November 01, 2003

A Charging Order Is the Exclusive Remedy Against a Partnership Interest: Fact or Fiction? (2003, 17:06)

A Charging Order Is the Exclusive Remedy Against a Partnership Interest: Fact or Fiction?

Creditors’ Rights Against Limited Partnership Interests in General

Probate and Property, November/December 2003, Voume 17, Number 6

By Elizabeth M. Schurig and Amy P. Jetel
Elizabeth M. Schurig is a partner and Amy P. Jetel is an associate with Giordani, Schurig, Beckett & Tackett, L.L.P. in Austin, Texas.

Ask any practitioner what remedies are available to a creditor against a debtor’s interest in a limited partnership and that practitioner will undoubtedly say that a “charging order” (which allows a creditor to receive any profits or other money payable to the debtor partner directly from the partnership) is the exclusive remedy against the debtor’s limited partnership interest.  

This certainty about remedies is likely because of the wording of Section 703 of the Revised Uniform Limited Partnership Act (1976) as amended in 1985 (the “1976 Act”), which says the following:

§ 703 Rights of Creditor

On application to a court of competent jurisdiction by any judgment creditor of a partner, the court may charge the partnership interest of the partner 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 partnership interest. This [Act] does not deprive any partner of the benefit of any exemption laws applicable to his [or her] partnership interest.

Although the 1976 Act says only that a court “may” charge the partnership interest with the payment of a judgment, some courts have interpreted this section to mean that a charging order is the exclusive remedy against a partnership interest. See, e.g., 91st Street Joint Venture v. Goldstein, 691 A.2d 272 (Md. Ct. Spec. App. 1997); In re Pischke, 11 B.R. 913 (Bankr. E.D. Va. 1981); Myrick v. Second National Bank of Clearwater, 335 So. 2d 343 (Fla. Dist. Ct. App. 1976).

From the creditor’s perspective, a charging order is an unattractive remedy because the creditor will receive nothing if there are no distributions to the debtor partner. A more attractive remedy is available to creditors, however, under the civil statutes of most states. This remedy is “foreclosure” upon the interest that is subject to the charging order. A charging order differs from a foreclosure: a foreclosure is permanent, but a charging order is in place only long enough to pay off the debt. A further difference is that the purchaser at a foreclosure enjoys the right to a proportionate share of the partnership’s assets upon dissolution—increasing the creditor’s chances of having the debt satisfied out of the partnership interest.

Changes to Creditors’ Rights in the Uniform Limited Partnership Act of 2001

Section 703 of the 1976 Act is currently subject to amendment by Section 703 of the new Uniform Limited Partnership Act (2001) (the “2001 Act”). Section 703 of the 2001 Act provides for creditors’ remedies against a debtor’s partnership interest. For comparison purposes, the full text of both sections is provided on page 59.

The most significant change that the 2001 Act makes to Section 703 is that, unlike the 1976 Act, it explicitly allows foreclosure upon a judgment debtor’s partnership interest. By explicitly stating that a court may foreclose upon a partnership interest that is subject to a charging order, the 2001 Act allows no room for an argument that a charging order is an exclusive remedy against a partnership interest. Thus, from an asset protection perspective, the 2001 Act is considerably less protective of a partner’s partnership interest than the 1976 Act.

The Most- and Least-Protective States

Forty-eight states and the District of Columbia have enacted the 1976 Act in some form. Nine of those states have altered Section 703 to provide either more or less protection to a debtor’s partnership interest. In 2000, Delaware rewrote its version of Section 703 to be substantially similar to the 2001 Act’s Section 703, and Nevada followed suit in 2001. Hawaii repealed its version of the 1976 Act entirely on June 26, 2003, and replaced it with the 2001 Act, to be effective July 1, 2004.

The table on pages 60 and 61 compares the states’ and D.C.’s various versions of Section 703.  In short, Alaska, Arizona, Oklahoma, and Texas have the most protective statutes, but California, Delaware, Georgia, Nevada, Wisconsin, and now Hawaii have the least protective partnership laws.

The Charging Order May Not Be the Exclusive Remedy in Every State

As stated above, many practitioners believe that under the 1976 Act the charging order is the exclusive remedy for a judgment creditor to satisfy a debt out of a judgment debtor’s partnership interest. This is, in fact, the majority view, despite the fact that the state statutes of all but a few states fail to specifically limit the remedy to a charging order. But the majority view may not be correct in all states that have adopted the Act. See, e.g., In re Allen, 228 B.R. 115 (Bankr. W.D. Pa., 1998) (interpreting Pennsylvania’s RULPA provision in light of other remedies available to judgment creditors under Pa. R. Civ. P. 3108(a)(3)). Without explicitly limiting a creditor’s remedy to a charging order, Section 703’s language stating that a court “may” charge the partner’s interest could arguably allow the imposition of other remedies normally available to a judgment creditor under other provisions of state law. Although an analysis of whether jurisdictions that have adopted the 1976 Act provide additional remedies to judgment creditors is outside the scope of this article, it is worth saying that the civil laws of most jurisdictions allow for foreclosure of a creditor’s lien if the lien is not otherwise satisfied. See, e.g., Tex. Civ. Prac. & Rem. Code § 31.002. For this reason, practitioners should be wary of advising clients that the charging order is the exclusive remedy of a creditor against a partnership interest without first researching this fact themselves. In addition, practitioners should consider carefully whether a partnership is the most effective protection vehicle for their clients, and, if a partnership is the desired vehicle, they should further determine which jurisdiction provides the best forum for the resolution of creditor disputes.

Case Study: How Texas’s Statute Compares to the Other Debtor-Protective States

Texas is generally an attractive jurisdiction for partnerships because it has no state income tax, Texas partnerships are not currently subject to a franchise tax, and a charging order is the sole remedy available against a partnership interest. But two threats to Texas’s position as a leading jurisdiction for attracting partnerships exist.

The first threat is the possibility that the Texas legislature will review the new Uniform Limited Partnership Act and adopt the new Section 703 of the 2001 Act. If it does, then Texas will fall into the category of the least-protective states.

The second threat is that recent amendments to the Limited Partnership Acts in other jurisdictions are more clearly drafted than Texas’s statute and thus arguably provide more protection against judgment creditors than does the Texas statute. These changes could draw business away from Texas and toward these other states. An analysis of the Texas statute will illustrate this point.

Texas’s version of the 1976 Act’s Section 703, in what appears to be an internal inconsistency in the statute, provides that the charging order is a creditor’s exclusive remedy, yet it states that a charged partnership interest may be redeemed before a foreclosure occurs. Tex. Rev. Civ. Stat. Ann. art. 6132a-1, § 7.03. It is difficult not to question why the Texas legislature allowed for redemption of a partnership interest before a foreclosure when the statute explicitly states that the charging order is the exclusive remedy. It is helpful to remember, however, that the Texas statute is one of the first to deviate from the language of the 1976 Act by providing more protection to partnership interests. Notice that, on pages 60 and 61, the jurisdictions that make the charging order the exclusive remedy adopted this language fairly recently (Alaska, 2000; Arizona, 1997; Oklahoma, 1998), but Texas adopted this language when it adopted the Act in 1987. The Texas drafters were faced with a provision in the Texas Civil Practice and Remedies Code that allows a court to “otherwise” apply a judgment debtor’s property to the satisfaction of the judgment. Tex. Civ. Prac. & Rem. Code § 31.002. This broad language would typically allow foreclosure as a remedy. As pioneers into a relatively unexplored area at the time, it could be that the drafters envisioned a case in which a creditor, despite the provision that the charging order is the exclusive remedy, would be able to win an argument that foreclosure is still available against a partnership interest under the Civil Practice and Remedies Code—in which case, the legislators wanted to allow the partnership to redeem the charged interest. But when compared to the statutes of the other debtor-protective states, Texas’s belt-and-suspenders approach becomes apparentlycreditor-friendly.

For instance, Arizona and Oklahoma have amended their statutes to clearly state that a charging order is a judgment creditor’s sole remedy against a debtor’s partnership interest. Unlike Texas’s statute, neither of these states’ statutes mentions a foreclosure, which weakens a creditor’s argument that foreclosure is still available under other provisions of law. And Alaska made an even clearer statement in its version of Section 703 by further stating that a court may not order a foreclosure against a partner’s partnership interest. This straightforward statute certainly pushes Alaska ahead of Texas in attracting the formation of partnerships.

In sum, practitioners in any state who are interested in the protective nature of partnerships should petition their respective legislatures not to adopt the 2001 Act and to further reword the current statute to be similar to Alaska’s to make it absolutely clear that a charging order is the exclusive remedy against a debtor’s interest in a limited partnership.