As partnership and LLC law has evolved, the various related uniform acts have allowed for the foreclosure of a charging order. Some states, such as California and Nevada, have adopted these changes, while other states, such as Oklahoma’s LLC Act, have adopted legislation that appear to forbid or restrict the effects of such foreclosure. Still other states have yet to adopt these changes one way or another.

Some individuals, and even some of the less-informed asset protection planners, fear the foreclosure of a charging order undermines the protection that COPEs have previously provided. A careful reading, however, shows this to not be the case.

To illustrate, let’s examine section 703(b) of the RULPA.

“(b) A charging order constitutes a lien on the judgment debtor’s transferable interest. The court may order a foreclosure upon the interest subject to the charging order at any time. The purchaser at the foreclosure sale has the rights of a transferee.” [Emphasis is ours.]

The key sentence here is that a purchaser of a foreclosed charging order has the rights of a transferee. What are those rights? Section 702 of the Act tells us:

“(a) A transfer, in whole or in part, of a partner’s transferable interest:

…

(2) does not by itself cause the partner’s dissociation or a dissolution and winding up of the limited partnership’s activities; and

(3) does not, as against the other partners or the limited partnership, entitle the transferee to participate in the management or conduct of the limited partnership’s activities, to require access to information concerning the limited partnership’s transactions except as otherwise provided in subsection (c), or to inspect or copy the required information or the limited partnership’s other records.

(b) A transferee has a right to receive, in accordance with the transfer:

(1) distributions to which the transferor would otherwise be entitled; and

(2) upon the dissolution and winding up of the limited partnership’s activities the net amount otherwise distributable to the transferor.

(c) In a dissolution and winding up, a transferee is entitled to an account of the limited partnership’s transactions only from the date of dissolution.

(d) Upon transfer, the transferor retains the rights of a partner other than the interest in distributions transferred and retains all duties and obligations of a partner.” [Emphasis is ours.]

The foregoing illustrates that foreclosing a charging order only gives the purchaser the rights of a charging order in perpetuity. In other words, a charging order is effective until the judgment is satisfied, but a foreclosed charging order extends those rights indefinitely. No other rights or powers arise from the foreclosure.

So how bad is it for someone to now hold a perpetual charging order interest? If the entity is structured correctly, then a foreclosed charging order will rarely be worse than an unforeclosed one. This is because, due to IRS Rev. Rul. 77-137, the holder of a foreclosed charging order will almost certainly receive the tax bill for his share of company profits, even if he never receives those profits. In other words, having a foreclosed charging order not only doesn’t ensure its holder will ever receive anything from the partnership, it also does ensure he’ll receive the tax bill for whatever it is he didn’t receive! Structuring an entity so as to lay this trap for unsuspecting creditors is discussed in Chapter 19.

Of course, if a foreclosed charging order ends up being all pain and no gain for the creditor, he will want to get rid of it, meaning that the foreclosed charging order will almost certainly not be in effect indefinitely.