Real Life Stories (Cases) on the Issue: In re Albright (Colorado).
In Albright, Albright was the debtor in bankruptcy and the sole member of a Colorado LLC, which owned certain real property.[1] The bankruptcy trustee contended that, because the debtor was the sole member and manager of the LLC at the time she filed bankruptcy, the trustee now controlled the LLC and could cause the LLC to sell the real property and distribute the net sales proceeds to the bankruptcy estate.[2] The debtor maintained that the trustee was entitled to a charging order at best and could not assume management of the LLC or cause the LLC to sell the real property.[3]
Under federal bankruptcy law, the commencement of a bankruptcy case creates a bankruptcy estate, which is comprised of all legal or equitable interests of the debtor as of the commencement of the case.[4] Here, noting that the debtor’s membership interest was the personal property of the member, the bankruptcy court said that, upon the debtor’s bankruptcy filing, the debtor-member effectively transferred her membership interest to the estate and the trustee became a “substituted member.”[5] Although the Colorado LLC statute required the unanimous written consent of “other members” in order to allow a transferee to participate in the management of the LLC, the court found that, because there were no other members, no written approval was necessary and, consequently, the trustee obtained all of the debtor-member’s rights, including the right to control the management of the LLC.[6] Similarly, because the Colorado LLC statute provides that the members, including the sole member, have the power to elect and change managers, and the trustee became the sole member of the LLC, the trustee could exercise management rights in the LLC to sell its sole asset and to distribute the proceeds to the trustee to be used to satisfy debts of the bankruptcy estate.[7] Most importantly, the court said that a charging order, which limits creditors to the right to receive distributions from the LLC, exists to protect other members of an LLC from having involuntarily to share governance responsibilities with someone they did not choose, or from having to accept a creditor of another member as a co-manager and, thus, serves no purpose in a single-member LLC because there are no other members to protect.[8] Accordingly, the court held that the trustee, as the sole member, controlled the LLC and could cause the LLC to sell its property and distribute net proceeds to the bankruptcy estate.[9]
Interestingly, the court also posited what might happen if the LLC had more than one member.[10] In such an event, the court said, if the non-debtor member did not consent to the admission of the trustee as a substituted member, even if that member held only an infinitesimal interest, the trustee would only be entitled to a share of distributions and have no role in the voting or governance of the LLC.[11] At the same time, the court warned that such limitation would not create an asset shelter for clever debtors; to the extent a debtor intends to hinder, delay or defraud creditors through a multi-member LLC with “peppercorn” co-members, bankruptcy avoidance provisions and fraudulent transfer law would provide creditors or a bankruptcy trustee with recourse.[12]
This post was a part of a multi-part blog series on single-member LLCs and creditors’ rights. You can find the other post by searching our blogs at www.mcbrideattorneys.com. In our next post, we will look at In re A-Z Electronics, LLC,[13] another bankruptcy case.
This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
Steps have been taken to verify the contents of this article prior to publication. However, readers should not, and may not, rely on this article. Please consult with counsel to verify all contents and do not rely solely on this article in planning your legal transactions.
About the Author
Shawn McBride – R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Office, P.L.L.C., which helps clients in legal issues related to starting companies, joint ventures, raising capital from and negotiating with investors and outside General Counsel functions. Shawn can be contacted at: 407-517-0064; [email protected], or www.mcbrideattorneys.com.
[1] See generally In re Albright, 01-11367 ABC (Bankr. D. Col. 2003).
[2] Id. at 1.
[3] Id. at 1–2.
[4] 11 U.S.C. § 541(a).
[5] In re Albright, 01-11367 ABC (Bankr. D. Col. 2003), at 2.
[6] Id. at 2–3. Although the court did not consider a situation where there is a provision in the LLC agreement on election of managers, given the court’s reasoning throughout the opinion, it seems likely to be considered inconsequential, as there are no other members.
[7] Id. at 4.
[8] Id. at 3.
[9] Id. at 4.
[10] See id. n.9.
[11] Id.
[12] Id.
[13] 350 B.R. 886 (Bankr. D. Idaho 2005).