Trustee can unilaterally wind up, dissolve LLC

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Where federal bankruptcy law provides that, upon filing a petition for bankruptcy, all of a debtor’s interests in a limited liability company become the property of the bankruptcy estate and are therefore subject to the control of the trustee, the trustee could unilaterally wind up an LLC of which the debtors were the majority owners.

Background

Legacy Wealth LLC was formed in 2015. Debtors Jerome and Michele Johnson each shared ownership interests in Legacy Wealth with their two adult children. Legacy Wealth’s sole asset was a home located in Ford, Virginia.

In October 2016, the Johnson family executed a consent to action by members without a meeting on behalf of Legacy Wealth. The 2016 consent purported to relinquish any and all rights to the property to Mary Ella Johnson.

In July 2019, the debtors jointly filed a voluntary bankruptcy petition under Chapter 7 of the Bankruptcy Code. In March 2021, the trustee proposed a plan to dissolve Legacy Wealth, sell the property and divert the proceeds toward paying off debtors’ outstanding debt. And, in July 2021, appellee initiated an adversary proceeding in the bankruptcy court to recover the property. Days later, Jerome Johnson again attempted to transfer the property from Legacy Wealth to Mary Ella Johnson—this time, through a gift deed for the nominal consideration of $1.00.

During the adversary proceedings, appellee argued that, as trustee of debtors’ bankruptcy estate, he assumed the debtors’ combined 76 percent membership interests in Legacy Wealth when they filed their bankruptcy petition; and, because the company’s operating agreement required only 52 percent of the membership to approve a decision to dissolve, he could unilaterally initiate the winding up of Legacy Wealth. Over the Johnsons’ objections, the bankruptcy court approved appellee’s plan and ordered Legacy Wealth to be wound up and dissolved.

The issues before the court on appeal are: (1) whether the debtors’ non-economic rights to manage Legacy Wealth became a part of their bankruptcy estate such that appellee, as trustee of that estate, could step into the debtors’ shoes and wind up the company (2) whether, notwithstanding appellee’s authority to manage Legacy Wealth, the property was validly transferred through either the 2016 consent or the 2021 gift deeds.

LLC

Virginia law and the Bankruptcy Code conflict on how membership rights in a limited liability company are affected by a voluntary bankruptcy filing. Under Virginia Code § 13.1-1040, members of a limited liability company are dissociated upon the filing of a bankruptcy petition; and, upon dissociation, the member loses all non-economic rights (i.e., the rights related to managing the company), but keeps their rights to share in the profits, losses and distributions of the company.

Under federal bankruptcy law, however, upon filing a petition for bankruptcy, all of a debtor’s interests in a limited liability company become the property of the bankruptcy estate and are therefore subject to the control of the trustee of that estate. The Bankruptcy Code is also clear that it preempts any “nonbankruptcy law” that may provide otherwise.

As such, the bankruptcy court was first required to decide whether § 13.1-1040 is a “nonbankruptcy law” that conflicted with the Bankruptcy Code. After a review of the applicable law, this court agrees with the bankruptcy court that it is. Thus, the state law is preempted and the federal standard applies. All of the debtors’ membership rights became the property of the bankruptcy estate and appellee was free to exercise those rights as he saw fit.

Transfer

Appellants argue that the property had already been transferred through the 2016 consent. However that instrument only memorialized the members’ “consent to the taking of the following action [i.e., transferring the property to Mary Ella Johnson] without a meeting of the members.” No formal deed was prepared to effectuate that transfer until 2021 — more than a year after the debtors’ filed for bankruptcy.

Appellants argue that, if not transferred in 2016, the property was transferred through the 2021 gift deeds. Because the debtors had already petitioned for bankruptcy, however, their interests in Legacy Wealth (including their right to manage the company) were the property of the bankruptcy estate and under the control of the trustee. And—because, at the time he attempted to ratify the 2021 gift deeds, Jerome Johnson had no interest in Legacy Wealth and because, under Virginia law, actions taken without proper authority are “null and void,”—the 2021 gift deeds were “without legal effect” as they “exceeded the scope of authority conferred by the operating agreement.”

Affirmed.

King v. Johnson, Case No. 1:22-cv-01037, Aug. 9, 2023. EDVA at Alexandria (Nachmanoff). VLW 023-3-468. 7 pp.