Kentucky Charging Order Issued For Interests In Out-Of-State LLCs In Big Sandy

A judgment creditor can obtain a charging order against debtor/member’s interest in an LLC. But what if that LLC is not formed in the state where the judgment has been entered, but in another state? Can the creditor still get a charging order against interests in out-of-state LLCs? Put another way, are only the courts of the state in which an LLC is organized empowered to enter a charging order as to those LLCs? If so, doesn’t that pretty much destroy the idea that certain out-of-state LLC statutes are better than the LLC statutes of the state in which the debtor resides? Stay tuned.

Big Sandy Company obtained judgment in excess of $20 million in the U.S. District Court for the Eastern District of Kentucky against American Carbon Corporation, mostly for the latter’s failure to diligently mine under a mineral lease. To collect on the judgment, Big Sandy sought charging orders against American Carbon’s interests in its subsidiaries that were organized as LLCs.

To defend against the Big Sandy’s application for the charging orders, American Carbon raised two defenses: First, the LLCs were not formed in Kentucky and therefore were not susceptible to a charging order under Kentucky law; and, second, the charging orders should not be granted without giving American Carbon’s other creditors notice of the putative charging orders and a right to be heard so that they could protect their own interests. All this led to the Memorandum Order in Big Sandy Co. v. American Carbon Corp., 2024 WL 5250401 (E.D.Ky., Dec. 30, 2024), which we will next examine.

The court started with the basics. Where a judgment has been entered in a federal court, then the applicable judgment procedures are those of the state in which the federal court sits. In this case, that meant Kentucky, and the charging order provision of the Kentucky LLC statute (KRS 275.260) provides that the “exclusive remedy” by which a creditor may enforce a judgment against a debtor/member’s interest in an LLC is by way of a charging order. As in the vast majority of states (and maybe all of them), the charging order creates a lien against the debtor/member’s rights to distributions, sometimes known as the economic interest, until the judgment has been satisfied. Therefore, the court had the authority to enter the charging order under Kentucky law if warranted.

American Carbon’s first argument that the charging order was not warranted was based on the fact that two of its subsidiary LLCs had been formed in Indiana and the other two in Delaware. Not being Kentucky LLCs, so American Carbon argued, Kentucky was not the proper jurisdiction for the entry of the charging orders. This implied that what Big Sandy needed to do was to register its judgment against American Carbon in Indiana and Delaware and then pursue charging orders in those states.

The court disagreed. The key thing was that the court had jurisdiction over the judgment debtor which was a member of the LLCs:

“While Kentucky authority is lacking, courts in other states have repeatedly found that a court may issue a charging order so long as that court has personal jurisdiction over the member. *** Therefore, because this Court maintains jurisdiction over Defendant, the Court has the authority to enter a charging order against Defendant’s interest in the non-party LLC.”

In a footnote, the court also remarked that other courts have refused to recognize a debtor/member’s jurisdictional challenge which was asserted on behalf of out-of-state LLCs on the basis that the debtor/member lacked standing to assert that challenge for them. Moreover, the four LLCs in which American Carbon had an interest had in fact registered to do business in Kentucky with the Kentucky Secretary of State’s office and all maintained a registered agent in Kentucky.

The court also relied heavily on prior similar opinions that my readers may be familiar with, including Vision Marketing, Brogdon, German American Capital and Rockstone Capital. The bottom line would be that American Carbon’s jurisdictional argument would be rejected. As brought to my attention by Kentucky attorney and noted commentator on LLC law Tom Rutledge of Stoll Keenon Ogden in Louisville, it is curious that not mentioned by the court is that Kentucky has an atypical provision in its charging order statute to the effect that the statute applies with respect to an interest in a foreign organized LLC., that provision adopted to address the Heather Apartments case I previously discussed in my article, Bad Facts Make For Bad Charging Order Law In Arayos (June 15, 2016).

American Carbon’s other argument was that the charging order should not be entered because the lien created thereby on the interests owned by American Carbon would prejudice the rights of other of American Carbon’s creditors. The prejudice would be that Big Sandy would take a priority lien interest over the rights of these other creditors without those creditors being given notice and an opportunity to be heard. The court easily swatted this argument away by pointing out that a charging order merely creates a lien against the debtor/member’s right to distributions but does not alter any lien priority in any way ― if some other creditor already had a lien against these interests, then Big Sandy’s charging order lien would simply fall behind it in line.

With American Carbon’s arguments rejected, the court entered the charging order against American Carbon’s interests in its subsidiary LLCs. If you want to read the charging order itself to see what one looks like, it is at the bottom of the order.

ANALYSIS

What we get out of this case, and all the similar cases that have been the subject of previous articles, is that the law in this area is now getting to be well-settled that a court rendering judgment can enter a charging order against the debtor/member’s interest in out-of-state LLCs even if the court doesn’t have jurisdiction over those other LLCs. There are several important ramifications to this.

The most important ramification is that folks who think they are accomplishing something by forming their LLC out-of-state probably are not, at least as far as charging order issues are concerned. While some states market themselves as having “better” charging order protection, this is somewhere between marketing schlock and an outright lie. As demonstrated in this and many other cases, the charging order will be entered according to the law of the state where enforcement against the debtor is made, and the laws of the state where the LLC is formed are seldom going to be relevant. I doubt that the promoters of LLCs in some of these “better charging order law” states will tell you any of that.

Perhaps there is some other good reason to form an LLC in another state, such as involving certain company governance issues, but differences in charging order law (they are all about the same) are illusory. All that forming an LLC out-of-state to do business in-state usually only accomplishes is that one has doubled their annual filing fees.

Another ramification goes to enforcement of the charging order. Here we must divide the effect of the order as to the debtor/member and the affected out-of-state LLC.

First, as to the debtor/member who is already within the personal jurisdiction of the court, the charging order is binding upon that member. Thus, if the debtor/member were to receive a distribution then the debtor/member would have to turn it over to the creditor or else face contempt for violating the charging order. This is true without regard to whether the LLC making the distribution is within the jurisdiction of the court.

Second, as to the out-of-state LLC, the charging order is effective as to being a lien on the debtor/member’s interest. This means that, upon being given notice of the charging order lien by the creditor, if the LLC makes a distribution of the debtor/members interest to anyone, including the debtor/member, the LLC can potentially be liable for conversion of the creditor’s lien interest.

Third, the out-of-state LLC might not be subject to the charging order as an order to pay unless the charging order is registered in a state which does have personal jurisdiction over the LLC. In other words, unless the creditor registers the charging order in a state where the LLC is amenable to personal jurisdiction, the LLC might not be held in contempt for violating the charging order (although, as discussed, it might be liable for conversion for violating the creditor’s lien rights). What this means is that a smart creditor will immediately seek to register the charging order as a sister-state order in a jurisdiction where the LLC is amendable to personal jurisdiction, i.e., where it is formed or conducting business.

Another ramification is ― as the court here pointed out ― a charging order only creates a lien but does not alter any lien priority in relation to other creditors. In other words, if another creditor has already perfected a security interest in the distributions that might be made by the LLC prior to the charging order being issued, then the creditor will go into second place in line to collect and not jump ahead to first place. It should also be pointed out that the debtor/member probably does not have standing to even make this argument on behalf of other creditors who are not parties to the proceeding.

Anyway, the availability of charging orders against out-of-state LLCs is increasingly a settled issue. They are available, deal with it.