and therefore disfavored. The Supreme Court differed, describing forfeiture not as a penalty but rather as a remedy for collection of a debt. The member’s interest is not divested without compensation, because the value of the foreclosed interest is applied against the member’s debt. Id.
Having swept the trial court’s considerations from the board, the Supreme Court pointed out that as an equitable matter, the forfeiture decision requires consideration of all the circumstances in the individual case. The court referenced opinions from Georgia and New Jersey, and concluded that the primary and usually determinative factor is whether the judgment creditor will be paid in a reasonable time through distributions via the charging order. Id.
The court’s review of the evidence showed that Kriti had received no payments on its judgment since the grant of its charging order in 2008, that Ashley River could not pay its debts, and that it was unlikely that any distributions would be made in the foreseeable future.
The court also found that Emerald had acted inequitably: “Emerald and Longman have attempted to game the system in order to avoid any consequences for their wrongful acts while at the same time trying to make a profit at Kriti and Ashley River II’s expense. On the other hand … Kriti has repeatedly been found to have acted appropriately.” Id. at *9.
The Supreme Court accordingly reversed the trial court and remanded for the entry of a foreclosure order on Emerald’s interest in Ashley River, without further delay. Id. at *10.
Comment. All state LLC statutes authorize courts to issue charging orders on LLC member interests, to satisfy judgments against the member. But only a minority of the state statutes go further and expressly allow foreclosure of the debtor’s LLC interest, as South Carolina’s Section 504 does.
Some of the statutes that don’t mention foreclosure say that a charging order is the creditor’s exclusive remedy. Others are silent on whether a charging order is the creditor’s only remedy, implying that it is not exclusive.
Delaware, for example, says: “The entry of a charging order is the exclusive remedy by which a judgment creditor of a member or of a member’s assignee may satisfy a judgment out of the judgment debtor’s limited liability company interest.” Del. Code Ann. tit. 6, § 18-703(d). Washington’s LLC Act, on the other hand, is silent on exclusivity. Wash. Rev. Code § 25.15.255.
The Kriti case does not address what happens after a judgment creditor forecloses on a debtor’s member interest. Assuming that a judgment creditor successfully forecloses, what then?
The creditor that acquires the debtor’s LLC interest at a foreclosure sale would become a transferee of the debtor’s member interest, but unless the LLC agreement or the other members allow it, the creditor would not be admitted as a member and would not have a member’s right to vote or participate in management. See, e.g., S.C. Code Ann. §§ 33-44-502, -503.
In Kriti this presumably would not be a problem, because Kriti is the only other member and could approve its own admission with regard to the LLC interest acquired from Emerald.
A recent decision of the New York Appellate Division, Gottlieb v. Northriver Trading Co. LLC (Jan. 27, 2009), garnered some controversy when it recognized that members of an LLC may seek an equitable accounting under common law. The New York LLC Law does not explicitly authorize an accounting remedy, and the court’s decision has been characterized by Professor Larry Ribstein as an example of the unpredictability of New York’s LLC law and as a contribution to the “impenetrable murk” of New York’s LLC Law.
The Gottlieb opinion relied on the reasoning of New York’s highest court in Tzolis v. Wolff. The court in Tzolis had to decide whether members of an LLC may bring a derivative suit on the LLC’s behalf, even though there were no provisions authorizing or governing derivative suites in New York’s LLC Law. The Tzolis court reasoned by analogy to both corporations and limited partnerships. The New York courts had in the past found an equitable right to a derivative suit for shareholders of a corporation and for limited partners in a limited partnership. In neither of those prior cases, at the times of their holdings, was there a statutory authorization of derivative suits for shareholders or limited partners.
Two recent cases from other states have dealt with this issue, both handed down just a month after publication of the New York court’s opinion in Gottlieb. One state had statutory language explicitly authorizing an accounting, one did not. Both upheld the availability of an accounting.
In February the Indiana Court of Appeals concluded in Perkins v. Brown that the trial court erred when it failed to order an accounting of an LLC’s finances in connection with the dissolution of the two-member LLC. Without discussing or analyzing whether Indiana’s LLC Act authorizes an accounting, the court simply concluded that an accounting was necessary to determine the LLC’s creditors and expenses and whether any improper distributions had been made. Indiana’s LLC Act does not expressly authorize an accounting, but it does provide that “[a] court may enforce an operating agreement by injunction or by granting other relief that the court in its discretion determines to be fair and appropriate in the circumstances.” Section 23-18-4-7(a). That section was also not discussed by the court.
In another February decision, the South Carolina Supreme Court recognized that its courts have “broad judicial discretion in fashioning remedies in actions by a member of an LLC against the LLC and/or other members,” including the remedy of an accounting. Historic Charleston Holdings, LLC v. Mallon. The court proceeded to reverse the trial court’s order for an accounting, but only because “a full financial accounting would unnecessarily prolong this otherwise simple matter.” The court’s conclusion about the authority for an accounting was based on South Carolina’s LLC Act. South Carolina has enacted the ULLCA, and Section 33-44-410(a)of South Carolina’s Act states that “[a] member or manager may maintain an action against a limited liability company or another member or manager for legal or equitable relief, with or without an accounting as to the company’s business . . . .”
In contrast to the explicit ULLCA language, the Revised Uniform Limited Liability Company Act (RULLCA), currently recommended by the National Conference of Commissioners on Uniform State Laws, states that “[u]nless displaced by particular provisions of this Act, the principles of law and equity supplement this Act.” Section 107. Many courts would likely see that as an implicit statutory approval of the accounting remedy for LLCs. RULLCA has been adopted by Idaho and Iowa.
The right to seek an accounting has long been recognized by U.S. courts as an equitable remedy with origins in England’s Chancery Courts. 1 Dan B. Dobbs, Law of Remedies 609-14 (2d ed. 1993). An accounting is generally available when there is a claim of breach of fiduciary duty or other wrongdoing, and is often used in partnership dissolution cases.
Washington, the state where I practice, danced around the issue of an LLC accounting in 2007, but concluded that it need not reach that issue on the facts of the case. Noble v. A&R Envtl. Services, LLC, 140 Wn. App. 29, 164 P.3d 519 (2007). One party appealed the trial Court’s refusal to order an accounting. The Court of Appeals decided that the trial court had not made sufficient findings of fact, remanded the case for adequate findings, and concluded that it need not reach the accounting argument.
The three opinions handed down this year (in New York, Indiana and South Carolina) all recognized that on request of a member of an LLC, an accounting may be ordered in appropriate situations. In none of the three was an accounting to be automatically granted – the analysis is fact-specific and will likely depend on whether there was fraud, breach of fiduciary duty or other wrongdoing, and whether the facts are complex enough to warrant the accounting process. The courts find the authority either in their LLC statute (explicitly or implicitly), by analogy to partnership and corporate law, or under general principles of equity.
These three opinions seem to reflect an unspoken reluctance to rule out the accounting remedy unless the applicable LLC Act expressly bars it, and I’m not aware of any LLC Act that does so. It seems likely that in the absence of such a statutory prohibition, most courts, when first presented with the issue and on request of a member of an LLC, will order an accounting in appropriate situations.