In Georgia Rehab., LLC v. Newnan Hospital, the Supreme Court held that arbitration clauses don’t always apply. Judicial dissolution, it
stated, is “an independent legal mechanism for the judicial and administrative dissolution of a limited liability company.” Georgia
Rehabilitation, 283 Ga. at 336. The upshot of all this is that a member of an LLC can become disgruntled and get the courts involved
even when he initially agreed that he wouldn’t. Needless to say, this can get expensive.
Your clients should know that the wary drafter of an OA may be able to get around the newly announced rule and allow for arbitration of
disputes in all circumstances.
Protections for minority members
Another recent Court of Appeals case revealed a nasty surprise for a minority member of an LLC and shows the dangers of the use of
“form” OA’s to draw up members’ rights. In Riverdale, LLC v. McChesney Capital Partners, the court examined an OA in which one
investor entered into an LLC with the understanding that it was entitled to certain protections against the possibility of the majority
voting away its rights. 292 Ga. App. 841 (2008). The protections could not be taken away by majority vote. Unfortunately, the OA allowed
amendments to the document by majority vote. The majority members therefore unethically (but as the court held, legally) voted to
amend their OA to take away the profit rights of the minority member.
Your clients would do well to consult with an attorney if they are minority members of an LLC to ensure their rights to profits are
protected.
Allocation of voting rights
Still another recent case demonstrated that LLC members should consult with counsel before allocating voting rights. As in many LLC’
s, the case involved a “moneyed” member, who contributed most of the capital. Hampton Island Founders, LLC v. Liberty Capital, LLC,
283 Ga. 289 (2008). In order to protect his investment, the member required that voting rights be allocated according to each member’s
share of the LLC’s capital account. Id. at 291, n. 1.
The result of this scheme was extreme uncertainty as to who had how much control of the LLC, and the case has not yet been resolved
in our appellate courts. The lesson to take away is that capital accounts can fluctuate greatly and may or may not reflect the actual
amount a member has contributed to an LLC.
The careful drafter of an OA will find a clear and fair way to allocate voting rights for members.
Rights of judgment creditors
Georgia’s debt-collection laws can contain surprises for unwitting members of an LLC. Most LLCs are formed as “close”
organizations, which is to say that ownership and management is vested in very few individuals. If, for example, Allen, Bob, and Carol
trust one another enough to form an LLC, then chances are that none of the members want an outsider to come along and buy up the
interest of one member, effectively inserting a non-trusted party into what was an intimate partnership.
To avoid the possibility of sales to outsiders, most LLC’s have OA’s that prohibit the “assignment” (i.e., transfer or sale) of a member’s
interest without the unanimous consent of the other members. So far so good. But debt collection law can turn the members’ intentions
upside-down. Here are a few ways:
1. Charging orders. If you owe a debt, then your creditors can obtain a judgment against you and then apply for a court order for the
rights to intercept payments your debtors make to you. The process is called a garnishment, and most people are familiar with the fact
that wages can be garnished.
Judgment creditors can obtain similar relief against an LLC member via a “charging order.” See Ga. Code Ann. § 14-11-504 (1993).
This court order allows them to collect any distributions made to an LLC’s member to which s/he would otherwise have been entitled
had the creditors been assigned an interest by the debtor/member. Ga. Code Ann. § 14-11-502(2) (2002). It does not matter if, as is
common, the LLC members had prohibited assignment in the OA.
The unpleasant surprise here is that non-debtor members of the LLC will find that every time they make a distribution of profits, they
pay themselves and a third party they may care nothing for. (And, as it turns out, the nasty surprise for the debtor/member is that he still
owes the IRS for taxes on the distribution. See IRS Rev. Rul. 77-137.)
2. Secured creditors. As stated, an LLC’s OA can prohibit assignment of an interest. But what if a member does it anyway? The
starting proposition is that the assignment is void, and the assignee cannot take an interest in the LLC. This proposition changes,
however, when the member grants a bank a security interest in his LLC membership in order to obtain credit.
According to the Uniform Commercial Code, which has been adopted in Georgia, no agreement between an LLC and its members
may prohibit the granting of a member’s interest as security against a loan. (n. 1) The best the other members of the LLC can do is to
sue the debtor/member for breach of the OA.
3. The trustee in bankruptcy. If a member of your client’s LLC files for bankruptcy, your client may want to get ready to have the Trustee
in Bankruptcy as his/her business partner. Under certain circumstances, a bankruptcy trustee may assume all rights of an LLC
member, notwithstanding the fact that the OA does not allow assignment of interests. (n. 2) Wary attorneys may be able to draft an LLC’
s OA such that this contingency will not occur.
What to do?
Careful planning and drafting of an operating agreement can avoid or mitigate the pitfalls mentioned above. If you or your clients are
members of LLC’s, it may be useful to have an experienced attorney review the company’s operating agreement before a court of law
does.
stated, is “an independent legal mechanism for the judicial and administrative dissolution of a limited liability company.” Georgia
Rehabilitation, 283 Ga. at 336. The upshot of all this is that a member of an LLC can become disgruntled and get the courts involved
even when he initially agreed that he wouldn’t. Needless to say, this can get expensive.
Your clients should know that the wary drafter of an OA may be able to get around the newly announced rule and allow for arbitration of
disputes in all circumstances.
Protections for minority members
Another recent Court of Appeals case revealed a nasty surprise for a minority member of an LLC and shows the dangers of the use of
“form” OA’s to draw up members’ rights. In Riverdale, LLC v. McChesney Capital Partners, the court examined an OA in which one
investor entered into an LLC with the understanding that it was entitled to certain protections against the possibility of the majority
voting away its rights. 292 Ga. App. 841 (2008). The protections could not be taken away by majority vote. Unfortunately, the OA allowed
amendments to the document by majority vote. The majority members therefore unethically (but as the court held, legally) voted to
amend their OA to take away the profit rights of the minority member.
Your clients would do well to consult with an attorney if they are minority members of an LLC to ensure their rights to profits are
protected.
Allocation of voting rights
Still another recent case demonstrated that LLC members should consult with counsel before allocating voting rights. As in many LLC’
s, the case involved a “moneyed” member, who contributed most of the capital. Hampton Island Founders, LLC v. Liberty Capital, LLC,
283 Ga. 289 (2008). In order to protect his investment, the member required that voting rights be allocated according to each member’s
share of the LLC’s capital account. Id. at 291, n. 1.
The result of this scheme was extreme uncertainty as to who had how much control of the LLC, and the case has not yet been resolved
in our appellate courts. The lesson to take away is that capital accounts can fluctuate greatly and may or may not reflect the actual
amount a member has contributed to an LLC.
The careful drafter of an OA will find a clear and fair way to allocate voting rights for members.
Rights of judgment creditors
Georgia’s debt-collection laws can contain surprises for unwitting members of an LLC. Most LLCs are formed as “close”
organizations, which is to say that ownership and management is vested in very few individuals. If, for example, Allen, Bob, and Carol
trust one another enough to form an LLC, then chances are that none of the members want an outsider to come along and buy up the
interest of one member, effectively inserting a non-trusted party into what was an intimate partnership.
To avoid the possibility of sales to outsiders, most LLC’s have OA’s that prohibit the “assignment” (i.e., transfer or sale) of a member’s
interest without the unanimous consent of the other members. So far so good. But debt collection law can turn the members’ intentions
upside-down. Here are a few ways:
1. Charging orders. If you owe a debt, then your creditors can obtain a judgment against you and then apply for a court order for the
rights to intercept payments your debtors make to you. The process is called a garnishment, and most people are familiar with the fact
that wages can be garnished.
Judgment creditors can obtain similar relief against an LLC member via a “charging order.” See Ga. Code Ann. § 14-11-504 (1993).
This court order allows them to collect any distributions made to an LLC’s member to which s/he would otherwise have been entitled
had the creditors been assigned an interest by the debtor/member. Ga. Code Ann. § 14-11-502(2) (2002). It does not matter if, as is
common, the LLC members had prohibited assignment in the OA.
The unpleasant surprise here is that non-debtor members of the LLC will find that every time they make a distribution of profits, they
pay themselves and a third party they may care nothing for. (And, as it turns out, the nasty surprise for the debtor/member is that he still
owes the IRS for taxes on the distribution. See IRS Rev. Rul. 77-137.)
2. Secured creditors. As stated, an LLC’s OA can prohibit assignment of an interest. But what if a member does it anyway? The
starting proposition is that the assignment is void, and the assignee cannot take an interest in the LLC. This proposition changes,
however, when the member grants a bank a security interest in his LLC membership in order to obtain credit.
According to the Uniform Commercial Code, which has been adopted in Georgia, no agreement between an LLC and its members
may prohibit the granting of a member’s interest as security against a loan. (n. 1) The best the other members of the LLC can do is to
sue the debtor/member for breach of the OA.
3. The trustee in bankruptcy. If a member of your client’s LLC files for bankruptcy, your client may want to get ready to have the Trustee
in Bankruptcy as his/her business partner. Under certain circumstances, a bankruptcy trustee may assume all rights of an LLC
member, notwithstanding the fact that the OA does not allow assignment of interests. (n. 2) Wary attorneys may be able to draft an LLC’
s OA such that this contingency will not occur.
What to do?
Careful planning and drafting of an operating agreement can avoid or mitigate the pitfalls mentioned above. If you or your clients are
members of LLC’s, it may be useful to have an experienced attorney review the company’s operating agreement before a court of law
does.
TANNER PITTMAN, LLC
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| TANNER PITTMAN, LLC |
LLC LAW UPDATE – AVOIDING COMMON SNARES
A number of your clients may have organized their businesses as limited liability companies
(LLC’s) using forms they purchased or operating agreements they drew up without
assistance of counsel. Such “cut-and-paste” LLC’s may well provide the asset protection for
which the business form was intended. But they are poor planning mechanisms when an
LLC contains more than one member. (A “member” is the rough equivalent of a “partner” in
common parlance).
An LLC is formed with two basic documents: the articles of organization and the operating
agreement (OA). The former can contain very little information (mine, for example, provides
only for my LLC’s name and the fact that I engage in the practice of law.) The latter governs
the relationship between (among) the LLC’s members. Where there is no OA, Georgia law
provides for default rules. Where there is one, almost all default rules can be contracted
around, and our courts give a high level of deference to the terms of the OA.
Judicial Dissolution and arbitration of disputes
Many LLCs’ OA’s require arbitration of disputes to prevent arguments from winding up in
court. A recent case, however, reveals that Georgia’s courts will not honor arbitration clauses
in all circumstances. Georgia Rehabilitation Ctr., Inc. v. Newnan Hosp., 283 Ga. 335 (2008).
The reason is that the Georgia Code provides for a process of “judicial dissolution” of an LLC
when “it is not reasonably practicable to carry on the business in conformity with the articles
of organization or a written operating agreement.” Ga. Code Ann. 14-11-603(a) (2008). It had
been supposed that if an OA contains an arbitration provision, then, we don’t need to deal
with the judicial system.
A number of your clients may have organized their businesses as limited liability companies
(LLC’s) using forms they purchased or operating agreements they drew up without
assistance of counsel. Such “cut-and-paste” LLC’s may well provide the asset protection for
which the business form was intended. But they are poor planning mechanisms when an
LLC contains more than one member. (A “member” is the rough equivalent of a “partner” in
common parlance).
An LLC is formed with two basic documents: the articles of organization and the operating
agreement (OA). The former can contain very little information (mine, for example, provides
only for my LLC’s name and the fact that I engage in the practice of law.) The latter governs
the relationship between (among) the LLC’s members. Where there is no OA, Georgia law
provides for default rules. Where there is one, almost all default rules can be contracted
around, and our courts give a high level of deference to the terms of the OA.
Judicial Dissolution and arbitration of disputes
Many LLCs’ OA’s require arbitration of disputes to prevent arguments from winding up in
court. A recent case, however, reveals that Georgia’s courts will not honor arbitration clauses
in all circumstances. Georgia Rehabilitation Ctr., Inc. v. Newnan Hosp., 283 Ga. 335 (2008).
The reason is that the Georgia Code provides for a process of “judicial dissolution” of an LLC
when “it is not reasonably practicable to carry on the business in conformity with the articles
of organization or a written operating agreement.” Ga. Code Ann. 14-11-603(a) (2008). It had
been supposed that if an OA contains an arbitration provision, then, we don’t need to deal
with the judicial system.
Notes
1.Ga. Code Ann. § 11-9-408(a) “[A] term in a[n] . . . agreement between an account debtor and a debtor which relates to a . .
. general intangible, . . . and which term prohibits, restricts, or requires the consent of the . . . account debtor to the
assignment or transfer of, or creation, attachment, or perfection of a security interest in, the . . . general intangible, is
ineffective to the extent that the term . . . [w]ould impair the creation, attachment, or perfection of a security interest.”
2.See 11 U.S.C.A. § 541(c)(1)“[A]n interest of the debtor in property becomes property of the estate … notwithstanding any
provision in an agreement, transfer instrument, or applicable nonbankruptcy law … that restricts or conditions transfer of
such interest by the debtor.”
1.Ga. Code Ann. § 11-9-408(a) “[A] term in a[n] . . . agreement between an account debtor and a debtor which relates to a . .
. general intangible, . . . and which term prohibits, restricts, or requires the consent of the . . . account debtor to the
assignment or transfer of, or creation, attachment, or perfection of a security interest in, the . . . general intangible, is
ineffective to the extent that the term . . . [w]ould impair the creation, attachment, or perfection of a security interest.”
2.See 11 U.S.C.A. § 541(c)(1)“[A]n interest of the debtor in property becomes property of the estate … notwithstanding any
provision in an agreement, transfer instrument, or applicable nonbankruptcy law … that restricts or conditions transfer of
such interest by the debtor.”