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In re Lahood

September 30, 2010

IN RE: MICHAEL E. LAHOOD AND ANNETTE M. WHITE LAHOOD, DEBTORS.
RICHARD J. LAHOOD AND FLLZ, LLC, DEBTOR-APPELLANT,
v.
CHARLES E. COVEY, TRUSTEE, APPELLEE.
HEARTLAND BANK AND TRUST COMPANY, PLAINTIFF-APPELLANT,
v.
CHARLES E. COVEY, TRUSTEE, RICHARD J. LAHOOD, AND FLLZ, L.L.C., DEFENDANTS-APPELLEES.



The opinion of the court was delivered by: Michael M. Mihm United States District Judge

Adv. Nos. 07-8156 & 07-8156

ORDER

This matter is now before the Court on Appellants Richard LaHood ("Richard") and FLLZ, LLC's Appeal from the Order of the Bankruptcy Court granting summary judgment in favor of the Trustee, as well as Appellant Heartland Bank and Trust Company's ("Heartland") appeal from the Order of the Bankruptcy Court granting in part and denying in part Heartland's Motion for Summary Judgment. For the reasons stated herein, the decision of the Bankruptcy Court with respect to the appeal of Richard and FLLZ is affirmed, and the decision with respect to the appeal of Heartland is reversed and remanded for further proceedings.

Procedural Background

On August 9, 2007, Michael LaHood ("Michael") and his wife filed a voluntary petition for bankruptcy under Chapter 7 of the Bankruptcy Code. At that time, Michael and Richard were the only members of FLLZ, a member managed, Illinois limited liability company, with each holding 50% of the shares. Prior to this time, FLLZ's principal asset was certain real estate commonly known as Route 26, East Peoria, Illinois (the "Real Estate"). Richard held a mortgage securing a mortgage note dated January 5, 2006, in the original principal amount of $427,079.49, which was made and delivered by Michael in favor of Richard and granted Richard first mortgage lien on the Real Estate. The mortgage note was further secured by a Security Agreement, dated January 5, 2006, executed by Michael in favor of Richard. At the time Michael filed his petition, Richard was owed $427,079.49 in principal plus interest.

On October 4, 2007, Richard executed a Declaration of Dissolution of FLLZ without consulting the Trustee or seeking the approval of the Bankruptcy Court. The same day, Richard caused FLLZ to execute two deeds, one conveying one-half interest in the Real Estate to himself and the other conveying a one-half interest in the Real Estate to Michael. Heartland is a creditor of Michael and claims that a lien in its favor attached to Michael's 50% membership interest in FLLZ as a result of a Judgment by Confession and Citation to Discover Assets on March 20, 2007.

The Trustee and Heartland argued that the distribution of the FLLZ Real Estate to Richard and Michael on October 4, 2007, was improper because it violated the automatic stay provisions. This argument was predicated on the suggestion that the Trustee, having stepped into the shoes of Michael as the debtor, had a right to participate in the winding-up of FLLZ. Richard and FLLZ argued that Michael was wrongfully dissociated from FLLZ upon filing the petition, making the distribution proper.

Heartland filed a Motion for Summary Judgment on its Complaint to determine the validity, priority, and extent of liens in the underlying adversary proceeding. On February 6, 2008, the Trustee and Heartland entered into a compromise, stipulating that Heartland's lien is valid and perfected as to 80% of the value of the estate's 50% membership interest in FLLZ and that Heartland is entitled to 80% of the proceeds of the winding-up of FLLZ, with the remaining 20% of the proceeds going to the estate. Based on a May 15, 2008, appraisal, the fair market value of the Real Estate was $1,180,000. This compromise was not accepted by the Bankruptcy Court.

In this appeal, Heartland asserts that a valid lien attached to Michael's interest in FLLZ after it served a citation to discover assets on him on March 20, 2007, pursuant to 735 ILCS 5/2-1402(m). On March 19, 2009, the Bankruptcy Court found against Richard and FLLZ, concluding that Michael's dissociation from FLLZ was not wrongful under the Operating Agreement, vesting the Trustee with the right to participate in the winding-up of FLLZ. Furthermore, the Bankruptcy Court found that under state law and the terms of the Operating Agreement, creditors must be paid first before any distribution of property to the Members. As a creditor holding a first mortgage lien, Richard was entitled to payment prior to any distribution of the Real Property. The Bankruptcy Court also concluded that the distribution was part of a plan by Richard to obtain property of FLLZ to the detriment of the bankruptcy estate and was therefore in violation of the automatic stay. With respect to Heartland, the Bankruptcy Court held that Heartland's lien on Michael's membership interest was invalid because the charging order procedure described in § 30-20(e) of the LLC Act is the exclusive remedy for a creditor seeking to attach or enforce a judgment against the interest of a member in an Illinois limited liability company.

These appeals follow.

Jurisdiction and Standard of Review

This Court has jurisdiction to review the decision of the Bankruptcy Judge pursuant to 28 U.S.C. § 158(a). District courts are to apply a dual standard of review when considering a bankruptcy appeal. The findings of fact of the Bankruptcy Judge are reviewed for clear error, while the conclusions of law are reviewed de novo. In re Midway Airlines, 383 F.3d 663, 668 (7th Cir. 2003); In re Smith, 286 F.3d 461, 465 (7th Cir. 2002); In re Yonikus, 996 F.2d 866, 868 (7th Cir. 1993); In re Ebbler Furniture and Appliances, Inc., 804 F.2d 87, 89 (7th Cir. 1986); see also, Bankruptcy Rule 8013 (West 1995).

Discussion

I. Appeal by Richard LaHood and FLLZ

Richard and FLLZ appeal raising several interrelated issues: (1) the Bankruptcy Court erred in finding that Michael was not a wrongfully dissociated member of FLLZ at the time the Petition was filed; (2) the Bankruptcy Court erred in finding that the Trustee has a right to participate in the winding up of FLLZ; (3) the Bankruptcy Court erred in finding that the Real Estate was not properly distributed on October 4, 2007; (4) the Bankruptcy Court erred in concluding that the post-petition conveyance by FLLZ to Michael was in violation of the automatic stay and void; and (5) the Bankruptcy Court erred in ruling on "merger" as it had not been briefed.

A. Wrongful Dissociation

Richard and FLLZ take the position that under the Illinois Limited Liability Company Act, 805 ILCS § 180/1-1 et seq. (hereinafter the"LLC Act"), as well as the terms of the FLLZ Operating Agreement, Michael dissociated from FLLZ on August 9, 2007, when he filed his Petition. 805 ILCS § 180/35-35(7)(A). Section 180/35-55(b) of the LLC Act then provides that if a member is dissociated from an LLC, the member's right to participate in the management and conduct of the company's business terminates with the exception of participating in the "winding up" of the company's business so long as the dissociation was not wrongful; the member ceases to be a member and is treated the same as a transferee of a member.

Richard and FLLZ contend that Michael's dissociation was wrongful. Under the LLC Act, dissociation is wrongful only if it is in breach of an express provision of the Operating Agreement. 805 ILCS § 180/35-50(b). Richard and FLLZ cite § 6.01 of the Operating Agreement, which provides in relevant part:

No Member . . . may sell, assign, transfer, give, exchange, pledge, or otherwise dispose of any Units or any interest therein now held or hereafter acquired by him (whether voluntary, involuntary, or by operation of law) without first giving written notice thereof ("Notice of Proposed Transfer") to the Company and otherwise complying with the notice procedures and other terms and conditions of this Article VI.

Similarly, § 6.05 of the Operating Agreement states that an assignee of a membership interest becomes a substituted Member entitled to all the rights of a Member only if all of the other Members consent in writing to the substitution. In essence, they assert that Michael voluntarily transferred his interest to the bankruptcy estate by operation of law without giving the notice required under the Operating Agreement, thereby acting in breach of an express provision and making his dissociation wrongful.

The Bankruptcy Court properly noted that Article IV of the Operating Agreement, which contains both §§ 6.01 and 6.05, addresses voluntary transfers by a member. The transfer at issue here was not this type of voluntary transfer, but rather a transfer that was compelled by operation of law, which is covered by Article VIII of the Operating Agreement. Section 8.01 provides that where a member files a petition for bankruptcy, the company has the option to purchase all or any part of the units owned by the member at a stipulated price.

Based on the existence of a separate article addressing transfers by operation of law, the Bankruptcy Court found that the specific notice and consent provisions relied on by Richard and FLLZ simply do not apply under the facts of this case. However, ยง 6.01 clearly indicates that the notice and offer provisions apply to any attempt to "sell, assign, transfer, give, exchange, pledge, or otherwise dispose of any Units or any interest therein now held or hereafter acquired by him (whether voluntary, involuntary, or by operation of law) . . . " This suggests that the requirements apply whether ...


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