Judgment debtors come in all shapes and sizes and can include both individuals and entities. In some cases, a creditor may obtain a judgment against both the entity and the individual owners of that entity. Other times, the judgment is only against the entity or the individual, but not both.
When a creditor has a judgment against an individual with an ownership interest in an entity, but not against the entity itself, what rights does the creditor have with respect to the entity?
Businesses are often established as either corporations or limited liability companies (LLCs). In many ways, the rules governing shareholders (the owners of a corporation) are similar to those regarding members (the owners of an LLC). However, when it comes to enforcing a judgment, the rules are slightly different.
An individual's ownership interest in a corporation depends on the number of shares the individual owns in the company. When an individual debtor owns shares of a corporation, the court may force the individual to sell his or her shares through the appointment of a receiver, whose job is to market and sell the shares. When that happens, the receiver gets a "commission" from the sale, and the rest of the proceeds are given to the creditor, up to the amount necessary to satisfy the judgment. Any money left over after the judgment is fully satisfied will be returned to the debtor, but the debtor will no longer own shares in the corporation.
Unlike ownership interests in a corporation, creditors cannot force the sale of a member's ownership interest in an LLC. Instead, creditors are limited to levying upon the monetary distributions that the LLC makes to the individual debtor/member. For example, if an LLC makes $100,000 in distributions to its members, and the debtor owns 10% of the LLC, then the creditor can take the debtor's 10% share of the distribution, or $10,000. However, the decision as to when and in what amounts the LLC makes any such distributions is either governed by the LLC's operating agreement or is left to the sole discretion of the members.
LLCs can be set up in different manners and can serve different purposes. In single member or family-owned LLCs, the operating agreement may not require any distributions by the LLC, making it very difficult for the creditor to get any money out of the company. In larger entities, such as a 20-member LLC established for real estate investments, chances are that the operating agreement requires the LLC to make distributions proportionally and periodically to its members. In that case, unless the other 19 members of the LLC are willing to forego their distributions in order to protect the debtor from having his or her distributions seized, the LLC will likely continue making distributions to its members, including to the debtor, and the creditor can take the debtor's share of any such distributions until the judgment is satisfied.
While a debtor's ownership interest in an entity may provide additional avenues by which the creditor can enforce a judgment, the creditor should note the type of entity in which the debtor has an ownership interest. Even if the debtor owns substantial assets through an entity, it may be very difficult for the creditor to collect money from the debtor through that entity. This does not preclude the creditor from pursuing other avenues in enforcing the judgment, but it does raise certain practical issues that the creditor should consider.
To learn more about how Katz Melinger can help you, contact us.
Kenneth J. Katz
Don't miss an update! Sign up for our newsletter here.