The Ninth Circuit B.A.P. has affirmed in In re Alameda Investments, LLC that transfer restrictions in a limited liability company operating agreement to which the debtor was a party do not prohibit transfer of the debtor’s entire membership interest (including voting rights) to a liquidating trust established pursuant to the debtor’s chapter 11 plan.
In this case, the debtor was a member of a two-member limited liability company, West Lakeside, LLC (the “Joint Venture”). Absent consent from a majority of other members, the Joint Venture’s operating agreement prohibited transfers of all components of a member’s interest, including voting rights. The debtor’s plan established a liquidating trust to liquidate the debtor’s remaining assets, including its interest in the Joint Venture. For well over a year, the Joint Venture permitted the liquidating trustee to participate in the management of the Joint Venture. However, the non-debtor member of the Joint Venture eventually questioned whether the liquidating trust had full membership rights (including voting rights) to the Joint Venture or whether it had only an economic interest in the Joint Venture.
Before the Bankruptcy Court, while the non-debtor member of the Joint Venture conceded that the debtor’s interest in the Joint Venture entered the bankruptcy estate without limitation, the non-bankrupt member disputed whether the bankruptcy estate could freely transfer that asset to the liquidating trustee. The non-debtor member of the Joint Venture argued that given the transfer restrictions in the Joint Venture’s operating agreement, the debtor’s complete membership interest could not have been assigned to the liquidating trust without a majority vote of the non-transferring members because the liquidating trust is a third party, separate from the debtor. The Bankruptcy Court held, and the Ninth Circuit B.A.P. agreed, that the transfer from the debtor’s estate to the liquidating trust was not a transfer to a third party because the liquidating trust was an extension of the debtor’s estate. The Ninth Circuit B.A.P. affirmed the Bankruptcy Court’s reasoning that the liquidating trust was merely a representative of the estate and there was no transfer out of the estate to a third party that could otherwise violate the anti-transfer clause in the Joint Venture’s operating agreement. The liquidating trust then had the same rights in the Joint Venture as the debtor had prior to bankruptcy.
Our takeaway from this case is that despite well-drafted transfer restrictions in an operating agreement, a non-bankrupt member cannot protect itself from becoming entangled with a liquidating trustee or court-appointed trustee – there is risk that those entities will likely succeed to the full membership rights of the debtor.
Further, in light of this case, two questions occur to us:
First, would there have been a different result if the liquidating trustee and the trust had not been involved in the management of the Joint Venture for over a year following post-confirmation? Probably not. The Bankruptcy Court’s and the Ninth Circuit B.A.P.’s reasoning do not rely on any argument that the non-debtor member waived its rights to argue that the liquidating trustee was not a full member of the Joint Venture.
Second, would the outcome have been different if the chapter 11 plan transferred the membership interest to an independent third party, i.e., not the liquidating trust? Possibly. The Bankruptcy Court relied on the fact that the transfer from the estate to the liquidating trust was not a transfer to a third party because the liquidating trust was an extension of the estate. The Ninth Circuit B.A.P. agreed, stating that the liquidating trustee was a “continuing representative of the bankruptcy estate” and “[a]t bottom, there was no transfer out of the estate to a third party . . . .”