CHARGING ORDERS. MATIAS E. GARCIA, Austin Barnett & Garcia. State Bar of Texas 13 th ANNUAL COLLECTIONS & CREDITORS RIGHTS May 14-15, 2015 Dallas

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1 CHARGING ORDERS MATIAS E. GARCIA, Austin Barnett & Garcia State Bar of Texas 13 th ANNUAL COLLECTIONS & CREDITORS RIGHTS May 14-15, 2015 Dallas CHAPTER 8

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3 Matias Eduardo Garcia LICENSES Admitted to practice, State Bar of Texas, November 1999, License Number: Admitted to practice in the Western District of Texas, August, 2004 Received Mediation Certificate in December 1997 LEGAL EXPERIENCE Barnett & Garcia, PLLC Austin, Texas Shareholder (07/03 present) Represent and defend individual, corporate and financial creditors in litigation, appeals, and alternative dispute forums involving actions for debt, breach of contract, sworn account, DTPA, FDCPA, foreclosure, and fraud. Represent and defend commercial, life, bond and workers compensation insurance carriers in civil litigation, appeals, and alternative dispute forums involving the collection of deductibles, commissions, additional premiums, deceptive insurance practices under Article of the Texas Insurance Code and subrogation claims. Counsel to Special Deputy Receiver, Prime Tempus, Inc., for Vesta and Highlands Insurance in Receivership; Previously Counsel to Special Deputy Receiver, Prime Tempus, Inc., for Colonial Insurance in Receivership. Counsel to Special Deputy Receiver, Resolution Oversight Corporation, for Gramercy in Receivership; Previously Counsel to Special Deputy Receiver, Resolution Oversight Corporation, for Financial Insurance Company of America. Counsel to Special Deputy Receiver, Milford Consulting, LLC, for San Antonio Indemnity Company in Receivership Previously Counsel to Special Deputy Receiver, H. Koehler, Inc., for Universal Insurance Exchange and Special Deputy Receiver, JoAnn Howard & Associates, for Metro West Health Plan, Inc. The Reyes Law Firm Austin, Texas Associate (05/00 07/03) Successfully litigated various cases involving breach of contract, sworn account, DTPA, fraud, foreclosures, and product liability on behalf of individual, corporate and financial creditors. Represented commercial, life, bond and workers compensation insurance companies in the collection of additional premiums, deductibles, commissions and subrogation claims. Managed the litigation and pre-litigation collection of over 10,000 delinquent retail and commercial accounts in the state of Texas on behalf of various individual, corporate and financial creditors. Drafted and advised corporate clients on governance issues, business and financial strategy, and B2B contracts. EDUCATION The University of Texas School of Law J. D. - May 1999 The University of Texas at Austin BBA - Dec MEMBERSHIPS American Inn of Court CXVIII Commercial Law League of America International Association of Commercial Collectors Commercial Collection Agencies of America

4 Austin Bar Association Hispanic Bar Association of Austin PRESENTATIONS Presenter: CLE: Exempt Property (05/01/14) Co-Presenter: CLE: 50 Ways to Lose your Law License (03/04/14) Presenter: CLE: Summary Judgment Proof: Toolkit and Forms (05/01/13) Co-Presenter: CLE: Turning Judgments into Cash (03/26/13) Co-Presenter: CLE: Passing the Paddle: Shifting School Discipline to the Courts (01/08/13) Presenter: CLE: Legislative Update (05/02/12 and 10/11/12) Co-Presenter: CLE: Driven to Distraction (04/10/12) Presenter: CLE: Post Judgment Remedies (04/14/11) Co-Presenter: CLE: Collateral Consequences in Criminal Prosecutions (02/08/11) Presenter: CLE: Exemptions under State Law (09/02/10) Co-Presenter: CLE: Biller - The Ethics of Billing and Collecting Legal Fees (10/12/09) Presenter: CLE: Exempt Property (07/09/09 and 07/16/09) Co-Presenter: CLE: DWI Presenter: CLE: Exempt Property Characterization, Conversion, What s Protected and Isn t Protected (09/11/08, 09/18, 2008 and 10/30/08) Co-Presenter: CLE: The Reporters Privilege (02/13/07) Presenter: CLE: The Care and Feeding of Clients: How to Organize Your Office to Service Your Client Best (08/18/06, 08/25/06 and 09/15/06) Co Presenter: CLE: Pitfalls of Multi-Party Representations: Ethical Dilemmas in Aggregate Settlements (02/08/05) Co-Presenter: Texas Bail Bond Course: Collecting on Bail Bond Debts: Pre and Post Judgment Remedies (11/12/04) Co-Presenter: CLE: The Trials and Tribulations of Pro Bono (04/25/04) Co-Presenter: CLE: American Civil Liberties and the War on Terrorism (02/18/03) PUBLICATIONS COMMUNITY Contributor to Chapter 14 of the Texas Collections Manual Supplement published by the State Bar of Texas expanding the explanation and use of receiverships in collections, including summarizing recent case law developments Travis County Children s Protective Services Board, Board Member and Treasurer Children s Protective Assistance, Inc., Board Member and Treasurer Texas Bar Foundation Fellow Center for Child Protection, Past Board Member Attorney Volunteer for Adoption Day sponsored by the Austin Bar Association, Past

5 Acknowledgment I wish to express my sincere thanks to Berenice Medellin, a law student with the University of Texas School of Law, who helped me write and research this paper.

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7 Charging Orders Chapter 8 TABLE OF CONTENTS I. OVERVIEW... 1 II. APPLICABLE STATUTES... 1 III. HISTORY... 1 IV. PROCEDURE FOR OBTAINING CHARGING ORDER... 2 V. APPEALS... 3 VI. CHARGING ORDER AS AN EXCLUSIVE REMEDY... 3 VII. THE SINGLE MEMBER LLC... 4 VIII. FRAUDULENT TRANSFERS AND REVERSE CORPORATE PIERCING VEIL... 4 IX. CONCLUSION... 4 ATTACHMENT... 5 i

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9 Charging Orders Chapter 8 CHARGING ORDERS I. OVERVIEW A charging order is used when you are collecting a judgment against an individual and through the course of your asset investigation you discover that the judgement debtor has an interest in a limited liability company, general partnership or limited partnership. Because this interest is non-exempt, a diligent judgment creditor will want to use this asset to satisfy its judgment. In the past, a judgment creditor could disrupt the business of an entire partnership by forcing an execution sale of a judgment debtor s partner s interest to satisfy a non-partnership debt. 1 When the Texas legislature added that the entry of a charging order was the exclusive remedy by which a judgment creditor could satisfy a judgment out of the judgment debtor s interest, it became more problematic for a judgment creditor to collect. 2 In Texas, when a charging order is issued, the court charges the judgment debtor s interest with the payment to satisfy the judgment and creates a nonforeclosable lien. 3 A judgment creditor only has the right to receive a distribution the judgment debtor receives. 4 Because the judgment creditor cannot participate in the management of the partnership or limited liability company, the problem for the judgment creditor occurs when the entity fails to make a distribution and/or there is no prospect for liquidation. While the statute appears clear cut, judgment creditors have been successful in attacking the exclusivity nature of the remedy. This paper will provide the practitioner with insight into the charging order, some ideas as to how to avoid the exclusivity nature of the remedy and the basics to move for and obtain a charging order. II. APPLICABLE STATUTES The statutes that provide for a charging order can be found in the Texas Business Organizations Code. The charging order statute for limited liability companies, limited partnerships and general partnerships can be found in their respective sections and each is similar for all practical purposes. For convenience, the table below references the applicable statutes. 1 See Stanley v. Reef Sec., Inc., 314 S.W.3d 659, 664 (Tex. App. Dallas 2010, no pet.). 2 Id. 3 TEX. BUS. ORGS. CODE ANN (a) (c) (2009). 4 Id. at (b). 1 Entity Type Texas Bus. Org. Code Limited Liability Company General Partnership Limited Partnership III. HISTORY The charging order is rooted in English law. Under English law, a judgment creditor maintained a legal interest in the debtor s property through a Charging Order. When the United Kingdom codified its partnership law in 1890, the Charging Order was included to protect judgment creditors. 5 Meanwhile, on the other side of the pond, the drafters of the Uniform Partnership Act (UPA) were also trying to figure out what to do. They relied on the English Partnership Act of 1890 for guidance and incorporated the charging order mechanism used in the English Act to provide the creditor of a debtor an opportunity to satisfy its judgment against the debtor from the debtor s member interest. 6 The Texas legislature passed the Texas Uniform Partnership Act in Initially, the Texas Uniform Partnership Act contained a provision for a Charging Order; however, when the legislature revised the Act it eliminated the Charging Order. 7 When Texas adopted the Business Organization Code (BOC) in 2006, the Business Organization Code included a Charging Order for limited partnerships and limited liability companies. In 2007, amendments to the BOC clarified and further restricted the effect of a charging order. The amendment followed the Delaware approach in determining how a creditor could access the debtor member s interest. 8 In essence this amendment codified that the charging order was the 5 See Jay D. Adkinsson, Charging Orders: The Misunderstood Theory vs The Trenches of Litigation University of Texas School of Law CLE Conference See Alan M. Weinberger, Making Partners Pay Child Support: The Charging Order at 100, 27 Hous. L. Rev. 297, (1990). 7 TEX. REV. CIV. STAT. ANN. art. 6132(b) (expired Jan. 1, 2010). The State of Texas Bar tasked the Business Law Section, Partnership Law Committee (Bar Committee), with drafting the Texas Revised Partnership Act. Once drafted, the Bar Committee offered commentary on its drafting. Therefore, the comments serve as a strong interpretative tool. In 1993, one of the comments from the Bar Committee expressed that TRPA [Texas Revised Partnership Act] eliminates the charging order... for a partner s personal creditor to enforce. The comment further notes, procedure is unnecessary in view of general procedures available to creditors. 8 House Comm. on Bus. & Indus., Bill Analysis, Tex. H.B. 1737, 80th Leg. R.S. (2007).

10 Charging Orders Chapter 8 exclusive remedy for a judgment creditor thereby limiting the charging order as a lien. 9 It was not until 2011 that Chapter 152 of the Business Organizations Code was amended to include a Charging Order for general partnerships. Section tracks the language of sections and IV. PROCEDURE FOR OBTAINING CHARGING ORDER A. Jurisdiction. Texas Business Organizations Code (sections , , ) does not specifically state whether the application for a charging order should be brought in a new action, ancillary action, or within the original suit. Unless other considerations apply, the attorney should file the application for a charging order in the court that rendered the underlying judgment similar to when one applies for receivership and turnover. B. Parties. Texas Business Organizations Code (sections , , ) does not require that you include the entity the judgment debtor has ownership in. Nevertheless, it is advisable that you include the entity if you intend to enforce the order against the partnership, limited partnership or limited liability company. C. Contents. The statute provides little guidance as to what should be included in the application for a charging order. Based on a review of Texas Business Organizations Code sections (a), (a), and (a), the movant should, at a minimum, show the court that the party owns a judgment against the debtor. A true and correct copy of the judgment should be included; however, the court should be able to take judicial notice of the judgment so long as you are in the same court. It is well recognized that a trial court may take judicial notice of its own records in a cause involving the same subject matter between the same, or practically the same parties. 10 In addition to proving that the movant is the judgment creditor, the movant should also provide some evidence that the judgment is unsatisfied and that the judgment debtor has an interest in a limited liability company, general partnership or limited partnership. 11 D. Notice of Hearing. There is no case law or statute governing whether notice is required. The United States Supreme Court has upheld ex parte, post-judgment collection efforts. 12 However, the more your application looks and smells like a temporary restraining order or injunction, the more a practitioner should follow the rules regarding notice and service for injunctions and restraining orders. It is this author s opinion that if the movant anticipates that it will need to enforce the Charging Order through further court proceedings, the movant should serve with citation both the entity and the judgment debtor. When enforcing a default judgment where the movant might be concerned about subsequent fraudulent transfers, the practitioner may want to consider serving the entity first and then the judgment debtor when the judgment debtor is one of several members or partners in the entity. E. Order. Likewise, the statute and case law provide little guidance as to what should be included in the Charging Order. At the very least, the Order should include a finding that the judgment debtor is an owner and that the movant is the judgment creditor. The order should clearly state that the interest of the judgment debtor is charged in favor of and for the benefit of the judgment creditor and that distributions owed or payable to the judgment debtor should now be paid directly to the judgment creditor. F. Other Drafting Considerations. Some items that a practitioner should consider adding to the application and order include: the type and amount of ownership; a method for determining the obligation of the entity to the judgment debtor; a method for the calculation of distribution; a provision as to when and how payment is to be made; a mechanism for reports to be filed in the trial court or obtaining books and records to conclusively show how much the entity owes and ensure that the court s order is followed; 9 TEX. BUS. ORG. CODE (c) and (d); TEX. BUS. ORG. CODE (c) and (d); TEX. BUS. ORG. CODE (c) and (d). 10 Sierad v. Barnett, 164 S.W.3d 471, 481 (Tex. App. Dallas 2005, no pet.) (quoting Gardner v. Martin, 345 S.W.2d 274, 276 (1961) TEX. BUS. ORG. CODE (a), (a) and (a). 12 Endicott-Johnson Corp v. Encyclopedia Press, Inc., 266 US 285 (1924).

11 Charging Orders Chapter 8 This judgment finally disposes of all parties and all claims and is appealable. 13 a Motion for Turnover and/or Appointment of a Receiver. Whether to include the first seven items requires the practitioner to consider whether he or she wants the Charging Order to act as a post judgment mandatory injunction, which is final and appealable, or simply charge the interest and leave the order interlocutory for further proceedings, if necessary, and un-appealable. 14 V. APPEALS The usual writs and orders to aid in execution to collect a final money judgment are not, in general, appealable orders. 15 There is no statutory authorization for appeals of charging orders, so the trial court s order is only appealable if it is operates as a mandatory injunction. 16 In Dispensa, the judgment creditor, University State Bank, filed an application that requested (1) a charging order against the judgment debtor s interest in the partnership, Gulf Properties; and, (2) that the partnership be ordered to file a complete accounting with the court as to the judgment debtor s interest in the partnership. 17 Contemporaneously with the filing of the application for a Charging Order, the judgment creditor filed and had heard an Application for Turnover and/or Appointment of a Receiver. 18 The trial court granted the judgment creditor s application and ordered the partnership to pay the judgment creditor Dispensa s [judgment debtor] share of the profits and other monies due to him until the judgment was satisfied. 19 No reference was made to the accounting, turnover or appointment of a receiver. The judgment debtor appealed alleging, among other things, that the Charging Order acted as a post judgment mandatory injunction, which is final and appealable. 20 The Court of Appeals disagreed, stating that the charging order in question did not rise to the 13 Lehmann v. Har-Con Corp., 39 S.W.3d 191, 206 (2001). 14 Dispensa v. Univ. State Bank, 951 S.W.2d 797 (Tex. App. Texarkana 1997, pet. denied). Note that the more the Charging Order functions like an injunction, the more you will need to ensure that you follow the drafting and notice provisions for an injunction. 15 Schultz vs. Fifth Judicial District Court of Appeals at Dallas, 810 S.W.2d 738, 738 (Tex. 1991). 16 Jack M. Sanders Family Ltd. P'ship vs. Roger T. Fridholm Revocable, Living Trust, 434 S.W.3d 236, 240 (Tex. App. Houston [1 st Dist.], 2014, no pet.). 17 Dispensa, 951 S.W.2d at Id. 19 Id. 20 Id. 3 level of a permanent injunction and therefore was unappealable. 21 To support its holding, the court noted that the trial court failed to dispose of all the issues raised and the charging order was interlocutory and not subject to appeal. 22 The Court reasoned that the charging order lacked clarity and certainty because it failed to (1) contain a Mother Hubbard clause or similar language, (2) provide a mechanism for an accounting to conclusively determine how much was owed to the judgment creditor, (3) state the judgment debtor s interest in the entity, and (4) provide for how and when payments were to be made. 23 Similarly, in Jack M. Sanders Family Limited Partnership, the First District Houston Court of Appeals held that the charging order was not an injunction because it failed to fully determine the substantive property rights of the parties involved and failed to inform the partnership as to how to comply with the order. 24 VI. CHARGING ORDER AS AN EXCLUSIVE REMEDY Texas Business Organizations Code sections , , or all provide that the entry of a charging order is the exclusive remedy by which a judgment creditor can satisfy a judgment out of the judgment debtor s interest in a LLC, LP or general partnership. In Stanley v. Reef Security, Inc., the judgment creditor, Reef Securities filed an application for turnover relief and appointment of a receiver to collect its judgment in the amount of $526, At issue were $20,000 payments that Stanley, the judgment debtor, was receiving. 26 At the hearing, the judgment debtor, Stanley, testified that he owned 90% of Stanley Interest, a limited liability company that accumulated oil assets, and that Stanley Interest was the sole general and managing partners of R.H.S Partners, Ltd. 27 Stanley further testified that he was a limited partner in R.H.1996 Partners, Ltd. and as its president and secretary was the sole employee. 28 As president of Stanley Interest, he determined his own salary based on his evaluation of his skills, talent and experience and conveyed that amount to himself as president of R.H.S. 29 Stanley then testified that R.H.S would pay 21 Id. 22 Id. 23 Id. 24 Jack M. Sanders Family P ship, 434 S.W. 3d at Reef Sec., Inc., 314 S.W.3d at Id. 27 Id. 28 Id. 29 Id. at 663.

12 Charging Orders Chapter 8 him that amount despite being an employee of Stanley Interests. 30 At the conclusion of the hearing, the trial court ruled that the $20,000 monthly payments were not current wages but instead distributions and ordered Stanley to turn them over to the Receiver. 31 Stanley appealed the trial court s post judgment turnover order stating, among other things, that the Charging Order was the exclusive remedy by which a judgment creditor could satisfy a judgment out of the judgment debtor s interest. 32 The trial court denied the appeal but not because it found that the Charging Order was not the exclusive remedy but because it found that once the distribution had been made, it ceased to be an interest and became personal property. 33 Therefore, the court concluded that the charging order against R.H.S. was not the exclusive remedy. 34 While the court did not find that the charging order was the appropriate remedy in this case, the language may question whether the charging order is the exclusive remedy in all scenarios. 35 In a crossappeal, Reef Securities argued that the court abused its discretion in denying Reef Securities request for a Receiver. 36 The appellate court disagreed stating that the trial court s authority to appoint a Receiver is discretionary. 37 Therefore, perhaps there is some wiggle room in the exclusivity of the charging order in light of the discretionary power the court has to appoint a receivership. 38 VII. THE SINGLE MEMBER LLC As discussed above, the original concept behind the charging order was to prevent a judgment creditor from disrupting a business by forcing an execution sale of a membership interest to satisfy a non-partnership debt. 39 An execution sale would be devastating for a partnership or LLC with few members. One can envision Sister Debbie Debtor now having to run the family business with Execution Ben Buyer. Compare Execution Ben Buyer and Sister Debbie Debtor with the scenario where there is only one member. 40 As the reader can see, the same concerns simply do not exist. In Olmstead v. FTC, the Florida Supreme Court majority decision was persuasive in holding that the charging order is not necessary in the single-member context because no other members needed protection. 41 VIII. FRAUDULENT TRANSFERS AND REVERSE CORPORATE PIERCING VEIL Under the Uniform Fraudulent Transfer Act, a transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor s claim arose before or within a reasonable time after the transfer was made or the obligation was incurred, if the debtor made the transfer... with... intent to hinder, delay or defraud any creditor of the debtor. 42 Further, under the alter ego theory, courts disregard the corporate entity when there exists such unity between the corporation and individual that the corporation ceases to be separate and when holding only the corporation liable would promote injustice. 43 For example, in In re Moore, the Texas Bankruptcy Court concluded that a LLC and a corporation is a distinction without a difference for purposes of applying veil-piercing principles. 44 The idea behind these strategies is to argue that if the assets were fraudulently transferred or if the LLC did not really exist; the assets are and always have been the property of the individual making them subject to remedies other than the charging order. 45 Therefore, it could be argued that courts can and will apply other remedies at least in the most egregious circumstances. 46 IX. CONCLUSION The original purpose of the Charging Order revolve around protecting the nondebtor partners from the judgment creditor. The Charging Order, as originally conceived, was never intended to be a vehicle for asset protection. That said, the language of the statute coupled with the lack of case law is problematic. What is encouraging is the fact the few opinions that do exist indicate the Court s willingness to aid the Creditor. 30 Id. 31 Id. 32 Id. at Id. at Id. 35 Elizabeth N. Kozlow, Note and Comment: A Charging Order Conundrum: Is It Really the Exclusive Remedy of an LLC Judgment Creditor?, 63 BAYLOR L. REV. 884, Id. 37 Reef Sec., Inc., 314 S.W.3d at Kozlow, supra note 37, at Reef Sec., Inc., 314 S.W.3d at See Jay D. Adkinsson, Charging Orders: The Misunderstood Theory vs The Trenches of Litigation University of Texas School of Law CLE Conference Olmstead v. FTC, 40 So.3d 76 (2010). 42 TEX. BUS. & COM. CODE ANN (a) (a)(1). 43 Mancorp, Inc. v. Culpepper, 802 S.W.2d 226, 228 (Tex. 1990). 44 In re Moore, 379 B.R. 284 (Bankr. N.D. Tex. 2007). 45 Kozlow, supra note 37, at 895. Kozlow also suggests that the exclusivity provision might be interpreted to preclude reverse piercing and fraudulent transfer; that said, it would seem to the author that this would be preposterous to reward a debtor who is found to have fraudulently transferred assets or participated in a scheme to defraud creditors the protection of a statute that is intended for limited liability companies. 46 Id. at 893.

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