Does Your LLC’s Operating Agreement Say What Happens if a Member or the LLC Gets a Judgment Against a Member?
Homer Simpson and Ned Flanders owned 60% and 40%, respectively, of World Wide Widgets, LLC, an Arizona limited liability company. WWW manufactures and sells widgets. Without WWW’s knowledge or consent Ned began working for Arizona Widgets, LLC, a competitor of World Wide Widgets, LLC.
WWW sued Ned for breach of fiduciary duty and misappropriation of trade secrets by disclosing information to Arizona Widgets, LLC. The Arizona court awarded WWW a judgment for $100,000 and ordered that Ned transfer his entire membership interest in the LLC to the LLC.
WWW can use the collection process to collect the money from Ned’s non-WWW assets, but can WWW acquire Ned’s membership interest in the LLC if Ned does not voluntarily transfer his membership interest to the LLC? Arizona Revised Statutes Section 29-655 states:
“On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the member’s interest in the limited liability company with payment of the unsatisfied amount of the judgment plus interest. To the extent so charged, the judgment creditor has only the rights of an assignee of the member’s interest. . . . This section provides the exclusive remedy by which a judgment creditor of a member may satisfy a judgment out of the judgment debtor’s interest in the limited liability company.”
Section 29-655 seems to prevent WWW from forcing Ned to transfer his membership interest to the LLC because the charging order is WWW’s sole remedy.
The WWW fact pattern is similar to the facts in a recent Texas LLC case called “Gillet v. ZUPT LLC,” Houston 14th Court of Appeals, Case No. 14-15-01033-CV, 2/23/17. In this case ZUPT, LLC, got a judgment that required its member Joel Gillet to transfer his entire membership interest to ZUPT, LLC. Like Arizona, Texas LLC law provides that the charging order is the sole remedy of a creditor who gets a judgment against a member of a Texas LLC.
The Texas Court of Appeals ruled that the charging order exclusive remedy statute did not prevent a court order that Gillet transfer his membership interest to the LLC. The Court stated:
“We hold that requiring turnover of a membership interest under these circumstances is proper for two reasons. First, the reasoning behind requiring a charging order as the exclusive remedy is inapposite when the judgment creditor seeking the membership interest is the entity from which the membership interest derives. Second, unlike a case in which a judgment creditor seeks to collect on its money judgment by forcing a sale of a membership interest, this case involves an explicit award of the membership interest itself from one party to the other as part of the judgment. For these reasons, we conclude that a charging order was not the exclusive remedy available to ZUPT, and the trial court did not abuse its discretion by ordering turnover of Gillet’s 45 percent interest in ZUPT.”
Unfortunately for Homer and World Wide Widgets, LLC, no Arizona appellate court has issued an opinion similar to the ZUPT, LLC, vs. Gillet opinion. WWW will be forced to litigate the issue and hope to get an order at the appellate level requiring transfer of the membership interest to WWW.
Warning for Multi-Member Arizona LLCs
The lesson to be learned from the ZUPT, LLC, vs Gillet case is that all multi-member LLCs should have provisions in their Operating Agreements that provide appropriate remedies if a member of the LLC or the LLC get a judgment against another member. The Operating Agreement should have language that creates remedies that allow the member or the LLC with the judgment to get around the exclusive remedy of Section 29-655. The remedies include a requirement that money be distributed to the creditor from funds payable to the debtor member and a requirement that the debtor member forfeit the debtor member’s membership interest in the LLC.
In an article called “Yet Another Intra-Member Dispute in ZUPT” debt collection attorney Jay Adkisson wrote:
“The decision by the Texas Court of Appeals is, in my humble opinion, right on target, but it by no means reflects (yet) anything like a majority rule or a judicial re-writing of the cold, hard language of the charging order statutes.
Practitioners who are drafting LLC and partnership agreements need to recognize this issue, and confer with the members as to what they want the outcome to be. If one member becomes indebted to the other members or the LLC, do they want to be restricted by a charging order or not? It should be relatively easy to draft around this issue, but in my experience almost nobody does so.”
As a result of ZUPT, LLC, vs Gillet and Jay Adkisson’s advice I have amended my multi-member LLC Operating Agreement to provide special remedies if a member or the LLC get a judgment against another member.