On Charging Orders, Bankruptcy, and the Scope of the Automatic Stay

On Charging Orders, Bankruptcy, and the Scope of the Automatic Stay

      In a recent decision out of Louisiana, the Federal District Court, sitting as the appellate court from a Bankruptcy Court, pointed out some important issues to be considered in connection with the bankruptcy of an individual member of an LLC and the scope of the automatic stay. In this instance, certain of those important matters had not been fully considered by the Bankruptcy Court. For that reason, remand was ordered. In the Matter of: Thomas Mack and Mary Susan Mack, Civ. Act. No. 17-3587, 2018 WL 1532979 (E.D. LA. March 29, 2018).

 

Consequent to some financial setbacks, Thomas Mack, along with certain others, was held liable to First Bank for some $400,000 plus attorneys’ fees and additional collection costs. Mack, in turn, was a member in two LLCs, but the only one relevant to the opinion was Matrix Hospitality Group, L.L.C. Therein, he held a 60% membership interest, and apparently it was only through Matrix that Mack had any income, specifically:

Mack is paid by Matrix in three ways: (1) a monthly salary as a 1099 employee; (2) a periodic disbursement of profits as a part-owner; and (3) a performance bonus paid in April by particular clients if Matrix is able to meet client-set goals.

Seeking to collect on the judgment debt of approximately $400,000, First Bank sought a charging order against Mack’s interest in Matrix. The charging order was awarded and served on the company, but it failed to respond in accordance with Louisiana procedure. In addition, Matrix made distributions to Mack after the charging order was served. When legal action was then initiated against Matrix, Mack (both Thomas and Mary Susan) filed for Chapter 11 bankruptcy. At that point, the value of First Bank’s judgment had increased to $789,212.85.

From there the chronology of what happened gets somewhat confusing. What is known is that, on January 31, 2017, First Bank moved for relief from the automatic stay. Ultimately that relief was denied.

The reason this is confusing is that when a member files for bankruptcy, and the LLC is not itself in bankruptcy, and activities of the LLC are not automatically subject to the automatic stay there is an exception to this rule when, in the presence of “unusual circumstances,” “there is such identity between the debtor and the third-party defendant at the debtor may be said to be the real party defendant and that a judgment against the third-party defendant will in effect be a judgment or finding against the debtor.” 2018 WL 1532979, *3. In those circumstances, the automatic stay may extend to a non-debtor, in this instance Matrix. In this instance, however,:

The Court is unable to evaluate the Bankruptcy Court’s decision in denying the modification of the scope [of the automatic stay] because the Bankruptcy Court never made a finding on whether the scope of the stay included Matrix. Although it is arguably implied that the Bankruptcy Court determined that it did because it denied First Bank’s motion for relief, neither party raised the issue and the Bankruptcy Court did not state on the record whether the automatic stay applies to Matrix. Further, the Bankruptcy Court held that First Bank had the burden to modify the automatic stay, but the appellees [i.e., Mack], the parties seeking to maintain the stay, actually had the burden. The Bankruptcy Court failed to apply the appropriate standard to determine if modifying the stay was appropriate. Because the Bankruptcy Court did not require the appellees to meet their burden, the factual record is not sufficiently developed for this Court to determine whether the circumstances justify the rare finding that the stay applies to non-debtors [i.e. Matrix].

Id. (bracketed language added).

So the matter will go back to the Bankruptcy Court to determine whether Matrix and Mack are of such unitary interests that First Bank cannot, outside of the bankruptcy proceedings, seek to enforce its judgment by means of a charging order.