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.
Monday, October 10, 2016
Petition of LLC to File for Bankruptcy Rejected: No Authority to File
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
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
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.