LLCs and LLPs in Bankruptcy

July 16, 2013

Table of Contents

I. Bankruptcy filings by or against such entities.
II. Having someone with general liability is the key distinction.
III. “Insolvency” as a variation among the entities.
. Disagreements as to whether to file a voluntary bankruptcy.
V. A limited partner or member as an “Insider”.
VI. Inadvertently discharging guarantors.
VII. One potential gift a real estate debtor can offer – tax savings.

I. Bankruptcy filings by or against such entities.

A. Who can be a “debtor”. 11 U.S.C. §109 governs what type of entity may be a debtor. In re: QDN LLC, 363 Fed. Appx. 873; 2010 U.S. App. LEXIS 2592 (Footnote 4) (3rd Cir.); In re: 4 WHIP, LLC, 332 B.R. 670, 2005 Bankr. LEXIS 2138, 45 Bankr. Ct. Dec. 168 (Bankr. Conn.); and see the other cases cited herein.

B. An entity that is dissolved before it files. [A dissolution not caused by a personal bankruptcy of a partner or member]. Aside from dissolutions that may be triggered by a personal bankruptcy of a member or partner, a Delaware limited partnership or a Delaware LLC should be able to file for bankruptcy (at least for the purpose of liquidating, rather than reorganizing) between the date that an act or dissolution occurs until a certificate of cancellation is filed. 6 Del. C. §§17-803 and 18-803. See In re: Lovell’s American Car Care, LLC, 2010 Bankr. LEXIS 2063 (Bankr. App. Panel for the 10th Cir.). Secondly, if the dissolution was caused by a failure, on the part of the entity, to make an annual state filing, many state statues permit a retroacte reval of the entity. See, for example, 6 Del. C. §15-1210(c) as to partnerships; 6 Del. C. §15-1003(f) as to LLPs; and 6 Del. C. §18-1109(c) as to LLCs. See In re: Nader Modanlo, 412 B.R. 715; 2006 Bankr. LEXIS 4526 (D.MD., Baltimore Dision). Thirdly, loss of all but one partner may not be fatal, either. Many statutes permit the partnership to convert to a single-member LLC. See, for example, 6 Del. C. §18-214 for the conversion of a “incorporated business”.

C. Repeat filers. Partnerships and LLC’s are treated as entities, not as indiduals, for determining whether a bankruptcy filing is abuse. Proving that a single member LLC is an abuse filer requires a lot more evidence that the mechanical 180-day bar of 11 USCS §109(g) for an “indidual”. See In re: 4 WHIP, LLC, supra; and United First Federal Savings and Loan Association v. The Westwind Corporation, 1988 U.S. Dist. LEXIS 17519 (N.D. Ga., Gainesville Dision). However, a stay relief order in a prior bankruptcy proceeding should be res judicata. In re: Taylor, 116 B.R. 728; 1990 Bankr. LEXIS 1537; Bankr. L. Rep. (CCH) P73,552; 20 Bankr. Ct. Doc. 1233 (E.D. Calif.)

II. Having someone with general liability is the key distinction. In re: Promedicus Health Group, LLP, 416 B.R. 389, 2009 Bankr. LEXIS 4066 (W.D.N.Y.).

A. Partnerships. Entities in which there is at least one partner with general liability. Under 11 U.S.C. §723, a general partner remains personally liable for the entity’s debts.

B. Corporations and corporation-like entities. LLCs and LLPs are generally treated in the same manner as corporations. In 11 U.S.C. §101, a “corporation” is defined as:

(9) The term “corporation”–
(A) includes–
(i) association having a power or prilege that a prate corporation, but not an indidual or a partnership, possesses;
(ii) partnership association organized under a law that makes only the capital subscribed responsible for the debts of such association;
(iii) joint-stock company;
() unincorporated company or association; or
(v) business trust; but
(B) does not include limited partnership.
[emphasis added]
C. LLPs. A partner of a LLP is personally liable, for the LLP’s debts, only to the extent that he/she is personally liable for those debts under the state statute under which the LLP was formed.

III. “Insolvency” as a variation among the entities. The definition of “insolvent” varies based upon the presence or absence of a general partner. 11 USCS §101, provides, in relevant part:

(32) The term “insolvent” means–
(A) with reference to an entity other than a partnership and a municipality, financial condition such that the sum of such entity’s debts is greater than all of such entity’s property, at a fair valuation, excluse of–
(i) property transferred, concealed, or removed with intent to hinder, delay, or defraud such entity’s creditors; and
(ii) property that may be exempted from property of the estate under section 522 of this title [11 USCS § 522];
(B) with reference to a partnership, financial condition such that the sum of such partnership’s debts is greater than the aggregate of, at a fair valuation–
(i) all of such partnership’s property, excluse of property of the kind specified in subparagraph (A)(i) of this paragraph; and
(ii) the sum of the excess of the value of each general partner’s nonpartnership property, excluse of property of the kind specified in subparagraph (A) of this paragraph, over such partner’s nonpartnership debts; and . . [emphasis added]
. Disagreements as to whether to file a voluntary bankruptcy. What happens if the partners or members disagree as to whether the entity should file a voluntary bankruptcy?

A. State law governs. Generally, the authority of the person(s) filing a voluntary bankruptcy on behalf of entity is governed by the organizational documents of the entity and the state law under which it was formed. See Jolly v. Pittore, 170 B.R. 793 (1994, Bankr. S.D.N.Y.):

A person filing a voluntary bankruptcy petition on a partnership’s behalf must be authorized to do so, and authorization must dere from state law. See Price v. Gurney, 324 U.S. 100, 106, 89 L. Ed. 776, 65 S. Ct. 513 (1945). See also Keenihan v. Heritage Press, Inc., 19 F.3d 1255 (8th Cir. 1994).

See, also, In re: Wyatt & McAlister, PLLC, 2010 Bankr. LEXIS 1413 (Bankr. S.D. Miss.).

B. Person in “control” to make the filing. However, the person filing a voluntary bankruptcy on behalf of an entity must be “in control” of that entity under Bankruptcy Rule 9001(5)(A). “Control” is not defined in the Bankruptcy Code. In In re: King Brand Food Products Inc., 52 B.R. 109; 1985 Bankr. LEXIS 5998 (Bankr. S.D. Fla.), the Court dissolved a voluntary petition filed, on behalf of the corporation, by a person who was in the middle of purchasing all of the capital stock of the debtor/corporation. In doing so, the Court to a close look at the particular facts and seemed to find the most important ones to be: (1) although the buyer may have had control, of the day-to-day operation of the corporation, on paper, the seller was still conducting those operations; and (2) that capital stock was still in escrow – among other things, the seller still had not finished paying for it. See, also, the definition of “insider” below.

C. Approval by a board of directors-like body may still be required. Furthermore, even entity officers may not have the requisite authority without getting broader approval. In King Brand Food Products, supra, the Court held:

Even if Mr. Duke were the president of the company, a corporate president does not have the authority to file a voluntary chapter 11 proceeding on behalf of the corporation in the absence of an enabling resolution by the board of directors. See In re Al-Wyn Food Distributors, Inc., 8 B.R. 42 (M.D. Fla. 1980). The filing of a chapter 11 proceeding is clearly not in the ordinary course of business and is an event, which requires more than presidential discretion. In re Al-Wyn, supra. Mr. Duke’s own testimony referred to the fact that nothing had happened in terms of board of directors actity. He characterized the status of the company as “being in limbo.” “Being in limbo” is not the same as being in control.

Thus, the partnership or operating agreement needs to be read carefully to distinguish between the general/managing partners (or manager’s) authority with respect to day-to-day operations, as opposed to extraordinary acts such as filing for bankruptcy; and, in any event, he/she may, inherently, not have the authority to make a bankruptcy filing.

D. A general partner has an additional way to break a deadlock. A general partner can break a deadlock by filing an involuntary bankruptcy. Another difference, between a partnership with a general partner, and an entity in which no member or partner is personally liable, is that a general partner can break a deadlock, as to whether the entity should file for bankruptcy, by filing an involuntary bankruptcy petition. 11 USCS §103, provides, in relevant part:

(b) An involuntary case against a person is commenced by the filing with the bankruptcy court of a petition under chapter 7 or 11 of this title [11 USCS §§ 701 et seq. or 1101 et seq.]–
(1) by three or more entities, each of which is either a holder of a claim against such person that is not contingent as to liability or the subject of a bona fide dispute as to liability or amount, or an indenture trustee representing such a holder, if such noncontingent, undisputed claims aggregate at least $ 15,325 more than the value of any lien on property of the debtor securing such claims held by the holders of such claims;
(2) if there are fewer than 12 such holders, excluding any employee or insider of such person and any transferee of a transfer that is voidable under section 544, 545, 547, 548, 549, or 724(a) of this title [11 USCS § 544, 545, 547, 548, 549, or 724(a)], by one or more of such holders that hold in the aggregate at least $ 15,325 of such claims;
(3) if such person is a partnership–
(A) by fewer than all of the general partners in such partnership; or
(B) if relief has been ordered under this title [11 USCS §§ 101 et seq.] with respect to all of the general partners in such partnership, by a general partner in such partnership, the trustee of such a general partner, or a holder of a claim against such partnership; or . . . (emphasis added)

In In re Century/ML Cable Venture, 294 B.R. 9, 2003 Bankr. LEXIS 446 (Bankr. S.D.N.Y.), the Court held:

The Bankruptcy Code, by its section 303(b)(3), 32 expressly authorizes the filing of involuntary cases by any one or more of the general partners, and without regard to the amount of claims or number of petitioners. See Resnick, Bankruptcy Law Manual § 3:17 at page 176 (5th Ed. 2002). It plainly contemplates that there may be differences of views amongst the general partners, and that it might be appropriate for a partnership to be in a case under the Code even though the consent of all partners is lacking. Here the Code expressly provides for the mechanics of involuntary proceedings to deal with situations where the consent of all partners cannot be obtained, and the Court does not regard the concerns voiced by Judge Shiff in Stavola/Manson, expressed in the context of a corporate filing, to be applicable, particularly to a material degree, to a partnership filing like the here. 33

Though Century’s ability to initiate a voluntary filing is debatable, the Court cannot and does not find that, by its action, Century forfeited the usual rights of a general partner to commence an involuntary bankruptcy case under section 303, especially since this case is in its infancy, and no substante actions — especially actions prejudicial to ML Media — have been taken. [Citations and descriptions omitted]

E. A limited partner or member as simply an equity holder. A limited partner is not, by reason of his/her status as such, a “creditor” and, thus, not able, as such, to seek an involuntary bankruptcy of the entity. In re: Royal Gate Associates, Ltd., 81 B.R. 165; 1988 Bankr. LEXIS 10 (Bankr. M.D. Ga., Albany Dision). The reason is that he/she is not deemed to need the same protection as a general partner. However, a member entitled to guaranteed payments, regardless of the LLC’s profits, may be a creditor, as well as an equity holder. In re: IDS Holding Company, LLC. IDS Holding Company, LLC v. Madsen, 292 B.R. 233, 2003 Bankr. LEXIS 400, 41 Bankr. Ct. Dec. 55 (Conn., 2003).

F. Conflicts of interest. “Bad boy guaranties” gen by partners or members create such conflicts. See the Decision and Order rendered by the Supreme Court of the State of New York in Lichtenstein v. Willkie Farr & Gallagher LLP (April 22, 2013), a copy of which is attached hereto; In re: USA Detergents, Inc., 418 B.R. 533, 2009 Bankr. LEXIS 3305 (Bankr. Dela.); and In re: Direct Response Media, Inc., 466 B.R. 626; 2012 Bankr. LEXIS 41 (Bankr. Dela.). Such conflicts may include an officer’s wanting to keep his/her job, to keep skeletons in the closet, or to purchase, personally, the debtor or its assets out of the bankruptcy estate (sometimes to eliminate dissenting members or partners).

G. Counting the votes. Except as otherwise provided in the LLC’s operating agreement, the assignee of a LLC interest is entitled to only his/her share of the profits and losses of the LLC, not the right to become a substitute member or to have the voting rights of the assignor, unless all of the other members consent. 6 Del. C. §§18-702 and 18-704.

V. A limited partner or member as an “Insider”.

11 USCS §547 extends the period during which a Trustee in Bankruptcy may seek to avoid a transfer by the debtor, to an “insider”, as follows:

(b) Except as provided in subsections (c) and (i) of this section, the trustee may avoid any transfer of an interest of the debtor in property–
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;
(3) made while the debtor was insolvent;
(4) made–
(A) on or within 90 days before the date of the filing of the petition; or
(B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and
(5) that enables such creditor to recee more than such creditor would recee if–
(A) the case were a case under chapter 7 of this title [11 USCS §§ 701 et seq.];
(B) the transfer had not been made; and
(C) such creditor receed payment of such debt to the extent provided by the provisions of this title [11 USCS §§ 101 et seq.]. [emphasis added]

11 U.S.C. §101 defines an “insider” as follows:

(31) The term “insider” includes–
(A) if the debtor is an indidual–
(i) relate of the debtor or of a general partner of the debtor;
(ii) partnership in which the debtor is a general partner;
(iii) general partner of the debtor; or
() corporation of which the debtor is a director, officer, or person in control;
(B) if the debtor is a corporation–
(i) director of the debtor;
(ii) officer of the debtor;
(iii) person in control of the debtor;
() partnership in which the debtor is a general partner;
(v) general partner of the debtor; or
(vi) relate of a general partner, director, officer, or person in control of the debtor;
(C) if the debtor is a partnership–
(i) general partner in the debtor;
(ii) relate of a general partner in, general partner of, or person in control of the debtor;
(iii) partnership in which the debtor is a general partner;
() general partner of the debtor; or
(v) person in control of the debtor;
(D) if the debtor is a municipality, elected official of the debtor or relate of an elected official of the debtor;
(E) affiliate, or insider of an affiliate as if such affiliate were the debtor; and
(F) managing agent of the debtor.

In judging whether a member is an “insider”, courts look to both (a) whether the member’s position as such ges him/her authority analogous to that of a director of a corporation (whether or not the member exercises that authority); and (b) whether he/she had actely participated in the management of the LLC. In re: Longview Aluminum, L.L.C. (Appeal of Forte), 657 F.3d 507, 2011 U.S. App. LEXIS 18302, Bankr. L. Rep. (CCH) p.82,067, 66 Collier Bankr. Cas. 2d (MB) 577, 55 Bankr. Ct. Dec. 111 (7th Cir.); In re: Land Resource, LLC, 2011 Bankr. LEXIS 5491; 23 Fla. L. Weekly Fed. B 351 (Bankr. M.D. Fla., Jacksonville Dision). LLC statutes generally provide that, in the absence of an agreement to the contrary, management of an LLC is vested in the members. See 6 De. C. §18-402. As to LPs, see 6 Del. C. §17-303; can a limited partner’s actions preserve his limited liability under state law, but still make him an “insider”?

VI. Inadvertently discharging guarantors. A restructuring of a guaranty, as part of a plan of reorganization in a bankruptcy of the borrower, even though that restructuring has no demonstrated practical adverse effect upon the liability of the guarantor, could result in discharging the guarantor. Ex Parte Eagerton, 2013 Ala. LEXIS 46 (2013).

VII. One potential gift a real estate debtor can offer – tax savings. A sale of real estate, under a plan of reorganization, can save state and local recordation and transfer taxes. A sale of real estate, under a confirmed plan of reorganization, is exempt from State and local recordation and transfer taxes. 11 USCS §1146. Florida Department of Revenue v. Piccadilly Cafeterias, Inc., 554 U.S. 33; 128 S. Ct. 2326; 171 L. Ed. 2d 203 (2008); and In re: New 118th, Inc., 398 B.R. 791; 2009 Bankr. LEXIS 6; 51 Bankr. Ct. Dec. 18 (Bankr. S.D.N.Y.)