Monday, October 10, 2016

Petition of LLC to File for Bankruptcy Rejected: No Authority to File

Petition of LLC to File for Bankruptcy Rejected: No Authority to File


      In the decision from earlier this year, a bankruptcy court in Mississippi considered whether there was appropriate authority to file a bankruptcy petition on behalf of an LLC.  Holding ultimately that a vote of the members was required to file for bankruptcy, in that there is been no member vote, the petition was rejected. In re: Mid-South Business Associates, LLC, ___ B.R. ___, 2016 WL 4717939 (N.D. Miss. March 30, 2016).

      At the relevant time, this LLC had four members.  Two of those members were designated the “managers” of the LLC; those two members held well in excess of a majority of the interests in the LLC.  For reasons that are not detailed in this decision, the two managers abandoned the LLC, and the two non-manager members stepped in to manage its affairs. There was never, however, any vote of the members or any other official action to endorse these changes.
      Ultimately, the two non-manager members would assert that the managers had, as members, abandoned their interests in the LLC.  Thereafter, they on the LLC's behalf filed a petition for re-organization in bankruptcy. At that juncture, the two majority members filed an objection to the bankruptcy petition, asserting there was no authority to make that filing.
      The bankruptcy court applied the Mississippi Limited Liability Company Act and this LLC’s operating agreement and determined that there was no authority to file the bankruptcy petition.
      As to the alleged abandonment of the LLC and the loss of member status, the court found there was no provision to that effect in the LLC Act or the operating agreement.  As such the manager/members remained members in the LLC.
      The court identified two independent bases for finding that the bankruptcy petition was not authorized. First, while the operating agreement vested authority over business operations in the managers, it identified certain actions that could not be undertaken without the approval of two-thirds of the members. While bankruptcy was not listed therein, it was held that:
The Operating Agreement vested the Managers with the sole right to manage the business operations of the Debtor as necessary in the ordinary course of business, subject to any restrictions found in the Act. The Operating Agreement lists certain situations which require a two-thirds majority vote of the membership interests. Although filing a bankruptcy petition is not an enumerated action explicitly requiring a two-thirds majority vote, it is well-settled that “a decision to file for bankruptcy protection is a decision outside the ordinary course of business, even for an entity in dissolution.” In re Avalon Hotel Partners, LLC, 302 B.R. 377, 379 (Bankr. D.Or.2003)(emphasis added). Accordingly, even the Managers were not authorized to file for bankruptcy protection without a membership vote, because doing so is not within the scope of their authority as Managers under the terms of the Operating Agreement.  2016 WL 4717939, *8.
On the same point, the decision later recited:
Furthermore, the filing of a bankruptcy petition on behalf of an LLC is an extraordinary action that would have required a two-thirds vote of the membership interests in the Debtor pursuant to the Operating Agreement. See In re Arkco Properties, Inc., 207 B.R. 624, 628 (Bankr. E.D. Ark. 1997)(collecting authority for the proposition that “a bankruptcy filing is a specific act requiring specific authorization.”). 2016 WL 4717939, *9.
      In addition, the court observed that a bankruptcy petition would transfer the LLC’s property to the bankruptcy estate. As the operating agreement required the approval of two-thirds of the members in order to transfer all of the LLC's property, and as there had been no vote of the members, the petition was invalid. 2016 WL 4717939, *9.




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