This blog, written by Thomas E. Rutledge, focuses primarily on business entity law in Kentucky. Postings on contract law, contractual and statutory construction, and the entity law of other jurisdictions appear as well. There may as well be some random discussions of classical, medieval and renaissance history.
Thursday, August 13, 2015
Court Holds that Bankruptcy Trustee Succeeded to Right to Control LLC
Holds that Bankruptcy Trustee Succeeded to Right to Control LLC
recent decision from the United States District Court for the Southern District
of Indiana, it affirmed a determination of the Bankruptcy Court that when a
member of an LLC with voting control thereof filed personal bankruptcy, that
right to control the LLC became vested, as part of the bankruptcy estate, in
the trustee. As such, going forward, the bankruptcy trustee has control of that
LLC. In re Lester L. Lee, No.
4-15-cv-00009-RLY-WGH, Adv. Proc. No. 14-59011 (S.D. Ind. August 10, 2015).
operating agreement of Lee Group Holding Company, LLC (“Lee Group”) identified
a number of members, allocating to them certain economic and voting rights
within the company. While Lester Lee did not enjoy any right to either interim
or liquidating distributions from the LLC, he was afforded 51 votes therein;
the balance of the members held, collectively, 50 votes. As such, Lester
individually controlled a majority of the voting rights in the company.
then filed personal bankruptcy. After that filing, with the consequent entry of
an automatic stay, the trustee’s counsel reviewed the Lee group operating
agreement and wrote a letter providing in part that “this non-economic interest
[in Lee Group] became property of the estate subject to control of the Trustee
on the filing of the [bankruptcy] petition pursuant to 11 U.S.C. § 541.”
Thereafter, the other members of the Lee Group executed documents purporting to
accept Lee’s resignation from the Lee Group and the termination of his voting
rights thereunder. These actions were taken in the face of a provision of the
operating agreement which provides, inter
alia, that decisions require the approval of 51% of the voting rights
allocated amongst the various members. They also sought to adopt amendments to
the operating agreement, again acting without consideration of the 51 voting
units held by Lester Lee. After these actions were challenged by the trustee,
the bankruptcy court “concluded that the Debtor’s voting rights were property
of the estate as of the filing of the Petition and that the [actions of the
other members of Lee Group] purporting to terminate his voting rights violated
the automatic stay imposed by 11 U.S.C. § 362 and, therefore, had no legal
effect.” In re Lester L. Lee, 524
B.R. 798 (Bankr. S.D. Ind. 2014).
from that ruling that this appeal to the District Court was taken. On appeal,
the Court’s primary focus was upon whether the right to vote in an LLC
constitutes “property of the estate,” defined by section 541(a)(1) of the Bankruptcy
Code as “all legal or equitable interest of the Debtor in property as of the
commencement of the case. After finding that Lee could be a “member” of the LLC
notwithstanding the absence of any share in the company’s profits and losses or
the distributions it should make, the Court was able to determine that Lee was
a member. In a belt and suspenders analysis, the Court determined also that the
voting rights themselves could constitute “economic rights in the company”
affording him the opportunity to, for example, “ensure his continued employment
as manager” thereof.
basis, the determination of the trial court to the effect that any effort to
strip Lee of his right to control the LLC through the exercise of the 51 voting
rights was invalid as a violation of the automatic stay. HERE IS A LINK to this
not addressed by this opinion (it was not addressed by the trial court below)
is Section 23-18-6-5(a)(3)(B) of the Indiana LLC Act, which provides that “a
person ceases to be a member of a [LLC] upon the occurrence of any of the
following events:… (3) the person is removed as a member:… (B)… By the
affirmative vote, approval or consent of a majority in interest of the members
after the member has assigned the member’s entire interest in the [LLC].” By
this omission, the Court may be saying that, in effect, the assumption by the
bankruptcy trustee of the voting rights within the estate is not an
“assignment” as contemplated by this provision. Whether that is the Court’s
thinking is, however, still unknown.
been a long series of cases that have addressed the question of whether the
bankruptcy estate succeeds to a member’s right to participate in the management
and affairs of an LLC. Famously, in In re
Ashley Albright, it was determined that the bankruptcy court did succeed to
the management rights. See also
Thomas E. Rutledge and Thomas Earl Geu, The Albright Decision - Why
a SMLLC is Not an Appropriate Asset Protection Vehicle, 5 Business Entities 16 (Sept./Oct.,
2003).That, however, was in the context
of a single member LLC; Lee Group was a multiple-member LLC in which different
concerns were present. This decision is yet another in which it was held, inter
alia, that multiple-member versus single-member is not of itself a
distinguishing factor (although certainly those fact changes may impact upon
the executor contract analysis).See, e.g.,
Matter of H&W Food Mart, LLC, 461
B.R. 904 (Bankr..N.D.Ga., 2011); Norberg
v. Hawks Prairie Casino, LLC (In re
McSwain), 2011 WL 4706982 (Bankr. W.D.Wa., 2011); In re Alameda Investments, LLC, 2013 WL 3216129 (Bankr.C.D.Cal.,
Essentially, the members of the Lee Group vested control in Lester Lee.
Now, for all effects and purposes, control of the LLC has been vested in Lester
Lee’s bankruptcy trustee, and it appears there is little the members may do
about that. While they may be trapped in that situation, counsel drafting LLC
operating agreements (similar issues can arise under limited partnership
agreements) need to carefully consider how voting control is allocated and
address mechanisms by which, subject to the limitations of the automatic stay,
operational control of the business venture may be properly removed from a
bankruptcy trustee should that eventuality arise.
response to a cross-posting of this review, Professor Carter Bishop
opinion is clear that for bankruptcy purposes BRC 541 sweeps into the debtor
member’s bankruptcy estate “property” that includes the LLC interest and voting
rights pertaining to that LLC interest, even if the member was a noneconomic
member. The other members devoted their entire argument to BRC 541. They never
addressed BRC 365. As long as 541 applies, any action to terminate those rights
violates the automatic stay and are void and infective. The court so held.
court did not state the trustee could exercise those voting rights.The next step is crucial. If the operating
agreement is an executory contract of a multi-member LLC, BRC 365 will normally
respect LLC state law restrictions as “applicable law” and deny the trustee the
right to exercise the debtor’s voting rights (similar outcome to a
non-delegable personal service contract).This was a managing member of a
multi-member LLC, so I assume BRC 365 blocks the trustee’s exercise.
don’t think the opinion is quite as broad as Tom’s title suggests. It merely
holds that BRC 541 requires the voting rights to be included in the estate.
That does not conclude the matter which next shifts to BRC 365.
To which I respond:
point you identify, namely the capacity to vote (as contrasted with hold) the
voting interests is, well, interesting.
this nor the prior decisions discuss the operating agreement as or not as an executory
agreement - 365 has not been identified (based upon the pleadings I have
reviewed) as an issue.
In In re Garrison-Ashburn, L.C., 253 B.R.
700 (Bankr. E.D. Va. 2000), and I'm here working from memory, it was found that
the voting rights were part of the estate, but that the estate was dissociated
from the LLC; I think you are making the point that a similar outcome could
follow if and when there is a later challenge to the estate's exercise of its
voting control.I would not be surprised
if a court were to find “I’ve already said the voting rights are part of the
estate, and (a) its too late for you to argue section 365 and/or (b) when I
said the voting rights were in the estate I necessarily meant as well that the
estate could exercise the voting rights.”
the point has been already raised and rejected, or it simply has not been
raised, is unknown.I’ll see what more I