By Kelly A. Karstaedt, Esq.
What happens to the rights of a member of a limited liability company when that member files bankruptcy? In Florida, that member is automatically terminated from membership in the LLC and any remaining interests in the LLC become property of the bankruptcy Trustee. But is it really that simple?
Limited liability companies (or LLC’s) formed in Florida are governed by Chapter 608 of the Florida Statutes, more commonly referred to as the Florida Limited Liability Company Act. This chapter dictates all the statutory requirements for formation, membership rights and dissolution of an LLC. But more specifically, one particular section concerning the rights of a member upon filing a bankruptcy action stood out. Section 608.4237 states as follows:
Membership termination upon events of bankruptcy.—A person ceases to be a member of a limited liability company upon the occurrence of any of the following:
(1) Unless otherwise provided in the articles of organization or operating agreement, or with the written consent of all members, a member:
(a) Makes an assignment for the benefit of creditors;
(b) Files a voluntary petition in bankruptcy;
(c) Is adjudged a bankrupt or insolvent, or has entered against the member an order for relief, in any bankruptcy or insolvency proceeding;
(d) Files a petition or answer seeking for herself or himself any reorganization, arrangement, composition, readjustment, liquidation, dissolution, or similar relief under any statute, law, or regulation;
(e) Files an answer or other pleading admitting or failing to contest the material allegations of a petition filed against the member in any proceeding of this nature; or
(f) Seeks, consents to, or acquiesces in the appointment of a trustee, receiver, or liquidator of the member or of all or any substantial part of the member’s properties; or
(2) Unless otherwise provided in the articles of organization or operating agreement, or with the written consent of all members, 120 days after the commencement of any proceeding against the member seeking reorganization, arrangement, composition, readjustment, liquidation, dissolution, or similar relief under any statute, law, or regulation, if the proceeding has not been dismissed, or if within 90 days after the appointment without the member’s consent or acquiescence of a trustee, receiver, or liquidator of the member or of all or any substantial part of the member’s properties, the appointment is not vacated or stayed, or within 90 days after the expiration of any such stay, the appointment is not vacated.
Basically, if a member of an LLC files for any type of bankruptcy protection, that member is automatically terminated from its position in the LLC. In order to ascertain exactly how this provision works, I turned to Florida case law to see how the courts treat a bankrupt LLC member. What I found was even more interest…nothing. There is next to no case law interpreting this statute. In fact, the U.S. District Court for the Southern District of Florida stated as much in Starkes v. Flechner, No. 11-62220, 2012 WL 360133 (S.D.Fla. Feb. 2, 2012). In this case, the individual bankruptcy debtors were both members and managers of an LLC. The debtors claimed that they were not required to comply with specific requests made by the remaining members of the LLC pursuant to their position as members because § 608.4237 terminated their membership. Id. The other members argued that, because the debtors membership rights were held as tenants by the entirety with the debtors’ spouses, § 608.4237 cannot operate to automatically terminate that membership because it would interfere with the tenancy by the entireties. Id at 2. The Court stated that it was “reluctant to opine on an area of Florida limited liability company law in which neither party has cited to any Florida court decisions addressing the application of § 608.4237…” Id. The Court went on to state that it failed to locate any case law on the subject as well. Id.
A bankruptcy case out of Colorado may be able to shed some light on how this statute applies in a bankruptcy proceeding. In the case of In re Albright, 291 B.R. 538 (Bankr. Court D. Colorado 2003), the debtor was the sole member of an LLC at the time the bankruptcy action was filed. Id at 539. Colorado’s Limited Liability Company Act required a unanimous vote of the members for a transferee to be able to manage the LLC. Id at 540. Further, because the Trustee is merely a conduit for creditors in a bankruptcy action, Colorado law would only allow for a charging order on debtor’s interest in the LLC in order to protect other LLC members from the Trustee stepping into a management position. Id. However, since debtor was the only member of the LLC, the Court reasoned that this need to protect other members was moot and that upon filing bankruptcy the debtor has essentially transferred all her rights in the LLC to the Trustee. Id at 541. The ruling from this case appears to be that when the sole member of a single member LLC files for bankruptcy, the Trustee can take that members’ position within the company and direct the distribution of assets. However, the notion is set forth that when the debtor is not the only member, the Trustee can only avail itself of what distributions and other property the debtor would normally be entitled to upon removal from the LLC.
The Bankruptcy Code states that upon the commencement of a case, an estate is created which includes “all legal or equitable interests of the debtor in property…” 11 U.S.C. § 541(a)(1). Since a member’s interest in an LLC is considered property, such property interest would automatically flow to the bankruptcy estate and fall under the control of the Trustee. However, if courts follow the theories set forth in In re Albright, how much control the Trustee may exert over this property depends upon whether the LLC is a single member entity or controlled by multiple members. Based on strict statutory interpretation and, regardless of what happens to the member’s property interests, a member is effectively terminated from the LLC upon filing for bankruptcy.