One of the most powerful tools available to creditors in judgment enforcement proceedings is to have a receiver appointed for the debtor. This is because a receiver performs three roles simultaneously. First, a receiver is essentially an appendage of the court, meaning that the power of court goes where the receiver goes; if somebody does not comply with an order of the receiver, they will have to show the court good cause why they should not be held in contempt. Second, the receiver is the legal agent of the debtor and is said to “step into the debtor’s shoes” for all legal purposes, much as if the receiver had the debtor’s power of attorney. Finally, the receiver acts as sort of a trustee for the debtor’s assets for the benefit of creditors. The combination of these powers makes a receiver an ideal tool to collect and marshal the assets of the debtor for the benefit of creditors.
Where the powers of the receiver get weird is when the debtor owns an interest in a limited liability company (LLC) or partnership.
Here, we have to distinguish between two types of receivers. One type of receiver is the general receiver which is a receiver who is appointed under the general judgment enforcement laws of a particular jurisdiction. A general receiver has, as the name suggests, general powers to do all sorts of things, such as to grab bank accounts, real property, cars, yachts, airplanes, art work, jewelry, and pretty much anything else that a debtor has of value.
The other type of a receiver is a limited purpose receiver which is a receiver who is appointed under some specific statute that allows the receiver to pretty much perform only one job and that job exclusively. An example of a limited purpose receiver is that found in section 503 of the Uniform Limited Liability Company Act (ULLCA), what allows a receiver to be appointed to receive the distributions from a charging order. A section 503 receiver really has only one power, which is to receive the distributions from a debtor’s interest in an LLC. Such a receiver does not have anything like general powers to raid bank accounts or get at other assets of the debtor, or even the assets of the LLC in which the debtor holds an interest. Such a receiver takes the distributions and sends those to creditors, and that is pretty much it. Their powers are so limited that the circumstances are rare where a creditor will even seek to have one appointed. This limited purpose receiver is described here only by way of contrast, and plays no role in the discussion that follows so we’ll forget about from here on out.
So, back to the general receiver who has general and broad powers to collect all sorts of the debtor’s assets. The question then becomes what powers a general receiver has to collect the debtor’s interest in an LLC or to get the distributions therefrom. This is not an easy question because of something called charging order exclusivity, by which ULLCA section 503 restricts a creditor’s remedy against a debtor’s interest in an LLC to the creditor getting a charging order. The charging order itself accomplishes two things: First, the charging order places a lien on the debtor’s transferable interest, which means the debtor’s rights to receive economic distributions (money or asset distributions); second, the charging order compels the LLC to re-direct any money or assets that would have been distributed to the debtor to be sent to the creditor instead.
All of which means that there is a tension in the law between the broad powers of the general receiver to do all sorts of things, and the restriction of ULLCA section 503 of the creditor’s remedy to a charging order. It is this tension which makes things, well, weird.
An example of this tension and how it can be resolved is found in the recent opinion of the Texas Court of Appeals in Klinek v. Luxeyard, Inc., 2023 WL 4497063 (Tex.App. 14th Distr., July 13, 2023).
A company called Luxeyard, Inc., obtained a disgorgement judgment in the Texas District Court against Robert Klinek for profits that Klinek had made through a pump-and-dump stock scheme. Klinek not only failed to pay the judgment, but he also failed to respond to certain post-judgment. That latter got Klinek in trouble with the court, which found him in contempt. This was the background when Luxeyard filed a turnover motion and to appoint a turnover receiver. Not surprisingly, the court granted the motion and Klinek appealed to the Texas Court of Appeal which issue the opinion that shall next be discussed.
Klinek’s argument on appeal is that the turnover order and appointment of the receiver was improper because he did not have any non-exempt assets that were subject to turnover. The problem was that Luxeyard had identified a number of non-exempt assets owned by Klinek, including cash and real property, so his appeal basically died on that basis. There is, however, an interesting discussion of Klinek’s interest in three LLCs and so we’ll focus on that alone.
The argument made by Klinek as to his LLC interests is that they are not subject to a turnover order for the reason that under the Texas Uniform Limited Liability Company Act, the “exclusive remedy” of a creditor against such interests is a charging order.
The court noted that the historic purpose of a charging order is to prevent disruption of the business of the LLC (or partnership). Thus, a charging order restricts a creditor to receiving only the distributions that the debtor would have otherwise received. Further, the creditor cannot force the LLC to make a distribution or take any action directly against the LLC’s property.
But what about the receiver? Well, the receiver was appointed to effectuate the turnover order, but the turnover order was an inappropriate way for Luxeyard to enforce its judgment against Klinek’s interest in the LLCs in the first place. Thus, even though the receiver was empowered to enforce the turnover order, the turnover order itself could not be used against Klinek’s LLC interests and so there was nothing for the receiver to do in regard to those interests.
Notably, the court pointed out that had Luxeyard sought a charging order, then there might be something for the receiver to do, but Luxeyard had not done that yet (hint, hint), so at least at this stage the turnover order and receiver as to Klinek’s LLC interests would be overruled by the court on appeal.
Why Luxeyard did not seek a charging order against Klinek’s interests in the LLCs is difficult to figure out, but it was clearly a mistake. That failure leaves us to do no more than speculate about the outcome had a charging order been granted. So here’s some speculation.
As noted earlier, one of the functions of a receiver is to basically step into a debtor’s shoes for all legal purposes, much as if the court had granted an involuntary power of attorney to the receiver to act on behalf of the debtor. With those powers, it is possible (but not a sure thing) that the court would allow the receiver to exercise whatever voting and managerial rights that Klinek had in the LLC, including presumably to vote to wind those entities up. Had that occurred, then the charging order that Luxeyard failed to get would have scooped up Klinek’s share of the assets of the LLCs as liquidating distributions.
That presumes, of course, that Klinek’s interests in the LLCs was a majority voting interest. If not — says Klinek was only one of four LLC members and held only a 25% interest — then the other LLC members could vote not to liquidate and the receiver (and therefore Luxeyard) would be stuck with only receiving any distributions made by the LLC, if any.
It is also about equally possible that the court would rule that the exclusive nature of a charging order would prohibit a receiver from taking that action; we just don’t know. In some other Texas cases, the Texas Court of Appeals allowed a receiver to effectuate a turnover of the debtor’s assets, including the debtor’s membership interest in LLCs, where the creditor held a charging order and the business was not conducting any business (the LLCs were simply holding companies for property) such that there was no business could be interfered with.
The hidden implication here is that if the debtor owns all of the interest in an LLC, known as a single-member LLC (SMLLC), a general receiver ought to be able to assert the debtor’s management rights in the SMLLC. I think this is correct for the reason that the sine qua non of the charging order to protect the rights of the non-debtor members simply doesn’t exist. But that also suggests that if there are other, non-debtor members in an LLC, it might be that a general receiver might be barred from taking some action that might negatively interfere with the rights of those other members to be free of another member’s creditors.
The bottom line is that the tension between a general receivership and charging order exclusivity remains, which means this area of law will remain weird until we get more court opinions on the subject.
But weird can be interesting, at least for us charging order nerds.