A trustee may not evade the transfer restrictions in the operating agreement of a limited liability company by selling only the “economic interest,” the Tenth Circuit Bankruptcy Appellate Panel said in an opinion interpreting Oklahoma law.
The debtor was an individual in chapter 7. The estate included the debtor’s membership interests in four LLCs. The operating agreements for all of the LLCs included restrictions on the transfer of the membership interests.
Evidently conceding that selling the debtor’s entire membership interests to the intended buyer would not comply with the transfer restrictions in the operating agreements, the chapter 7 trustee filed a motion for authority to sell only the debtor’s capital interests in the LLC, not the debtor’s complete membership interests.
In a nonprecedential opinion for the BAP on November 23, Bankruptcy Judge Michael E. Romero explained that the terms “capital interest” and “economic interest” are synonymous. Because the Oklahoma statute uses the term “capital interest,” that’s the term he used to mean the member’s rights to receive distributions and share in profits.
The trustee contended that the transfer restrictions did not prohibit sale of the capital interests. And if the transfer restrictions in the operating agreements also barred sale of the capital interests, the trustee argued that the restrictions were unenforceable in bankruptcy.
In bankruptcy court, the trustee lost on both counts. Now-retired Bankruptcy Judge Dana L. Rasure of Tulsa ruled that the transfer restrictions were enforceable under both Oklahoma and bankruptcy law. The trustee appealed, to no avail.
Although the statute might seem ambiguous to a novice, Judge Romero upheld Judge Rasure by deducing that Oklahoma law allows an LLC’s operating agreement to restrict the sale of capital interests, not only the entire membership interests.
On the next level of appeal, the trustee asserted that Section 541(c)(1) overrides state law and permits the sale of capital interests otherwise prohibited by state law.
Judge Romero paraphrased the statute as follows:
Section 541(c)(1)(A) invalidates any restriction or condition that prevents a debtor’s interest from becoming property of the estate, and § 541(c)(1)(B) invalidates any clauses — including ipso facto clauses — to the extent they expressly or implicitly cause a forfeiture, modification, or termination of a debtor’s interest in property from entering the estate. [Citations omitted.]
In short, Judge Romero said that “the Bankruptcy Code will not enforce contractual provisions that prohibit a debtor’s property from entering the bankruptcy estate.” He disagreed with the notion that Section 541(c)(1)(B) makes the transfer restrictions altogether invalid.
Judge Romero said that “§ 541(c)(1)(A) is meant to protect the transfer of pre-petition personal property to the bankruptcy estate.” Because the “Transfer Restrictions here did not prevent the LLC Interests from becoming part of Kramer’s bankruptcy estate,” Judge Romero held that “the Transfer Restrictions do not violate § 541(c)(1).”
The BAP affirmed Bankruptcy Judge Rasure and held that the transfer restrictions were enforceable against the trustee.
A trustee may not evade the transfer restrictions in the operating agreement of a limited liability company by selling only the “economic interest,” the Tenth Circuit Bankruptcy Appellate Panel said in an opinion interpreting Oklahoma law.
The debtor was an individual in chapter 7. The estate included the debtor’s membership interests in four LLCs. The operating agreements for all of the LLCs included restrictions on the transfer of the membership interests.
Evidently conceding that selling the debtor’s entire membership interests to the intended buyer would not comply with the transfer restrictions in the operating agreements, the chapter 7 trustee filed a motion for authority to sell only the debtor’s capital interests in the LLC, not the debtor’s complete membership interests.
In a nonprecedential opinion for the BAP on November 23, Bankruptcy Judge Michael E. Romero explained that the terms “capital interest” and “economic interest” are synonymous. Because the Oklahoma statute uses the term “capital interest,” that’s the term he used to mean the member’s rights to receive distributions and share in profits.