Recent Articles tagged collection and foreclosure from LexMonitor

Charging Order Protection for Multi-Member and Single Member LLCs

Fri, 09 Dec 2011 15:44:23 GMT

In the course of their business, bankers routinely encounter single member limited liability companies ("SMLLCs"), entities commonly used in real estate and small businesses. Despite the prevalence of SMLLCs, there is a fundamental legal uncertainty as to whether the assets of an SMLLC share the same level of protection from its member's creditors as is provided to the assets of a multi-member LLC through the charging order remedy.

Depending on state law, bankers may or may not be able to reach the assets of their debtors' SMLLCs through a charging order. Furthermore, changes to Ohio law have recently been discussed in the Ohio Legislature which attempt to remove any uncertainty and would prevent bankers and other creditors from reaching assets of a SMLLC through a charging order.

The following analysis discusses recent case law from around the country examining a judgment creditor's ability to reach the assets of an SMLLC in which its debtor holds the sole membership interest. The LLC charging order is a remedy through which a creditor who has won a judgment may reach its debtor's membership interest in an LLC. State LLC statutes generally require the unanimous consent of all members (other than the assigning member) in order for the assignee of an LLC membership interest, such as a creditor who has attached its debtor's membership interest, to participate "as a member" in the management of the LLC. To protect this approval right of the other members in a multi-member LLC, a charging order entitles a creditor only to the debtor's share of distributions and assets upon dissolution, and not to the right to participate in the management of the LLC. This prevents the judgment creditor from selling the LLC's assets and distributing the proceeds to itself.

Where the debtor's interest is in an SMLLC however, there are no other members to consent to the assignment of the debtor's management rights. In such circumstances, whether a charging order will provide the same level of asset protection to a SMLLC as it would to a multi-member LLC, and thus prevent a creditor from satisfying its judgment through the sale of the SMLLC's assets, depends upon the statutory framework of the state in which the LLC is organized.

Recent Case Law

The Kansas Revised Limited Liability Company Act ("KRLLCA") specifically provides that where the member of an SMLLC assigns its interest, "the assignee shall have the right to participate in the management of the business and affairs of the limited liability company as a member." (Kan. Stat. Ann. § 17-76, 112(f)). In October 2011, a court interpreting this provision held that it applies to a judgment creditor who becomes an assignee pursuant to the entry of a charging order. (Meyer v. Christie, No. 07-2230-CM (D. Kan., Oct. 13, 2011)). This explicit provision of the KRLLCA makes it clear that in Kansas a charging order does not provide the same level of asset protection to a SMLLC as it would to a multi-member LLC. Under the Kansas framework, a creditor can use a charging order to reach the assets of its member's SMLLC to satisfy its judgment.

The Supreme Court of Florida's 2010 determination of the issue, on the other hand, hinged on whether or not the statutory charging order was the sole remedy through which a creditor could reach its debtor's SMLLC interest. (Olmstead v. FTC, 44 So. 3d 76 (Fla. 2010)). Although the court found that Florida's charging order remedy "clearly does not authorize the transfer to a judgment creditor of all an LLC member's 'right, title and interest' in an LLC," it also held that the charging order was not the judgment creditor's exclusive remedy. (Id.) Florida's generally applicable law subjecting a judgment debtor's corporate stock to levy and sale under execution, combined with the "uncontested right of the owner of the single-member LLC to transfer the owner's full interest in the LLC," permitted the court to order the debtor to surrender all right, title and interest in its SMLLC to satisfy an outstanding judgment. (Id.) While the Florida charging order remedy protects the rights of non-debtor members of a multi-member LLC, the availability of this additional remedy allows a creditor to go beyond the charging order protections and reach its debtor's full SMLLC membership interest, including management rights.

Similarly, a U.S. Bankruptcy Court applying Colorado law has held that "the charging order limitation serves no purpose in a SMLLC, because there are no other parties' interests affected." The court found that without the protections of a charging order as an exclusive remedy, a debtor's bankruptcy filing effectively transferred her full membership interest in her SMLLC, including her management rights, to the bankruptcy estate. (In re Albright, 291 BR 358 (Banker. Court D. Colorado, 2003)). This allowed the Bankruptcy Trustee to obtain management rights and to cause the SMLLC to sell its assets and distribute the proceeds to the estate, without being hindered by the protections of a charging order.

Ohio Proposed Amendment

While Ohio courts have not addressed whether the same charging order protections offered to multi-member LLCs are also available to SMLLCs, changes to Ohio law recently discussed in the Ohio Senate Judiciary Committee begin to address this issue. If enacted, proposed amendments to Section 1705.19 of the Ohio Revised Code, to be contained in HB 48, would expressly provide that a charging order is the exclusive remedy of a creditor seeking to satisfy judgment against the LLC membership interest of a debtor. Furthermore, the amendment would prohibit any creditor of a member of an LLC from having any right to obtain possession of, or to exercise legal or equitable remedies with respect to, the property of the LLC. The proposed amendment does not differentiate between SMLLCs and multi-member LLCs.

Under the analysis used in the above cases, this change would most likely prevent a judgment creditor from obtaining management rights in an SMLLC, since there would be no specific statutory exception for SMLLCs and the charging order would be the exclusive remedy available to the creditor to reach the debtor's membership interest. If the amendment is enacted and Ohio courts interpret the statute to provide SMLLCs with the same charging order protections as multi-member LLCs, creditors will be unable to recover judgments by forcing the sale of their debtors' SMLLC assets and distributing proceeds.

Bankers should be aware of this possibility and take necessary precautions to avoid relying on unreachable assets of the debtor's SMLLC as security for the credit they extend. In most cases, the straight-forward solution is prepare loan documentation reflecting the SMLLC as a borrower.

Kreisler or Yellowstone? The Reach of the Equitable Subordination Doctrine

krathburn@porterwright.com (Ken Rathburn) — Fri, 21 Aug 2009 20:06:47 GMT

The recent equitable subordination cases of In re Kreisler and Erenberg, 546 F.3d 863 (7^th Cir. 2008) and Credit Suisse v. Official Committee of Unsecured Creditors (In re Yellowstone Mountain Club, LLC), Bankr. D. Mont., No. 09-00014 show a possible deviation in the courts regarding the proper application of the doctrine of equitable subordination. Accordingly, secured lenders should stay abreast of these different interpretations and possibly consider adjusting their lending practices. Those who fail to do so could see their claims in bankruptcy move further down the chain of priority.

The doctrine of equitable subordination allows a bankruptcy court, using principles of equity, to subordinate all or part of one creditor’s claim to all or part of another creditor’s claim where the inequitable conduct of one creditor has caused injury to the interests of another creditor. Codified at 11 U.S.C. § 510(c), the doctrine is simple to state and yet, at least it would appear, is rather difficult to apply.

Courts have adopted the Mobile Steel Test as a method to decide when it is appropriate to invoke the doctrine of equitable subordination. The Mobile Steel Test, as its name suggests, originates in the case of In re Mobile Steel Co., 563 F.2d 692 (5^th Cir. 1977). The Mobile Steel Test lays out three conditions that must be satisfied before exercising the power of equitable subordination. They are as follows:

The creditor making the claim on the debtor in bankruptcy must have engaged in some sort of inequitable conduct;
That inequitable conduct must have resulted in either injury to the other creditors or an unfair advantage to the creditor who engaged in such inequitable conduct; and
The reordering of the claims must be consistent with the provisions of the Bankruptcy Code.

Within conditions 1 and 2 above, courts have developed standards of measurement. For example, when the claims involve a non-insider and non-fiduciary, the inequitable conduct must have been gross and egregious. In re First Alliance Mort. Co., 471 F.3d 977, 1006 (9^th Cir. 2006). Also, the purpose of the doctrine is remedial not punitive. That is to say, the claims of the inequitable-acting creditor should be subordinated only to the extent necessary to offset the harm suffered by other creditors; it is not meant as a source of punishment. In re Mobile Steel, 563 F.2d at 701.

Kreisler:

In Kreisler, two Chicago real estate developers in Chapter 7 proceedings formed a new corporation and purchased the first priority secured claim of Community Bank. They then asserted the secured claim in the name of the newly formed corporation, essentially to ensure that the bulk of the assets went to them and not to any other creditors standing in line. The bankruptcy judge discovered their actions and subordinated their claim to that of all the other creditors in the proceeding, secured and unsecured. The appellate court affirmed, but Seventh Circuit reversed. The Seventh Circuit held that there is no evidence that the actions of the two developers harmed any other creditors in the proceeding. Despite using their insider status and knowledge that Community Bank was willing to sell its claim, their purchase of that claim did not change anyone’s place in line or alter any other creditors’ claims. Community Bank could sell the claim to anyone, so it simply did not matter that the “anyone” were the debtors themselves. Put simply, even if you concede that condition 1 was satisfied, condition 2 was not.

Yellowstone:

In Yellowstone, a high-end golf and ski development in Montana went under after the developer refinanced the entire project through Credit Suisse and then used the proceeds for personal purposes. In the bankruptcy judge’s recent order deciding the ordering of the claims, the judge criticized the lack of due diligence on the part of Credit Suisse. The judge found that Credit Suisse had acted recklessly in loaning against the project when a fair amount of due diligence would have uncovered that it was doomed for failure. Further, the judge held that the fact that the project went into bankruptcy was, itself, a harm to the other creditors. In short, condition 1 was satisfied by Credit Suisse’s negligent lending, and condition 2 was satisfied by the resultant bankruptcy. The judge subordinated Credit Suisse’s first priority secured claim to that of all the other creditors in the proceeding, secured and unsecured.

Analysis:

It would be easy to simply dismiss Yellowstone out of hand because the case involves extremely bad facts. The resort development was an enormous undertaking for the area, to the point where nearly every contractor within the region had invested its time and resources on the project and was awaiting payment. Because of Credit Suisse’s large financing of the project, it took a first priority position with collateral insufficient to cover even its own credit extensions. If it remained in first position, virtually no contractor or other creditor would receive a dime. The judge simply used the doctrine of equitable subordination as a tool to ensure that all of the other contractors and various creditors of the project would receive some payment. Thus, one could consider this an outlier case and instead choose to view Kreisler as the standard bearer on the doctrine of equitable subordination. But, while such a view may be reasonable when discussing these cases as theory or policy, adopting such a view in practice could be a dangerous course of action for secured lenders.

Whether or not Yellowstone stands, the case clearly shows that secured lenders must consider with their legal counsel whether or not their current lending practices, including underwriting, collateral review and other front-end activities, will sufficiently protect them from the Yellowstone-type application of the doctrine of equitable subordination. Otherwise, any bankruptcy judge looking to protect the businesses of the surrounding area could follow Yellowstone’s lead and use the doctrine of equitable subordination as a means to an end.

Ohio Supreme Court Confirms Legality of Attorney Fees Provisions Related to Defaulted Residential Mortgage Loans

MMoberg@porterwright.com (Matt Moberg) — Tue, 07 Jul 2009 16:42:58 GMT

In Wilborn v. Bank One Corporation (Slip Opinion No. 2009-Ohio-306), the Supreme Court of Ohio upheld a provision in a residential mortgage contract that required a defaulting borrower to pay a lender's reasonable attorney fees as a condition for reinstating a defaulted loan and terminating foreclosure proceedings. Although this decision merely upholds a common practice among lenders, there should be little doubt now that Ohio lenders may require the payment of attorney fees to reinstate a mortgage in foreclosure, particularly if the mortgage was a standardized Fannie Mae or Freddie Mac document.

The crux of the Wilbon matter centered on the apparent conflict between the mortgage document (which required payment of attorney fees as a condition of loan reinstatement after default) and Ohio public policy and common law dating back to 1893 (prohibiting the recovery of attorney fees resulting from a default upon a consumer or residential debt obligation).

The Court walked a twisting and very narrow path to arrive at its conclusion, first finding that the current statutory scheme under R.C. 1301.21 authorizing the payment of attorney fees was merely illustrative and did not prohibit recovery in all other circumstances. Next, the Court distinguished between the borrower's contractual right to reinstatement of the loan from its legal right to redeem the property. Holding that while attorney fees may not be recovered as a condition to redemption, the payment of such fees was a reasonable bargin for the lender to agree to terminate foreclosure proceedings and voluntarily re-enter the loan arrangement with the consumer. Finally, the Court found that the Fannie Mae/Freddie Mac documents were not contracts of adhesion because industry groups and consumer advocate groups were heavily involved in the negotiation and implementation of these form documents. So while the individual borrower may have little power to alter the terms and conditions of the mortgage, the process by which the template for these forms came about was sufficient to protect the borrower's interests in this regard.

The takeaway from this case is that borrowers can likely be required to pay their lenders' attorney fees as a condition to loan reinstatement, and lenders can erase any doubt as to the enforcibility of these provisions by using Fannie/Freddie standardized loan documents rather than their own customized loan documents.

Widespread Changes in Ohio Foreclosure Procedures

MMoberg@porterwright.com (Matt Moberg) — Tue, 07 Jul 2009 15:17:59 GMT

House Bill 138, effective September 11, 2008, makes sweeping and widespread changes to the substantive and procedural aspects of foreclosures in Ohio. Although the actual implementation of these new standards may vary and each county's procedures must be verified for all current and future foreclosure cases, those currently in progress as of September 11, 2008 should be subject to the former statutes as to substantive matters but will be subject to the procedural changes in the new legislation. Highlights are as follows:

The court may require mediation of any foreclosure at any point during the proceeding and may require the personal attendance of both the mortgagor and mortgagee.
The lis pendens date is changed from the date service is perfected on the principal defendant(s) to the date the complaint is actually filed. Although this change doesn't eliminate the requirement that service be obtained on the defendant at some point in the case, it does create some certainty about the point at which subsequent liens are barred.
In residential foreclosures a Preliminary Judicial Report (PJR) obtained from a title company must be filed within 14 days of the complaint and updated by a Final Judicial Report prior to the court issuing an order of sale. Commercial foreclosures have the option of using a PJR or a standard title commitment.
The officer making the sale is required to collect certain purchaser information, such as contact information, the name of the purchaser and the name to which title should be conveyed, and other information. This requirement applies to the foreclosing lender as well, should that lender be the successful bidder at the sale.
An obligation is placed on the parties to have the sale confirmed within thirty days of the sale, and the purchaser must pay the balance due within that time. Failure to do so may be treated as a contempt of court and may result in forfeiture of the deposit. The court is also granted broad authority to stay confirmation to give the defaulting borrower time to redeem the property or "for any other reason the court deems appropriate."
The deed must now be prepared by the lender's attorney and submitted to the sheriff, who now handles recording. Because taxes, conveyance fees and other charges must be paid prior to recording, lenders are being asked to submit a certain amount of money (varying by county) to cover these costs.

Some of the foregoing changes, such as the revised lis pendens date, will speed the foreclosure process along and make title examination much easier. Other changes will benefit consumers and title agents, such as the residential PJR requirements. Lenders should note, however, that there are a number of pitfalls in this legislation that have the potential to extent foreclosure proceedings. First, the possibility of mediation could result in delay, particularly when the borrower gives at least the appearance of being able to bring the loan current. In addition, the court now has the discretion to stay a sale confirmation to give the defaulting borrower additional time to redeem the property or for any other reason the court deems appropriate. How courts will use this apparently unfettered discretion remains to be seen. In all events lenders will be saddled with additional costs and delays in what is already a time-consuming process.