Contributed by Victoria Vron
Transfer restrictions and anti-assignment clauses are a common feature in operating agreements of joint ventures. In In re Alameda Investments, LLC, a bankruptcy court addressed the applicability of one such transfer restriction to the transfer of a debtor’s entire interest (membership, economic and otherwise) in a joint venture to the liquidating trust that was set up pursuant to the debtor’s chapter 11 plan to liquidate and distribute its assets.
In 2003, three entities — Alameda, Phoenix, LLC and AKT Investments, Inc. — entered into an operating agreement to form West Lakeside, LCC, a limited liability company that would develop a 133-acre tract of land in Sacramento County, California. Alameda and Phoenix each owned a 50% membership interest in West Lakeside, and AKT was its managing member. The operating agreement prohibited the transfer of, among other things, all or any portion of member, beneficial or economic interests by any member without the prior written approval of a majority of the members. Section 17301(a)(1) of the California Corporations Code also prohibited the transfer of membership interests without the consent of a majority of the non-transferring members.
On January 9, 2009, Alameda and certain of its affiliates filed for chapter 11 protection. The debtors’ joint chapter 11 plan established a liquidating trust for the primary purpose of liquidating and distributing Alameda’s assets. The plan provided that, with certain exceptions not relevant here, all of Alameda’s rights, title and interest in and to Alameda’s assets were “irrevocably transferred, absolutely assigned, conveyed, set over and delivered to the Alameda Liquidating Trust” for the benefit of the trust beneficiaries.
After the chapter 11 plan became effective, Phoenix and AKT disputed the extent and nature of Alameda’s interests in West Lakeside that the Alameda liquidating trust received. The liquidating trustee argued that, because the operating agreement was not an executory contract, the trust received the same membership interests and benefits in West Lakeside to which Alamedia was entitled prior to the chapter 11 filing or confirmation of the chapter 11 plan. AKT and Phoenix disagreed, arguing that the liquidating trust received at best only an economic interest in West Lakeside and that the membership interest could not have been assigned without the majority vote of the non-transferring members.
The bankruptcy court found that the operating agreement is not an executory contract and that the transfer restrictions in the operating agreement and the California Corporations Code do not affect the liquidating trust’s interests (whether membership, economic or otherwise) in West Lakeside.
In holding that the operating agreement is not an executory contract, the court looked at whether there was any performance due thereunder by each party as of the petition date, such that failure of such performance would constitute a material breach of the operating agreement. Alameda’s outstanding obligations under the operating agreement were to vote on certain matters and participate therein in good faith. AKT argued that an operating agreement can be executory if material events requiring a debtor to vote are imminent, and the debtor has an obligation to participate in good faith. The court disagreed and held that a limited voting right, by itself, does not make the operating agreement executory. Further, no vote on West Lakeside was imminent or likely, because the 133-acre tract of land was years away from development, and there was no evidence presented that failure to vote would constitute a material breach excusing other parties from performance.
AKT and Phoenix then tried to argue that, even if the operating agreement is not an executory contract, Alameda’s entire interest in West Lakeside did not transfer to the liquidating trust, and the trust received no more than an economic interest in West Lakeside because of the following language in the chapter 11 plan and the confirmation order:
any provisions of a limited liability company agreement or operating agreement of a limited liability company or similar entity which purports to restrict the transfer of the economic interest in such entity to one of its members which is one of the Debtors herein, or its assignee, is invalidated as an ‘ipso facto’ clause under Section 365(e) of the Bankruptcy Code, to the extent that Section 365 applies.
Because this language only invalidated clauses restricting transfers of the economic interest, AKT and Phoenix argued that restrictions on transfer of membership or beneficial interests were not invalidated as ipso facto clauses. Again, the bankruptcy court disagreed, holding that the plan and confirmation order language only applies to executory contracts and unexpired leases; as the court already held that the operating agreement is not an executory contract, this language and section 365 of the Bankruptcy Code did not apply to the operating agreement. Instead, section 541(c)(1)(A) of the Bankruptcy Code governed and preempted the anti-assignment provisions of the operating agreement and the California Corporations Code, such that Alameda’s entire interest in West Lakeside became property of Alameda’s estate upon the commencement of the chapter 11 case.
Finally, the court held that, even if the transfer restrictions in the operating agreement and the California Corporations Code were to apply to restrict the transfer of Alameda’s entire interest to a third party, the liquidating trust is not a third party. The chapter 11 plan provided that the liquidating trust would be Alameda’s successor-in-interest with respect to all claims and causes of action that could have been brought by Alameda prior to the effective date of the plan and that the liquidating trustee was the representative of the Alameda estate within the meaning of section 1123(b)(3)(B) of the Bankruptcy Code. Accordingly, the court held that the liquidating trust holds Alameda’s entire interest (membership, economic or otherwise) in West Lakeside under the operating agreement as the estate representative.