We have frequently discussed the use of charging orders to enforce judgments against a debtor/member’s interest in an LLC or partnership. But what if the charging order is based on a judgment that arises out of an illegal contract, such as involving a marijuana business? The U.S. Tenth Circuit Court of Appeals has given us an answer to that question — sort of — in its opinion in Bartch v. Bartch, 2024 WL 3560748 (10th Cir., July 29, 2024).
Josh and Mackie Barch sought to create a new business called Doctor’s Orders Maryland (“DOMD”) which was to be in the marijuana business. But, because Josh had a misdemeanor drug possession record in Colorado which could hurt the Maryland license application, Josh temporarily relinquished his interest in DOMD with the understanding that he could later re-assert his interest. Mackie agreed to this. But when the time came for Josh to re-join DOMD, Mackie prevented Josh from doing that. Thereafter, DOMD was renamed to Culta LLC and it conducted the marijuana business without Josh.
Josh then sued Mackie, and a Mackie-owned company (Trellis Holdings Maryland, Inc.) which held a 30% minority interest in Culta. There was a trial, and Josh won a $6.4 million judgment in the U.S. District Court for the District of Colorado for breach of contract against Mackie and Trellis. Mackie and Trellis never appealed and never paid this judgment. Very importantly, as we shall see, Mackie and Trellis also did not plead that the agreement between Josh and Mackie was illegal under the federal drug laws.
Now came the time for Josh to enforce the judgment. Josh registered the judgment issued by the District of Colorado in the District of Maryland. Josh next obtained a charging order against Trellis’ interest in Culta which required that any distribution due to Trellis would be paid to Josh instead.
Shortly thereafter, the U.S. District Court for the District of Colorado ordered Mackie to sell the 30% Trellis interest in Culta and turn over the sales proceeds to Josh. Mackie and Trellis appealed this order to the U.S. Tenth Circuit Court of Appeals, arguing for the first time that Josh lacked standing to sue regarding a marijuana business because of the Controlled Substances Act (“CSA”). Mackie and Trellis also argued that the U.S. District Court’s order violated Colorado law which restricted the remedy of a judgment creditor like Josh to a charging order against Mackie’s and Trellis’ interests in Culta.
Meanwhile, though they had appealed, Mackie and Trellis also moved the U.S. District Court to set aside the judgment because, they argued, it enforced an agreement which was illegal under the CSA. The U.S. District Court denied this motion and Mackie and Trellis appealed it to the Tenth Circuit as well.
All this resulted in the Tenth Circuit’s opinion that will next be related.
The Tenth Circuit denied Mackie’s and Trellis’ appeal on setting the judgment aside for a variety of very technical grounds not related to our discussion, so we will skip over those. That brings us to the judgment enforcement issue that is the subject of interest here, which is the District of Colorado’s order that Mackie liquidate Trellis’ interest in Culta and pay that amount of money over to Josh.
When a U.S. District Court enforces a judgment which, as here, arises in diversity jurisdiction, the court will employ the judgment enforcement laws of the state in which the district sits. That means Colorado law in this case.
Colorado law has two competing laws, at least as the Tenth Circuit saw it. First, the Colorado LLC Act provided for the remedy of a charging order. Second, under Colorado Rule of Civil Procedure 69(g), a court may order a debtor to apply the debtor’s property towards satisfaction of a judgment.
Mackie and Trellis argued that the charging order is the “exclusive” remedy which cuts off the application of Rule 69(g). The problem with that argument, the Tenth Circuit noted, is that the Colorado LLC Act is not drafted — like so many other states’ laws — to make the charging order the exclusive remedy. Therefore, in Colorado at least, a creditor can order a debtor’s interest in an LLC to be sold to satisfy the judgment.
The next argument was that the order for Mackie to sell Trellis’ interest in Culta, and turn the proceeds over to Josh, violated public policy because it basically enforced a contract that was illegal because marijuana is a controlled substance under federal law. The Tenth Circuit thought that federal law regarding controlled substances was not applicable to this situation, since the District of Colorado was only ordering Mackie to sell Trellis’ interest to satisfy Josh’s judgment, and not to cultivate or distribute cannabis.
Nonetheless, because marijuana is such a touchy subject, the Tenth Circuit ultimately punted on the issue and remanded the case back to the District of Colorado to further develop the record regarding the Rule 69(g) order as it relates to a marijuana business.
Circuit Judge Baldock filed a dissent to the effect that Culta was clearly engaged in illegal activity under federal law, and thus a federal court should not be enforcing any contract that related to the marijuana business.
ANALYSIS
The important lesson of this case is that one should not presume that a charging order will be the exclusive remedy available to a creditor against a debtor/member of an LLC. With the Uniform Limited Liability Company Act (“ULLCA” or “RULLCA” in its revised format) this is made clear, but in some non-uniform organic state LLC and partnership statutes it is not. The instant case provides an excellent example of this lesson.
It is noteworthy that the Tenth Circuit’s opinion glosses over some important issues. One of these issues relates to conflict of laws, or which state’s law should apply to determine the outcome. For instance, Josh obtained the charging order against Trellis’ interest in Maryland, but the Rule 69(g) order for that interest in Colorado. The latter state does not provide for a charging order to be the exclusive remedy, but Maryland (which follows ULLCA) does. Personally, I believe that the Tenth Circuit got the result correct in applying Colorado law, but it would have been interesting to have seen a much longer discussion of that issue.
Another noteworthy issue is that Culta was effectively a single-member LLC (“SMLLC”), at least when one collapses Trellis’ interest (which Mackie wholly owned) with Mackie’s own interest. The purpose of charging order exclusivity of remedy is to protect the non-debtor members from being forced into an involuntary partnership with a creditor. Where, as here, both debtors (Mackie and Trellis) were the only members of Culta, or Tellis’ interest could be equitably collapsed into Mackie’s interest, there are no non-debtor members in this case whose interests deserve charging order exclusivity. The Tenth Circuit glosses over this issue as well.
The bigger point — which I have made in numerous previous articles — is that charging order exclusivity of remedy is very much like Swiss cheese insofar as it has lots of holes. There are numerous proven ways to get around charging order exclusivity, such that in many situations it will be no more than a brief illusion.
Just ask Mackie about that.
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