By: Robert G. Tweel and Justin R. Johnson
In many states, members of multi-member limited liability companies (“MLLC’s”) find comfort under applicable state law providing a charging order[1] as the sole and exclusive remedy available to creditors of a debtor-member in an MLLC with respect to the debtor-member’s ownership interest in such entity. Despite this common state law limitation, the recent decision in United States v. Driscoll, Civil Action No. 18-11762 (RK) (RLS)[2] calls this relatively ubiquitous protection into question, at least in the context of claims for delinquent federal taxes.
Section 6321 of the Internal Revenue Code (the “Code”) grants to the United States (the Government”) a lien upon all property and rights to property, belonging to a person who fails to pay federal taxes. Code § 7403(a) further authorizes the Government to enforce its tax lien, or to “subject any property, of whatever nature, of the delinquent [taxpayer], or in which he has any right, title, or interest, to the payment of such tax or liability,” through a civil action filed in federal district court, naming “all persons having liens upon or claiming any interest in the property involved in such action [as] parties thereto.”
In United States v. Rodgers, 461 U.S. 677 (1983) the Supreme Court of the United States examined Code § 7403 to determine whether it authorized, for payment of delinquent federal taxes, the sale of property in which a delinquent taxpayer owned an interest together with another party not liable for such delinquent taxes. Answering in the affirmative, the Court examined legislative history and notably cited Code § 7403(a)’s joinder requirement, holding that “no joinder of persons claiming independent interests in the property would be necessary if the government were only authorized to seek the sale of the delinquent taxpayer’s own interests.” Ultimately, the Court resolved that Code § 7403 authorizes “not merely the sale of the delinquent taxpayer’s own interest, but the sale of the entire property,” without deference to state law exemptions or limitations.[3]
The Rodgers Court, recognizing that a court’s power to authorize foreclosure on such property is limited to “some degree by equitable discretion,” also described four factors to be analyzed together with “common sense and consideration of special circumstances” in the exercise of such discretion. Namely:
(1) the extent to which the Government’s financial interests would be prejudiced it if were relegated to a forced sale of the partial interest actually liable for the delinquent taxes;
(2) whether the third party with a non-liable separate interest in the property would, in the normal course of events (leaving aside § 7403 and eminent domain proceedings), have a legally recognized expectation that separate property would not be subject to forced sale by the delinquent taxpayer or his or her creditors;
(3) the likely prejudice to the third party, both in personal dislocation costs and in … practical undercompensation; and
(4) the relative character and value of the non-liable and liable interests held in the property.
In Driscoll, the Court applied the Rodgers factors to determine whether the Government could foreclose a tax lien against an MLLC operated as a dental practice and owned fifty percent by the delinquent taxpayer and fifty percent by a party without liability for the delinquent taxes, by forcing a sale of the MLLC in its entirety.[4] Upholding the Government’s right to foreclose on the entire MLLC (and not only the delinquent taxpayer’s interest), the Court found only one of the Rodgers factors – the other MLLC member’s legally recognized expectation that his separate property would not be subject to forced sale by the delinquent taxpayer or his creditors – to weigh against a forced sale. Notably, while recognizing that property interests provided under state law are specifically relevant to this factor, the Court failed to analyze the exclusive nature of a charging order as the “sole remedy of a judgment creditor” under applicable state law, and its impact on this factor. Instead, focusing only on the statutorily required “consent of all members in an LLC to ‘sell, lease, exchange, or otherwise dispose of all, or substantial all, of the company’s property,’” the Court found that this single factor did not preclude authorization of the sale in its discretion, as evidenced by its ruling.[5]
Driscoll is a stark reminder of the broad construction given to Code § 7403, its override of otherwise applicable state law protections, and the surprising impact that an individual’s personal financial woes, particularly delinquent federal taxes, may have on innocent coventurer’s interests in jointly owned property. Further consideration of its impact on future business relationships and structuring ownership property co-ownership is warranted.
[1] A charging order is a process that is used to “charge the interest” of an LLC member, instead of foreclosing on the member’s interest in the LLC altogether. While most often the exclusive remedy with respect to MLLC’s, some states’ limited liability company statutes provide the same protection for single-member LLC’s.
[2] Neither published nor unpublished federal district court decisions constitute binding precedent, but may be considered by courts as persuasive, with published district court decisions being viewed by courts as more persuasive than unpublished decisions.
[3] Pursuant to Code 7403(c), “the court shall proceed to adjudicate all matters involved therein and finally determine the merits of all claims to and liens upon the property, and, in all cases where a claim or interest of the United States therein is established, may decree a sale of such property, by the proper officer of the court, and a distribution of the proceeds of such sale according to the findings of the court in respect to the interests of the parties and of the United States…”
[4] The decision also considered the application of § 7403 and the Rodgers factors to real property owned as cotenants by the MLLC members. The opinion notes that while the parties briefing analyzed the potential sale of the real property with respect to the Rodgers factors, neither party applied the analysis to the potential sale of the MLLC.
[5] The Court specifically authorized the sale of the MLLC. The Court’s consideration of state law applicable instead to a sale of the MLLC’s underlying property is thus arguably inapplicable to the factor analysis.