When we file a Chapter 7 bankruptcy petition for an individual, clients often ask which assets they will be able to keep after the bankruptcy case is closed.
Oftentimes, clients own interests in LLCs or partnerships and want to know if they will lose that interest in Chapter 7 bankruptcy.
Forbes recently published an article by Jay Adkisson titled “Can an LLC Interest Owned by a Debtor Be Sold by the Bankruptcy Trustee?” In this well-written article, Mr. Adkisson analyzes a recent case of first impression in the Eastern District of Kentucky, captioned Business Aircraft Leasing v. Ultra Energy Resources LLC (In re Addington).
The bankruptcy court held that in a Chapter 7 bankruptcy filing, a bankruptcy trustee can sell an economic right in an LLC member's interest. In the Addington case, Larry Addington filed for Chapter 11 bankruptcy, which was later converted to Chapter 7. He owned a 36% membership interest in a limited liability company called Ultra Energy Resources, LLC.
The judge in the Addington case discusses that an LLC membership interest consists of a governance interest, which includes the right to manage the LLC, vote to admit members or dissolve the LLC, and the economic rights of an LLC, which are the rights to distributions of money or property from the LLC.
The dispute in the case was whether the creditor who purchased the LLC interest from the Chapter 7 Bankruptcy Trustee acquired governance interests or economic rights. The LLC's position was that the purchaser had simply acquired economic rights, and the bankruptcy court, in a declaratory judgment, held that the purchaser had indeed only acquired economic rights, not governance interests.
In reaching his decision, the Bankruptcy Judge analogized to a charging lien that a judgment creditor obtained on a debtor LLC member's interest.
The Addington case is one of the first to involve the sale of a membership interest in an LLC by a Bankruptcy Trustee in a Chapter 7 proceeding.
Mr. Adkisson, in his article, notes that the managers of a closely held LLC are unlikely to admit the purchaser as a member unless they know the purchaser will be friendly.
A few comments based on our experience:
1. If the LLC is a single-member LLC, the Bankruptcy Trustee will be able to sell the member's governance and economic interest.
2. Whether a governance or economic interest can be sold will often depend on the terms of the Operating Agreement and state LLC law.
Individuals or their advisors with questions pertaining to the sale of LLC member interests in a chapter 7 bankruptcy filing should contact Jim Shenwick, Esq.
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Jim Shenwick, Esq 917 363 3391 jshenwick@gmail.com
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