LLC Interests and a Member’s Bankruptcy, Part III

[The other articles in this seven-part series are here:  Part IPart II, Part IV, Part V, Part VI, Part VII.]

The Indiana Business Flexibility Act creates two distinct categories of LLC rights:  (1) interest, or “a member’s economic rights in the limited liability company, including the member’s share of the profits and losses of the limited liability company and the right to receive distributions from the limited liability company,” I.C. 23‑18‑1‑10; and (2) other rights that are conferred upon members.  Many courts refer to the two categories as economic and noneconomic rights.  The Business Flexibility Act treats those two categories of rights very differently.[1]

It is indisputably clear that economic rights in an Indiana LLC are property rights because the Indiana statute expressly says so:

IC 23-18-6-2
Interest of member; nature
Sec. 2. The interest of a member in a limited liability company is personal property.

Moreover, the Indiana statute treats economic rights as if they are property rights.  For example, one of the traditional hallmarks of property rights is transferability.  Under the Indiana LLC statute, interest in a limited liability company is transferable, albeit with some restrictions and limitations, even to persons who are not members of the LLC.  Interest can be voluntarily assigned, designated as transfer-on-death property, held in joint tenancy, acquired by a deceased member’s personal representative, and reached by the creditors of the person holding the interest (albeit with some statutory boundaries).

A member’s noneconomic rights are different. The statute does not designate noneconomic rights as property, and it does not treat noneconomic rights as property.  In particular, noneconome rights are nontransferable. A person can acquire noneconomic rights only by being admitted as a member of the LLC, which requires the agreement of the other members, either as set forth in the operating agreement or in their unanimous consent. Absent such an agreement, noneconomic rights cannot be voluntarily assigned;  designated as transfer-on-death property, held in joint tenancy, or acquired by a member’s personal representative upon the member’s death; or reached by the member’s creditors.

If noneconomic rights are not property rights, what are they?  There are two possible answers.  The least likely is that membership rights are personal, similar to rights of privacy, rights of publicity, and the moral rights of attribution and integrity that belong to the creators of certain types of art.  However, in contrast to membership rights in a limited liability company, those rights arise without the participation, agreement, or consent of any other person. The better answer is that membership rights in a limited liability company are contractual, acquired by an agreement with the other members of the LLC, by in the form of consent or in the form of an operating agreement.

Getting back to the bankruptcy case of In re Lee discussed in Part II, does that mean that, because noneconomic rights are not property rights,  a bankruptcy trustee does not acquire the member’s noneconomic rights as “property of the estate”?  It may come as a surprise to anyone but a bankruptcy lawyer, but the answer is no.  Federal courts interpret “property of the estate,” as that term is used in Section 541 of the Bankruptcy Code, broadly enough to encompass rights that are not traditionally considered to be property, such as a debtor’s rights that arise under a contract.  Even so, the Bankruptcy Code treats contract rights differently from other types of property of the estate. That’s the subject of Part IV of the series.

[1] The nature of the rights in single-member LLCs and multi-member LLCs may differ significantly.  The discussion in this entire series is restricted to multi-member LLCs.


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