Protecting Your Project From Litigation: Limited Liability Company vs. Partnership

If you have multiple investors/owners, one of the benefits of using a Limited Liability Company (LLC) to own real property rather than using a partnership is that the LLC offers better protection of the real property from creditors of any individual part-owner (LLC member or partner).  A judgment creditor of an LLC member is limited to getting a charging order against the member’s interest in the LLC.  The charging order gives the judgment creditor the rights of an assignee of the member’s interest.  This assignee position simply gives the judgment creditor the “passive” right to receive the distributions from the LLC (if any) that would otherwise go to the LLC member.  The judgment creditor of the LLC member is then at the mercy of the LLC managers to distribute funds.  Importantly, the charging order does not enable the judgment creditor of the LLC member to seek dissolution of the LLC or otherwise force a sale of the real property owned by the LLC.  See A.R.S. §§ 29-655 & 29-732. 

In the circumstance where the real property is owned by a partnership, a judgment creditor of an individual partner can likewise obtain a charging order against the individual partner’s interest in the partnership, but the real difference is what the judgment creditor of the individual partner can do with the charging order.  In contrast to the LLC situation, the judgment creditor of an individual partner may be able to dissolve the partnership and force the sale of the real property.  For the judgment creditor of the individual partner, getting the charging order may simply be the first step in a more “active” and fruitful series of actions.  The charging order constitutes a lien on the partnership interest.  The court may then allow foreclosure of the lien; and the purchaser at the foreclosure sale then has the rights of a transferee.  The transferee, in turn, has a right to receive, on dissolution and winding up of the partnership business, the net amount otherwise distributable to the partner whose interest was foreclosed upon.  The transferee may not have to simply wait for the other partners to dissolve and wind up the partnership, but instead has an opportunity to seek a judicial determination that it is equitable to wind up the partnership business.  Such application by the transferee can be made in one of three circumstances: (i) at the end of the definite term, if the partnership is for a definite term; (ii) after completion of the undertaking, if the partnership was for a particular undertaking; or (iii) at any time, if the partnership was a partnership at will.  See A.R.S. §§ 29-1043(B); 29-1044; 29-1071(6).  At this final “equitable determination” stage, there may be a debate whether the partnership was “for a particular undertaking” or “at will.”  One Arizona court has held that a partnership for acquisition, development, and sale of real property would qualify as a partnership for a particular undertaking, but if the partnership agreement included operating or leasing the property, the partnership would not qualify as a partnership for a particular undertaking, because the property could conceivably be operated or leased for an indefinite period of time.  Chandler Medical Building Partners v. Chandler Dental Group, 175 Ariz. 273, 855 P.2d 787 (App. 1993).  Therefore, a partnership that gave the partners the option to operate or lease the property would likely be a partnership “at will,” and the judgment creditor of the individual partner would have the ability to ask the court to dissolve the partnership and force the sale of the property over the objection of the partners.