Charging Orders for Limited Partnerships

In the case of the limited partnership (LP), the law takes the concept of a creditor attacking an owner's partnership interest (and not the partnership's assets) a step further. The creditor with a charging order cannot foreclose on that interest and force a liquidation of the partnership to reach the specific partnership assets, in order to satisfy the owner's personal debt liability.

Where does that leave the creditor? The creditor is given the rights of an "assignee." As an assignee, the creditor takes over the rights of the partner to receive any income or assets that otherwise, in the normal course of business, would have been distributed to the partner.

However, the relationship among partners is a personal one. For example, new partners may not be admitted except upon the consent of all of the existing partners. Because of this concept, the creditor does not become a partner and, accordingly, cannot participate in management of the business (by voting or otherwise); therefore, the creditor cannot legally force a distribution of income or assets that otherwise would not have taken place.

The business owners can simply stop making ordinary distributions of income. Typically, a distribution of the business's assets (other than undistributed income) would take place only on liquidation, which would not occur in the normal course of business. Thus, if no income is being generated, or no income or assets are being distributed, the creditor will be holding an interest that will provide no benefit whatsoever.

Worse yet for the creditor is the fact that a holder of a partnership interest in an LP must pay federal incomes taxes on his or her allocated share of earnings, even if they are not distributed. Thus, a creditor with a charging order will be taxed on the owner's share of earnings, even though the creditor receives no income.

Many creditors, knowing that this is a likely outcome, may decide not to pursue the matter, give up collection efforts, or accept a reduced settlement, especially after the debt goes uncollected for a long period of time. However, many potential creditors, knowing this, will be hesitant to extend financing or favorable terms to the business.

Work Smart All states (except Louisiana) have enacted either the Uniform Limited Partnership Act (ULPA) or the Revised Uniform Limited Partnership Act (RULPA), and will follow these rules with respect to charging orders and limited partnerships. Because the limited partnership laws of Louisiana are based on the older law, they are likely to follow the "liquidation view" that applies to general partnerships and charging orders. The special rules regarding charging orders described above do not apply to other entities such as general partnerships, limited liability partnerships (LLPs), sole proprietorships or corporations. Further, the limited liability company (LLC) has special rules of its own.