Daily Development for Thursday, July 5, 2001

Daily Development for Tuesday, June 26, 2001

By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

Jack Murray supplied this case and comments. I have edited the materials, but I hope I have been true to the substance of Jack's report. Note that there are two separate reports on different aspects of the same case.

BANKRUPTCY; LIMITED LIABILITY COMPANIES; ELIGIBILITY TO FILE:

LLC is eligible under the Bankruptcy Code ("Code") to file a Chapter 7 bankruptcy petition, but cannot do so without the assistance of counsel. In re ICLNDS Notes Acquisition, LLC, 259 B.R. 289 (Bankr. N.D. Ohio 2001).

Because limited liability companies ("LLCs") are still relatively new statelaw creations, the treatment of these entities in bankruptcy is uncertain, i.e., will they be treated as partnerships or corporations for bankruptcy purposes? Also, because LLCs are neither partnerships nor corporations though they have characteristics of both can a member or manager file a bankruptcy petition on behalf of the LLC without engaging in the unauthorized practice of law?

The court here held that the debtor, ICLNDS Notes Acquisition ("ICLNDS"), an Ohio LLC, was not eligible to file. If further concluded that ICLNDS's manager engaged in the unauthorized practice of law by filing the petition. This second holding is discussed in a separate report under the heading: "Limited Liability Companies; Manager; Characterization."

ICLNDS's voluntary bankruptcy petition (with attached schedules) was signed by David Bruno both as "Manager" of ICLNDS and as the nonattorney petition preparer under § 110 of the Bankruptcy Code ("Code"). (Section 110 regulates the activities of nonlawyers of nonlawyers who prepare bankruptcy petitions for compensation, and permits a lay person to assist another person with ministerial acts such as typing a petition).

ICLNDS did not file an application to employ an attorney in connection with the filing.

(It is not certain from the court's decision whether the manager was a member of the LLC, or an independent manager. Under Ohio law, an LLC may be managed by a manager who is not a member. Ohio Rev. Code Ann. § 1705.25).

The court noted that, under §§ 109(a) and 101(13) of the Code, the debtor must be a person or a municipality, and that § 101(41) of the Code defines "person" as including individuals, corporations, and partnerships. The court then stated that although there is no specific reference in the Code to LLCs, "[u]nder the rules of construction applicable to the Code . . . the use of the term 'includes' is not limiting (citation omitted). In other words, individuals, corporations and partnerships are clearly eligible for relief, but other similar entities are as well").

The court determined that under Ohio law (as in other states), an LLC is neither a partnership nor a corporation, but a "hybrid" that has features of both a corporation and a partnership. Therefore, it held, "[a]s corporations and partnerships are eligible to be debtors, and because an LLC draws its character from both of those forms of doing business, an LLC is similar enough to those entities that it also comes within the definition of 'person' and is eligible for protection under the Code."

The court then turned to the issue which appeared to the court to be one of first impression of whether ICLNDS could make a pro se appearance in court through its manager (who was not an attorney), or could only be represented by counsel. Here, the filing had been made by the manager of the LLC, who was not a lawyer.

The court stated that although, under 28 U.S.C. § 1654, individuals have the right to represent themselves without a lawyer in federal proceedings, "[t]hat right does not extend to permit them to represent other people or entities because by doing so they would be engaging in the unauthorized practice of law. The general rule is that corporations, which are artificial entities, may only appear in court through an attorney." The court noted that the Ohio Supreme Court had adopted a similar rule. The court also noted that this same general rule, supported by the vast majority of case law, applied to partnerships as well, i.e., partnerships must be represented by counsel in legal proceedings. Accordingly, the court ruled that whether an LLC is viewed as a corporation, a partnership, or a hybrid, it could only appear in court through an attorney.

Had ICLNDS so requested, it ordinarily would have granted an additional period of time for it to obtain legal counsel. But, because ICLNDS failed to respond to the motion to dismiss and did not file a motion to employ counsel the coury felt that it was necessary to dismiss the case.

Comment 1: The court's holding in that an LLC, though not defined in the Code, is eligible to file (or have filed against it) a bankruptcy proceeding is welcome, though not surprising. Some commentators believe that, at least under the Delaware Limited Liability Company Act, Del. Code Ann. tit. 6, § 18101 et seq. ("DLCC Act"), an LLC should be treated as a corporation because the LLC operating agreement is similar to a certificate of incorporation and a member's interest is analogous to a share of stock in a corporation. See Larry E. Ribstein and Robert R.

Keatings, Limited Liability Companies, § 14.04, at 1418 (2000) ("[F]rom a policy standpoint, LLCs probably should be considered corporations for bankruptcy purposes because the special bankruptcy provisions that apply to partnerships primarily relate to the general partner's duty to contribute to payment of the firm's debts"); Carter G. Bishop and Daniel S. Kleinberger, Limited Liability Companies Tax and Business Law, ¶1.04 (2 )(a) (1999).

There are no specific provisions in the Code or Bankruptcy Rules that deal with LLCs, and the application of bankruptcy law and specific Code provisions is uncertain. The Code does not include an LLC within the definition of a debtor that is eligible for relief. However, it is likely that a bankruptcy court would conclude that an LLC would qualify as a debtor under the Code.

Under the rules of construction applicable to the Code, however, the use of the term "includes" in the Code's definition of "person" is not limiting . . . . . In other words, individuals, corporations and partnerships are clearly eligible for relief, but other similar entities are as well; Committee on Bankruptcy and Corporate Reorganization of the Association of the Bar of the City of New York, Limited Liability Companies in Bankruptcy, in The Best Entity for Doing the Deal, at 747, 76364 (PLI Corp. Law and Practice Course Handbook Series No. 747 (1996)).

Case law is just beginning to develop in this area. Does an LLC qualify as a "corporation" (which includes an "association having a power or privilege that a private corporation, but not an individual or a partnership, possesses" and a "partnership association organized under a law that makes only the capital subscribed responsible for the debts of such association") as defined in sec. 101(9) of the Code, or does it qualify as a "person" (which includes an "individual, partnership and corporation") as defined in sec. 101(41) of the Code? As noted above, the Code currently does not recognize an LLC as a distinct or separately defined entity.

However, a court may find that an LLC has significant similarities to both partnership and corporate entities to qualify as a "person" entitled to protection under the Code. As the court stated here: "As corporations and partnerships are eligible to be debtors, and because an LLC draws its character from both of those forms of doing business, an LLC is similar enough to those entities that it also comes within the definition of "person" and is eligible for protection under the Code").

Where and whether an LLC files a bankruptcy petition can be different depending on whether corporate or partnership characteristics are deemed to apply. Proper authorization for the filing of a voluntary bankruptcy petition will depend on whether the LLC is treated as a partnership or a corporation, and such determination may be different depending on whether the LLC is membermanaged or managermanaged. If the LLC is membermanaged and is treated as a partnership under the Code, all of the members would be required to consent to a bankruptcy filing. If the LLC is managed by one or more designated managers, it is unclear (absent specific provisions in the LLC's operating agreement) whether the manager(s) alone may determine whether to file a bankruptcy proceeding, or whether the filing of a bankruptcy petition is such an extraordinary event that all members would be required to consent. An LLC's operating agreement should expressly address who is authorized to file a bankruptcy petit ion on behalf of the LLC. See Thomas F. Blakemore, Limited Liability Companies and the Bankruptcy Code, 13 Am. Bankr. Inst. J. 12 (June 1994); Federal Rule of Bankruptcy Procedure 1004 (which requires the consent of all partners to the filing of a voluntary petition on behalf of a partnership and requires service of an involuntary petition on all nonpetitioning general partners).

Comment 2: It is also unclear whether an LLC could contest the filing of an involuntary Chapter 7 or Chapter 11 bankruptcy petition against it on the basis that it is not a "person" under sec. 101(41) of the Code, or whether an LLC could convert a Chapter 11 proceeding to a Chapter 7 proceeding. Section 303(a) of the Code states that an involuntary bankruptcy proceeding may be filed only against "a person, except a farmer, family farmer, or a corporation that is not a moneyed, business, or commercial corporation, that may be a debtor under the chapter under which such case is commenced." Under sec. 303(d) of the Code, a general partner in a partnership debtor that did not join in the filing of an involuntary bankruptcy petition may challenge the petition and seek to have it denied. This provision would apply to an LLC only if it is treated the same as a partnership in bankruptcy. If an LLC is treated as a corporation in bankruptcy, only creditors would be permitted to file an inv oluntary petition against the LLC, and individual members could not file an involuntary proceeding against the LLC. (The operating agreement could even expressly prohibit such a filing).

Comment 3: It is uncertain whether, in the absence of clearcut case law, the Code will eventually be amended to specifically define and deal with LLCs. At a 1997 meeting of the National Bankruptcy Review Commission, which considered proposed amendments to the Code, the Small Business, Partnership and Single Asset Real Estate Working Group submitted a Memorandum suggesting that the Code be amended to provide for similar treatment of partners and LLC members under the Code, the exclusion of partnership and LLC agreements from the executory contract provisions of Section 365, and the unenforceability of ipso facto clauses.

The Memorandum did not suggest altering the overall treatment of debtor LLCs in bankruptcy, but only provided for specific treatment of the LLC relationship for LLC member or LLC manager debtors. The Memorandum stated that LLC members are similar to general partners in membermanaged LLCs and similar to limited partners or shareholders in managermanaged LLCs. No further action has been taken on this proposal and a legislative solution does not appear imminent, as the proposed revisions to the Code being considered by Congress as of the date of this article do not include any provisions addressing LLC issues.

Comment 4:. The court's rulings in that an LLC can only appear in court through an attorney, and that a nonlawyer who prepares and files a bankruptcy petition on behalf of an LLC is engaged in the unauthorized practice of law (whether an LLC is regarded as a corporation, partnership, or hybrid entity), brings some muchneeded guidance to what had heretofore been an unanswered question. The court's analysis of this issue is sound and well reasoned, and should encourage LLCs to retain and consult counsel before making the decision to file a bankruptcy petition.

LIMITED LIABILITY COMPANIES; MANAGERS; CHARACTERIZATION: LLC manager engaged in the unauthorized practice of law by filing for bankruptcy on behalf of the LLC.

In re ICLNDS Notes Acquisition, LLC, 259 B.R. 289 (Bankr. N.D. Ohio 2001).

ICLNDS did not file an application to employ an attorney in connection with the filing.

The court dismissed the case because it found that an LLC, although eligible to file for bankruptcy, could not do so pro se and was required to be represented by counsel. As an additional reason to dismiss the case, the court cited the fact that Mr. Bruno's actions in preparing and filing the bankruptcy petition and schedules constituted the unauthorized practice of law. It stated that under Ohio law, the practice of law "includes commencing an action or proceeding in which the person is not a party (citation omitted)." Id. at 294. Therefore, an individual who prepares and signs a bankruptcy petition (which commences the case) other than in the individual's own name, is commencing the case for another and has engaged in the unauthorized practice of law.

The court found that the fact that Mr. Bruno signed the petition as a nonlawyer bankruptcy petition preparer did not protect him because § 110 of the Code "does not authorize a nonlawyer to give substantive advice and counsel about the bankruptcy process or otherwise to engage in the practice of law (citations omitted)." It noted that the unauthorized practice of law would include counseling another individual or entity on financial matters in connection with bankruptcy. While Bankruptcy Rule 9010 authorizes a debtor's agent, attorney in fact, or proxy to appear in court and act in the debtor's behalf, this Rule expressly states that such representative may only "perform any act not constituting the unauthorized practice of law."

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