Enforcement Case of the Month -- LLC You In Court: Recent Second Circuit Decision Affirms New York Law’s Creditor-Friendly Approach to Seizing LLC Membership Interests

Consumers of investigative podcasts and Netflix documentaries could be forgiven for believing that debtors and other ne’er-do-wells ordinarily stash their wealth among the palm trees in balmy offshore locales. Sadly, the reality can often be much more mundane. In fact, it is an American invention—the Limited Liability Company—that is most frequently encountered by judgment creditors as an obstacle thrown up by recalcitrant debtors. But a recent decision by the U.S. Court of Appeals for the Second Circuit provides some reason for optimism that, at least for debtors subject to personal jurisdiction in New York, these corporate shell games may not be entertained by courts in America’s financial hub.

Debtors’ strategy of using LLCs to frustrate creditors is, by now, a well-worn playbook. By transferring personal assets into an LLC (which can be formed in a matter of hours for just a few hundred dollars), judgment debtors try to retain the benefit of those assets while keeping creditors at arm’s length. That strategy is aided by many states’ LLC statutes, a number of which provide that a judgment creditor may not seize an LLC ownership stake held by a debtor (thus potentially enabling the creditor to liquidate the ownership stake to satisfy the debt or, sometimes, to vote the interest to liquidate LLC property). Instead, many states’ LLC statutes provide that a judgment creditor's exclusive remedy against an LLC interest is a charging order. This prevents the debtor from receiving distributions made by the LLC, but does not allow the creditor to seize the LLC interest itself.¹ It enables a judgment debtor, in certain circumstances, to simply wait out a creditor by ceasing distributions from a controlled LLC. And if the assets held by the LLC are depreciating—such as cars, boats, or planes—the judgment debtor may leave a creditor empty-handed while enjoying the benefit of the assets for their useful lives. Of course, in such cases creditors have the option of incurring further expense for litigation to claw back fraudulent transfers or have an LLC declared an alter ego of the judgment debtor. But a recent decision by the Second Circuit provides reason for optimism that this may not be necessary.

In 245 Park Member LLC v. HNA Group (International) Company Ltd.,² the Second Circuit reviewed a decision from the Southern District of New York (Koeltl, J.) which, among other things, directed HNA International to turn over certain LLC membership interests it owns in a Delaware LLC in satisfaction of a $185 million judgment resulting from an arbitration award.³ HNA International argued that, because Delaware law establishes charging orders as the exclusive remedy for judgment creditors as to Delaware LLC interests, turnover of the interest should not have been permitted.

The Second Circuit rejected this argument, affirming the District Court’s conclusion under Federal Rule of Civil Procedure 69 that New York judgment collection procedures apply because the court enforcing the judgment sits in New York. In this case, those procedures are captured by New York Civil Practice Law and Rules (“CPLR”) § 5225, allowing a creditor to obtain an order directing the turnover of assets to satisfy a judgment. Under New York law, as interpreted by the District Court and affirmed by the Second Circuit, a court can direct a judgment debtor over whom it has personal jurisdiction to turn over any “assignable and transferable” property under CPLR § 5225, including “a membership interest in an out-of-state LLC.”⁴ The District Court also concluded, and the Second Circuit affirmed, that it is irrelevant that New York’s own LLC act permits judgment creditors to place charging orders on debtors’ LLC membership interests. As the New York Appellate Division has explained, and as echoed by the District Court, New York’s LLC act does “does not say that this is the creditor’s exclusive remedy, nor does it purport to abolish or limit” the right to turnover under CPLR § 5225. Simply put, judgment debtors in New York courts now face the prospect of turning over LLC interests or landing in contempt proceedings if they refuse.

This result is consistent with New York law’s general principle that a party within the jurisdiction of a New York court can be compelled to turn over property—even out-of-state or overseas property—to satisfy a New York judgment.⁵ And while this principle may be firmly entrenched in New York’s state courts, it will be helpful to practitioners and judgment creditors litigating in New York’s federal courts that the Second Circuit has so clearly and unequivocally endorsed this principle as to out-of-state LLC membership interests.

Stubborn judgment debtors routinely look for ways to delay or increase the cost of collection. Aided by a vibrant “asset protection” industry in certain U.S. jurisdictions, they frequently turn to LLCs in those jurisdictions to retain the benefit of their property while shielding it from creditors, hoping that enforcement courts will defer to those states’ LLC acts and prevent turnover of membership interests. In 245 Park Member LLC v. HNA Group (International) Co. Ltd., the Second Circuit has confirmed that debtors subject to jurisdiction in New York can no longer subject creditors to a game of judgment collection whack-a-mole with respect to LLCs. Judgment creditors and their counsel should consider whether there is an argument for jurisdiction over their debtors in New York to take advantage of this creditor-friendly doctrine.