Monday, April 28, 2003

An All Bright Opinion

I've always believed that most legal concepts are fairly simple. A corollary to that belief is my feeling that the prevalence of bad writing, both among members of the bar and the bench, is a product of muddled thinking. It is a happy day when one comes across a judicial opinion that is both well written and well reasoned. Today was such a happy day because I came across the opinion of the United States Bankruptcy Court for the District of Colorado in the case of In re Allbright.

Allbright was the sole owner and member of an LLC that owns real estate in Colorado. The trustee in Allbright’s bankruptcy asserted the ability to take over the LLC, liquidate its property, and then distribute the proceeds pursuant to the bankruptcy proceeding. Allbright contended that "at best, the Trustee is entitled to a charging order and cannot assume management of the LLC or cause the LLC to sell" its assets.

The court noted that, under Colorado law, an interest in an LLC is personal property. By virtue of the bankruptcy filing, all of Allbright's personal property, including her interest in the LLC, was transferred to the bankruptcy trustee. Brushing aside Allbright's attempt to parse the difference between the right to manage the property and the right of a member to distributions from the LLC, the court went to the nub of the matter and said: "[T]he charging order, as set forth in [the Colorado LLC Act] exists to protect other members of an LLC from having involuntarily to share governance responsibilities with someone they did not choose, or from having to accept a creditor of another member as a comanager. A charging order protects the autonomy of the original members, and their ability to manage their own enterprise. In a single-member entity, there are no non-debtor members to protect. The charging order limitation serves no purpose in a single member limited liability company, because there are no other parties’ interests affected."

In a footnote, the court provided a common sense guide to future cases involving multi-member LLCs, when it stated: "The harder question would involve an LLC where one member effectively controls and dominates the membership and management of an LLC that also involves a passive member with a minimal interest. If the dominant member files bankruptcy, would a trustee obtain the right to govern the LLC? Pursuant to [the Colorado LLC Act], if the non-debtor member did not consent, even if she held only an infinitesimal interest, the answer would be no. The Trustee would only be entitled to a share of distributions, and would have no role in the voting or governance of the company. Notwithstanding this limitation, [the provision of the Colorado LLC Act dealing with charging orders] does not create an asset shelter for clever debtors. To the extent a debtor intends to hinder, delay or defraud creditors through a multi-member LLC with 'peppercorn' co-members, bankruptcy avoidance provisions and fraudulent transfer law would provide creditors or a bankruptcy trustee with recourse. 11 U.S.C. Sections 544(b)(1) and 548(a)."

There are numerous charlatans who contend that there is some secret hocus-pocus inherent in charging orders. Somehow, against common sense, they argue that if one puts assets in an LLC, the setup will has the same effect on the creditors of the members of the LLC as garlic does to vampires. They contend that not only are the assets themselves beyond the reach of the creditors, but the creditors can get allocated taxable income without the benefit of receiving cash to pay the resulting tax. (If you don’t believe me, punch the term "charging order" into any search engine.)

By contrast, Allbright is short, clear, and well-reasoned. It's message is surprisingly simple: What a debtor controls, belongs to his or her creditors, unless there are others who hold legitimate interests with legitimate expectancies that, unless they gave their consent, they would not have to deal with third-parties. This holding is consonant with such well-reasoned Maryland cases such as 91st Street Joint Venture v. Goldstein, 114 Md. App. 561 (1997). It ain't rocket science.

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