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Disposition of Partial LLC Interests in Bankruptcy

By Richard J. Mason and Patricia K. Smoots

Bankruptcy estates often own a partial interest (typically called a membership interest) in a limited liability company. Sometimes the LLC has been created for proper purposes well before bankruptcy was on the horizon. At other times, the LLC has been formed as an asset protection device by a debtor contemplating an insolvency proceeding and is part of a strategy to deter creditors. The most obvious and logical candidates to purchase the estate's LLC interests are the other, non-bankrupt members because the market for selling privately held LLC interests is thin, and dispositions to third parties may raise complications concerning sales of unregistered securities.

But what if the other members refuse to purchase the interest for more than a nominal amount while simultaneously treating the bankruptcy estate representatives in a hostile manner, such as by resisting efforts of the estate to sell to third parties, making unneeded capital calls, withholding distributions, burdening the estate with non-cash taxable income, or causing the LLC to engage in non-market transactions? What strategies can the estate pursue? Unfortunately, the answer usually lies in a tangle of confusing LLC statutes that vary from state to state, complicated by an overlay of imprecise provisions of the Bankruptcy Code.

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