Tuesday, December 30, 2014

Stripping Member of Management Rights in LLC After Bankruptcy Violated Automatic Stay

Stripping Member of Management Rights in LLC After Bankruptcy
Violated Automatic Stay


In a recent decision, it was held that stripping an LLC’s member of the right to vote in and control an LLC after bankruptcy violated the automatic stay.  This is an important decision as it responds to the question of whether or not the right to participate in management, as contrasted with the right to participate in the economics of the LLC, shall be deemed part of the bankruptcy estate.  Walro v. The Lee Group Holding Co., LLC (In re Lee), Case No. 12-90007-JJG-7A, Adv. Pro. No. 14-59011 (Bankr. S.D. Ind. Dec 18, 2014).
Lee held 51 of the 100 voting units in and therefore controlled The Lee Group Holding Company, LLC.  He held, however, no economic rights in the LLC.  After he filed for bankruptcty protection the trustee asserted that Lee’s “non-economic interest [in the voting rights] became property of the estate subject to control by the Trustee on the filing of the petition pursuant to 11 U.S.C. § 541.”  Slip op. at 9. The other members then executed a Resolution wherein they purported to accept Lee’s withdrawal as a member or the LLC – this removal was identified as being pursuant to section 3.7 of the operating agreement, but its language is not recited in the opinion.  They also purported to remove him as a manager and to elect a replacement manager.
The trustee brought this action challenging Lee’s removal as a member and manager of the LLC.
Curiously, the members defended their action on the basis that Lee was not really a member in that he did not share in the economics of the LLC, a notion that was quickly rejected by the court, it noting that the operating agreement referred to lee as a member.  The court also found that as Lee held a majority of the voting rights in the LLC it was not possible for the other members to alter the terms of the operating agreement.
The opinion did not reference the section of the LLC Act providing, inter alia, that a member is disassociated (and loses their voting rights) upon bankruptcy.  Likely the other members did not rely upon that provision in light of the many decisions that have found such statutes to violate the Bankruptcy Code’s prohibitions on ipso facto clauses.
Ultimately, Lee was not removed as a member and he remains the manager of the LLC; the actions of the other members purporting a different outcome violated the automatic stay and were void.

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