New amendments to the Maryland Limited Liability Company Act provide greater certainty as to the effect of a charging order on the ownership interests of a member of an LLC.
New amendments to the Maryland LLC Act, which took effect October 1, address the effect of charging orders on the ownership interests of a member of an LLC. A charging order is a court-imposed lien on a membership interest allowing a creditor of a member to obtain payment from an LLC of amounts due to the member. While these amendments establish default rules, members can opt out of most of them in the articles of organization or operating agreement of the LLC, or by unanimous written consent.
The amendments clarify that a creditor may only obtain a charging order on the economic interest of a member and not the non-economic interests. Economic interests are defined as a member’s “share of the profits and losses of a limited liability company and the right to receive distributions from a limited liability company.” Non-economic rights are all of the rights of a member other than the economic interests, including, the right to inspect the books and records of the LLC, participate in the management of the LLC, vote on LLC matters and act as an agent of the LLC. This clarification benefits members and the LLC as it provides certainty that creditors can only obtain economic rights and cannot interfere with the operations of the LLC.
Another default rule is that, on a showing that distributions under a charging order would be insufficient to pay the amount owed to the creditor within a reasonable time, the court may order the foreclosure or sale of the economic interest subject to the charging order. However, members can opt out of this rule, which will prevent the potential for a compelled sale of economic interests in the LLC to unrelated and potentially adverse third parties.
The amendments also provide that, unless the members agree otherwise, upon assignment of all of a member’s economic interest in the LLC, the member ceases to be a member and forfeits the member’s non-economic interests in the LLC as well. Further, an assignee of an economic interest may become a member if there are no remaining members of the LLC at the time the assignment occurs. Thus, if a creditor of a sole member of an LLC forecloses on the economic interests of such member, that member ceases to be a member under the default rules, and the purchaser at the foreclosure may elect to become a member of the LLC, which would allow the purchaser to control the operations and likely dissolve the LLC. As such, a sole member of an LLC should strongly consider opting out of this default rule.
Members forming an LLC as well as existing members of LLCs should consider whether they should opt out of the default rules. Failure to consider these issues can lead to severe but avoidable consequences.
For more information please contact William G. Sturm at 410-583-2400 or firstname.lastname@example.org.