363 Sale of 50% Interest in LLC Did Not Convey Membership in the Company When drafting multi-member LLC operating agreements (OAs), it is important
363 Sale of 50% Interest in LLC Did Not Convey Membership in the Company When drafting multi-member LLC operating agreements (OAs), it is important
to keep in mind that the flexibility inherent to this type of business structure is sometimes curtailed in bankruptcy. However, there are ways to draft an OA such as to increase the possibility that certain
provisions are enforced by a bankruptcy court. OAs can include provisions which restrict the transferability of membership interests, or otherwise control the admission and withdrawal of members.
Most courts have held that membership interests are part of a member’s bankruptcy estate, regardless of any so-called “dissociation” provisions which purport to limit economic or governance rights in the event of a bankruptcy.
On the other hand, courts are sharply divided on whether membership interests can be assumed and assigned in bankruptcy without complying with the applicable provisions of an OA, such as the consent of all or some of the other members.
A recent decision out of the U.S. Bankruptcy Court for the E.D. of Kentucky held that they could not. In that case, pursuant to a §363 sale, the plaintiff acquired the debtor’s 50% interest in an LLC. The defendant owned the other 50%.
The plaintiff sought a declaratory judgment that it became a member and acquired the debtor’s governance and economic rights. The defendants argued that the plaintiff acquired the debtor’s interest subject to the terms of the OA, which limited transfers without the consent of the defendant. The defendant consented to the sale (and the transfer of the debtor’s economic rights to the plaintiff) but did not consent to admitting the plaintiff as a member.
According to the plaintiff, the consent requirement was an unenforceable anti-assignment provision under 11 U.S.C. §365(e). However, for such provision to apply, the OA had to be considered an executory contract.
The court concluded that the OA was not an executory contract because the members did not have any outstanding substantive obligations. It noted that, while other courts have considered contribution requirements or management duties as ongoing obligations, the OA in this case provided that any future contributions were voluntary. Moreover, the members’ management duties were delegated to managers.
In other words, if the OA had provided for mandatory contributions, or if the members had retained certain management duties or otherwise assumed any ongoing material obligations, the OA could have been deemed an executory contract.
In such event, it is possible that the consent requirement would have been unenforceable. However, even if the OA was deemed an executory contract, the defendant could have argued that “applicable law excuse[d] [it] from accepting performance from or rendering performance to an entity other than the debtor or the debtor in possession[.]”