Fun and Games and LLCs: In re Stacey Friedrich

Fun and Games and LLCs: In re Stacey Friedrich

       In a recent decision from a Bankruptcy Court in Wisconsin, the court considered and rejected efforts by the sole member of an LLC, through its dissolution, to change the nature of its assets and in so doing prevent a lender from exercising its rights.  In re: Stacey L. Friedrich, Case No. 19-13843-13, 2020 WL 2306532 (Bankr. W.D. Wisc. May 5, 2020).

        Friedrich was the sole member of Total Body Laser Center, LLC, it organized in Wisconsin. The LLC had entered into three loans with State Bank of Cross Plains (the “Bank”), which were secured by the LLCs assets and as well personally guaranteed by Friedrich. The LLC defaulted on the notes, and the Bank filed a lawsuit seeking the appointment of the state law receiver. On the day that motion was to be considered, Friedrich dissolved the LLC, purported to transfer to himself all of its assets and debts. Still, the receivership motion was heard, and the receiver was appointed. On that same day, Friedrich filed for personal bankruptcy under Chapter 13. The question being considered in this opinion is whether the LLCs assets were or were not part of Friedrich's bankruptcy estate. Another issue would be whether those liabilities, now personally assumed by Friedrich, would be characterized as secured or unsecured. In order to be eligible for Chapter 13 bankruptcy, Friedrich needed to fall within the scope of 11 U.S.C. § 109(e), which provides that: 

Only an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $419,275 ... may be a debtor under Chapter 13 of this title. 2020 WL 2306532, *2.

The court framed the dispute as follows:

The Bank asserts it did not consent to the transfer of its collateral from the LLC to the Debtor. The Bank argues the LLC’s assets are not part of the Debtor’s bankruptcy estate as the Assignment is void and ineffective under Wisconsin law. The bank also argues that even if the Assignment was successful, the LLC’s assets do not qualify as part of the Debtor’s secured debt in his Chapter 13 case. In other words, the Assignment did not change the Debtor’s obligation to the Bank - flowing from the personal guarantee on the Notes - from an unsecured to a secured claim. As a result, the Bank believes it's unsecured claim against the Debtor stands at $620,121.97. Debtor counters that the Bank’s $621,121.97 claim is secured against the Debtor by virtue of the transfer of all of the LLC’s assets and liabilities to himself personally. Id., *1.

As to the question of whether the LLC’s assets became property of Friedrich and from there part of his bankruptcy estate, the court answered in the negative. While LLC property may be transferred by an instrument executed by a member of the LLC in its name (Wisc. Stat. § 183.0702(1)), a transfer may not be made if, consequent thereto, the LLC will be unable to pay its debts as they come due in the ordinary course of business. Id. § 183.0607(1)(a). Furthermore, in liquidation, the assets of an LLC must first be distributed to its creditors. Id. § 183.0905. From there the court observed: 

Here, it is clear the LLC was unable to pay its debts as they became due. The attempted transfer of all the LLC’s assets further impaired its ability to pay its debts to the Bank. The LLC’s attempted distribution of its assets occurred in violation of Wis. Stat. § 183.0607(1)(a). It also violated the established priority for distribution of assets under Wis. Stat. § 183.0905. During its wind-upstage, the LLC’s assets must have first been distributed to its creditors, such as the Bank, and not to its sole member, the Debtor. 2020 WL 2306532, *3.

Turning to the question of whether, when assumed by Friedrich, the LLC’s obligations to the bank remained secured (a hurdle with respect to whether he was eligible to file for Chapter 13 bankruptcy), the court again answered in the negative. Recall that, on an unsecured basis, Frederick had guaranteed the LLC’s Bank debt. As argued by the Bank: 

The Bank argues that even if the Assignment was valid, the transferred LLC assets do not qualify as part of a secured debt in the current Chapter 13 case because the Debtor now owns assets subject to the Bank’s liens. Mere title to the asset does not create secured debt. Put differently, the Debtor’s acquisition of assets did not convert the Bank’s position and status as an unsecured creditor in his case to that of a secured creditor. Id., *4.

Agreeing with the bank, and after reviewing the applicable provisions of the Uniform Commercial Code, the court observed: 

The LLC’s attempt to transfer the Bank’s collateral to the Debtor does not mean the Debtor has pledged assets to the Bank. The Assignment did not change the Debtor’s relationship with the Bank. Assuming the Assignment was valid, the Debtor - as the new owner of the LLC’s assets, now owns assets subject to the Bank’s liens. Id., *6.

Holding that Friedrich’s liability to the Bank under his unsecured guarantee of the LLC’s  debt is valued at $620,121.97, his unsecured debt exceeded the statutory limit of $419,275 as set by 11 U.S.C. § 109(e), and for that reason it was held that he could not seek relief under Chapter 13 of the Bankruptcy Code.