Intersection of section 365 of the Bankruptcy Code and the sale of interests of members of the LLC

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Debtors and Trustees are faced with the task of maximizing the value of real estate assets in bankruptcy in the face of many obstacles, such as the limited liquidity trail and the competing interests of various creditors and stakeholders. An estate asset that may present particular challenges in maximizing value is the sale of the debtor’s interest in a limited liability company (LLC) when it is subject to assignment restrictions under the operating agreement of LLC and state law. For example, the LLC’s operating agreement may give other members of the LLC the right to approve the admission of a new transferee member or grant them the right of first refusal in connection with any deemed sale of the LLC. ‘a contribution. Likewise, the statutes of state LLCs generally contain similar restrictions. For example, the North Carolina Limited Liability Company Act contains restrictions on the transfer of member interests. See NC Gen. Stat. Anne. § 57D-3-03 (“Approval of all members is required for… [a]admit any person as a member ”); NC Gen. Stat. Anne. § 57D-5-04 (the holder of an economic interest can only become a member if this is provided for in the operating agreement or by approval of other members); NC Gen. Stat. Anne. § 57D-5-02 (“The transfer of an economic interest or part thereof does not give the assignee the right to become or to exercise any rights of a member other than to receive the interest economic or the part of it assigned to the assignee ”).

One potential avenue through this network of restrictions is section 365 of the Bankruptcy Code. The applicability of Section 365 depends on whether the LLC’s operating agreement qualifies as a “binding contract.”[1] There is no general rule as to whether LLC operating agreements are enforceable. Courts must review each operating agreement on a case-by-case basis. When the members of the LLC have significant unfulfilled obligations under the agreement, the courts consistently rule that the operating agreements are enforceable. See, for example, In the case of Allentown Ambassadors, Inc., 361 BR 422, 444 (Bankr. ED Pa. 2007) (The LLC operating agreement was enforceable because the members had continuing, material and unperformed obligations to each other and to the LLC at the start of this bankruptcy case, which included (i) the obligation to manage the LLC and (ii) the obligation to make additional contributions in cash if the LLC needs them); Case of Daugherty Const., Inc., 188 BR 607, 612 (Bankr.D. Neb. 1995) (finding that an LLC agreement is an enforceable contract); In re DeLuca, 194 BR 65, 77 (Bankr.EDVa.1996) (finding that an LLC agreement is a binding contract where the parties had continuing duties and responsibilities); At sunset Developers, 69 BR 710, 712 (Bankr.D.Idaho 1987) (considering that a partnership agreement imposing continuing mutual obligations is an enforceable agreement).

If the debtor or the trustee succeeds in convincing the bankruptcy court that the operating contract is enforceable, the debtor / trustee can argue that Article 365 (f) (1) allows the debtor / trustee to assume and assign the operating contract to a third party. the buyer, notwithstanding the restrictions of the operating contract and applicable law. Section 365 (f) (1) provides that, “notwithstanding any provision in an enforceable contract or unexpired lease of the debtor, or in applicable law, which prohibits, restricts or conditions the assignment of such contract or lease , the trustee may assign such contract or lease. 11 USC § 365 (f) (1). See also In re Trak Auto Corp., 367 F.3d 237, 241 (4th Cir. 2004) (recognizing that Article 365 (f) (1) “generally allows a debtor to assign his lease [or executory contract] notwithstanding a provision restricting the assignment ”); 6711 Glen Burnie Retail, LLC v Toys “R” Us, Inc., 2018 WL 6787942, at * 2 (ED Va. Dec. 26, 2018) (Section 365 (f) (1) “prohibits bankruptcy enforcement of anti-assignment clauses” contained in enforceable contracts and leases not due) (internal citations omitted); In Re Bulldog Trucking, Inc., 1994 WL 835073, at * 17 (Bankr. WDNC February 18, 1994) (“Section 365 (f) (1).. Generally renders inapplicable a provision of applicable law which prohibits, restricts or conditions the assignment of an enforceable contract or unexpired lease ”) (internal citations omitted); At EZ Serve, Inc. convenience stores, 289 BR 45, 49 (Bankr. MDNC 2003) (“[w]hen a trustee is required to assume a contract as a whole, the court may strike out provisions contrary to the provisions of the Bankruptcy Code such as those which impose restrictions on the assignment ”).

The debtor’s / trustee’s adversary, however, is certain to argue that what section 365 (f) (1) gives, section 365 (c) (1) (A) takes away. Section 365 (c) (1) (A) appears to conflict with Section 365 (f) (1), which states the following:

The trustee may not assume or assign an enforceable contract or an unexpired lease of the debtor, whether this contract or this lease prohibits or restricts the assignment of rights or the delegation of functions, if:

(1)

(A) applicable law exempts a party, other than the debtor, to such contract or lease from accepting performance or rendering performance to an entity other than the debtor or the debtor in possession, than that contract or this lease prohibits or restricts the transfer of rights or delegation of duties; and

(B) that party does not consent to any such assumption or assignment.

The apparent inconsistency between Sections 365 (f) (1) and 365 (c) has been discussed and analyzed on numerous occasions in various jurisdictions. See, for example, In re Buildnet, Inc., 2002 WL 31103235, at * 4 (Bankr. MDNC September 20, 2002) (“applicable law in 365 (c) means non-bankruptcy law which exempts the non-debtor from accepting or rendering performance to anyone other than the debtor ”) (internal citations and citations omitted). Also in In the case of Allentown Ambassadors, Inc., 361 BR 422, 444 (Bankr. ED Pa. 2007), the court noted “that section 365 (c) and (f) are provisions difficult to understand, harmonize and apply” and that “[t]there may now be up to seven (7) lines of business dealing with the meaning and interrelation between § 365 (c) and (f). »Identifier. at 446-47. The Allentown court also summarized the statute interpreting sections 365 (c) and 365 (f) as follows:

Most courts, however, have resolved the apparent conflict between Sections 365 (c) (1) and 365 (f) by assigning a different meaning to the term “applicable law” appearing in each section. For example, the United States Court of Appeals for the First Circuit interpreted the phrase “applicable law” in Section 365 (f) to apply only to the laws of those states that apply contractual provisions that prohibit, restrict or condition the assignment, and the phrase “applicable law” in section 365 (c) (1) as applying to the laws of states which, by their own terms, prohibit, restrict or condition the assignment of a particular type of contract.

Other courts have … attempted a similar method to resolve the apparent conflict between Articles 365 (c) (1) and 365 (f) (1) of the Bankruptcy Code. For example, the United States Courts of Appeal for the Fourth, Sixth, Ninth, and Eleventh Circuits have interpreted the term “applicable law” in Section 365 (f) (1) to apply to general prohibitions against assignment, and the phrase “applicable law” in section 365 (c) (1) as applying to specific laws which exempt a contracting party from performing or accepting performance by a third party. According to this interpretation, Article 365 (c) (1) applies where the identity of the originating contracting party is material.

Identifier. at 447 (internal citations omitted). See also In re ANC Rental Corp., Inc., 277 BR 226, 235 (Bankr. D. Del. 2002) (describing the apparent conflict between Sections 365 (c) and (f) as resulting from “their respective ‘applicable law’ treatments, as each subsection recognizes a law “of significantly different scope”) (internal citations and citations omitted). As described in ANC Rental Corp., “A majority of courts have held section 365 (c) (1) applicable only where the identity of the contracting party is crucial under applicable law. ANC Rental Corp., 277 BR to 235 (collection of cases applying majority rule). The Fourth Circuit adopted this view in 2004. See Sunterra Corp., 361 F.3d at 266. There the court held that “under the general rule of § 365 (f) (1), the ‘applicable law’ is the law prohibiting or restricting the assignments as such; while “applicable law” under § 365 (c) (1) encompasses legal excuses for refusing to make or accept performance, regardless of the contract’s status as assignable. “) Identifier. (internal citations and citation omitted). The court also held that “section 365 (c) (1). . . creates a carefully crafted exception to the general rule, whereby the applicable law not only sets out a general prohibition on assignment, but more specifically excuses a party. . . to accept performance or to return performance to an entity different from that with which the party initially contracted. Identifier. Therefore, on the basis of this reasoning, the court held that only “the applicable anti-assignment law based on the justification that the identity of the contracting party is important for the agreement is resurrected by § 365 (c ) (1) ”. Identifier. at 266-67 (also holding, “[p]given on this interpretation, we agree with circuits which apply § 365 (c) (1) literally – the provisions of § 365 (c) (1) are not inevitably at odds with the provisions of § 365 ( f) (1) ”).

While the case law dealing with reconciliation between sections 365 (c) and (f) (1) in the context of a transfer of interests in an LLC appears limited, at least one court has addressed the issue. In Allentown, the court – applying the majority view to an earlier version of the North Carolina LLC Act – held that the earlier LLC law did not contain a clear and unambiguous prohibition on assignment without the consent of others parties to the contract, and therefore the no – the debtor parties were not exempted from accepting the performance of a party other than the debtor. See Allentown, 361 BR at 455 (courts must “consider whether the nature of [the LLC] are such that a change in the identity of an assignee would constitute a material interference with the rights of other members ”in determining whether the limited exception in section 365 (c) applies). Holding thus, the Allentown The court shows a narrow path through the confusing maze of state LLC law and section 365 – and gives hope to debtors and trustees looking to sell an LLC stake for profit of the bankruptcy estate and its creditors.


[1] Most courts use the “peasant test” to determine whether a contract is “enforceable”. See In re Sunterra Corp., 361 F.3d 257, 264 (4th Cir. 2004) (citing Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985)). According to the Countryman test, a contract is enforceable if the “obligations of both the bankrupt and the other party to the contract are not fulfilled to such an extent that the failure of either to perform the contract. execution would constitute a material violation excusing the execution of the other ”. Identifier. (internal citations omitted). The Sunterra court explained that a contract meets Countryman’s definition where each party has “at least one continuing material obligation to the other under the agreement,” such as a “continuing obligation to maintain confidentiality. Of the content of the agreement. Identifier.

Copyright © 2021 Nelson Mullins Riley & Scarborough LLPRevue nationale de droit, volume XI, number 278



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