Harvest Properties, LLC, was formed by Lee Baker and Kenneth Duffus to do a real estate project near Anchorage, Alaska. The project failed, as did a similar project called Marion Bowen. Baker and Duffus then had a falling out, and litigation between the two ensued.
Regarding the Harvest Properties project, Baker and Duffus were both personally liable to the bank that had financed the project, and the bank sued the two on the guarantees. Both Baker and Duffus settled with the bank, but then went on to sue each other. This resulted in a jury trial and a jury verdict of $1.2 million in favor of Duffus and against Baker. While Baker appealed, Duffus obtained a charging order against Baker’s 50% interest in an LLC called Aurora Park which held an apartment complex in Anchorage.
In the litigation over the Marion Bowen project, Baker agreed to confess judgment and pay $150,000 plus interest to Duffus. Additionally, Baker partially assigned to Duffus any proceeds that Baker was to receive from Aurora Park. Baker and Duffus agreed that if the apartments did not sell within five years that Duffus could then enforce the confession of judgment against Baker.
Later, Baker transferred his membership interest to the other member of Aurora Park (who was not Duffus) as part of yet another settlement agreement, albeit this one between Baker and the other Aurora Park member. The apartments did not sell within five years, and Duffus then started to enforce his judgment against Baker, which by that time had grown to $252,585.06.
The upshot is that Baker ended up owing Duffus a little over $1.5 million between the Harvest Properties and Marion Bowen projects. But Duffus was to find that collecting on this judgment was easier said than done.
Let’s start with Aurora Park, LLC, which held the Anchorage apartment complex. Aurora Park’s manager was yet another entity called Northern Trust Real Estate, Inc., which was owned and managed 50% by the third-party co-investor of Baker in Aurora Park, and the other 50% owner and manager was Patricia Baker, who was Baker’s ex-wife.
When Duffus acquired the charging order against Baker from the Harvest Property litigation, that triggered a clause in the Aurora Park operating agreement that would have allowed Aurora Park to basically buy out Baker’s 50%. Indeed, Patricia, Aurora Park and Duffus had reached an agreement whereby Aurora Park would sell the apartment complex and distribute 50% of the proceeds to Duffus. But the apartment complex never sold.
In the meantime, Northern Trust had itself (along with Aurora Park) sued Baker, alleging that Baker violated his fiduciary duties to Aurora Park and that he had failed to respond to cash calls. Eventually, Northern Trust and Aurora Park settled with Baker, but the settlement was complicated: The settlement agreement set out four different contingencies depending on whether Aurora Park could either sell or refinance the apartment complex. Under the contingency that actually happened, several things happened:
(1) Baker quitclaimed his interest in Aurora Park to Patricia in exchange for a $50,000 payment by Baker; and
(2) Patricia and Northern Trust agreed to pay $250,000 to Jones Law Group (JLG) to pay the law firm’s fees for representing Baker in the Aurora Park litigation and other litigation. This payment was itself structured so that $50,000 was paid to JLG, with an additional $200,000 to be paid over time at $3,000 per month. In the event that Patricia and Northern Trust defaulted on these payments, Patricia and Northern Trust agreed to execute a $200,000 confession of judgment.
Upon the settlement being reach, Patricia paid Baker $50,000 and Patricia paid JLG $50,000 with both of those payments being deposited with the court registry, i.e., “into court”.
Not happy about the Baker/Aurora Park settlement which benefitted him not at all, Duffus attempted to intervene in this litigation and asserted that his charging order against Baker’s 50% interest in Aurora Park, plus Baker and Aurora Park had violated their agreements that the apartment complex would be sold. It is here that the court hearing the Baker/Aurora Park case told Duffus that he was in the wrong court, and that he needed to instead raise these matters with the court that had rendered judgment in the Baker/Harvest Properties case. That court (i.e., the Baker/Harvest Properties court) held that the Duffus charging order applied to the entire settlement proceeds and ordered them paid from the court fund to Duffus.
If all this were not complicated enough, Baker’s appeal of the Harvest Property judgment turned out to be successful in part, and the Alaska Supreme Court remanded the case for a new trial.
Meanwhile, Duffus still held his $150,000 judgment against Baker resulting from the Marion Bowen litigation, which had increased over time and with fees and expenses to $460,000, and Duffus asked the court hearing the Marion Bowen litigation to issue its own charging order against Baker’s 50% interest in Aurora Park and the settlement funds held in the court funds. The Marion Bowen court agreed with Duffus, and entered the requested charging order and additionally ordered that the court funds be distributed to Duffus, on the grounds that the purported settlement payments were really in the nature of distributions from Aurora Park that were picked up by the Duffus charging order. This ran counter to the findings of the Harvest Property court that it was Patricia, and not Aurora Park, which had paid the settlement funds and would thus store up even more trouble for all involved.
Moreover, after the Marion Brown court entered its charging order, that court learned for the first time that JLG had filed its own lien against the settlement funds held by the court so as to secure the attorneys fees owed to JLG. The court determined that the lien created by the Duffus charging order had priority of the funds already held by the court (by this time $122,000) but JLG’s lien would have priority over the remaining $128,000 still owed to the law firm.
It is the review of this order which now tees up the opinion of the Alaska Supreme Court that I shall next relate in Duffus v. Baker, 513 P.3d 264 (Alaska, July 15, 2022), which examines the validity of the Duffus charging order lien and the JLG attorneys fee lien, and their priority in relation to each other.
The court first noted that a charging order causes those distributions that would have been made to the debtor/member to instead be paid to the judgment creditor. The initial question was thus whether the Aurora Park settlement proceeds were distributions in this sense.
Baker attempted to argue that since the term “distribution” was not defined by the Alaska LLC statute, the term should instead be defined by Aurora Park’s operating agreements which defined the term as meaning something like “excess cash”. The court disagreed with Baker that the Alaska LLC statute did not define “distribution”, but instead pointed to two provisions where the statute recognizes interim distributions (distributions made while the entity is operating) and final distributions (distributions made upon liquidation of the entity and its assets). The court noted that this statutory definition of distribution was somewhat different than the way the term was defined in Aurora Park’s operating agreement, but declined to say whether that distinction ultimately made any difference in how the case would be resolved.
Baker also argued that the settlement moneys were paid by Patricia and Northern Trust, such that the moneys were not a distribution from Aurora Park even if the moneys originated there. The court agreed that it was unclear whether the settlement funds were in the nature of a distribution from Aurora Park and thus remanded this issue back to the district court to make additional findings.
The next issue was that of JLG’s lien for attorneys fees. Duffus argued that there was no evidence that JLG was owed compensation in relation to the Aurora Park lawsuit, much less $250,000 in fees. Duffus also sought to, essentially, have the court equitably subordinate the JLG attorneys fee lien to its own charging order lien.
The court noted that JLG had represented Aurora Park in the litigation, and while the court thought that it was “unusual” that JLG was paid its fees as part of the settlement, that did not render it wrongful or destructive of JLG’s lien. However, the court noted the lack of evidence that JLG was owed this amount of fees, and so similarly remanded the case back to the district court for additional finding on that issue as well.
It is notable that the Alaska Supreme Court declined at this time to settle the main issue in the case, which was the priority of the competing liens of Duffus and JLG. Instead, the court punted on the aforementioned factual issues and requested additional findings. Maybe later the court will get around to sorting out the priority issues, or maybe not.
The purpose of this article is to note that in extensive creditor-debtor litigation, such as between Duffus and Baker, it is important that the creditor get its liens down as early as possible, and that includes the liens created by charging orders. The reason for this urgency is illustrated here: Other parties may assert their own liens, which would then have priority over a particular creditor’s lien if those other liens are obtained first. Liens are very much a “first in time, first in right” sort of deal, and attempts by creditors to equitably subordinate somebody else’s lien so that the creditor can get paid on the judgment are never better than longshots.
Another reason for a creditor’s urgency in getting its liens down is also illustrated by this case, being that other parties may settle around the creditor, and if a debtor’s unsecured assets are part of the settlement, the creditor may forever lose the right to collect against those assets. This is because the laws of most states allow a debtor to prefer one creditor over another, at least outside of bankruptcy and so long as the other creditor is not an insider of the debtor.
There is something else that we need to talk about because it comes up in this case. Sometimes a creditor will get a charging order against a debtor’s interest in an LLC or partnership, but then the underlying judgment will be reversed on appeal. That reversal negates the judgment and vitiates the charging order and the lien that goes along with it. In such cases, the creditor should seek a prejudgment attachment of the debtor’s interest in the LLC or partnership, or else ― as happened here ― the creditor risks another party getting a lien against that interest by the time a new judgment and new charging order is obtained.
When judgment creditors chase debtors, they typically follow a straightforward and common sense plan known as “LIE”, which is an anachronym for “Lien, Investigate, Execute”. The first thing that a creditor will do is to get blanket liens down, such as by filing abstracts of judgments and permissible filings on the debtor’s personal assets with the Secretary of State’s office where allowed. The second thing the creditor will do will be to conduct debtor and third-party examinations and other discovery to try to ferret out the debtor’s assets. Finally, third, the creditor will move to enforce against the assets which have been discovered.
This is not strictly a linear process of course, since if a creditor finds a debtor’s asset, the creditor will want to get a lien down on that asset as quickly as possible for all the reasons discussed above. Also, even as the creditor is executing the judgment against some of the debtor’s assets, the creditor may be finding new ones. The salient point is that creditor liens play a big part in this plan, since they preserve assets until the creditor may execute on them, and the process of a creditor taking and maintaining liens on the debtor’s property is often a continuing one until the judgment has been satisfied or settled.
A final takeaway of this opinion goes to the more practical aspects of charging order litigation, which is to not make the mistake of presuming that the court is even minimally familiar with charging orders. The opinion of the Alaska Supreme Court here is quaint to a significant degree. The court writes about limited liability companies being a new form of business entity, although LLCs have been around for 30 years (admittedly, a short time in the long history of Anglo-American jurisprudence) and have been the entity-of-choice of for most new business formations for the last two decades. When discussing charging orders, the court gets a number of basic things wrong, just as stating that a creditor holding a charging order becomes an assignee of the interest ― in fact, the holder of a charging order is a mere lienholder and not an assignee at all (if the charging order is foreclosed, the purchaser at the ensuing judicial sale only at that time and not before becomes an involuntary assignee of the debtor’s former interest).
Indeed, one gets the inescapable impression that this is the first time that the Alaska Supreme Court (or at least the justice writing the opinion) has ever heard about this thing called a charging order. This frankly is not that unusual, particularly for the appellate courts of smaller states that do not have a high volume of business litigation. It is not unusual at all for district or superior court judges to have never heard of a charging order, and I can’t even begin to count the number of times that a judge has asked me to the effect of “What is a charging order?”
The point being that unless one is litigating before a court that they know is familiar with charging orders, it is necessary for the litigants to take the time to educate the court with the basics of what a charging order is, how it works, and what it does. If the court already knows this, or parts of it, then it is much easier for the court to simply skim past those parts of the briefs than it is to be stuck with a court that doesn’t understand the basics because the parties did not attempt to explain it adequately. In this case, there seems to be confusion at some points because one or more of the parties involved presumed that the Alaska Supreme Court knew things about charging orders that it obviously did not in retrospect.
Take that little piece of practice advice to heart.