Recovering a member’s interest in an LLC
The bankruptcy protector
In my last post on this blog, I explored a potential avenue for a debtor to maximize the value of the sale of their interest in a bankrupt Limited Liability Company (“LLC”), notwithstanding any sale restrictions in the LLC’s Operating Agreement and Applicable State Law. In this article, I discuss the means by which a creditor can recover membership interest from its debtor. To set the stage, consider this common scenario: in making a loan for real estate development, a lender extends credit based in part on the personal net worth of a guarantor developer, much of which is attributable to his interests in corporations. with limited liability. If that loan defaults and the lender turns to their guarantor for payment, can they recover that interest in the LLCs? The underlying state law provides the answer. In South Carolina, the current law governing LLCs is the Uniform Limited Liability Company Act of 1996, SC Code Ann. § 33-44-101 et seq. (the “LLC Law”). The LLC Act sets out a specific process for recovering a debtor’s economic interests in an LLC, as described below.
As a first step in recovering an LLC member’s interest after obtaining a judgment against the member, the LCC Act provides that the court may seize a charge lien on a member’s distribution interest. to satisfy a judgment and appoint a receiver for that part of the distributions due or becoming due. SC Code Ann. § 33-44-504(a). “Distribution Interest” means “all interests of a Member in Distributions” by the LLC. SC Code Ann. § 33-44-101(6). Because of its charging privilege, if the LLC makes a distribution to the judgment debtor member, the lender would be entitled to receive the distribution and apply it to the judgment debts. However, the judgment debtor member retains its membership interest and, until severed as set forth below, the right to manage the LLC. The judgment creditor does not have the right to direct the actions of the LLC (i.e. its property.
Foreclosure on Charge Lien
Under the code SC Ann. § 33-44-504(b), a court may order the foreclosure of the charge lien. At any time before the foreclosure sale, the debtor or another member can “redeem” the distribution interest by paying the amount owed to the judgment creditor. If the interest is not repaid and is sold at foreclosure, the buyer at the foreclosure sale has the rights of an “assignee”. Under the code SC Ann. §§ 33-44-502 and 33-44-503, the transfer of a distributive participation does not give the transferee the right to exercise the rights of shareholder (such as the right to participate in the management) and does not give right to the transferee than to receive the distributions to which the transferor would be entitled. Additionally, upon the dissolution and liquidation of the LLC, the transferee receives the amount of property distributable to the transferor.
Following the foreclosure of the charge lien, another option is to force the dissolution of the LLC. Under SC Code § 33-44-503(e), an assignee may seek a court order that it is fair to dissolve and liquidate the business. In the event of dissolution, in accordance with SC § 33-44-806, the assets of the LLC are distributed to the members after payment of the creditors of the LLC.
Dissociation of the Member
Finally, with respect to the judgment debtor’s right to manage the LLC, pursuant to SC Code Ann. § 33-44-601(7)(iv), 90 days after the appointment of the receiver for the member’s distribution interest, if the order is not appealed, the member is “disassociated” as member. The member would then lose their right to manage the LLC, other than to participate in the liquidation of the LLC. See SC Code Ann. § 33-44-603(3).
SC Code Ann. § 33-44-504(e) provides that the section is the exclusive remedy by which a judgment creditor may satisfy a judgment on distribution interests in an LLC. Courts have recognized that this “exclusive remedy” provision refers to the remedies provided by the LLC Act and does not abrogate other remedies of a judgment creditor against a judgment debtor, such as the appointment of a receiver or the powers of a receiver or bankruptcy. curator. The appointment of a receiver in this context is often a more effective and efficient method of recovering the assets of a judgment debtor.
The potential loss of a member’s economic interest may be enough pressure to lead to a bankruptcy filing by the member. To the extent that the charge lien was granted prior to the bankruptcy, the judgment creditor should have a secured claim for an amount equal to the value of its interest. The debtor or trustee can assert that the lien is avoidable as a preference if it was granted within 90 days of filing. Additionally, if a receiver has been appointed and the 90-day period provided for in 33-44-601(7)(iv) has expired, resulting in the dissociation of the member, the creditor may be able to assert that the debtor member has lost the required authority to manage or sell the LLC, notwithstanding its filing for bankruptcy.
Given the limitations and various hurdles a judgment creditor must jump through under the LLC Act, I expect some judgment creditors to find the process slow and somewhat cumbersome. On the other hand, the ultimate effectiveness of proceedings to strip a member’s economic interest in the LCC and potentially lead to the dissolution of the LLC could certainly cause a member to question the effectiveness of the LCC. “asset protection” under the LLC Act. In this way, the collection provisions of the LLC Act balance the interests of the creditor, debtor, LLC and other members.