Wednesday, July 24, 2024

Second Circuit Nixes New York Charging Order Protection For Many LLCs

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It is rare that any post-judgment enforcement case makes it to the U.S. Court of Appeals, and rarer still that such a case involves a charging order. Thus, when such an opinion appears, it is usually momentous and such it is with a recent Second Circuit opinion arising from the U.S. District Court in New York, and thus decided under New York law, about a Delaware LLC. The opinion is 245 Park Member LLC v. HNA Group (Int’l) Co., 2024 WL 1506798 (2nd Cir., April 8, 2024), and is well worth examining.

The debtor in this case is a Hong Kong company by the name of HNA Group (International) Company Limited, which will be referred to as simply HNA Int’l. That company owned a 100% interest in a subsidiary that was organized as a Delaware LLC called HNA North America, LLC, or the shorthand HNA N.A.

The creditor was 245 Park Member LLC, referred to as 245 Park, and which held a 49% minority interest in another entity, 245 Park JV LLC, which the Second Circuit refers to as the “Company”.

In essence, HNA Int’l apparently persuaded 245 Park to invest in the Company. HNA Int’l also gave 245 Park a guarantee that 245 Park’s investment in the Company would be protected. However, the Company went bankrupt. Starting on June 9, 2022, proceedings began in the Bankruptcy Court to start auctioning off the 51% interest in HNA N.A. that was owned by HNA Int’l. There would eventually be an auction in which there was no bidders except for 245 Park. Thus, 245 Park was able to win on its auction bid of buying the 51% HNA Int’l interest for $68 million, taking over the Company’s debts, and reduce the amount that the Company owed 245 Park by $40 million. Of course, 245 Park already owned a 49% interest and so by acquiring the 51% HNA Int’l interest now owned 100% of the Company.

The Company’s bankruptcy also triggered the liability of HNA Int’l on the guarantee. Ultimately, on July 25, 2022, 245 Park ended up with a $185.4 million judgment against HNA Int’l from the U.S District Court for the Southern District of New York. Now our story really begins.

The same day that the judgment was issued, the District Court issued an attachment order (an order which places an involuntary judicial lien on assets) on HNA Int’l assets. The attachment order also ordered HNA Int’l to give 245 Park an advanced notice of 14 days if HNA Int’l attempted to sell any asset in which HNA Int’l had a direct or indirect interest. Specifically included in the order was a requirement of such notice for a Conference Center located in Rockland County, New York.

Moving forward a couple of months to October 11, 2022, other subsidiaries of HNA Int’l proposed a plan to the Bankruptcy Court which included the sale of a Chicago office tower to China-based affiliates of HNA Int’l. The price of the sale was zero. The Bankruptcy Court blocked this “sale” upon the objection of 245 Park and noted the proposal was not in good faith.

This now brings us back to the Conference Center that was part of the July 25, 2022, order which required that 245 Park be given 14 days advance notice of the sale. On February 1, 2023, HNA Int’l advised the District Court that the Conference Center was to be sold just two days later (February 3) despite HNA Int’l not having given 245 Park the requisite 14 days notice.

On that same February 3, the District Court enjoined HNA Int’l from selling the Conference Center. The same day, HNA Int’l filed a motion seeking relief from the judgment on the basis that either 245 Park had already been satisfied on its judgment through its purchase of the Company in the Bankruptcy Court, or else that the judgment should be reduced by the $40 million which 245 Park had bid for its purchase of the Company.

Three months later, everything finally came to a head before the District Court. The District Court denied the motion of HNA Int’l to amend the judgment. Also, and critically important for our purposes here, further ordered HNA Int’l to turn over its 100% membership interest in HNA N.A. directly to 245 Park so as to satisfy the judgment. HNA Int’l then appealed to the Second Circuit and that leads us to the opinion therein that we shall next discuss.

To jump ahead in the Second Circuit’s opinion, that court denied the appeal of HNA Int’l on its motion to amend the judgment, based on the District Court’s finding that the judgment had not been fully satisfied by the bankruptcy sale of the Company but was instead substantially unpaid.

Now let’s get to the juicy issue: How could the District Court order HNA Int’l to simply turn over its membership in HNA N.A. when that company was an LLC and thus presumably 245 Park would have been limited to a charging order as its remedy? Fasten your seatbelt.

The Second Circuit started its analysis by pointing out that when a creditor holds a judgment in federal court, then the judgment enforcement procedures follow those of the particular state in which the District Court is located. In this case, it meant that New York’s procedures for enforcing money judgments would apply.

Under New York law, a judgment may be enforced against any non-exempt property which could either be assigned or transferred. Further, New York provides for a court to order a judgment debtor to turn over money or property to satisfy the judgment.

A fly in the ointment here was that HNA N.A. was organized as a Delaware LLC. Under Delaware law, a creditor is restricted to a charging order against a debtor’s assignable interest in an LLC and it is prohibited for a court to order the turn over of such LLC shares. The Second Circuit held, however, that the interest in HNA N.A. was simply property in New York and thus Delaware law would not apply. So, what did New York law say?

Here it is important to understand that New York has not adopted the Uniform Limited Liability Company Act (ULLCA) like almost everybody else. Instead, New York has its own organic LLC law which differs somewhat from ULLCA when it comes to dealing with the creditors of an LLC members. This is found in the New York LLC law at 34 Consol. Laws N.Y. § 607 as follows:

Ҥ 607. Rights of creditors of members.

“(a) On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the membership interest of the member with payment of the unsatisfied amount of the judgment with interest. To the extent so charged, the judgment creditor has only the rights of an assignee of the membership interest. This chapter does not deprive any member of the benefit of any exemption laws applicable to his or her membership interest.

“(b) No creditor of a member shall have any right to obtain possession of, or otherwise exercise legal or equitable remedies with respect to, the property of the limited liability company.”

Under New York’s LLC law, membership interests are not assignable except for a member’s right to economic distributions of profits and losses. However, opinions from the New York Court of Appeals have held that LLC membership interests are indeed assignable and transferable for creditor purposes. Thus, in New York a creditor has the discretion whether to issue either a charging order (which places a lien on the economic interests and directs payments to the creditor) or a turnover order which transfers the debtor’s LLC interest outright to the creditor. The upshot is that in New York there is no limitation to the charging order remedy.

The last question was then whether the District Court had properly exercised its discretion in issuing a turnover order instead of a charging order. The Second Circuit thought that it did, in part because HNA Int’l had tried to frustrate the collection of 245 Park’s judgment by, for example, trying to sell the Chicago property to the China-based affiliates of HNA Int’l without giving the required 14 day notice.

And with all that, the Second Circuit affirmed the District Court and thereby denied the appeal of HNA Int’l.

ANALYSIS

The first thing to be considered is that this ruling is applicable to New York judgment enforcement actions only, thank goodness, and thus does not have any impact upon the states which have enacted ULLCA or their own LLC statutes.

The second thing to consider is that HNA Int’l held a 100% interest in HNA N.A., or, in other words, HNA N.A. was a single-member LLC. This requires a digression to explain that the purpose of charging order protection is not asset protection for the debtor, contrary to popular but incorrect belief, but rather exists to protect the non-debtor members from being forced into what amounts to a shotgun marriage with the debtor/member’s creditor. When an LLC is a single-member LLC, and thus has no non-debtor members with interests to protect, this raison d’etre of the charging order no longer exists. Recognizing this, the laws or court opinions of some states — and the most current iteration of ULLCA — provides a carve-out for single-member LLCs such that a creditor is not restricted to the charging order remedy in that circumstance.

The New York statute is silent on the issue, thus setting it up for judicial interpretation. Applied here, there was no reason to restrict 245 Park to a charging order against the interest in HNA N.A. that was owned by HNA Int’l. Instead, a turnover order became a viable remedy and the District Court exercised its discretion to allow that alternative remedy. The Second Circuit does not go into an explanation of this, but one can sort of read between the lines to see that perhaps this was a behind-the-scenes consideration.

The third thing to consider is that HNA N.A. as a Delaware LLC was considered to be a foreign LLC under New York’s LLC law. That creates a problem under the aforementioned § 607 of the New York LLC law as it is not clear whether section just applies to LLCs that are formed in New York or also applies to foreign LLCs. If foreign LLCs are not included within the ambit of § 607, then all remedies (including turnover orders) are available to creditors to enforce a judgment against a debtor’s interest in a foreign LLC. This issue is known as the Heather Apartments Issue for one of the first landmark opinions in which it came up, and has been the subject of several of my previous articles such as Charging Order Jurisdictional And Foreign LLC Issues Become Clearer In Vision Marketing (Oct. 14, 2015).

The fourth thing is that the Delaware courts have no say in this matter, even if Delaware law would lead to a completely different result. A creditor is not a party to an LLC’s operating agreement and is not bound by its terms, including any choice of law clause. Issues involving creditors are also not an “internal affair” that might require resolution by the courts of the state of formation; rather, a creditor’s enforcement of a judgment against an LLC’s member is a textbook “external affair” issue which means that the laws of the state of judgment will apply.

The bottom line to all this is that New York LLC law is a mess as it relates to the remedies of a creditor against a debtor who holds an LLC interest. If the LLC is a single-member LLC or an LLC formed in another state, then a creditor might or might not be limited to the remedy of a charging order depending upon the discretion of the court. At the very least, this opinion stands for the proposition that if a debtor’s interest is in an LLC that is both single member and a foreign LLC, then the creditor may be able to get a turnover order for the debtor’s entire interest, which of course would give the creditor complete control over the LLC and its assets. Counsel who have clients holding such LLC interests should consider warning them of these problems.

This is all good news for creditors but bad news for New York debtors who are trying to figure out their exposure to the enforcement of a judgment. It will also likely require a statutory fix, and New York would be well advised to update its LLC law by adopting the latest revision of ULLCA instead. This will be an issue worth watching going forward, but it certainly is dangerous in New York today.

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