Problems of Dealing with Limited Liability Company Interests(originally published in the Fall 2011 Edition of NABTALK, the Journal of the National Association of Bankruptcy Trustees)
Trustees are often faced with reviewing Debtors’ interests in businesses. As the tax benefits of pass-through entities became more popular, Debtors chose the Subchapter “S” Corporation (“S-Corporations”) format for their businesses. However, there were restrictions regarding the nature and number of shareholders in S-Corporations and the number of classes of stock ownership. The Limited Liability Company (“LLC”) became the answer to the SCorporation restrictions, since LLCs did not have to conform to all such restrictions.
Unlike corporations or partnerships, LLCs present unique issues. LLCs are formed by filing Articles of Organization with the appropriate state government agency on a prescribed form. The governance of the LLC is typically set forth in an Operating Agreement. The LLC can be managed by its members or a manager. If the LLC is run by a manager, the role of a Bankruptcy Debtor Member may become just a passive activity, simply waiting for periodic distributions from the LLC, provided it is profitable.
It is important to understand the issues related to the LLC membership interests of the Debtors to determine if you have an asset with sufficient value to sell or liquidate for the benefit of the Bankruptcy Estate. As with any business interest of the Debtor, you need to obtain reliable information regarding whether the LLC’s liabilities exceed the value of its assets. You should request and obtain copies of the Articles of Organization and the Operating Agreement for the LLC. It is also important to determine how the Debtor’s membership interest compares to the total number of memberships outstanding in the LLC. If there is any other document, other than the Operating Agreement, which restricts how membership interest may be transformed, a copy of that document should also be obtained. Lastly, ask if other members’ interests have been sold in the LLC and obtain details of these transactions.
Now you are ready to review the LLC membership interest of the Debtor and see if administration of the interest can be of benefit to the estate. There have been relatively few reported decisions on the administration of LLC interests by Trustees and even fewer by Chapter 7 Trustees. There are a number of issues that are particularly relevant in determining the relationship between the Debtor’s membership interest in the LLC and a Trustee’s ability to sell that interest, protect that interest from creditors outside of the Debtor’s bankruptcy or prevent the Debtor from dissipating assets of the LLC.
LLCs where the Debtor is the single member and the LLC is member-managed:
Authority for the Trustee to assume control over the single member LLC:
One of the threshold questions in determining the extent of a Trustee’s rights in a Debtor’s LLC membership interest is whether there are other membership interests in that LLC. The traditional rule with LLCs in bankruptcy has been that the property of the estate encompasses only the Debtor’s economic interests (i.e., rights to payment and distribution) and not any of the Debtor’s authority to manage or control the LLC. This is the typical result when a charging order is granted with respect to the LLC. In Modanlo the court, applying Delaware law, held that, though this truism did apply in situations where there were other members in the LLC besides the Debtor (“in order to protect them from the rigors of an undesired comanagement relationship”), it did not apply where the Debtor was the sole member of the LLC.1 Because the Chapter 11 Debtor was a sole member, and because Delaware law provides that a person ceases to be a member of an LLC if that person files a petition for bankruptcy, when the bankruptcy was filed, the LLC no longer had any members by operation of law and when an LLC “is dissolved for lack of remaining members, Del. Code Ann. Tit. 6, § 18-806 empowers the bankruptcy Trustee, as personal representative of the last remaining member, to consent to the continuation of the LLC and to become the sole managing member of the LLC.”2
Because the LLC in question in Modanlo was a single member LLC, the bankruptcy court found that the Trustee “had the power to place [the LLC] into bankruptcy upon his appointment, and, standing in the shoes of the Debtor and complying with the mandates of the Delaware Act, possesses both the economic and governance rights to participate in the management of the LLC that the Debtor himself enjoyed prior to his bankruptcy filing.”3 The Colorado District Court inAlbright came to a similar conclusion, holding that, upon the filing of the Chapter 7 Bankruptcy, the Trustee was effectively assigned the Debtor’s membership interest in the LLC, pursuant to 11 U.S.C. § 541.4 The Trustee, therefore, controlled the governance of the LLC and had the power to elect and change managers, pursuant to Colorado’s Limited Liability Act.5
The Debtor’s argument in Albright was that the Trustee only held a Charging Order against the Debtor’s interest. If the Trustee is limited to a Charging Order remedy, only the income stream due by the Debtor will be available for administration (as is typically the case with a Debtor’s membership in a multi-member LLC). The Debtor’s argument failed because this was a single member LLC and there were no other members’ interests to protect. In a footnote, the Bankruptcy Court noted that fraudulent transfer provisions pursuant to 11 U.S.C. § 541(a)(1) and 548 (a) could be used to avoid transfers of minority interests in Limited Liability Companies by clever Debtors trying to frustrate creditors.6
An analogous result was reached in In re A-Z Electronics. In that case, the Chapter 11 Trustee moved to dismiss the Chapter 11 petition as unauthorized because the managing and sole member of the LLC, who sought to file a Chapter 11 petition on behalf of the LLC, was himself in the process of a Chapter 7 bankruptcy.7 The court agreed with the Trustee, finding that when the Debtor filed his Chapter 7 bankruptcy, under Idaho law, the Debtor’s interest in the LLC was personal property that became property of the estate.8 As such, the Debtor had no authority to file the Chapter 11 bankruptcy on behalf of the LLC because the LLC was at that point “subject to the sole and exclusive authority of the [Debtors’] Trustee. That Trustee was the only one entitled to manage the [LLC] and decide inter alia whether the LLC would or would not file bankruptcy.”9 Similarly on point with respect to this issue, the court in In re First Protection stated that:
We conclude that all of the Debtors’ contractual rights and interest in [the LLC] became property of the estate under § 541(a)(1) by operation of law when they filed their petition. Section 541(c)(1)(A) overrides both contract and state law restrictions on the transfers or assignment of Debtor’s interest in [the LLC] in order to sweep all their interests into their estate. . .As a result, the Trustee was not a mere assignee, but stepped into Debtors’ shoes, succeeding to all of their rights, including the right to control [the LLC].10
Narrowing the above line of cases is In re Desmond.11 In Desmond, the Debtor filed a Chapter 11 petition in November of 2003 and in his schedules he listed his 100% ownership interest in an LLC.12 Shortly after the Debtor’s petition, the LLC entered into a contract with another entity, which contract the LLC allegedly breached—giving rise to the other entity’s efforts to sell the collateral securing the contract.13 The Trustee and the Debtor filed suit against the other entity, seeking to enjoin the sale under the theory expressed in Albright that the Debtor’s ownership interest in the single member LLC included management rights, such that the assets of the LLC should be encompassed by the automatic stay.14 The court held that the LLC
“is not a Debtor under the protection of [the Bankruptcy Code]. The actions taken by the Defendants against [the LLC], are actions between two non-Debtor entities. Prior to the Debtor’s filing of his complaint. . ., the Debtor treated [the LLC] as a separate entity. . .This Court, on the facts of this case, will not exercise its power to enjoin a creditor from pursuing its alleged rights against a non-Debtor LLC.”15
The court distinguishes Albright in that the action in dispute in that case (namely, the Debtor’s attempt to cause her LLC to file for bankruptcy) was one undertakenafter the Debtor had filed his own Chapter 7 petition whereas in the case sub judice, the action giving rise to the creditor’s claim (entering into the contract with the defendants secured by collateral) was one that had taken place prior to the filing of the bankruptcy petition—and therefore actions undertaken by creditors pursuant to the Debtor’s pre-petition actions could not be enjoined by the Trustee.16
Assets of the LLC or assets of the Debtor: how do exemptions and the automatic stay apply?
The Desmond case provides an appropriate segue to the next issue. Armed with the knowledge that a Trustee can potentially seize control of an LLC where the Debtor is the sole member, the next question is whether there will be any assets left in the LLC by the time the Trustee takes action. Typically the automatic stay would prohibit creditors from seizing particular assets that are part of the bankruptcy estate, but are assets of a single member LLC included in the Bankruptcy Estate for purposes of the application of the automatic stay prior to the Trustee’s seizure of control? The majority position appears to be “no.” In addition to the holding in Desmond, supra, in the case of In re Calhoun and cases citing it, the courts express the traditional notion that an LLC’s assets are separate from the Debtor’s and therefore the automatic stay does not protect the assets of an LLC, even if the Debtor is the sole member.17 In re Furlong, citing Calhoun, phrases the rule aptly: “unless a corporation is itself a bankruptcy Debtor, the automatic stay afforded to an individual Debtor under § 362(a) does not extend to the assets of a corporation in which the Debtor has an interest, even if the interest is 100% of the corporate stock.”18 The court in Calhoun further advised that, despite the Debtor having named his LLCs in his petition, the separate LLCs needed to file their own bankruptcies to involve the Automatic Stay.19 Extending the logic in this case is In Re Aldape Telford Glazier, Inc., holding that subsidiaries, which were separate entities from the parent company Debtor, were required to file separate cases even if the LLCs were winding up of their affairs—winding up cannot be done through the parent’s case because the Chapter 7 Trustee for the Debtor could not be forced to wind up the affairs of the subsidiary LLCs.20
For a similar result, see In re Rodio.21 In that case, the court held that if a Creditor holds a security interest in an asset owned by a LLC, the Debtor cannot move for the valuation of the asset in the Chapter 13 case and fend off a Motion for Relief from Stay and Abandonment because the asset (a tractor) was owned by the LLC, even though the Debtor scheduled the tractor as his individual asset.22 Although the Creditor held a purchase money security interest in the tractor, the Debtor contended that he had an equitable interest in the tractor and that the tractor was needed for his reorganization.23 The Court found that the only asset in the Estate was the Debtor’s membership interest in the LLC and, accordingly, the stay was not applicable to the tractor, thus no determination under §506(a) was necessary.24 Coming to a similar conclusion is In re Penn, which recognized that “once the sole owner of an LLC files a bankruptcy petition, the membership interests themselves become property of the owner’s estate, but it does not compel the conclusion that the actual assets of the LLC are property of the owner’s estate. Accordingly, the Debtor’s argument that the automatic stay applied to protect [the LLC], a nonDebtor, from the [creditor]’s foreclosure must be rejected.”25
The conflicting approach, that the automatic stay can encompass assets held by a Debtor’s single member LLC, is presented in the Ealy case.26 In Ealy the Debtors operated a child care center and they wanted to own the real estate housing the center.27 The Ealys formed an LLC to take title to the real estate.28 The mortgage lender foreclosed on the real estate, but the Debtors filed a bankruptcy case just prior to the Sheriff’s Sale.29 The Bankruptcy Court found that the Debtors held equitable title, since they never intended that the real estate would be titled solely in the LLC’s name.30 Accordingly, the Automatic Stay extended to the real estate, protecting the real estate from the Creditor’s Foreclosure Action.31 Though the court in Ealy found that the real estate titled in the name of the LLC wasprotected by the automatic stay arising from the Debtor’s bankruptcy petition, both the bankruptcy court and the district court on review placed heavy emphasis on the intent of the Debtors (the plaintiffs neither intended to form the LLC for purposes of obtaining liability nor for the title to the property to be held solely by the LLC—rather, they thought formation of the LLC was a necessary formality required in order to execute the real estate transaction), thus limiting any broad applicability of the holding.32
Taking a similar approach as the Ealy case is In re Schwab.33 Schwab differs in that, rather than determining the Debtor’s ownership in assets with respect to the LLC for purposes of the applicability of the automatic stay, the court instead determined that the Debtor rather than the LLC, owned the assets for purposes of applying certain of the Debtor’s personal exemptions to those assets.34 The policy and ultimate result, however, were ultimately the same: the Debtor rather than the LLC was considered the owner of the assets when the evidence and equities dictated such a result. Specifically, the assets at issue were tools and certain receivables.35 The Trustee argued that both should be determined to be assets of the LLC, which would then be a part of the Debtor’s ownership interest in the LLC, and would therefore qualify under the much smaller intangible asset exemption.36 The court, however, agreed with the Debtor in holding that the tools were property of the Debtor (and thus exempt as tools of the trade) because, though their depreciation had been assigned to the LLC in the Debtor’s tax return, the court found that the Debtor purchased the tools with her personal line of credit and in her own name and thus the Debtor had not intended them to be assets of the LLC.37 The court determined that the receivables were charges for the Debtor’s labor and thus constituted earnings—a portion of which were exempted by statute.38 This ruling can be differentiated from In re Rodio in that the LLC in this case was free from the interests of creditors and the tools at issue were titled in the individual’s name rather than in the name of the LLC.
Transfers of membership interests and assets from a Debtor’s single-member LLC as fraudulent transfers:
Though the majority of cases appear to provide that the automatic stay falls short of encompassing actions against a Debtor’s single-member LLCs, what about transfers from those LLCs to other entities. Are these sorts of transfers potentially avoidable by the Trustee? Seemingly not. Though the footnote in Albrightstates that transfers of a Debtor’s ownership interest in an LLC could qualify as an avoidable transfer, most cases have found that transfer of the LLCs assets do not qualify as such (providing a pretty simple end run around the membership interest transfer limitation for the Debtor). Under the rubric applied with respect to the majority of the automatic stay cases above, the LLC is a separate and distinct entity and, if the automatic stay does not protect them from creditors, the extension of that logic is that fraudulent and preferential transfer restrictions would not apply to that LLC either. This is the approach taken in In re Adams.39 In Adams, the husband and wife Debtors obtained property in 2005 and transferred that interest to an LLC owned by the husband.40 In March of 2007 the property was transferred to a corporation owned by the Debtors’ son.41 In November of 2007 the Debtors filed their petition (17 days after they had recorded a warranty deed transferring the LLC to the son’s corporation).42 The court held that because the property was owned by the husband’s LLC at the time of the transfer, it was not property of the individual Debtor subject to the provisions of § 547(b) and thus could not be avoided by the Trustee.43 The court stated that “[u]nder principles of corporate law, the Debtor's property interest is narrowly confined to the intangible rights represented by the stock certificate or other ownership documentation. Accordingly, the property of [the LLC] cannot be drawn into the bankruptcy estate, and any transfers the L.L.C. made are not attributable to the Debtors and are not preferential transfers to be recovered by the bankruptcy Trustee.”44
It is evident how the Adams result is somewhat problematic in terms of preservation of estate assets. Had Mr. Adams tried to transfer ownership of his LLC to his son during the preference period, this would obviously have constituted an avoidable transfer. Instead, by taking the most significant asset owned by his LLC and transferring that to his son’s LLC, thereby limiting the value of the Debtor’s (and therefore the bankruptcy estate’s) interest in the LLC, Mr. Adams effectuates the same result without triggering any of the Trustee’s avoidance powers.
Single-Member LLC Operating Agreements as Executory Contracts
The court in In re First Protection further noted that § 365 relating to executory contracts was not applicable to that case because “there is no reason to prohibit a Trustee in bankruptcy from assuming all of the rights and obligations of a Debtor who is the only member of a single member LLC. In that case, there are no non-Debtor members whose interests could be harmed by the operation of the LLC by a Trustee or a Debtor in possession.”45 As is discussed infra, the approach that courts will take on this issue in the context of multi-member LLCs is less clear.
Authority for Trustee to sell Debtor’s membership interest
The situation in In re Harding presents what is probably the ideal situation when a Trustee seeks to sell the Debtor’s membership interest in a multi-member LLC.46 In that case the court affirmed the Trustee’s efforts to sell the Debtor’s 50% membership interest in two LLCs to the other 50% member of those LLCs.47 The court specifically found that because the Trustee conducted an auction of the assets which failed to yield any offer even close to that which was offered by the proposed buyer, the buyer’s offer constituted the ‘highest and best’ offer and thus it was a fair and arm’s-length transaction.48 Further, the court noted that, “[t]he Membership Interests are not readily marketable and the Trustee has not received any offers at a five figure price other than the sale described herein. In particular, any new owner, holding precisely 50% of the equity, would be limited in his/her ability to change or control existing management.”49 For a similar attempt and result, see In re Rosbottom, where the court granted the Chapter 11 Trustee’s motion for sale of the Debtor’s 50% and 25% interest in two LLCs to a remaining member of those LLCs free and clear of all encumbrances under the authority of § 363(b).50 Again, the court noted that it was an arm’s length transaction and specifically mentioned that the Trustee had rejected the initial purchase price for the 25% interest in one LLC and that the current price was based on the Trustee’s subsequent counteroffer.51 In sum, these cases stand for the proposition that the Trustee can sell the Debtor/estate’s interest in a multi-member LLC to the other members—but the courts will continue to give a hard look to those offers to reduce the prevalence of sweetheart deals that would be detrimental the estate’s creditors.
Reduction of the Debtor’s interest by the other members
Just as the court may sell the Debtor’s membership interest as part of the estate, it follows that an attempt by another member of the LLC (in which the Debtor owned an interest as of the petition date) to reallocate membership interests post-petition constitutes a violation of the Automatic Stay—as that interest is part of the estate which receives that protection.52 The court in In re McCabe held that such attempts are null and void, and further such attempts were enjoined--the Debtor’s membership interest is available for liquidation by the Trustee.53
Extent of the ownership interests and authority transferred to the Trustee:
The general rule, as articulated in In Re Erpenbeck, is that the Trustee of a Debtor member is unable to administer the assets of the LLC themselves.54 In that case, the Debtor owned a 50% interest in an entity, which in turn owned a piece of real property, and the Debtor transferred his interest in the LLC to a separate LLC for no consideration.55 The separate LLC then transferred that interest to a trust in favor of the Debtor’s children, also for no consideration.56 The court held that both transfers of the interest in the original LLC were transfers of ‘property of the estate’ such that those transfers could be avoided if the other requirements for avoidance were met.57 The court also held, however, with respect to the Trustee’s attempt to sell the real property under § 363 that, under Kentucky law governing LLCs “property transferred to or otherwise acquired by a limited liability company shall be the property of the limited liability company and the members individually. Accordingly, the Debtor does not and never has held a ‘legal or equitable interest’ in the Property. . .Thus, the Property does not constitute property of the estate and may not, therefore, be sold under §363 of the Bankruptcy Code.”58 Again, just as in the Mays single-member LLC case described, supra, this distinction allows the Debtors to avoid the impact of the first part of the holding (Debtor’s ownership interest in the LLC is property of the estate) by simply transferring all of the assets of the LLC to some other entity in which the Debtor does not have an interest (such as a trust for the benefit of the Debtor’s children). Also in this vein is Beane v. Beane, wherein the court held that a Defendant’s proposed counterclaim, which alleged that a foreclosure of interests in an LLC’s property (that property being a tort claim against the other LLC member) violated the automatic stay put in place by defendant’s bankruptcy, was futile because the foreclosure gave plaintiff possession of the LLC’s property, which was not property of defendant’s bankruptcy estate under 11 U.S.C.S. § 361(a)(1) because, under N.H. Rev. Stat. Ann. §304-C:45 “[a] limited liability interest is intangible personal property,” and an individual “member has no interest in limited liability company property.”59
Similar results have been reached in the context of fraudulent transfers. The court in In re Mulder stated in dicta that “[e]ven if [Debtor] owned such an interest [in the LLC], only that interest would be property of the bankruptcy estate . . . Property belonging to the limited liability company itself would not . . . A member is not a co-owner of, and has no transferable interest in, property of a limited liability company . . . If the sale [of the LLC property] were voided as a fraudulent conveyance, then, the monies recovered would belong to [the LLC] and not [the Debtor].”60
A similar, and yet divergent, categorization of the Debtor’s interest in a multi-member LLC been applied with respect to exemptions. In In re Mays, a case arising under Indiana statutes governing the formation of LLCs, the Debtors argued that any transferable interest they had was limited to ‘economic interests’ and because the revenues from the LLC were zero, the entire interest was exempt.61 The Court sustained the Trustee’s objection to the Debtor’s exemptions, holding the Debtors were limited to the $350 in available exemptions for intangible assets provided under Indiana law (rather than the 100% exemption sought by the Debtors), similar to the determination in Beane, supra.62 Additionally, in a footnote the court in Mays questioned the Trustee’s concession that he was limited to the rights of an “assignee” of a membership interest in the LLC, as §541(a) allows the Trustee to succeed to the Debtor’s ownership of the LLC interest.63 This suggests that the Court’s view was that the Trustee’s position is superior to that of a Judgment Creditor, which is generally given the status of an ‘assignee’ and therefore does not confer any management rights—leaving open the door for an extension of the reasoning in Albright and Modanlo (supra, dealing with single-member LLCs) to multi-member LLCs.
In accordance with this footnote from Mays, the principle that a Trustee of a Debtor in a multi-member LLC only succeeds to ‘economic rights’ is further eroded in the case of In re Allentown Ambassadors.64 In that Chapter 11 case, the Debtor was a corporation that operated a minor league baseball team.65 This corporation/baseball team was a member of a league formed as an LLC.66 Shortly after the Debtor filed its petition for Chapter 11 bankruptcy, the league voted to dissolve itself.67 Three months later, all of the members of the original league LLC except the Debtor formed a new league through a new LLC.68 The Debtor then brought an adversary proceeding in its bankruptcy against the other league members.69 One of the key issues in the case is whether the Debtor (and hence the Trustee) maintained an interest in the management of the LLC after the Debtor’s petition, despite ipso facto clauses in the LLC Operating Agreement and applicable portions of Pennsylvania’s Limited Liability Company Act stating that the member’s management interests terminate upon bankruptcy filing.70 The court only went so far as to hold that summary judgment in favor of the defendants (the league members who formed the new LLC) was not appropriate, and therefore it “must reject the Defendants’ contention that the only property interests at issue under 11 U.S.C. § 362(a)(3) are the Debtor’s economic rights as an assignee of a membership interest in the NAB, LLC. For purposes of the Motion, I must also assume that the Debtor may have retained its status as a member of the LLC.”71 Because the other members’ actions in forming the new league could potentially be proven to affect both the Debtor’s economic and membership interests (which could potentially continue after the petition was filed), the Debtor’s complaint was allowed to move forward as to both of these claims. For a similar result, see In Re Lahood, wherein the court held that ipso facto clauses contained in both the Illinois LLC Act and the operating agreement governing the LLC at issue which required the Debtor to be disassociated were not enforceable and therefore could not terminate the Trustee’s membership interest in the LLC because § 541(c) trumped those provisions.72
LLC Operating Agreements as Executory Contracts
Another issue in Allentown Ambassadors and other cases is the extent to which the operating agreement of a multi-member LLC constitutes an executory contract. The position taken in Allentown Ambassadors and Daugherty Construction is that the operating agreement of an LLC is an executory contract such that the provisions of § 365 (particularly subsection (e)) are applicable.73 Under § 365(e), the terms of an operating agreement stating that the LLC must be dissolved upon a member’s bankruptcy, death, etc. are rendered unenforceable so long as the contract is executory (i.e., “a contract under which the obligation of both the bankruptcy and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other.”)74
In another case, a member of an LLC filed a Chapter 11 Bankruptcy. That Court held that the ipso facto clause in the LLC’s operating agreement, providing that it would be an event of disassociation for any member to petition for bankruptcy relief, did not prevent the Debtor’s 62% membership interest in the LLC from being included in property of the estate. There the Arkansas state statue provided that a party ceases to be a member of a limited liability company when the party “[f]iles a voluntary petition in bankruptcy” was preempted by 11 U.S.C. § 541(c)(1), and did not prevent Debtor’s membership interest from being included in the Debtor’s Chapter 11 Estate.75
See also In re Garrison-Ashburn76, which held that the operating agreement was not an executory contract and therefore ipso facto clauses were not enforceable. The case was also important because it discusses assignment of both control and economic rights in a multimember LLC. Similarly, the court in In re DeLuca77 held that the operating agreement was executory because it required personal services and therefore the Trustee could not assume the member’s management interests pursuant to §365(b)(1)).
The court in In Re Lahood held that, although the charging order process outlined in the Illinois LLC Act was not the only means for a creditor to obtain a lien against a member’s interest in a multi-member LLC, in order to establish priority and actually execute and satisfy the judgment lien, a charging order must be obtained.78 By contrast, the Florida Supreme Court held in the FL Olmstead case, in response to a certified question from the 11th Circuit that, with respect to a single-member LLC, a charging order under the LLC statute was not the exclusive remedy for a creditor of the single-member LLC.79 The FL Olmstead court clearly emphasized the fact that they were dealing with a single-member LLC.80 A charging order, essentially limiting the creditor to the Debtor-member’s distributional (i.e., economic) interest in the LLC, serves as a means by which creditors can receive some payment on their lien without influencing the operation of the LLC to the detriment of the other members.81 In FL Olmstead, the court clearly concluded that the policy reasons supporting the use of charging orders as an exclusive remedy for satisfaction of a judgment in the context of multi-member LLCs simply did not apply to single-member LLCs because there is no interest to protect besides the Debtor’s.82
Given these conflicts and problematic issues with respect to the applicability of bankruptcy rules to LLCs, it has been recommended by the National Bankruptcy Review Commission Recommendation (“Recommendation”) issued in 1997 that LLCs should be specifically exempted from the application of certain portions of the Bankruptcy Code and, instead, new sections designed specifically for LLCs should be drafted and enacted. See, Bankruptcy: The Next Twenty Years. Included in this proposed overhaul would be a provision requiring
[D]ebtor LLC members in member-managed LLCs should be treated like General Partners under the Bankruptcy Code. Similarly, Debtor managers of manager-managed LLCs should be treated like general partners under the Bankruptcy Code. This treatment should be limited to three aspects of the LLC member or LLC manager relationship: (1) continuity of LLC after LLC member’s or manager’s bankruptcy filing; (2) transferability of LLC ownership interest; and (3) management rights in the LLC.
Recommendation, reproduced at Bankruptcy: The Next Twenty Years, p. 424.
Another recommendation is the removal of LLCs and partnerships from consideration under § 365 dealing with executory contracts—followed by the addition of a new section to the Bankruptcy Code that would specifically govern documents and relationships in LLCs and partnerships. Id. at 428. Further, the Recommendation suggests that ipso facto provisions (those that operate to terminate or modify the rights of a member or partner based on insolvency, financial condition, or commencement of a bankruptcy case) in non-bankruptcy statutes (primarily state statutes modeled after the Uniform Limited Liability Company Act) and similar provisions in partnership or LLC governing documents should be rendered unenforceable. This directly tracks the logic from cases such as In re Allentown Ambassadors, which have held such provisions to be unenforceable.
There are a number of published decisions regarding LLC interests in bankruptcy cases. You can make arguments to administer many of these interests and their respective rights as you administer a member Debtor’s Bankruptcy Estate. Unfortunately, the multi-member LLC still presents problems for administration of anything but distributions due the Debtor, unless there is a market for that LLC’s membership interests to sell those interests to third parties.
1 In re Modanlo, 2006 U.S. Dist. LEXIS 96045 at *31 (D. MD. 2006), affirmed, Final Analysis Commun. Servs. v. Ahan (In re Modanlo), 2008 U.S. App. LEXIS 3685 (4th Cir. 2008).
2 Id. See also, In re Dwek, 2011 U.S. Dist. LEXIS 2011 (Mar. 31, 2011) (citing Modanlo in holding that a determination of whether a third party had a membership interest in certain LLCs in addition to the Debtor’s interest, thus resulting in the LLCs being multi-member LLCs, was threshold to determining whether the Trustee had authority to participate in the management of the affairs of the LLCs). 3 In re Modanlo, 412 B.R. 715, 731 (Bankr. D. Md. 2006).
4 In re Albright, 291 B.R. 538, (Bankr. D. Colo. 2003) 5 Id. at 541.
6 Id. Also, please note that Movitz v. Fiesta Investments, LLC (In Re Ehmann) 319 B.R. 200, 206 (Bankr. D. Ariz. reached the same result as Albright for multi-member LLCs, but it has been vacated due to a settlement.
7 In re A-Z Electronics, LLC, 350 B.R. 886 (Bankr. D. Id. 2006).
8 Id. at 890.
9 Id. at 891.
10 Fursman v. Ulrich, (In re First Protection Inc.), 440 B.R. 821 (9th Cir. B.A.P. 2010)
11 Desmond v. U.S. Asset Funding, LP (In re Desmond), 316 B.R. 593 (Bankr. D. N.H. 2004) 12 Id. at 594.
13 Id. at 594-95.
14 Id. at 595.
16 Id. at 595-96.
17 In re Calhoun, 312 B.R. 380 (Bankr. N.D. Iowa 2009), cited with approval by, In re Furlong, 437 B.R. 712, 721 (Bankr. D. Mass. 2010); In Re Aldape Telford Glazier, Inc., 410 B.R. 60, 64 at n. 5 (Bankr. D. Idaho 2009). 18 Furlong, 437 B.R. at 721.
19 In re Calhoun, 312 B.R. at 383.
20 In Re Aldape Telford Glazier, Inc., 410 B.R. at 66.
21 In re Rodio, 257 B.R. 699 (Bankr. D. Conn. 2001)
22 Id. at 701-02.
23 Id. at 701.
24 Id. at 702.
25 In re Penn, 2010 Bankr. LEXIS 1546 at *11 (Bankr. N.D. Ga. 2010).
26 In re Ealy, 307 B.R. 653, 658 (Bankr. E.D. Ark. 2004)
27 Id. at 655-56.
29 Id. at 656.
30 Id. at 658.
33 In re Schwab, 378 B.R. 854 (Bankr. D. Minn. 2007).
34 Id. at 857.
35 Id. at 857-58.
39 Nossaman-Petitt v. Adams Enters. Inc. (In re Adams), 2009 Bankr. LEXIS 3164, at *8 (Bankr. D. Neb. 2009).
40 Id. at **5-6.
41 Id. at *6.
43 Id. at **8-9.
45 In re First Protection Mortgage, 440 B.R. at 832 (citing Modanlo, 412 B.R. at 727).
46 In re Harding, 2009 Bankr. LEXIS 4206 (Bankr. D. Mass. 2009) (also note, contained in the reported version of this case is the Trustee’s actual motion seeking approval of the sale of the LLC interests—it provides an excellent template.) 47 Id. at **14-18.
48 Id. at **4-6.
49 Id. at *17.
50 In re Rosbottom, 2010 Bankr LEXIS 2864 (Bankr. W.D. La. 2010) further proceedings at, 2010 Bankr LEXIS 2873 (Bankr. W.D. La. 2010).
52 See, e.g., In re McCabe, Plaintiff, v. George Panagiotou and GEDCO, LLC, Defendants., 345 B.R. 1 (D. Mass.
2006); In Re Erpenbeck, 2004 Bankr. LEXIS 739 (Bankr. E.D. KY 2009) (similar ruling where Debtor himself tried to transfer his membership interest to another entity.) 53 McCabe, 345 B.R. at 10.
54 Erpenbeck, at *8.
55 Id. at *4.
57 Id. at *7.
58 Id. at *8.
59 Beane v. Beane, 2011 U.S. Dist. LEXIS 8872 at *27 (D. N.H. 2011).
60 Baker Dev. Corp. v. Mulder (In re Mulder), 307 B.R. 637, 647 (Bankr. N.D. Ill. 2004).
61 In re Jeffrey V. Mays and Edith R. Mays, U.S. Bankruptcy Court for S.D. of Indiana, Case No. 10-11132-JKC-7A, Order dated December 3, 2010. 62 Id. at *5.
63 Id. at *4, n. 1.
64 In re Allentown Ambassadors, 361 B.R. 422 (Bankr. E.D. Pa. 2007).
65 Id. at 426.
67 Id. at 431.
70 Id. at 446-47.
71 Id. at 457.
72 In Re Lahood, 437 B.R. 330 (D. C.D. ILL. 2010).
73 Allentown Ambassadords, 361 B.R. at 444; In re Daugherty Construction., Inc., 188 B.R. 607, 612 (Bankr. D. Neb. 1995).
74 In re Tsiaoushis, 2007 U.S. Dist. LEXIS 53376 at *5 (quoting Countryman, Executory Contracts in Bankruptcy, 57 MINN. L. REV, 439, 446 (1973))
75 Duncan v. Dixie Mgmt. & Inv., Ltd. Partners (In re Dixie Management & Inv Ltd Partners), 2011 Bankr. LEXIS 1686 (Bankr. W.D. Ark. 2011)
76 253 B.R. 700 (Bankr. E.D. Va. 200)
77 194 B.R. 65 (Bankr. E.D. Va. 1996)
78 In Re Lahood, 437 B.R. at 330
79 Olmstead v. FTC, 44 So. 3d 76, 83 (Fla. 2010).
80 Id. at 81.
81 Id. at 78-79.
82 Id. at 81.
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