There are relatively few types of assets that are statutorily protected from claims of creditors. Membership interests in limited liability companies (“LLCs”) and partnership interests are afforded a significant level of protection through the charging order mechanism.
The Importance of History
Before the advent of the charging order, a creditor pursuing a partner in a partnership was able to obtain from the court a writ of execution directly against the partnership’s assets, which led to the seizure of such assets by the sheriff. This result was possible because the partnership itself was not treated as a juridical person, but simply as an aggregate of its partners.
The seizure of partnership assets meant that the sheriff could shut down the partnership’s place of business. That caused the non-debtor partners to suffer financial losses, sometimes on par with the debtor partner, a process one court referred to as “clumsy.”
To protect the non-debtor partners from the creditor of the debtor-partner, and to keep the creditor out of partnership affairs, it was necessary to keep the creditor from seizing partnership assets. This was also in line with the developing perception of partnerships as legal entities and not simple aggregates of partners. These objectives could be accomplished only by limiting the collection remedies that creditors previously enjoyed. Because any limitation on a creditor’s remedies is a boon to the debtor, over the years charging orders have come to be perceived as asset protection tools.
The rationale behind the charging order limitation applied initially only to general partnerships, where every partner was involved in carrying on the business of the partnership; it did not apply to corporations because of their centralized management structure. However, over the years the charging order protection was extended to limited partners and LLC members.