Dissociation from LLC upon Bankruptcy Violates Ipso Facto

Dissociation from LLC upon Bankruptcy Violates Ipso Facto (So says one Court)

     In In re: Dixie Management & Investment, Limited Partners, No. 5-08-6K-73874 (Bankr. W.D.Ark. May 9, 2011), the Court addressed whether the limited partnership, upon its chapter 11 filing, was dissociated as a member from Moberly Investment Group, LLC (“MIG”).  MIG’s operating agreement and the Arkansas statute (§ 4-32-802(a)(4)(B)) provide for dissociation upon bankruptcy.  Dixie was a 62% member in MIG.

     Responding to the assertion of automatic dissociation upon bankruptcy, Dixie argued the operating agreement is an executory contract and that dissociation violated the Bankr. Code § 365(e)(1) ipso facto clause.  Even if not executory, Dixie continued, dissociation would violate the Bankr. Code § 541(c)(1) ipso facto clause.

     Focusing upon § 541 (no evidence having been presented as to whether or not the operating agreement was executory under the Countryman test), the Court observed that Dixie’s interest in MIG became property of Dixie’s bankruptcy estate.  Rejecting automatic dissociation, the Court wrote:

Under § 541(c)(1), Dixie’s membership in MIG continues to exist and constitutes property of the estate, despite the conflicting provisions in the [operating agreement] and contrary state law.

The Court holds that the [operating agreement] language regarding the alleged dissociation of a member based on the filing of its bankruptcy petition is in contravention of the bankruptcy code, specifically § 541(c)(1), and, therefore, is ineffective….  Further, under § 363(l), Dixie is permitted the use and benefit of its interest in the LLC and has the right to continue as a member of the LLC.