Friday, July 24, 2020

Control of a Single Member LLC: In re Thomas

Control of a Single Member LLC: In re Thomas

In a decision handed down in May, a Tennessee Bankruptcy Court considered who would have control of a single-member LLC whose sole owner was in bankruptcy.  In this instance it was held that the member’s bankruptcy filing conveyed both the economic and management rights of the member to the bankruptcy estate and the trustee.  In re Thomas, 2020 WL 2569993 (Bankr. W.D. Tenn. May 8, 2020).

This decision was rendered in response to a motion by the trustee for an order directing that both the economic and the management rights of the bankrupt be in the estate to the effect that the chapter 11 trustee is the only authorized representative of an LLC. The debtor was the sole member of the LLC, and the Tennessee LLC Act (as do most of the acts across the country) provides that a member is disassociated (i.e., ceases to be a member and ceases to have the right to participate in the LLC’s management) upon the member filing bankruptcy. Tenn. Code Ann. § 48-249-503(a)(7)(A); id. § 48-249-505(a)(1). The only management rights that are reserved are those to participate in the LLC’s winding up is the LLC is to be terminated. The conflict was framed by the Court as follows:

At issue … is the question of a trustee in bankruptcy’s governance rights with respect to a [LLC] wholly owned by a debtor before the commencement of a voluntary bankruptcy case. The Trustee argues that by virtue of the filing of the bankruptcy petition and his appointment as Trustee, he holds both the financial rights and governance rights that make up the membership interest in TI Properties. Ms. Thomas argues that the Trustee holds only the financial rights but not the governance rights. The Debtor insists that the filing of his bankruptcy petition did not constitute a transfer of his governance rights under Tennessee law. 2020 WL 2569993, *1.

Under the Tennessee LLC Act a “membership interest” includes both the “financial rights” and the “governance rights.”  Tenn. Code Ann. §§ 48-249-102(22), (11) and (13).  Absent contractually agreed to limitations upon doing so, the financial rights are freely transferable, but the transferee has no right to participate in the LLC’s management.  Tenn. Code Ann. § 48-249-507(b).

In reviewing the statute the court determined that in multi-member LLCs a member’s bankruptcy filing results in the transfer and therefore termination of the debtor’s governance rights, but not of the financial rights, citing In re Albright, 291 B.R. 538, n. 7 (Bankr. D. Colo. 2003). However, Thomas the court concluded that there must be something different when the subject LLC had as its sole member the person in bankruptcy:

[T]his case presents the question of governance rights when the sole member of a single-member limited liability company files a petition in bankruptcy. The Tennessee Revised Act appears to limit a trustee in bankruptcy to the exercise of only those governance rights needed to wind up the affairs of the limited liability company reserved to a member whose membership interest is terminated. The Tennessee Revised Act does not address the governance rights of a single-member limited liability company when the membership interest terminates as the result of the filing of a bankruptcy petition but the trustee in bankruptcy desires to continue the business of the LLC for the benefit of creditors of the bankruptcy estate. 2020 WL 2569993, *3.

The Trustee argued that the provision of the LLC Act stripping a member of governance rights consequent to filing for bankruptcy was an invalid ipso facto clause, and that the governance rights became property of the estate, exercisable by the trustee, just as are the financial rights. Thomas would argue that even if the financial rights became property of the estate, the non-transferable governance rights remain with the now bankrupt debtor who continues to be vested with the authority to manage the LLC.  The Court would hold that in a single-member LLC, a member’s bankruptcy petition results in the transfer (under § 541(a)(1) of the Bankruptcy Code) of all aspects of the membership interest, financial and governance, to the trustee. 

The Trustee is correct. Upon the filing of his bankruptcy petition, all the Debtor’s interests in property, both legal and equitable, became property of his bankruptcy estate. The Tennessee Revised Act defines the membership interest of a member in an LLC as personal property. As such, it became property of the bankruptcy estate upon the filing of the bankruptcy petition. The Tennessee Revised Act attempts to prevent this result by providing for the “termination” of a membership interest upon the filing of a petition in bankruptcy by a member. This result is preempted, however, by  section 541(c)(1)(B) of the Bankruptcy Code. 2020 WL 2569993, *37.

FYI, the debtor is identified as William Thomas, and in several cases the decision uses male pronouns in refereeing to the debtor.  There are however numerous references to the debtor with “Ms.” and “she.”

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