Waiver of Member’s Dissociation by Reason of Bankruptcy

Waiver of Member’s Dissociation by Reason of Bankruptcy

     It is a standard provision in LLC Acts that a member’s bankruptcy dissociates that member, converting them into a mere assignee with no right to participate in management.  See, e.g., KRS §§ 275.280(1)(d), (e); Wa. Stat. §§ 25.15.130(1)(d), (e).  A member so dissociated, now an assignee, may be readmitted to member status by a vote of the incumbent members.  See, e.g., KRS § 275.275(1)(d); Wa. Stat. § 25.15.260(1).  A recent decision of a Washington state bankruptcy court determined that a member’s dissociation by reason of bankruptcy was waived.

     Charles McSwain was a member in Hawks Prairie Casino, LLC, a Washington limited liability company.  McSwain and his wife filed for bankruptcy under Chapter 11, listing their interest in Hawks Prairie as personal property.  The McSwains’ Plan of Reorganization provided:

Confirmation of the Plan shall automatically reinstate all of the debtors’ legal, equitable and other rights and Interests as existing immediately prior to the Petition Date with respect to Debtors’ interest in … Hawks Prairie Casino, LLC.

     Hawks Prairie objected to the Plan on the grounds that it was inconsistent with its operating agreement and the Washington LLC Act and “would impermissibly reinstate McSwain as a member with full management rights.”

     The Court, in what was ultimately dicta, engaged in an analysis of whether the operating agreement of Hawks Prairie was or was not an executory agreement, indicating that it satisfied two of the applicable elements of that analysis as employed in the Ninth Circuit, but then leaving the third element unaddressed as it moved to separate the basis of its holding. 

     Ultimately the Court concluded that there had been an implicit waiver of McSwain’s bankruptcy and the resultant dissociation.  Norberg had testified that she knew “from the very beginning” of the bankruptcy proceeding that by operation of law McSwain was an assignee.  However, even after his bankruptcy filing:

McSwain continued to be fully involved in all activity of Hawks Prairie and its management and Norberg treated him as a full member until May 22, 2009.  Norberg, as President of Hawks Prairie allowed McSwain to participate fully in managing the company and exercise all membership rights, including the right to vote.  Slip op. at 7.

     In at least one instance, McSwain’s vote in favor of a transaction was a condition precedent to the company having engaged in the transaction, an insufficient number of other members having voted in favor thereof. 

     The Court found that Norberg, having permitted McSwain to participate in management after his bankruptcy, waived the right to treat him as an assignee.  Having treated him as a full member in the face of knowledge that it was entitled to treat him as an assignee, the right to enforce the statutory and contractual consequences of bankruptcy were waived.  Consequent thereto:

Under Washington law and the Hawks Prairie Operating Agreement, McSwain is entitled to exercise his full management and membership rights in Hawks Prairie Casino, LLC.