Security Interest
Security Agreement, Perfected by the Filing of a UCC Financing Statement Filed with the Secretary of State (Perfected before D. Moved for His Charging Order)
Charging Order (Not to Confuse with Judgment Lien on Personal Property)
Lien (Obtained Through a Charging Order)
Assignment (Deemed to be a Security Interest, Hence, to be Perfected by a Filling with the Secretary of State)
Collateral
Priority Between Statutory Lien and Prior Security Agreement?
Disgorgement
Order Disgorging $X. Payment to Attorney Legal Fees
Alter Ego Theory
Ethics
California Law
When a “money judgment is rendered against” a member of an LLC, but not against the LLC itself, the member’s interest in the LLC “may be applied toward the satisfaction of the judgment by an order charging the judgment debtor’s interest pursuant to Section . . . 17705.03 of the Corporations Code.” (Code Civ. Proc., § 708.310.)
APPEAL from an order of the Superior Court of Los Angeles County, Rupert A. Byrdsong, Judge. Reversed and remanded with directions.
Appellant Glaser Weil Fink Howard Avchen & Shapiro, LLC (Glaser Weil), former counsel of plaintiff William Rice, appeals from an order disgorging a $450,000 payment to Glaser Weil by Triton Community Development LLC (Triton), an entity owned and controlled by Rice. The trial court concluded the payment should instead have gone to defendant and respondent Gary Downs, who had obtained an order charging Rice’s interest in Triton to satisfy an earlier judgment entered in Downs’ favor.
In contesting disgorgement, Rice and Glaser Weil asserted that before Downs had moved for the charging order, Glaser Weil had entered into agreements with Triton and Rice to ensure payment of Glaser Weil’s legal fees, and those agreements took precedence over the charging order. Specifically, Triton had agreed to become co-obligor on Rice’s debt to Glaser Weil, and Rice had also pledged his interest in Triton to Glaser Weil as security on his debt. Although Rice and Glaser Weil did not provide these agreements to the trial court, Rice and a Glaser Weil partner submitted declarations attesting to the agreements, along with a Uniform Commercial Code (UCC) financing statement filed with the Secretary of State referencing, among other things, Glaser Weil’s security interest in Triton.
Glaser Weil argued that Triton made the $450,000 payment for its own obligations as co-obligor on Rice’s debt, and therefore the payment was not a “distribution” to Rice subject to the charging order. Alternatively, if the payment was a distribution to Rice, Glaser Weil contended its security interest, perfected before Downs moved for his charging order, had priority over that order.
The trial court found that Triton was Rice’s alter ego, and rejected the argument that the payment was for Triton’s obligation as opposed to Rice’s debt. The court agreed in theory with Glaser Weil’s lien priority argument, but relied on its equitable authority to place the charging order ahead of Glaser Weil’s security interest.
Like the trial court, we conclude that when Rice, as sole managing member of Triton, directed the company to disburse funds to pay his legal bills, it constituted a distribution to him subject to the charging order.
We disagree with the trial court on the lien priority question, however, and hold that Glaser Weil’s security agreement, perfected by the filing of a financing statement, has priority over the later charging order. In the unpublished portion of the opinion, we further conclude there was no equitable basis to override Glaser Weil’s lien priority here, assuming arguendo a trial court can override a statutory lien priority by exercising its equitable power.
(…) Rice filed for Chapter 11 bankruptcy on January 27, 2020. During that proceeding, he filed a monthly operating report disclosing that in February 2020, Triton had paid $450,000 to Glaser Weil, the firm representing Rice in his litigation against Downs.
(…) Attached to Cypers’ declaration, however, was a UCC financing statement filed by Glaser Weil with the Secretary of State on July 15, 2019. The statement identified Rice as debtor and Glaser Weil as the secured party. Exhibit A to the financing statement described the collateral securing Rice’s debt to Glaser Weil. The collateral included, inter alia, “All of Debtor’s right, title and interest in the property described in that certain Pledge and Security Agreement dated June 27, 2019,” and “100% of Debtor’s membership interests in Triton Community Development LLC, a California limited liability company, together with the certificates (if any) evidencing the same . . . .”
The full description of the collateral is as follows: “All of Debtor’s right, title and interest in the property described in that certain Pledge and Security Agreement dated June 27, 2019, by Debtor, as pledgor, for the benefit of the Secured Party (‘Pledge and Security Agreement’), whether now owned by Debtor or hereafter acquired and whether now existing or hereafter coming into existence; 100% of Debtor’s membership interests in Triton Community Development LLC, a California limited liability company, together with the certificates (if any) evidencing the same; All ownership interests, membership interests, shares, securities, moneys, instruments or property representing a dividend, a distribution or return of capital upon or in respect of the Pledged Interests, or otherwise received in exchange therefor, and any warrants, rights or options issued to the holders of, or otherwise in respect of, the Pledged Interests; All rights of Debtor under the Relevant Documents or any other agreement or instrument relating to the Pledged Interests, including, without limitation, (i) all rights of Debtor to receive moneys or distributions with respect to the Pledged Interests due and to become due under or pursuant to the Relevant Documents, (ii) all rights of Debtor to receive proceeds of any indemnity, warranty or guaranty with respect to the Pledged Interests, (iii) all claims of Debtor for damages arising out of or for breach of or default under a Relevant Document, and (iv) any right of Debtor to perform thereunder and to compel performance and otherwise exercise all rights and remedies thereunder; and all proceeds of and to any of the property of Debtor described herein and in that certain Pledge and Security Agreement and, to the extent documenting any property described in said clauses or such proceeds, all books, correspondence, credit files, records, invoices and other papers. All Current Fees plus interest, all Costs plus interest and all Deferred Fees plus interest as defined in that certain Engagement Letter dated April 18, 2014, December 10, 2014, June 4, 2015, May 2, 2017 and June 27, 2019, by and between Debtor and Secured Party, as amended and modified (collectively ‘Engagement Letter’). All terms made here but not defined shall have the meaning given to such terms in the Pledge and Security Agreement and the Engagement Letter.”
(…) Glaser Weil’s argument focused on MDQ, LLC v. Gilbert, Kelly, Crowley & Jennett LLP (2019) 32 Cal.App.5th 702 (MDQ), a case involving priority between a charging order and a security interest granted by a judgment debtor to his attorneys. (See id. at pp. 704–705.) After taking a recess to review the case, the trial court stated, “It does appear that Glaser Weil is on the right side of the law with regard to having the priority, even over my charging order.
A. The Payment Was a Distribution Subject to the Charging Order
For the reasons that follow, we reject Glaser Weil’s position that the $450,000 payment was not a distribution subject to the charging order.
When a “money judgment is rendered against” a member of an LLC, but not against the LLC itself, the member’s interest in the LLC “may be applied toward the satisfaction of the judgment by an order charging the judgment debtor’s interest pursuant to Section . . . 17705.03 of the Corporations Code.” (Code Civ. Proc., § 708.310.)
Corporations Code section 17705.03, subdivision (a), empowers a court to “enter a charging order against the transferable interest of the judgment debtor for the unsatisfied amount of the judgment. A charging order constitutes a lien on a judgment debtor’s transferable interest and requires the limited liability company to pay over to the person to which the charging order was issued any distribution that would otherwise be paid to the judgment debtor.”
As used in Corporations Code section 17705.03, a “transferable interest” is “the right, as originally associated with a person’s capacity as a member, to receive distributions from a limited liability company in accordance with the operating agreement, whether or not the person remains a member or continues to own any part of the right.” (Corp. Code, § 17701.02, subd. (aa).) A “distribution” is “a transfer of money or other property from a limited liability company to another person on account of a transferable interest.” (Id., subd. (f).)
By emphasizing the statutory language referring to the LLC’s operating agreement, Glaser Weil appears to be limiting the reach of a charging order to distributions formalized under that agreement, such as dividends or other entitlements granted to members. This narrow reading disregards the reality that many LLCs, like Triton, are completely controlled by a single person who may distribute funds at his or her discretion. (See Curci Investments, LLC v. Baldwin (2017) 14 Cal.App.5th 214, 224 [managing member with “near complete interest” in LLC “effectively has complete control over what the LLC does and does not do, including whether it makes any disbursements to its members”].) Under Glaser Weil’s interpretation, such entities easily could evade charging orders by eschewing formal distributions and instead taking funds out of the LLC as the need arose.
The language of the applicable statutes does not compel this
result. Again, a charging order is against an LLC’s member’s “transferable
interest,” defined as “the right, as originally associated with a person’s
capacity as a member, to receive distributions from a limited liability company
in accordance with the operating agreement . . . .” (Corp. Code, §
17701.02, subd. (aa).) When a managing member of an LLC directs the LLC to
disburse funds for the managing member’s own purposes, the managing member does
so based on the
“right . . . associated with his or her capacity as a member,” invoking powers
“in accordance with the operating agreement.” (See ibid.) Put another
way, the managing member has access to that money only by virtue of his or her
status as managing member, just as members have the right to formal
distributions by virtue of their status as members. We
see no basis to treat the two types of disbursements differently, particularly
when doing so would encourage evasion of charging orders.
We express no opinion as to how a charging order might affect disbursements made to a member for reasons other than membership, for example if the member were also an employee drawing a salary. Nor do we suggest that a charging order compels a managing member to disburse funds from an LLC, only that when the managing member does so for his or her own purposes, that disbursement is subject to a charging order (fn. 4).
(…) Given its unchallenged finding that Triton was Rice’s alter ego, the trial court could look past the corporate formalities and deem the transaction as Rice distributing money to himself from Triton to pay his legal bills. The fact that as a technical matter it was Triton that made the payment pursuant to its own purported obligations was immaterial because Triton and Rice were effectively one and the same.
B. Glaser Weil’s Security Interest Has Priority Over the Charging Order, But Remand Is Necessary To Determine the Terms of That Security Interest
Turning to Glaser Weil’s second argument, we agree that Glaser Weil’s security interest, perfected by filing the financing statement with the Secretary of State, has priority over the charging order that Downs later requested and obtained. We further agree there was no equitable basis for the trial court to override that priority. We therefore reverse the disgorgement order. Remand is necessary, however, for the trial court to determine the terms of Glaser Weil’s security interest. The trial court has yet to make this determination, having instead relied on its equitable authority to place the charging order ahead of Glaser Weil’s security interest.
“Other things being equal, different liens upon the same
property have priority according to the time of their creation . . . .” (Civ.
Code, § 2897.) Numerous statutes apply this general first-in-time principle to
specific types of liens or security interests. For example, Commercial Code
section 9322 governs priorities between competing security interests, ranking
them “according to priority in time of filing or perfection.” (Com. Code, §
9322, subd. (a)(1).) Similarly, Code of Civil Procedure
section 697.590 governs priorities between judgment liens on personal property
and security interests in the same property, ranking those interests “according
to priority in time of filing or perfection.” (§ 697.590, subd. (b).)
We have not found, nor have the parties identified, a statute specifically addressing the priority of charging orders in relation to other liens and security interests.
As Glaser Weil correctly notes elsewhere, however, a charging order is not equivalent to a judgment lien on personal property, the subject of section 697.590. Judgment liens on personal property are created pursuant to section 697.510 by filing a notice with the Secretary of State. (§ 697.510, subd. (a); § 697.590, subd. (a)(1)(A).) Charging order liens, in contrast, are created under section 708.320 “by service of a notice of motion for a charging order . . . .” (§ 708.320, subd. (a).) “If a charging order is issued, the lien . . . continues under the terms of the order. If issuance of the charging order is denied, the lien is extinguished.” (Id., subd. (b).)
In the absence of a statute specifically addressing the priority of charging orders, we rely on the general first-in-time rule stated in Civil Code section 2897. (See Bluxome Street Associates v. Fireman’s Fund Ins. Co. (1988) 206 Cal.App.3d 1149, 1158; cf. Ahart, Cal. Prac. Guide: Enforcement of Judgments and Debts (The Rutter Group 2015) ¶ 6:1472.1 [citing Civil Code section 2897 in support of proposition that “Where judgment creditors have obtained charging order liens on the same interests, priority should be given to the first creditor that obtained a lien”].)
Under this principle, it is evident that Glaser Weil’s security interest has priority over Downs’ charging order. As stated, the priority of a security interest is determined “according to priority in time of filing or perfection.” (Com. Code, § 9322, subd. (a)(1).) A security interest is perfected by filing a financing statement with the Secretary of State. (Id., § 9310, subd. (a); id., § 9501, subd. (a)(2); MDQ, supra, 32 Cal.App.5th at p. 711.) Glaser Weil filed a financing statement with the Secretary of State in July 2019.
Downs obtained his lien several months later, in October 2019, when he served notice of his second motion for a charging order, which motion—in contrast to his first motion— was granted. (§ 708.320, subd. (a).) Glaser Weil’s earlier perfected security interest therefore has priority.
Our conclusion that Glaser Weil’s security interest has priority over the charging order is supported by MDQ, which to some degree presents the converse of the factual pattern in the instant case. The underlying litigation in MDQ concerned plaintiff Cleopatra Records, Inc. (Cleopatra), and defendant Floyd Mutrux. (MDQ, supra, 32 Cal.App.5th at p. 705.) The trial court issued a proposed statement of decision awarding Cleopatra over a million dollars. (Ibid.) Shortly thereafter, Mutrux assigned to his attorneys, the law firm of Gilbert, Kelly, Crowley & Jennett LLP (Gilbert Kelly), a portion of his economic interests in four LLCs “ ‘in consideration for legal services provided . . . and to be provided hereafter . . . .’ ” (Ibid.) In the assignment, Mutrux directed the LLCs to make specified percentages of payments due to Mutrux to Gilbert Kelly instead. (Ibid.) Gilbert Kelly did not file a UCC financing statement. (Id. at p. 707.)
Months later, the trial court entered judgment of just under a million dollars in favor of Cleopatra. (MDQ, supra, 32 Cal.App.5th at p. 706.) Cleopatra recorded a judgment lien under section 697.590. (Id. at p. 707.) Cleopatra then moved for a charging order against Mutrux’s interests in the LLCs, which the trial court granted, directing the LLCs “ ‘to pay any and all profits, distributions, disbursements or other payments otherwise due to” Mutrux to Cleopatra. (Id. at 706.)
The LLCs filed an interpleader action to resolve the competing interests of Cleopatra and Gilbert Kelly. (MDQ, supra, 32 Cal.App.5th at p. 706.) The trial court found that because Gilbert Kelly had never filed a financing statement, Cleopatra’s judgment lien had priority over Gilbert Kelly’s assignment. (Id. at p. 707.)
Our colleagues in Division Eight affirmed the trial court’s ruling. (MDQ, supra, 32 Cal.App.5th at p. 704.) The appellate court rejected Gilbert Kelly’s argument that the assignment was not a security interest: “While Gilbert Kelly’s assignment may differ from some other secured transactions, in that the collateral securing Mutrux’s obligation to Gilbert Kelly is being paid as it accrues to satisfy that obligation, rather than securing payment from another source, Gilbert Kelly offers us no rationale under which we can conclude that it is not a security interest within the meaning of the California Uniform Commercial Code.” (Id. at p. 710.)
Downs argues that Glaser Weil did not notify him of the security interest, but he identifies no authority that Glaser Weil had an obligation to do so. As discussed, the law requires that a secured party perfect its interest by filing a financing statement with the Secretary of State, a rule “premised upon the assumption that the filing . . . will permit prospective purchasers and encumbrancers to ascertain the existence of security interest in the property by checking a centralized record system.” (T & O Mobile Homes, Inc. v. United California Bank (1985) 40 Cal.3d 441, 448.) Thus Downs, like any other creditor, could look to that “centralized record system” to determine if there were any competing claims to Rice’s interest in Triton.
Ethics
(…) Nor does Downs or anyone else suggest it is inappropriate for a law firm to obtain a security interest to ensure payment of its fees, assuming the firm complies with all ethical and other requirements concerning contracts with clients.
Secondary sources: Ahart, Cal. Prac. Guide: Enforcement of Judgments and Debts (The Rutter Group 2015).
(California Court of Appeal, Second Appellate District, Dec 27, 2021, Rice v. Downs, Docket No. B307780, Certified for Partial Publication)
