LLC Operating Agreements May Prohibit Bankruptcy Filings

                

In a case of first impression, In re DB Capital Holdings, LLC,[1] the Bankruptcy Appellate Panel for the Tenth Circuit (“B.A.P.”) held that a provision in a limited liability company’s (“LLC”) operating agreement prohibiting the LLC’s members or its management from filing a bankruptcy petition is valid.[2]  In May 2010, DB Capital’s manager filed a chapter 11 bankruptcy petition on behalf of DB Capital (“the debtor”).[3]  The B.A.P. affirmed the bankruptcy court’s order dismissing the chapter 11 case pursuant to 11 U.S.C. § 1112(b),[4] holding that a provision in the operating agreement expressly barring the debtor’s manager from filing for bankruptcy was valid.[5]

 

Although the Colorado Limited Liability Company Act (“LLC Act”)[6] does not explicitly countenance anti-bankruptcy provisions, section 7-80-108(1)(a) provides that “[t]he operating agreement may contain any provisions” for the affairs and conduct of the LLC “to the extent such provisions are consistent with law.”  The B.A.P. acknowledged the case law holding that a contractual provision with a third-party to waive bankruptcy protection is unenforceable, but could not locate any case “standing for the proposition that members of an LLC cannot agree among themselves not to file bankruptcy, and that if they do, such agreement is void as against public policy.”[7]  Moreover, there was no evidence of coercion by a creditor that led the members to adopt the anti-bankruptcy provision.[8]  Therefore, the B.A.P. opined that, under these circumstances, the prohibition on bankruptcy was valid and enforceable.[9]  The B.A.P. explained that the anti-bankruptcy provision in the debtor’s operating agreement deprived the manager of the right to file a petition for bankruptcy because it limited management’s “rights and powers” to the “management of the affairs of the business in the ordinary course.”[10]  Because filing for bankruptcy makes it impossible for a company to carry on its ordinary business,[11] debtor’s manager was precluded from filing for bankruptcy, regardless of the presence of an explicit ban, or not.

 

As a case of first impression, there are four potential implications of In re DB Capital.  First, the B.A.P. specifically refused to determine whether a similar provision, coerced by a creditor would be enforceable.  As the case law implies however, such a ban may be impermissible as a matter of public policy.[12]  Second, the B.A.P. heavily relied on the language of DB Capital’s Operating Agreement, rather than case law, in rationalizing its holding.[13]  Thus, if the language of another operating agreement containing a similar provision were to vary even slightly, it is possible that the B.A.P. could find the agreement unenforceable.  Lastly, the DB Capital decision walks a fine line differentiating the anti-bankruptcy provision at issue to the existing bankruptcy case law.  Here, the dispute was between members, as opposed to creditors seeking to preclude a debtor from filing bankruptcy.  In DB Capital, one member was asserting his rights, as outlined by the Operating Agreement, against the other member (and manager) of the LLC.[14]  Therefore, it is uncertain whether other jurisdictions will follow the Tenth Circuit B.A.P.’s analysis if faced with the same question.