Pub. 8 2013-2013 Issue 5

www.nebankers.org 12 Extraordinary Service for Extraordinary Members. L imited liabilit y companies (LLCs) have consistently gained in popularity in Nebraska since the state first adopted the Lim- ited Liability Company Act in 1993. As the popularity of LLCs has increased, it has become common practice for creditors to take a security interest in a debtor’s LLC membership interest. Although an LLC membership inter- est may seem like adequate security for a loan, creditors should be aware that unlike foreclosing upon a corpo- ration’s stock, foreclosure on an LLC membership interest will not provide the creditor with the same governance rights the debtor enjoys. This is the first article in a two-part series intended to provide you with a basic understanding of what “transfer- able interest” a creditor obtains and what a creditor can do to protect its security interest in the debtor’s LLC membership interest. This article dis- cusses what rights a creditor obtains upon the foreclosure on an LLC mem- bership interest. The second part of the series will address ways in which credi- tors can protect their security interests in a debtor’s LLC membership interest and better protect the value of its inter- est in the event the creditor forecloses on the LLC membership interest. One of the most fundamental prin- ciples of LLC law is that members are free to pick their own partners. For this reason, the Nebraska UniformLimited Liability Act (the Act) is designed to divide amember’s rights in an LLC into two categories: (1) the economic rights (i.e., the “transferable interest”), which constitute the rights to the distribu- COUNSELOR’S CORNER tions of the LLC 1 ; and (2) the gover- nance rights (i.e., management rights, consent rights, rights to information, and the right to seek judicial interven- tion). The Act provides that a member may transfer or pledge its “transfer- able interest” in an LLC provided that the transferee does not have any right to participate in the management of the LLC or have access to the records or information concerning the LLC’s activities. 2 Creditors often assume that hav- ing a perfected interest in a debtor’s LLC membership interest entitles the creditor to all of the same rights as the debtor upon foreclosing the LLCmem- bership interest. This assumption is incorrect. While the economic interest in the LLC transfers, the debtor retains all governance rights along with all duties and obligations of membership in the LLC. If the creditor holds a valid Mem- bership Interest Pledge Agreement, the creditor can enforce its rights to the economic interest of the member once the debtor defaults on the loan. The agreement will provide all the remedies the creditor is entitled to, which presumably includes the ability to transfer its interest in the economic benefits of the LLC. In addition, a credi- tor is entitled to obtain a charging order against the economic interest of the debtor. A charging order is a lien on the economic interest of the debtor and im- poses an obligation on the LLC to pay the creditor any distributions to which the debtor is entitled. 3 The court issu- ing the charging order may appoint a receiver tomake all inquiries the debtor maymake to the extent necessary to ef- fectuate the collection of distributions pursuant to a charging order. 4 If the creditor is unable to recoup its debt within a reasonable amount of time, the creditor has the power to ask the court to foreclose on the lien and order the sale of the LLC membership interest. 5 What Is the Transferable Interest? Part 1 of 2 1 Neb. Rev. Stat. § 21-102. 3 Neb. Rev. Stat. § 21-142. 5 Neb. Rev. Stat. § 21-142. 2 Neb. Rev. Stat. § 21-141. 4 Revised Uniform Limited Liability Act § 503 cmt. (b)(1). Allan Williams , Husch Blackwell LLP LLCMembership Interest as Collateral: