Co-authored by Cristine Pirro and Victoria Vron
You may recall an earlier article we posted here addressing the applicability of a transfer restriction in an operating agreement of a joint venture.  The Ninth Circuit B.A.P. recently affirmed the bankruptcy court’s order in In re Alameda Investments, LLC, which held that transfer restrictions in an operating agreement to which the debtor was a party do not prohibit the transfer of the debtor’s membership interest in a joint venture to the liquidating trust established pursuant to the debtor’s chapter 11 plan.
As a refresher, here are the pertinent facts of the case: Three entities – Alameda Investments, Inc., Phoenix, LLC, and AKT Investments, Inc. – entered into an operating agreement to form West Lakeside, LLC, a limited liability company that would develop a 133-acre tract of land in California.  Alameda and Phoenix each owned a 50 percent membership interest in West Lakeside, LLC, and AKT served as the managing member.  The operating agreement prohibited transfers of a member’s interest (membership, economic, and otherwise) without prior written approval of a majority of the other members.  Section 17301 (a) 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 in the United States Bankruptcy Court for the Central District of California.  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.  Although the liquidating trustee and the trust were involved in the management of West Lakeside for the first couple of years post-confirmation, by 2011 AKT began to question whether the trust had voting rights in West Lakeside, or was instead the holder of only an economic interest.  Shortly thereafter, AKT stopped involving the trust in the management of its operations.
In 2013, the liquidating trustee filed a motion in the bankruptcy court for an order determining that its membership interest in West Lakeside was unaffected by the plan because the plan transferred the debtor’s membership interest in West Lakeside to the trust.  The liquidating trustee further 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 Alameda was entitled prior to the chapter 11 filing or confirmation of the chapter 11 plan.  As discussed in our prior blog post, the bankruptcy court held that the operating agreement was not an executory contract because there was no performance due by each party as of the petition date such that the failure to perform would constitute a material breach of the operating agreement.  Phoenix did not appeal this holding.
AKT and Phoenix had also argued that, even if the operating agreement is not an executory contract, the plan limited the trust’s interests in West Lakeside to an economic interest because the plan and the confirmation order provided that any provision of a limited liability company agreement that purported to restrict the transfer of an economic interest could be invalidated as an ipso facto clause under section 365(e) of the Bankruptcy Code.  Because the plan and confirmation order only invalidated clauses restricting transfers of economic interests, Phoenix and AKT argued that restrictions on the transfer of membership or beneficial interests were not invalidated as ipso facto clauses.  The bankruptcy court and the Ninth Circuit B.A.P. disagreed, holding that the specific sections of the plan and confirmation order cited by Phoenix and AKT dealt exclusively with executory contracts and unexpired leases.  Because the operating agreement was not an executory contract (or unexpired lease), those particular sections of the confirmation order and plan did not apply.
The Ninth Circuit B.A.P. buttressed the bankruptcy court’s finding with California contract law, which applied in interpreting the plan.  California contract law disfavors construing contractual provisions in any way that would render other provisions mere surplusage.  Phoenix’s construction of the plan not only ignored the context of that section (which only addressed executory contracts and unexpired leases, and which explicitly referenced section 365 of the Bankruptcy Code), but also ignored the sections of the plan and confirmation order that provided all of Alameda’s interest in the trust assets to be deemed irrevocably transferred and delivered to the trust.  The section dealing explicitly with the interests of the trust is what governed whether the entire operating agreement transferred to the trust.
AKT and Phoenix further contended that the 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 and thus section 541(c) of the Bankruptcy Code is not applicable.  Section 541(a) of the Bankruptcy Code provides that the petition creates an estate of “all legal or equitable interests of the debtor in property as of the commencement of the case.”  11 U.S.C. § 541(a)(1).  An interest of the debtor in property becomes property of the estate notwithstanding a provision in an agreement, transfer instrument, or applicable nonbankruptcy law that restricts or conditions the transfer of such interest by the debtor.  11 U.S.C. § 541(c)(1)(A).  Section 541 allows the estate to take a debtor’s assets free and clear of prepetition contractual or statutory restrictions on a transfer.  Although Phoenix agreed that the debtor’s interest in West Lakeside came into the estate without limitations, Phoenix disputed whether the bankruptcy estate could transfer that asset to a third party unencumbered by prepetition restrictions.  The bankruptcy court held 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, pointing to section 1123(b)(3)(B) of the Bankruptcy Code, which allows a plan to provide for “the retention and enforcement by the debtor, by the trustee, or by a representative of the estate appointed for such purpose, of any claim or interest.”  11 U.S.C. § 1123(b)(3)(B).  Section 1123 provides a mechanism for the appointment of a liquidating trustee that will serve as a continuing representative of the estate and become the “functional equivalent” of a chapter 11 trustee.  The trust was merely a representative of the estate concerning enforcement of Debtor’s interest in West Lakeside under section 1123 of the Bankruptcy Code, and there was no transfer out of the estate to a third party that could otherwise violate the contractual anti-assignment clause in the operating agreement.  The trust was then able to enjoy the same membership interest in West Lakeside as the Debtor had prior to bankruptcy.
Alameda serves as a reminder that even the most careful drafting of an anti-transfer provision in an LLC agreement may not prevent a transfer of an LLC interest (whether economic, membership or otherwise) to a liquidating trust.