Pub. 10 2015-2016 Issue 5

January/February 2016 15 Extraordinary Service for Extraordinary Members.  Counselor’s Corner — continued on page 16 mere pledge of the security interest was not sufficient to trans - fer such rights to the creditor. Instead, the then-controlling member retained such rights until such time as the creditor enforced the security agreement, foreclosed on the member interests, and became the member. To do otherwise, accord- ing to the court, would permit someone who was not a mem- ber to control the limited liability company. Moreover, in the court’s view, to allow a dismissal would “create confusion and disputes over the legitimacy of filings whenever an ownership interest has been pledged as security.” In re Lake County, 441 B.R. at 655. Although it did not grant the creditor’s motion to dismiss, the court signaled to the creditor that the court was “quite willing to entertain” a motion (that it could hear on an expedited basis) to stay the bankruptcy cases in order to permit the creditor to take such steps as would be necessary to enforce its rights under the security agreement in order to replace the then-current members. Id. In re Crossover Fin. I, LLC, 477 B.R. 196 (Bankr. D. Colo. 2012) In re Crossover is very similar to In re Lake County. The creditor in this case, however, waited more than two years after the default and six months after the bankruptcy filing to raise the argument about its approach being self-executing. “Under the Act, and consistent with the holdings of the vari- ous state court rulings, Colorado law requires a secured credi- tor to enforce the security agreement and become admitted as a member before voting rights associated with membership interests pledged as collateral can be exercised.” In re Cross- over Fin. I, LLC, 477 B.R. 196, 206 (Bankr. D. Colo. 2012). Based on In re Crossover and In re Lake County , the chances for success with a self-executing provision appear dim. In re DB Capital Holdings, LLC, 463 B.R. 142 (B.A.P. 10th Cir. 2010) The debtor was a manager-managed Colorado limited li- ability company. In 2006, the debtor entered into amortgage loan agreement with WestLB, as lender, and in connection with the loan amended its operating agreement to incorporate bankruptcy-remoteness provisions required by the lender. In addition to the customary bankruptcy-remoteness provisions, i.e., limiting the debtor’s business activities (requiring that they relate solely to the ownership, development, and opera- tion of the subject property) and adding appropriate separate- ness covenants, the lender required that the debtor include in its operating agreement a covenant that the debtor would not commence a voluntary bankruptcy or similar insolvency proceeding. The debtor eventually defaulted on the loan and the lender was successful in having a receiver appointed over the debtor’s property. Approximately two months later, one of the two members of the debtor sought to have the debtor dissolved, upon which the manager of the debtor (an affili - ate of the other member of the debtor) filed the debtor into bankruptcy. The member that had sought dissolution filed its motion to dismiss the debtor’s bankruptcy on the basis that the bankruptcy case was filed without requisite author - ity, citing the bankruptcy covenant in the debtor’s operating agreement. The bankruptcy court granted the motion to dismiss and the United States Bankruptcy Appellate Panel of the Tenth Circuit affirmed. In granting the motion to dismiss, the bankruptcy court characterized the bankruptcy covenant found in the debtor’s operating agreement as an agreement among the LLC mem- bers and not as an agreement between the debtor and a third party, thus distinguishing the instant case from the line of cases that would hold such an agreement, if made with a third party, unenforceable as against public policy. According to the bankruptcy court, such an agreement among LLC mem- bers, which could be later amended by the members should they decide to permit a bankruptcy filing, did not operate as a waiver of the benefits of bankruptcy. So long as it was not the product of lender coercion, such an agreement by the LLC members not to permit a bankruptcy filing by the LLC was a matter internal to the LLC and did not implicate public policy considerations. It was on this basis that the bankruptcy court dismissed the debtor’s bankruptcy, which was subsequently affirmed by the Tenth Circuit B.A.P. Although the DBCapital Holdings decision fromthe Tenth Circuit B.A.P. is an important development in the law relevant to bankruptcy-remoteness, the decision raises a number of questions that were not clearly addressed by either the lower court or the appellate court. 1 First, the bankruptcy covenant (along with the other bankruptcy-remoteness covenants) was added to the debtor’s operating agreement at the request of and expressly for the benefit of the lender as a condition to the loan. Practically speaking, the substance of such a covenant would appear to differ very little from a similar covenant placed in a loan agreement (see the In re Bay Club decision below). Nevertheless, the formof the covenant, i.e., an agree- ment between LLCmembers in the first case versus an agree - ment between the LLC and a third-party lender in the second, appears to have been viewed by at least these two courts as a material difference. Secondly, the Tenth Circuit B.A.P. as well as the bankruptcy court below expressly left open the question as to whether such a covenant could be rendered unenforceable if obtained by coercion. Although neither court provided any guidance as to what might constitute coercion, the facts in DB Capital Holdings would suggest that a bank- ruptcy covenant added to the borrower’s organic documents at the request of a lender, even if required as a condition to making a loan, without more, would not be coercive. Lastly, and perhaps most importantly, the conclusion reached by the bankruptcy court suggests that the LLC members should have the ability to amend the operating agreement to permit a bankruptcy filing, should they decide to do so. 2 In re Bay Club Partners-472, LLC, No. BR 14- 30394-RLD11, 2014WL 1796688 (Bankr. D. Or. May 6, 2014)