LLC Interests and a Member’s Bankuptcy, Part VII

[The last in a seve-part series. The other articles in the series are here:  Part IPart II, Part IIIPart IV, Part V, Part VI.]

With the bankruptcy courts’ inconsistent treatment of a debtor’s LLC membership rights, how should someone structure a limited liability company to maximize the possibility that, should the member file for bankruptcy protection, the member’s noneconomic rights will not end up in the hands of a bankruptcy trustee and, possibly, a subsequent acquirer?  With the current state of case law, there seems to be no sure-fire way, but the following factors may help.  Please recognize, however, that other, these factors may run counter to other goals and the decision to include them should be made cautiously with the advice of counsel.

  • Avoid LLCs owned by one person or by a married couple. There appears to be no way of preventing a bankruptcy trustee from acquiring the economic and noneconomic rights in a single-member LLC or in, in the case of joint bankruptcy of a married couple, a limited liability company owned entirely by two spouses.
  • Always have a written operating agreement, and make sure it imposes continuing obligations on the member.
  • Although we did not discuss this aspect of Section 365 in detail, the ongoing obligations of a member should be obligations that are personal in nature, not obligations that anyone could fulfill. The idea is that the other members of the LLC should have the right to refuse performance by anyone other than the member.
  • The operating agreement should include strong pick-your-partner provisions, or provisions that prohibit the admission of a new member except with consent of the other members, preferably the unanimous consent.
  • The operating agreement should require each new member, as a condition of admission, to accept the operating agreement in writing.
  • The operating agreement should prohibit amendments except with the unanimous written agreement of the members.

Please feel free to contact us if you would like to set up a new limited liability company, establish an operating agreement for an existing LLC, resolve a dispute among LLC members, or have any other questions regarding LLCs.


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