Single Owner LLC, Analytical comparison between Saudi System and US system.

Citation: Carter G. Bishop, Reverse Piercing: A Single Member LLC Paradox, 54 S.D. L. Rev. 199, 232 (2009) Provided by: <br>SMU Underwood Law Library

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REVERSE PIERCING: A SINGLE MEMBER LLC PARADOX

CARTER G. BISHOPt

I. IN TR O D U C T IO N ......................................................................................... 200 II. ENTITY TAX CLASSIFICATION & LLC LEGISLATION ..................... 202

A. PARTNERSHIP VERSUS CORPORATE CLASSIFICATION ....................... 203 B. SINGLE MEMBER LIMITED LIABILITY COMPANY TAx

C LA SSIFICATION .............................................................................. 209 III. OWNERSHIP INTEREST TRANSFER PARADIGM .............................. 210

A. TRANSFER OF PARTNERSHIP & LLC INTERESTS ............................... 211 B. TRANSFER OF SM LLC INTERESTS ..................................................... 217

IV. ALTERNATIVE CREDITOR PATHWAYS ............................................. 220 A. BANKRUPTCY OF THE ONLY MEMBER OF A SMLLC ........................ 221 B. FEDERAL TAX LIENS AGAINST THE MEMBER OF A SMLLC ............. 225 C. ARTICLE 9 SECURED CREDITOR OF THE MEMBER OF A SMLLC ....... 227 D. REVERSE PIERCING & FRAUDULENT TRANSFERS ............................. 228

V . C O N C L U SIO N ........................................................................................... 231

All states permit a limited liability company to be formed with only one member (SMLLC) and asset protectionists seek shelter for clients under its pro- tective liability umbrella to shield client assets from the obligations of its only member. Surprisingly, member creditor access to the assets of the SMiLLC de- pends upon the context of the obligation. A secured creditor of a member can protect itself by obtaining the member's advance consent to admit the creditor as a substituted member should the creditor foreclose and purchase the interest. The substituted member may then liquidate the SMLLC. Since federal bankrupt- cy laws trump both state LLC law and the operating agreement, creditors of a member filing bankruptcy will have access to the assets of the SMLLC but at the expense of sharing asset values with other creditors. Federal tax liens have a superior but often dubious status achieved by assuming the SMLLC assets are in some cases the property of the only member. However, rules outside secured creditor, federal bankruptcy and tax rules are not as favorable. A transfer of the membership interest to an unsecured creditor who purchases at a foreclosure sale generally allows the creditor to assume ownership of only the right to re- ceive future distribution when and if made. Unfortunately, unless the transferor debtor consents to admit the transferee as the substitute member, the transferor

t Professor of Law at Suffolk University Law School, Boston, Massachusetts. The author was a chair and co-reporter for the drafting and adoption of the Minnesota Limited Liability Company and Limited Liability Partnership Acts. He was also a National Conference of Commissioners on Uniform State Laws reporter for the Uniform Limited Liability Company Act (1996), the reporter for the Limited Lia- bility Partnership amendments to the Revised Uniform Partnership Act (1997), and a co-reporter for the Revised Uniform Limited Liability Company Act (2006).

SOUTH DAKOTA LAW REVIEW

generally continues as the only member with control over the timing of the dis- tributions. Thus, while the debtor member no longer owns afinancial interest in the SMLLC, that member nevertheless guards the entity holding the assets and is in a position to favor its own economic interests over those of the creditor owner of the entire economic interest. While fraudulent transfer and conveyance laws are generally ineffective, the reverse piercing doctrine offers limited protection. This Article traces the plight of the creditor in these unique circumstances and suggests statutory clarifications.

I. INTRODUCTION

A separate creditor of a corporate shareholder may reduce an obligation to judgment, foreclose on the corporate stock and purchase the stock at the foreclo- sure sale. Absent enforceable contractual limitations, the purchasing creditor steps into the shoes of the former shareholder and owns all the former sharehold- ers rights represented by the shares. The transfer does not diminish or alter the nature of the shares. By contrast, when a foreclosing creditor purchases a part- nership or limited liability company interest from a debtor partner or member, the creditor only acquires the rights of the debtor to receive future partnership or limited liability company distributions, when and if made. The creditor may not exercise the debtor partner or member's rights to participate in the management. This rule is largely historical and designed to protect the remaining partners or members from accepting services from a stranger. When the debtor is the only member in a single member limited liability company, these outcomes produce often bizarre and unexpected results. Namely, the creditor owns the rights to all future distributions but the authority to declare the distributions and operate or liquidate the entity is controlled by the member who no longer has any economic incentive to operate the business. This extraordinary result has encouraged asset protectionists to advise clients to transfer assets to a single member limited lia- bility company with the hope that the creditor's untenable status will force the creditor to settle for less. The other result is more likely, as informed creditors will simply not extend credit without an alternate route to avoid this dilemma. This means the asset protection value of the plan truly affects only unsecured judgment creditors, normally unsuspecting tort creditors. From a policy perspec- tive, the result seems unworthy. This Article explores these outcomes in various contexts in which the rights of the creditor depend upon the context. The evolu- tion of the limited liability company and the unique single member limited liabil- ity company hold invaluable insights into both the problem and solutions.

The limited liability company has a storied history traced in part to initial failed legislative attempts in Alaska followed by adoption in Wyoming in 1997. The limited liability company seemed almost too good to be true. The entity possessed a corporate styled limited liability shield where no member was per- sonally liable for entity obligations but was nonetheless taxed like a partnership or sole proprietorship. At that time, federal tax regulations stated a corporate re- semblance test that taxed an unincorporated entity as a corporation if it possessed more corporate characteristics than partnership characteristics. The Service was

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slow to confirm that the tax classification of an unincorporated Wyoming limited liability company would be classified and taxed as a partnership rather than as a corporation. A private letter ruling determination was finally obtained in 1980, but the victory was bittersweet because the Treasury released proposed regula- tions at the same time that, unlike the Wyoming ruling, required all unincorpo- rated organizations with a corporate styled limited liability shield to be classified as corporations. The proposed regulations stalled most state enactments and on- ly Florida adopted legislation in 1982. Due to heavy criticism, the proposed reg- ulations were withdrawn in 1983 and the Service committed to a project to study the proper effect of limited liability in the classification scheme.

The Service concluded the study in 1988 and released the watershed Reve- nue Ruling 88-76.1 That ruling classified a Wyoming limited liability company as a partnership because, under the resemblance regulations, it lacked the corpo- rate characteristics of continuity of life and free transferability of interests. Spe- cifically, a Wyoming limited liability company lacked corporate perpetual life because the dissociation of any member for any reason caused the dissolution of the entity. Similarly, it lacked corporate free transferability of interests because no member could transfer their interest to a third person and make that person a member without the consent of all the remaining members ("pick-your-partner" rule). By 1996 all states had adopted specific limited liability company legisla- tion and the burden of ruling determinations under those statutes was crushing. Consequently, the Service released the so-called check-the-box (CTB) tax classi- fication regulations effective for entities formed after January 1, 1997. The CTB regulations classified most unincorporated entities with two or more members as partnerships unless the entity elected to be classified as a corporation.

2

Importantly, the CTB regulations clarified an important but as of then unre- solved controversy concerning the proper tax classification of a limited liability company formed and operated with only one member (SMLLC). The absence of at least two members meant that such entities could not be classified as partner- ships because there were no "partners" to share income and loss. Consequently, the classification of a SMLLC as either a sole proprietorship or a corporation was in doubt. The first state to permit a limited liability company to be formed and operated with only one member was Texas in 1992, but legislative amend- ments were slow before the CTB regulations determined that the SMLLC is classified as a sole proprietorship rather than a corporation unless it elects to be taxed like a corporation. Every state now permits a limited liability company to be formed and operated with only one member. Oddly, because of the limited liability company historical partnership connections, the transfer of the only member's interest to a third party still requires that the "remaining" transferring member consent to admit the transferee as a member. While such consent can be implied in a voluntary transfer, the implication deteriorates when the transfer is involuntary. In involuntary transfer cases, the structure of the SMLLC laws

1. In re Albright, 291 B.R. 538 (Bankr. D. Colo. 2003). 2. Treas. Reg. §§ 301.7701-1 to 7701-3 (as amended by T.D. 8697, 1997-2 I.R.B. 11).

20091

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permits the transferring member to retain the member status and the right to con- trol the entity even though that person no longer has any continuing economic interest in the entity. This perverse result permits the transferring member to prefer its own non-ownership economic position through salaries and other pay- ments at the expense of the only true economic owner. Because the creditor is a mere transferee, the member owes no fiduciary duty of fairness to the creditor who is isolated by the statutes. This article explores this plight and offers some suggestions.

Part II explores the tax classification evolution of the limited liability com- pany and later the SMLLC. The tax classification regulations were in large part responsible for the modern structure of the limited liability company. Part III explores the ownership transfer paradigm under state law. In particular, the na- ture of the obscure judgment creditor charging order limitation is examined. Fi- nally, using the base of information from Parts II and III, Part IV explores vari- ous creditor pathways a member creditor may press its claim against a member and, if unsatisfied, the assets of a SMLLC. This journey travels through the en- viable rights of a secured party, the acceptable rights of a bankruptcy trustee, and the little understood federal tax lien and levy process. Finally, the section ex- plores the residual creditor, often a tort victim holding a judgment as a general unsecured creditor. That section considers unsatisfactory fraudulent transfer and conveyance rules with the backstop of the reverse piercing doctrine. Ultimately, the creditor problem created by awkward SMLLC statutes can only be cured by ad hoc equitable judicial remedies or amending the statutory law to create a more sensible result.

II. ENTITY TAX CLASSIFICATION & LLC LEGISLATION

The consequences involving the transfer of a limited liability company membership interest generally, and a single member limited liability company specifically, implicate partnership law and the development of the limited liabili- ty company. An important factor in the prominence of a limited liability compa- ny with two or more members is its federal tax classification as a partnership ra- ther than a corporation. A single member limited liability company depends upon federal tax classification as a sole proprietorship rather than a corporation.

Under tax regulations existing prior to 1997, unincorporated entities with two or more owners were classified either as partnerships or corporations. 3 The classification outcome depended upon whether the entity more closely resembled a general partnership or a corporation based upon four critical criteria stated in the regulations.5 One of the criteria related to whether the ownership interests in the entity were freely transferable like corporate stock or not like a partnership interest. A single member limited liability company could not be classified as a

3. Former Treas. Reg. § 301.7701-2(a)(3) (as amended in 1993). 4. Id. 5. Id. § 301.7701-1(c) (as amended in 1977). 6. Id. § 301.7701-2(a)(1) (as amended in 1993).

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partnership because it has only one member. Therefore, the tax regulations did not address this classification issue that devolved to obscure rulings.

In 1997, the check-the-box (CTB) regulations were released classifying all unincorporated entities as partnerships, if two or more members, or as disre- garded entities, if only one member. Since that time, use of the limited liability company form has dominated entity choice. However, prior to 1997, the various tax classification criteria were a major part of how limited liability company leg- islation developed. Early limited liability company legislation often adopted state law characteristics, including free transferability of interests, designed to permit an entity formed under the legislation to be classified as partnership. Consequently, the historical development of the limited liability company in general, and the membership transfer aspects, can be directly traced to tax classi- fication issues related to partnerships.

A. PARTNERSHIP VERSUS CORPORATE CLASSIFICATION

Limited liability company tax classification played an important role im- pacting state legislative adoptions and hence the proliferation of the entity. A few states led the early development of the limited liability company as a prin- cipled alternative to corporation and partnership entity forms 7 even before the release of important tax classification releases clarifying the tax classification.

8

Early limited liability company legislation roots can be traced to Alaska. In 1975, the Hamilton Brothers Oil Company in Denver, Colorado, unsuccessfully promoted limited liability company legislation in Alaska. 9 Hamilton Brothers was familiar with South American limitadas 1 ° and sponsored the legislation based on that entity form. The new form had a corporate styled liability shield for owners but like partnerships lacked free transferability of interests and conti- nuity of life.11 As a consequence they were classified as partnerships under the

7. The limited liability company resembles a pre-dated partnership operating form with full cor- porate-styled limited liability for all members referred to as limitadas and limited partnership associa- tions. Limitadas are foreign organizations that can be structured to lack the corporate characteristics of continuity of life and free transferability of interests. In I.R.S. Priv. Ltr. Rul. 8003072 (Oct. 25, 1979), the Internal Revenue Service classified a Brazilian limitada as a partnership for tax purposes. See also I.R.S. Priv. Ltr. Rul. 7841042 (July 14, 1978); I.R.S. Priv. Ltr. Rul. 8019112 (February 15, 1980). Limi- tadas were rarely used in the United States because of capital and natural person ownership restrictions as well as concerns regarding whether the liability shield would be fully recognized. See Richard John- son, Comment, The Limited Liability Company Act, 11 FLA. ST. U. L. REv. 387 (1983). Limited part- nership associations exist in a few states also possess limited liability for all members and can be struc- tured to lack two of the three remaining corporate characteristics. In I.R.S. Priv. Ltr. Rul. 75052903 10A (May 29, 1975), the Internal Revenue Service classified a Michigan limited partnership association as a partnership for tax purposes providing that its creation and conduct were in substantial compliance with all state statutes pertaining to limited partnerships. Again, seldom used because of various restrictions. See, e.g., MICH. COMP. LAWS SERV. § 449.301 (LexisNexis 2006) (limited liability for all members).

8. Susan Pace Hamill, The Limited Liability Company: A Catalyst Exposing The Corporate Inte- gration Question, 95 MICH. L. REv. 393-94 (1996).

9. Joseph A. Rodriguez, Comment, Wyoming Limited Liability Companies: Limited Liability and Taxation Concerns in Other Jurisdictions, 27 LAND & WATER L. REv. 539, 544 (1992).

10. See supra note 7. 11. See, e.g., I.R.S. Priv. Ltr. Rul. 8003072 (Oct. 25, 1979).

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then existing corporate resemblance tax classification regulations. The new enti- ty was projected to produce filing fee and tax revenue in Alaska 12 but the legisla- tive effort collapsed over concerns that it would be classified as a corporation for federal tax purposes. 13 Notwithstanding the prediction that the entity form would be classified as a partnership, no ruling had yet been obtained confirming that result. Hamilton Oil later shifted its legislative efforts to Wyoming where in 1977, notwithstanding the same Alaska tax classification concerns, legislation was introduced and enacted.

14

Unlike Alaska, the Wyoming legislature adopted its law prior to confirming the federal tax classification issue.15 An official ruling was soon requested and in 1980 the Service determined that a Wyoming limited liability company would be classified as a partnership rather than a corporation for federal tax purposes.

16

As expected, the ruling determined that a Wyoming limited liability company would lack the corporate characteristics of free transferability of interests and continuity of life.

Unfortunately the ruling did not settle the matter because the prior day, the Service released proposed regulations inconsistent with the ruling. 17 The pro- posed regulations provided that an unincorporated entity would be classified as a corporation for federal tax purposes if no member was personally liable for the debts of the organization under state law. 18 The regulations made corporate li- mited liability a controlling characteristic trumping others such as free transfera- bility of interests. Since limited liability was essential to the success of any modem business enterprise, the proposed regulations severely limited acceptance and use of the Wyoming limited liability company. Indeed, only thirty limited liability companies were formed in the first eleven years following enactment.

19

Contrary to the first ruling classifying a Wyoming limited liability company as a partnership, a subsequent 1982 ruling, based on the proposed regulations, classi-

12. Rodriguez, supra note 9, at 544. 13. Id. 14. The Wyoming Limited Liability Company Act, codified at WYO. STAT. ANN. §§ 17-15-101 to

-147 (2007). 15. Rodriguez, supra note 9, at 545. 16. I.R.S. Priv. Ltr. Rul. 8106082 (Nov. 18, 1980) ("Since it will lack continuity of life and free

transferability of interests, Z will not have a preponderance of corporate characteristics. Therefore, Z will be treated as a partnership for Federal income tax purposes and not as an association taxable as a corporation.").

17. 45 Fed. Reg. 75,709 (Nov. 17, 1980) (codified at 26 C.F.R. 301); Prop. Treas. Reg. §§ 301.7701-2(a)(2), (3) & (4), 48 Fed. Reg. 75710 (Nov. 17, 1980).

18. 45 Fed. Reg. 75,709 (Nov. 17, 1980) (codified at 26 C.F.R. 301). Also, Prop. Treas. Reg. § 301.7701-2(a)(2), 48 Fed. Reg. 75710 (Nov. 17, 1980) states:

However, such an organization will be classified as an association if under local law no member of the organization is personally liable for debts of the organization. For purposes of the preced- ing sentence, only liability arising solely from membership in the organization shall be taken in- to account; liability of a member as a guarantor on an obligation of the organization shall be dis- regarded.

Id. 19. Rodriguez, supra note 9, at 557.

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flied a limited liability company as a corporation. The proposed regulations al- so had the effect of chilling further legislative enactments. Only Florida adopted limited liability company legislation by 1982.21

Under the tax classifications regulations applicable when Wyoming adopted its legislation in 1977, an unincorporated business entity including a limited lia- bility company could be classified as a corporation or a partnership depending on whether the entity more closely resembled a corporation or a partnership.

2

While state law determined whether a particular characteristic existed, federal law controlled the tax classification significance of that characteristic. 21 When an unincorporated entity more closely resembled a corporation than a partner- ship, the regulations regarded the entity as an association and taxed it as if it were a corporation. 2 4 The regulations identified six characteristics indicative of corporate status: (1) associates, (2) an objective to carry on business and divide the gains, (3) continuity of life, (4) centralization of management, (5) limited lia- bility, and (6) free transferability of interests.

25

Characteristics common to both compared organizations were ignored. 26

To determine corporate versus partnership status, the associates and business ob- jective characteristics were ignored because both are common to both entities.

27

Thus, a limited liability company would be classified as a partnership if it pos- sessed no more than two of the remaining four characteristics. 28 A Wyoming limited liability company possessed the corporate limited liability characteristic because no member was personally liable for the debts or claims against the or- ganization. 29 Thus, unless limited liability was a super controlling factor, the 1977 regulations classified a limited liability company as a corporation only if it possessed two of the three remaining characteristics: (1) continuity of life, (2) centralization of management, or (6) free transferability of interests.

For a limited liability company to possess the corporate characteristic of free transferability of interests, substantially all of the owners must have the power to transfer, without the consent of any other owner, all attributes of own- ership in the organization to a person not then a member of the organization.

30

An unlimited right to assign only the interest in profits without a right to partici- pate in management and otherwise exercise full rights of ownership did not con-

20. I.R.S. Priv. Ltr. Rul. 8304138 (Oct. 29, 1982). 21. FLA. STAT. §§ 608.401 to 608.514 (2007); see Johnson, supra note 7, at 387. 22. Former Treas. Reg. § 301.7701-1(c) (as amended in1977). 23. Id. 24. Id. § 301.7701-2(a)(3) (as amended in 1993). 25. Id. § 301.7701-2(a)(1). 26. Id. § 301.7701-2(a)(3). 27. Id. 28. Id. 29. Id. § 301.7701-2(d). WYO. STAT. ANN. § 17-15-113 (2007) ("Neither the members of a limited

liability company nor the managers of a limited liability company managed by a manager or managers are liable under a judgment, decree or order of a court, or in any other manner, for a debt, obligation or liability of the limited liability company.").

30. Former Treas. Reg. § 301.7701-2(e) (as amended in 1993).

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stitute free transferability of interests. 3 1 Like a general partnership, 32 a Wyom- ing limited liability company lacked free transferability of interests because no person can become a member without the consent of all the remaining mem- bers.3 3 Accordingly, unless limited liability was accorded weighted significance, a Wyoming limited liability company would be classified as a partnership for federal tax provided it lacked either continuity of life or centralization of man- agement.

For a limited liability company to possess the corporate characteristic of continuity of life it must not cease to exist merely because one or more of its original owners dies, retires, resigns, or suffers insanity, bankruptcy, or expul- sion.34 Thus, if an entity dissolves by reason of the occurrence of any of these events, it lacks the corporate characteristic of continuity of life. 35 A Wyoming limited liability company shall be dissolved at the earlier of: (1) expiration of the period fixed for its duration, (2) the unanimous written agreement of the members to terminate, or (3) the death, retirement, resignation, insanity, bank- ruptcy or expulsion of a member, unless all remaining members consent to con- tinue the business. 36 Accordingly, unless limited liability was accorded weighted significance, a Wyoming limited liability company would always lack continuity of life and hence be classified as a partnership regardless of the out- come on the centralized management characteristic. In essence, the Wyoming limited liability company dissolution provisions were nearly identical to those applicable to general partnerships.

37

By 1983, public criticism of the proposed regulation finally caused the Ser- vice to withdraw the proposed regulations and commit to study the effect of li- mited liability on entity tax classification. 38 At the same time, the Service an- nounced it would not issue further rulings until the study was completed.3 9

The uncertainty caused by the classification study and the no-ruling policy

31. Id. 32. See UNIF. P'SHIP ACT § 18(g) (1914), 6 U.L.A. 101 (2001). 33. WYO. STAT. ANN. § 17-15-122 (2007). This statute reads, in part:

The interest of all members in a limited liability company constitutes the personal estate of the member, and may be transferred or assigned as provided in the operating agreement. However, if all of the other members of the limited liability company other than the member proposing to dispose of his or its interest do not approve of the proposed transfer or assignment by unanimous written consent, the transferee of the member's interest shall have no right to participate in the management of the business and affairs of the limited liability company or to become a member. The transferee shall only be entitled to receive the share of profits or other compensation by way of income and the return of contributions, to which that member would otherwise be entitled.

Id. 34. Former Treas. Reg. § 301.7701-2(b)(1) (as amended in 1993). 35. Id. 36. WYO. STAT. ANN. § 17-15-123 (2007). 37. See UNIF. P'SHIP ACT § 31 (1914), 6 U.L.A. 370 (2001). 38. Announcement 83-4, 1983-2 I.R.B. 31 (Jan. 10, 1983) ("After considering the public comments

received after the proposed regulations were published, the Service has decided to withdraw them and undertake a study of the rules for classification of entities for federal tax purposes with special focus on the significance of the characteristic of limited liability.").

39. Rev. Proc. 83-15, 1983-1 C.B. 676.

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severely limited the use of Wyoming and Florida limited liability companies. The Service completed its classification study in 1988 and declared that limited liability would not receive special treatment in delineating between corporations and partnerships. On the same day, Revenue Ruling 88-76 was released dec- laring that a "Wyoming limited liability company, none of whose members or designated managers" were personally liable for any debts of the entity, would

41be classified as a partnership for federal income tax purposes. Specifically, Revenue Ruling 88-76 classified an unincorporated organization formed under the Wyoming law as a partnership because the limited liability company lacked the corporate characteristics of continuity of life and free transferability of inter- ests. 42 Consequently, the limited liability company was classified as a partner- ship even though it possessed the corporate characteristic of limited liability.

4 3

Revenue Ruling 88-76 was welcome news for the Wyoming limited liabili- ty company but it failed to address the tax classification of entities formed under Florida law. While a Wyoming limited liability company enjoyed "bullet-proof' partnership tax classification because of its statutes regarding free transferability of interests and continuity of life, 44 the 1982 version of the Florida limited liabil- ity company dissolution statute was more flexible. Specifically, unlike in Wyoming, a Florida limited liability company could negate dissolution (and hence possess continuity of life) when the articles of organization so specified.

4 5

Thus, under Florida law, if the articles of organization provide a right to continue the business, then the limited liability company will not dissolve upon the death, retirement, resignation, insanity, bankruptcy, or expulsion of a member, even if all the remaining members refuse to consent to continue the business. While providing important flexibility, this anomaly meant that every Florida limited liability company must be examined to determine whether the articles negated continuity of life. As a consequence, Revenue Ruling 88-76 only addressed the tax classification of a bullet proof Wyoming limited liability company. A few later private letter rulings determined that a Florida limited liability company formed without the toxic provision in the articles was classified as a partnership for federal tax purposes. Still later, that message was formalized in Revenue

40. Rev. Proc. 88-44, 1988-2 C.B. 634; Announcement 88-118, 1988-38 I.R.B. 25. 41. Rev. Rul. 88-76, 1988-2 C.B. 360. 42. Id. at 361. 43. Id. 44. A few other states with later bullet proof statutes also received revenue rulings: Rev. Rul. 93-5,

1993-1 C.B. 227 (Virginia); Rev. Rul. 93-6, 1993-1 C.B. 229 (Colorado); Rev. Rul. 93-30, 1993-1 C.B. 231 (Nevada); Rev. Rul. 93-50, 1993-2 C.B. 310 (West Virginia); Rev. Rul. 93-91, 1993-2 C.B. 316 (Utah); Rev. Rul. 94-30, 1994-1 C.B. 316 (Kansas).

45. FLA. STAT. § 608.441(1)(c) (2007), stating: Upon the death, bankruptcy, or dissolution of a member or upon the occurrence of any other event which terminates the continued membership of a member in the limited liability company, unless the business of the limited liability company is continued by the consent of all the re- maining members or under a right to continue stated in the articles of organization of the limited liability company.

Id. 46. See, e.g., I.R.S. Priv. Ltr. Rul. 8937010 (Sept. 15, 1989); I.R.S. Priv. Ltr. Rul. 9030013 (July

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Ruling 93-53.47 The same fate was applied to a limited liability company formed in Delaware

4 8 and a few other states. 4 9

Whether bullet proof or flexible, by 1996 and less than eight years after the release of Revenue Ruling 88-76, all fifty states had adopted specific limited lia- bility company statutes and the Uniform Limited Liability Company Act was re- leased for state adoption. 50 As more states adopted legislation, limited liability company formations rose exponentially creating a critical mass requiring serious tax regulatory responses. 5 1 Especially burdensome was the fact that every state was submitting requests for a ruling regarding the tax classification of a limited liability company formed under its state laws. The avalanche of ruling requests, none of which were in serious doubt because every state statute was based either on the Wyoming bullet-proof model or the Florida flexible model, added a crushing Internal Revenue Service administrative burden.5 2 Besides tax classifi- cation, tax concerns hovered around whether a limited liability company manag- er could be treated like a general partner for federal tax purposes and whether the same tax classification rules applied as flexibly as to limited partnerships.

53

In early 1995, the Internal Revenue Service eliminated most of the remain- ing tax handicaps by treating limited liability company managers as general partners and otherwise applied the partnership classification regulations in the same flexible manner as applied to limited partnerships.

54 Shortly thereafter, 55

proposed amendments to the classification regulations were released permitting unincorporated businesses to choose partnership or corporate taxation regardless

27, 1990); I.R.S. Priv. Ltr. Rul. 9443018 (Oct. 28, 1994). 47. Rev. Rul. 93-53, 1993-2 C.B. 312. 48. Rev. Rul. 93-38, 1993-1 C.B. 233. Many non-bullet proof states never received a public reve-

nue ruling but only a private letter ruling like the early Florida rulings. See, e.g., I.R.S. Priv. Ltr. Rul. 9210019 (Mar. 6, 1992) (Texas); I.R.S. Priv. Ltr. Rul. 9644059, (Nov. 1, 1996) (Iowa).

49. See, e.g., Rev. Rul. 93-93, 1993-2 C.B. 321 (Arizona); Rev. Rul. 93-49, 1993-2 C.B. 308 (Illi- nois); Rev. Rul. 94-5, 1994-1 C.B. 312 (Louisiana); Rev. Rul. 93-92, 1993-2 C.B. 318 (Oklahoma); Rev. Rul. 93-81, 1993-2 C.B. 314 (Rhode Island); Rev. Rul. 94-6, 1994-1 C.B. 314 (Alabama); Rev. Rul. 94- 79, 1994-2 C.B. 409 (Connecticut); Rev. Rul. 94-51, 1994-2 C.B. 407 (New Jersey); Rev. Rul. 95-9, 1995-3 I.R.B. 17 (South Dakota).

50. Hamill, supra note 8, at 403-404. In 1990, Kansas and Colorado adopted LLC statutes. Id. at 403. In 1991, four states adopted LLC statutes including Nevada, Texas, Utah and Virginia. Id. In 1992, ten states adopted LLC statutes including Arizona, Delaware, Illinois, Iowa, Louisiana, Maryland, Minnesota, Oklahoma, Rhode Island and West Virginia. Id. at 403. In 1993, eighteen states adopted LLC statutes including Alabama, Arkansas, Connecticut, Georgia, Idaho, Indiana, Michigan, Missouri, Montana, Nebraska, New Hampshire, New Jersey, New Mexico, North Carolina, North Dakota, Oregon, South Dakota, and Wisconsin. Id. at 403-404. The remaining states and the District of Columbia all adopted LLC statutes by 1996. Id.

51. Susan Pace Hamill, The Taxation of Domestic Limited Liability Companies and Limited Part- nerships: A Case For Eliminating the Partnership Classification Regulations, 73 WASH. U. L.Q. 564, 566 (1995).

52. Id. at 589-90. 53. Id. at 591. 54. Rev. Proc. 95-10, 1995-1 C.B. 501. See discussion in CARTER G. BISHOP & DANIEL S.

KLEINBERGER, LIMITED LIABILITY COMPANIES: TAX & BUSINESS LAW T 1.0][3][d] (1994, 2008-2 Supplement).

55. I.R.S. Notice 95-14, 1995-14 I.R.B. 7.

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of their business characteristics. 56 These regulations were finalized on Decem- ber 18, 1996, and effective for entities formed after January 1, 1997. 5 7 The regu- lations became known as the CTB regulations.

B. SINGLE MEMBER LIMITED LIABILITY COMPANY TAx CLASSIFICATION

A single member liability company cannot be classified as a partnership be- cause it lacks associates in the sense of two or more owners. Neither Revenue Ruling 88-76 nor pre-CTB history fully resolved the tax classification of the sin- gle member limited liability company as a sole proprietorship or a corporation under the corporate characteristics test. Consequently, although most states au- thorized formation of multiple member limited liability companies prior to the 1997 CTB regulations, few states authorized the formation and use of a limited liability company with just one member.5 8 Once the CTB regulations resolved the single member tax classification issue, all fifty states amended their state li- mited liability company laws to permit the formation and operation of a single member limited liability company.

59

Prior to the release of the CTB regulations, the tax classification of a single member limited liability company was uncertain. While the absence of two members precluded partnership status, it did not preclude corporate status. 60 A single member limited liability company conducting a business for profit could be classified either as a corporation or as a sole proprietorship. An early ruling determined a single member trust was not a partnership because it lacked asso- ciates and was not a corporation because it lacked continuity of life and limited liability. 6 1 It was uncertain whether adding limited liability would tilt classifica- tion toward corporation status. As late as 1995, the Service was ambiguous re- garding the tax classification of a single member limited liability company. 62 As a result, early limited liability statutes required the presence of two or more members since more certain partnership tax status was the target. 63 Since a li-

56. Prop. Treas. Reg. §§ 301.7701-1 to 7701-3, 61 Fed. Reg. 21989-01 (May 13, 1996). 57. Treas. Reg. §§ 301.7701-1 to 7701-3 (as amended by T.D. 8697, 1997-2 I.R.B. 11). 58. Texas was the first state to authorize the formation of a limited liability company with one

member. TEX. REv. Civ. STAT. ANN art. 1528n, § 4.01A (Vernon 2003) ("A limited liability company may have one or more members."). Prior to the release of the CTB regulations, the Internal Revenue Service did not release a ruling regarding a Texas limited liability company with one member. A pre- CTB ruling was released regarding a Texas limited liability company but the entity had three members, associates, and therefore could be classified as a partnership. I.R.S. Priv. Ltr. Rul. 9218078 (May 1, 1992).

59. BISHOP & KLEINBERGER, supra note 54, at 1.07[7]. 60. See, e.g., I.R.S. Gen. Couns. Mem. 38,707 (May 1, 1981); I.R.S. Gen. Couns. Mem. 39,395

(Aug. 5, 1985). 61. I.R.S. Gen. Couns. Mem. 39395 (Aug. 5, 1985). 62. Rev. Proc. 95-10, § 4.01, 1995-1 C.B. 501 ("The Service will consider a ruling request that re-

lates to classification of an LLC as a partnership for federal tax purposes only if the LLC has at least two members and, to the extent applicable, the conditions in sections 4 and 5 of this revenue procedure are satisfied.").

63. WYO. STAT. ANN. § 17-15-106 (2007) ("Any person may form a limited liability company which shall have two (2) or more members by signing and delivering one (1) original and one (1) exact or conformed copy of the articles of organization to the secretary of state for filing. The person forming

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mited liability company clearly has limited liability, pre-CTB classification de- pended on the entity lacking two of the three remaining characteristics - normal- ly continuity of life and free transferability of interests. 6 4 The CTB regulations resolved the treatment of a single member limited liability company as a sole proprietorship.

65

The 1997 CTB regulations provide that a domestic eligible entity 66 with a single owner is disregarded for all federal tax purposes, 67 unless the entity elects to be classified as an association taxable as a corporation.

6 8

The pre-CTB analysis of the single member issue focused on a general counsel memorandum (GCM) that considered the classification of a wholly owned New York business trust.69 The GCM concluded that the business trust was not a corporation because it lacked continuity of life and limited liability, two of the four then essential corporate characteristics. The GCM also noted that while a single member organization could be treated as having associates for purposes of determining if it is an association, associates did not exist in the partnership sense and therefore such an organization cannot be a partnership. Thus, a single member limited liability company was neither an association nor a partnership. The GCM concluded that the entity should be regarded as "an ar- rangement along the lines of a sole proprietorship that conducts business through an agent."

70

The CTB regulations formalized the GCM's position making single mem- ber eligible entities more useful, in some respects, than eligible entities taxed as partnerships. Although partnership income and losses pass through to an entity's owners, a partnership is nevertheless recognized as a separate entity for purposes of determining taxable income and making tax elections. 7 1 A disregarded entity,in contrast, is completely "transparent."

III. OWNERSHIP INTEREST TRANSFER PARADIGM

Free transferability of ownership interests was one of the hallmarks of cor- porate tax classification under the pre-CTB regime. Absent restrictions imposed by agreement, corporate stock is freely transferable and a transfer confers all the

the company need not be a member of the limited liability company."). 64. See supra notes 19-37 and accompanying text. 65. Treas. Reg. § 301.7701-3(b)(1)(ii) (as amended in 2006). 66. A foreign eligible entity is classified under a dual default test: (1) always a corporation unless

at least one member of the entity has personal liability for entity assets under local law, and (ii) if so, the number of members. Thus, a foreign eligible entity with at least one member with personal liability is classified as either a partnership or disregarded entity depending on whether it has more than one mem- ber. See id. § 301-7701-3(b)(2)(i)(A). A foreign eligible entity may elect to change its default classifi- cation from either a corporation or a partnership or disregarded entity. See id. § 301-7701-3(c)(1)(i). Per se corporate status cannot be altered by election in either the domestic or foreign context.

67. Id. § 301.7701-3(a). 68. Id. 69. I.R.S. Gen. Couns. Mem. 39,395 (June 24, 1983). 70. Id. 71. See, e.g., I.R.C. § 701 (West Supp. 2009).

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ownership attributes to the transferee. Partnership interests have never been freely transferable in the same sense. Stated as a vestige of the so-called "pick- your-partner" rule, a transferring partner has never been able to unilaterally ad- mit a transferee to partner status. The final step has always required the affirma- tive assent of all the other partners. Having explored the tax classification roots of this notion, the approach turns to an examination of the pick-your-partner rule first in the context of partnership law and finally in the context of a single mem- ber limited liability company. The application of the pick-your-partner rule to frustrate the legitimate, fair and reasonable expectations of creditors of a single member is the ultimate focus of this Article. Specifically, should a single mem- ber be able to assert its status as such to block a transferee creditor from obtain- ing access to limited liability company assets? In part, understanding the entire problem also requires knowledge of special "charging order" creditor procedures applicable to creditors of a single member limited liability company.

A. TRANSFER OF PARTNERSHIP & LLC INTERESTS

Early general partnership law declared that a partnership interest is personal property and represented a share of profits and surplus. 72 A partner also has the equal right to participate "in the management and conduct of the partnership business." 73 However, while a transfer of a partnership interest does not dis- solve the partnership, the transfer does not entitle the transferee "to interfere in the management or administration of the partnership business or affairs .... 74

Rather, the transfer merely entitles the transferee to receive profits that the trans- 75feror would otherwise have received. Confirming that no person can become a

partner merely by transfer of a partnership interest, the early law provided that a person cannot become a partner without the consent of all the partners. 76 Read together, these statutes confirm that a transferee will only become a partner if the remaining partners consent.

The question remained regarding what interest a partner creditor could ob- tain in the partner's share of partnership assets. A partner after all was a co- owner with other partners of specific partnership property 77 as a tenant in part- nership. 7 8 However, the statutory incidents of that tenancy are minimal. While a partner has an equal right with other partners to possess specific partnership property for partnership purposes, no partner has the right to do so for any other purpose. 79 This is reinforced by two provisions confirming that, unlike a part- ner's interest in the partnership, a partner's right in specific partnership property

72. UNIF. P'SHIP ACT § 26 (1914), 6 U.L.A. 326 (2001). 73. Id. § 18(e), 6 U.L.A. 101. 74. Id. § 27(1), 6 U.L.A. 332. 75. Id. 76. Id. § 18(g), 6 U.L.A. 101. 77. Id. § 24(1), 6 U.L.A. 291. 78. Id. § 25(1), 6 U.L.A. 294. 79. Id. § 25(2)(a), 6 U.L.A. 294.

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is not separately assignable and "is not subject to attachment or execution ex- cept, on a claim against the partnership."

8 1

The latter provision is especially notable as it precludes a partner's creditor from attaching or executing a claim against partnership assets on account of a claim against a partner. In order to clarify a partner's creditor rights against the debtor partner's partnership interest and that partner's interest in partnership as- sets, a separate provision limits the right of partner creditor to obtain a charging order against the debtor partner's partnership interest. 82 The charging order pro- vision permits a partner's judgment creditor to obtain a judicial order charging the partner's partnership interest with the amount of the judgment. 83 In effect, the charging order is a judicial lien on the debtor partner's partnership interest and operates like a garnishment order. 84 In this case, the partnership is not the debtor but may be in possession of property of the debtor partner. The partner- ship is directed by the charging order to pay any amount to be distributed to the debtor partner directly to the judgment creditor or, if appointed, a receiver. 85 A partnership violating the charging order by making a payment to the debtor part- ner will be subject to contempt of court and a turnover order requiring the part- nership to make a similar payment to the judgment creditor.

86

While the charging order is not expressly stated to be an exclusive partner creditor remedy, it has been so judicially construed. 8 7 The charging order provi- sion is derived from a corollary provision in the English Partnership Act of 1890. 88 The charging order provision is designed to clarify that a creditor of a partner but not the partnership may not levy or execute against partnership as- sets, even to the extent of the debtor's partner's undivided interest in those as- sets.89 An old English partnership decision90 states the problem as follows:

When a creditor obtained a judgment against one partner and he wanted to obtain the benefit of that judgment against the share of that partner in the

80. Id. § 25(2)(b), 6 U.L.A. 294. 81. Id. § 25(2)(c), 6 U.L.A. 294. 82. Id. § 28(1), 6 U.L.A. 341. 83. Id. 84. REVISED UNIF. P'SHIP ACT § 504(b) (1997), 6 U.L.A. 160 (2001); see Med. Mut. Liab. Ins.

Soc. of Md. v. Davis, 883 A.2d 158 (Md. 2005). 85. UNIF. P'SHIP ACT § 28(1) (1914), 6 U.L.A. 341 (2001). 86. PB Real Estate, Inc. v. DEM II Properties, 719 A.2d 73 (1998). 87. The exclusivity of the charging order remedy was not designed to protect the debtor partner

from foreclosure but really to limit credit rights against the partnership assets. Daniel S. Kleinberger, Carter G. Bishop & Thomas Earl Geu, Charging Orders and the New Uniform Limited Partnership Act: Dispelling Rumors of Disaster, 18 PROB. & PROP. 30, 31 (July/Aug. 2004). Until the Revised Uniform Partnership Act, exclusivity was declared judicially but did not appear in statutory language. See, e.g., In re Pischke, II B.R. 913 (Bankr. E.D. Va. 1981); Baum v. Baum, 335 P.2d 481 (Cal. 1959); Atlantic Mobile Homes, Inc. v. LeFever, 481 So. 2d 1002 (Fla. Dist. Ct. App. 1986); see also REVISED UNIF. P'SHIP ACT § 504(e) (1997), 6 U.L.A. 160 (2001) (stating that the charging order remedy is exclusive).

88. See J. Gordon Gose, The Charging Order Under the Uniform Partnership Act, 28 WASH. L. REV. I (1953); Kleinberger et al., supra note 87, at 31. The comments to the Uniform Partnership Act of 1914 confirm the English Partnership Act of 1890 as the source of the charging order provision. UNIF. P'SHIP ACT § 28 cmts. (1914), 6 U.L.A. 341 (2001).

89. Kleinberger et al., supra note 87, at 31. 90. Brown, Janson & Co. v. A. Hutchinson & Co., 1895 Q.B. 737 (Eng. C.A.).

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firm, the first thing was to issue a [writ of execution], and the sheriff went down to the partnership place of business, seized everything, stopped the business, drove the solvent partners wild, and caused the execution credi- tor to bring an action in Chancery in order to get an injunction to take an account and pay over that which was due by the execution debtor. A more clumsy method of proceeding could hardly have grown up. The charging order is thus designed to prevent this opportunistic behavior

by placing a statutory block against the creditor of a debtor partner pursuing a partner's specific interest in partnership assets.

When the charging order will be unable to satisfy the judgment within a reasonable time, equity permits the further foreclosure of the debtor's equity in the charged partnership interest. 9 1 While early general partnership statutory law did not expressly authorize foreclosure, it did recognize foreclosure by providing that the debtor partner could redeem the partnership interest from the charging order at any time prior to foreclosure. 92 Moreover, the charged interest may be purchased without causing dissolution of the partnership.

93

Finally, the mention of dissolution implicates a question regarding whether the creditor holding a charging order or later purchasing the interest at a foreclo- sure sale can seek dissolution of the partnership on other grounds. If so, the pro- tection accorded to the other partners by the charging order is hollow because upon dissolution a creditor can reach any partner's interest in partnership assets. Generally, only partners have the right to apply for judicial dissolution94 and then only on narrowly specified egregious grounds. 9 5 A creditor holding a charging order is not a partner by that fact alone and does not own the debtor, 96 partner's economic partnership interest. However, a purchaser at a foreclosure sale9 7 does not become a partner absent the unanimous consent of the remaining

partners. 9 8 Thus, the purchaser at a foreclosure sale does not by purchase alone acquire any right to participate in management and only obtains the right to re- ceive any distributions the debtor partner might have otherwise received.

99

While such a purchaser has statutory standing to seek judicial dissolution, the grounds upon which dissolution may be sought are extremely narrow.

100

91. Frankil v. Frankil, 15 Pa. Dist. & Cy. Rep. 103 (1931) ("This part of section twenty-eight is meaningless unless construed as conferring upon the court the right to direct a sale.") (on file with au- thor).

92. UNIF. P'SHIP ACT § 28(2) (1914), 6 U.L.A. 341 (2001) 93. Id. 94. Id. § 31(1), 6 U.L.A. 370. 95. Id. Some narrow grounds for dissolution include: a partner declared a lunatic; a partner incap-

able of performing contractual duties; a partner guilty of conduct that prejudices carrying on the partner- ship business; partner conduct having the effect of making it not reasonably practicable to carry on the partnership business with that partner; the partnership can no longer be conducted profitably; or, if other circumstances render dissolution equitable. Id.

96. BIsHOP & KLE1NBERGER, supra note 54, at 5.04[2][c]. 97. The foreclosure sale does not dissolve the partnership. UNIF. P'SHIP ACT § 27(1) (1914), 6

U.L.A. 332 (2001). 98. Id. § 18(g), 6 U.L.A. 101. 99. Id. § 27(1), 6 U.L.A. 332.

100. Id. § 32(2), 6 U.L.A. 404 (stating dissolution occurs upon application by a purchaser of a part-

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Revisions to the Uniform Partnership Act by the Revised Uniform Partner- ship Act law made relatively few changes to these rules. However, the nomen- clature changed. A partnership interest remains personal property.l0l Each partner has an equal share of partnership profits and losses 1° 2 that is transfera- ble. 10 3 A partner is not a co-owner of partnership property and has no interest therein that can be transferred voluntarily or involuntarily.l14 A partner has the equal right to participate in management and the conduct of the partnership busi- ness.10 5 A transfer of a partnership interest does not dissolve the partnership nor result in the dissociation of the partner 106 and does not entitle the transferee to interfere in the management or administration of the partnership business or af- fairs. 10 7 Rather, the transfer merely entitles the transferee to receive profits that the transferor would otherwise have received. 108 While the transfer of all or substantially all a transferable interest does not itself dissociate a person as a partner, 109 such a transfer empowers the remaining partners to expel the transfer- ring partner. 110 Otherwise, the transferring partner retains the rights and duties of a partner other than in the interest in distributions transferred.)1 Confirming that no person can become a partner merely by transfer of a partnership interest, a person cannot become a partner without the consent of all the partners.

1 12

Read together, these statutes confirm that a transferee will only become a partner if the remaining partners consent.

The question regarding what interest a partner's creditor could obtain in the partner's share of partnership assets was somewhat clarified. A partner was no longer a co-owner with other partners of specific partnership property 113 and the concept of tenant in partnership was eliminated. Partnership property belongs to the partnership and not any partner 114 and no partner has the right to use or pos- sess partnership property except on behalf of the partnership.1

5

Once again, a separate provision limits the right of a partner creditor to ob- tain a charging order against the debtor partner's partnership interest. 116 The charging order provision permits a partner's judgment creditor to obtain a judi- cial order charging the partner's transferable interest with the amount of the

ner's interest upon expiration of a term partnership or any time if an at-will partnership). 101. REVISED UNIF. P'SHIP ACT § 502 (1997), 6 U.L.A. 156 (2001). 102. Id. § 401(b), 6 U.L.A. 133. 103. Id. § 502, 6 U.L.A. 156. 104. Id. § 501,6 U.L.A. 155. 105. Id. § 401(f), 6 U.L.A. 133. 106. Id. § 503(a)(2), 6 U.L.A. 157. 107. Id. § 503(a)(3), 6 U.L.A. 157. 108. Id. § 503(b), 6 U.L.A. 157. 109. For this purpose, the entry of a charging order is not a transfer. Id. § 601(4)(ii), 6 U.L.A. 163. 110, Id. 111. Id. § 503(d), 6 U.L.A. 157. 112, Id. § 401(i), 6 U.L.A. 133. 113. Id. § 501, 6 U.L.A. 155. 114. Id. § 203, 6 U.L.A. 96. 115. Id. § 401(g), 6 U.L.A. 133. 116. Id.§504,6U.LA. 160.

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judgment. 117 In effect, the charging order is a judicial lien on the debtor part- ner's partnership interest and operates like a garnishment order. 118 The partner- ship is directed by the charging order to pay any amount to be distributed to the debtor partner directly to the judgment creditor or, if appointed, a receiver.

1 1 9

Unlike the Uniform Partnership Act that left the issue of exclusivity of re- medy to common law, the charging order is expressly stated to be an exclusive partner creditor remedy. 120 Thus, a charging order is the exclusive remedy by which a judgment creditor of a partner may satisfy a judgment out of the judg- ment debtor's transferable interest in the partnership. 12 Commentary makes clear exclusivity is designed to clarify that a judgment creditor may not attach or otherwise execute against any partnership assets on the account of a judgment against a partner but not against the partnership.

12 2

Finally, like the Uniform Partnership Act, foreclosure is not specifically au- thorized but is contemplated because redemption prior to foreclosure is recog- nized. 12 3 Unfortunately, unlike the Uniform Partnership Act, the new charging order provision introduced a confusing provision by stating that a purchaser at the foreclosure sale has the "rights of a transferee."' 12 4 Since most would con- sider the purchaser an actual transferee, the issue relates to whether a purchaser at foreclosure merely had rights similar or limited to those of a transferee or was actually a transferee. Certainly, the judgment creditor did not have similar rights prior to foreclosure and merely as the beneficiary of a charging order. A sepa- rate section helps to clarify that the entry of a charging order in favor of a judg-125 ment creditor is not a transfer of the transferable interest. Rather, the entry of a charging order is analogized to a transfer for security purposes and thus the debtor partner remains a partner and is not dissociated as such.126 Neither provi- sion is a model of clarity.

This is especially confusing since the phrase appears to have been borrowed from the Revised Uniform Limited Partnership Act that provides that pre- foreclosure a judgment creditor holding a charging order has the "rights of an as- signee."' 127 It may be clearer in the context of a limited partnership since an as- signee is described as a person entitled to receive distributions to which the as- signor would have been entitled 12 8 but not entitled to exercise any rights of a partner. 129 Unlike general partnership law, a limited partner transferring their

117. Id. § 504(a),6U.L.A. 160. 118. Id. § 504(b), 6 U.L.A. 160. 119. Id. § 504(a), 6 U.L.A. 160. 120. Id. § 504(e), 6 U.L.A. 160. 121. Id. 122. Id. § 50 4 (e) cmt. e, 6 U.L.A. 160. 123. Id. 124. Id. 125. Id. § 601(4)(ii), 6 U.L.A. 163. 126. Id. 127. REVISED UNIF. LTD. P'SHIP ACT § 703 (1976, as amended 1985), 6B U.L.A. 313 (2008). 128. Id. § 702, 6B U.L.A. 306. 129. Id.

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entire partnership economic interest automatically ceased to be a partner without expulsion. 130 In the limited partner context, describing a pre-foreclosure charg- ing order creditor as a person with the "rights of an assignee" appears defensible because no actual ownership transfer has occurred through a foreclosure sale. The limited partnership provision does not further define the rights of a purchas- er at a foreclosure sale. However, general partnership law appears to have im- properly exported the limited partner pre-foreclosure charging order provision to define a purchaser at foreclosure rather than a person merely holding a charging order. The language confusion is extremely unfortunate as it creates uncertainty as to whether a person holding a charging order not yet foreclosed is, similar to a purchaser at foreclosure, an owner of the transferable interest and therefore taxa- ble on distributions.

13 1

The "rights of a transferee" language was repeated in the Uniform Limited Liability Company Act but the language was limited to a purchaser at foreclo- sure of a transferable interest subject to a charging order. Unfortunately, the Uniform Limited Partnership Act compounded the confusion be stating in the same section that both a person holding a charging order 133 and a person pur- chasing at a foreclosure sale 134 have the "rights of a transferee."

The Revised Uniform Limited Liability Company Act clarified several components of the charging order foreclosure sale continuum. 135 The entry of a charging order is only a lien against the debtor's transferable interest. 13 6 The na- ture of the lien requires the limited liability company to pay to the holder of the charging order distributions that would otherwise be paid to the judgment debtor. Thus, the charging order does not authorize the judgment creditor to require the limited liability company to make distributions or alter its own business judg- ment. Upon a showing that the distributions will not pay the judgment within a reasonable time, the court may foreclose the lien and order a sale of the transfer- able interest. 137 In such a case, the purchaser does not thereby become a mem- ber and acquires only the transferable interest. 138 This portion eliminates the confusing "rights of a transferee" language both in connection with the entry of the charging order and in connection with the purchaser at a foreclosure sale. The fact that the entry of a charging order does not effectuate a transfer of the transferable interest is further confirmed elsewhere by excluding such an entry

130. Compare REVISED UNIF. LTD. P'SHIP ACT § 702 (1976, as amended 1985), with REVISED UN- IF. P'SHIP ACT § 601(4)(ii) (1997).

13 1. The pre-foreclosure ownership of the interest is important. For example, the owner is consi- dered a partner for federal tax purposes even though not for state law purposes. Therefore, if the holder of a mere charging order is the owner of the interest, the judgment creditor would be taxable on all dis- tributions rather than the debtor partner. See Rev. Rul. 77-137, 1977-1 C.B. 178; Kleinberger et al., su- pra note 90, at 32-33; BISHOP & KLEINBERGER, supra note 54, at 1.04[3][d].

132. UNIF. LTD. LIAB. Co. ACT § 504(b) (1996), 6A U.L.A. 607 (2003). 133. UNIF. LTD. P'SHIP ACT § 703(a) (2001), 6A U.L.A. 463 (2008). 134. Id. § 703(b), 6 U.L.A. 463. 135. REVISED UNIF. LTD. LIAB. Co. ACT § 503 (2006), 6B U.L.A. 498-99 (2008). 136. Id. § 503(a), 6B U.L.A. 498. 137. Id. § 503(c), 6B U.L.A. 498. 138. Id.

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from the scope of a transfer of all the interest invoking the power of expul- sion.

13 9

The charging order is again stated to be the exclusive remedy. 140 The ex- clusiveness is related to a how a person seeking to enforce a judgment against a member may satisfy the judgment against the transferable interest and not against limited liability company assets. 14 1 Importantly, the comments specifi- cally provide that the exclusivity is not designed to override reverse piercing: "[t]his subsection is not intended to prevent a court from effecting a 'reverse pierce' where appropriate. In a reverse pierce, the court conflates the entity and its owner to hold the entity liable for a debt of the owner."' 142 The exclusive re- medy section does not override the rights of a secured creditor under Article 9 of the Uniform Commercial Code. The meaning of Article 9 and reverse piercing override, both specific exceptions to the exclusive remedy language, are the top- ics of the remainder of the Article.

B. TRANSFER OF SMLLC INTERESTS

The voluntary or involuntary transfer of the only membership interest of a single member limited liability company raises special and unique questions. Since the only member has transferred the only interest, there are no other own- ers remaining to consent to admit the transferee as a member of the limited lia- bility company. Further, the transfer of the entire remaining interest raises spe- cial problems of whether the limited liability company can even continue or must dissolve.

The original Uniform Limited Liability Company Act stated several rele- vant provisions. A limited liability company could be organized by one or more persons and formed with only one member. 143 A voluntary or involuntary trans- fer of all of the only member's interest to another person does not, merely by the transfer, permit the transferee to exercise the rights of a member. 144 Rather, by implication, the transferring member retains the rights of a member other than the interest in distributions, all of which are transferred to the transferee. 14 5 The transferee then does not become a member in substitution for the only transfer- ring member simply by default. Rather, the transferee must obtain the consent of the transferor to become the only substituted member. 14 6 However, upon the transfer of all a member's distributional interest, a member is dissociated. 147 A

139. Id. § 602(4)(B), 6B U.L.A. 503. 140. Id. § 503(g), 6B U.L.A. 499. 141. Id. 142. Id. § 503(g) cmt. subsection g, 6B U.L.A. 500 (citing Litchfield Asset Mgmt. Corp. v. Howell,

799 A.2d 298, 312 (Conn. App. Ct. 2002) (approving a reverse pierce where a judgment debtor had es- tablished a limited liability company in a patent attempt frustrate the judgment creditor)).

143. UNIF. LTD. LIAB. Co. ACT § 202(a) (1996), 6A U.L.A. 578 (2003). 144. Id. § 502, 6A U.L.A. 604; Id. § 503(d), 6A U.L.A. 605. 145. Id. § 502, 6A U.L.A. 604. 146. Id. § 503(a), 6A U.L.A. 605. 147. Id. § 601(3), 6A U.L.A. 608.

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careful exception exists to make certain that a transfer for a charging order until the creditor forecloses on the interest.

14 8

The statutory framework quickly breaks down from there. Contemplating a multimember limited liability company, the member's dissociation in an at-will limited liability company requires the distributional interest to be purchased

149

by the entity. 15 Where there are no other members, this means that the transfer effectively dissolves the limited liability company.151 However, if the limited liability company is a term company, the entity need not purchase the interest until the expiration of the term. 152 Again, a failure to do so will effectively dis- solve the entity. 15 3 A limited liability company will only be a term company if the articles of organization expressly so state. 154 Thus, at-will status is the de- fault rule.

Required entity dissolution in the case of an at-will company is not in ac- cord with the reasonable expectations of the parties. If the parties contemplated entity dissolution, the purchaser could easily structure the acquisition of the enti- ty's assets rather than as a membership interest purchase. Thus, dissolution fru- strates the intent that the entity and business continue. In order to avoid dissolu- tion, the transferring member can simply consent to the admission of the transfe- ree. 155 Further, since an operating agreement may be oral in this respect, the course of performance by both parties would be evidence that such consent had been effectively obtained. 156 Prudence requires the consent be memorialized in writing but the fact that the transferring member no longer acts as a member and the purchaser continues the entity is strong evidence of an implied oral consent to admit the transferee as a substituted member.

Implied consent does not fit well with an involuntary transfer, however. Where a judgment creditor obtains a charging order 157 and then later foreclos- es, 15 8 the result is much less certain. Whether the creditor or a third party pur- chases the interest at the foreclosure sale, the purchaser only becomes a transfe- ree. 15 9 Indeed, the transferring member will attempt to exercise control over the business operations in order to prevent the creditor from having access to the entity's assets. However, the automatic dissociation rule will force the debtor member to cause the entity to purchase the transferred interest immediately in an at-will company and after the term in a term limited liability company. Absent

148. Id. 149. Id. § 603(a)(1), 6A U.L.A. 612. 150. Id. § 701(a), 6A U.L.A. 614. 151. Id. § 801(4)(iv), 6A U.L.A. 619. 152. Id. § 603(a)(2)(ii), 6A U.L.A. 612. 153. Id. § 801(4)(iv), 6A U.L.A. 619. 154. Id. § 203(a)(5), 6A U.L.A. 579. 155. Id. § 503(a), 6A U.L.A. 605. 156. Id. § 103(a), 6A U.L.A. 567. 157. Id. § 504, 6A U.L.A. 607. 158. Id. § 504(b), 6A U.L.A. 607. 159. Id. § 502, 6A U.L.A. 604.

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the purchase, the entity would be effectively dissolved. 160 In an at-will compa- ny, the automatic member dissociation and the immediate required purchase of the transferred interest probably does fit the reasonable expectations of the forec- losing creditor who purchases at foreclosure. The result in a term company is less desirable to the creditor. In a corporation, the purchasing creditor could simply vote the stock to liquidate the company and reach the entity assets. In a single member term limited liability company, the creditor is locked in until the expiration of the term. Of course, Article 9 creditors could simply avoid this re- sult by obtaining the debtor member's advance written consent to admit a pur- chasing foreclosing creditor in the security agreement. But other unsecured creditors who purchase by way of a charging order and foreclosure sale will be less fortunate without other remedies.

The result was modified in several important ways in the Revised Uniform Limited Liability Company Act. Again, a limited liability company could be or-161 162 ganized by one or more persons and formed with only one member. A vo- luntary or involuntary transfer of all the only member's interest to another per- son does not, merely by the transfer, cause the member's dissociation 163 or a dis- solution 16 4 and winding up of the entity.165 The transferor retains the rights of a member other than any further interest in distributions. 166 The transferee has the right to receive all distributions the transferor otherwise would have been en- titled 167 but may not participate in management. 168 The transferee then does not become a member in substitution for the only transferring member simply by de- fault. Rather, the transferee must obtain the consent of the transferor to become the only substituted member.

169

Unlike with the Uniform Limited Liability Company Act, 17 the transfer of all a member's transferable interest no longer automatically causes a dissociation of the transferring member. Also, the at-will and term distinction was not con- tinued and as a result, member dissociation does not trigger a default purchase of the dissociated member's interest. A related provision allows for the remaining members to expel a member who transfers all their transferable interest 17 1 even when the operating agreement does not provide a right to expel.

17 2

160. Id. § 801(4)(iv), 6A U.L.A. 619. 161. REVISED UNIF. LTD. LIAB. Co. ACT § 201(a) (2006), 6B U.L.A. 456 (2008). 162. Id. § 401(a), 6B UL.A. 478. 163. Id. § 603, 6B U.L.A. 504-05. Therefore voluntary or involuntary transfer alone does not termi-

nate the right to participate in management. Id. § 502(a)(2), 6B U.L.A. 496. 164. Id. § 701(a)(3), 6B U.L.A. 506. Therefore the entity continues the membership of the transfe-

ror and avoids the absence of a member to trigger dissolution. Id. § 502(a)(2), 6B U.L.A. 496. 165. Id. 166. Id. § 502(g), 6B U.L.A. 497. 167. Id. § 502(b), 6B U.L.A. 496. 168. Id. § 502(a)(3)(A), 6B U.L.A. 496. 169. Id. § 401(d)(3), 6B U.L.A. 478. 170. UNIF. LTD. LIAB. Co. ACT § 601(3) (1996), 6A U.L.A. 608-09 (2003). 171. REVISED UNIF. LTD. LIAB. Co. ACT § 602(4)(B) (2006), 6B U.L.A. 503 (2008). 172. Id. § 602(4), 6B U.L.A. 503.

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By eliminating the at-will and term distinction, these rules at least prevent a different outcome in each case. By eliminating the automatic dissociation on a transfer of all the transferable interest, these rules also preserve the member sta- tus of the transferor. However, the rules simply do not address the specific cir- cumstance under which the only member transfers all the transferable interest to another. Unless the transferring member consents to admit the transferee as a member, the transferee is confined to own a transferee's interest and may not ex- ercise a member's rights to dissolve the entity to reach the entity's assets.

Again, an operating agreement need not be in writing and may be oral. 17 3

Consequently, it may be possible to infer the consent to admit from the post- transfer conduct of both parties. This is most likely in the case of a voluntary transfer or an involuntary transfer where consent was obtained in a written secu- rity agreement. Implied consent with an involuntary transfer remains unlikely. Indeed, the transferring member may well insist on continuing as the only rightful member to prevent the creditor from reaching the entity's assets. In these cases, the creditor will be effectively precluded from reaching those assets under statutory approaches inherent in the limited liability company law. This means access to the entity assets in these circumstances must emanate from other laws or theories and are explored below.

IV. ALTERNATIVE CREDITOR PATHWAYS

This section considers various creditor approaches to reach the assets of a single member limited liability company when that creditor has purchased the full transferable interest of the single member who remains a member under state law. Since the member no longer has any economic interest in the entity now owned exclusively by the creditor, the member will remain in a unique position to constrain distributions to the creditor. The failure of the member to declare distributions and otherwise control the assets of the entity raise important policy questions neither addressed nor contemplated by most limited liability company statutes. Where the limited liability company interest is the only significant non- exempt asset owned by the debtor member, the failure of limited liability com- pany laws to construct a reasonable balance between the rights of a single mem- ber to operate a business and a creditor to be paid from non-exempt assets en- courage untoward use of the entity as an asset protection vehicle. 174 As use pro- liferates courts will inevitably turn to equitable powers to construe laws and doc- trines to reach a sensible result and balance. The following discussion considers four contexts-bankruptcy, tax liens, Article 9 secured creditors, and finally a residual of equitable powers reflected in doctrines such as reverse piercing and fraudulent transfers and conveyances.

173. Id. § 102(13), 6B U.L.A. 429. 174. See Thomas E. Rutledge & Thomas Earl Geu, The Albright Decision - Why an SMLLC Is Not

an Appropriate Asset Protection Vehicle, 5 BUS. ENTITIES 16 (2003).

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A. BANKRUPTCY OF THE ONLY MEMBER OF A SMLLC

Statutory law is inconsistent regarding whether a bankruptcy filing by a member results in the dissociation of that member from the limited liability company. The Uniform Limited Liability Company Act provided that a member was dissociated from the limited liability company when the member became a debtor in bankruptcy.175 Later, without comment, the Revised Uniform Limited Liability Company Act limited member dissociation upon a bankruptcy filing to a member of a member-managed limited liability company. 176 Presumably, the change was designed to recognize the difference in management structures such as the effect of the bankruptcy of a general partner from a general partnership, versus the bankruptcy of a general or limited partner from a limited partner- ship. 177 In any event, limited liability cases are divided whether such state law clauses are invalid ipsofacto clauses that improperly terminate or modify a deb- tor's contract or property rights merely because of a bankruptcy filing. 17 8 The issue may ultimately depend upon whether the dissociation results in dissolution of the limited liability company. In most statutes, member dissociation no long- er, as a default rule, results in entity dissolution.

179

The far more important question is the effect of the state law pick-your- partner rule that strips management rights from the transfer of a transferable in- terest under federal bankruptcy law.' In a corporate context, a trustee in bank- ruptcy succeeds to the stock ownership economic and management rights and is entitled to vote the stock to liquidate the corporation. Generally, the filing of a petition in bankruptcy creates a bankruptcy estate consisting, by operation of law, of all of the debtor's property, including the limited liability company inter-

est. 18 1 Technically, there is no state law transfer upon creation of the bankruptcy estate to trigger the pick-your-partner rule to potentially strip away rights. This allows the bankruptcy trustee to step into the shoes of the bankrupt member and,

175. UNIF. LTD. LIAB. Co. ACT § 601(7)(i) (1996), 6A U.L.A. 608 (2003).

176. REVISED UNIF. LTD. LIAB. Co. ACT § 602(7)(A) (2006), 6B U.L.A. 503-04 (2008). 177. Compare UNIF. P'SHIP ACT § 31(5) (1914), 6 U.L.A. 370 (2001) (stating bankruptcy of a gen-

eral partner causes dissolution of the partnership), and REV. UNIF. P'SHIP ACT § 601(6)(i) (1997), 6 U.L.A. 163 (2001) (stating a partner's dissociation upon becoming a debtor in bankruptcy), with RE- VISED UNIF. LTD. P'SHIP ACT § 402(4)(ii) (1976, as amended 1985), 6B U.L.A. 216 (2008) (stating a partner ceases to be a general partner upon filing bankruptcy), and UNIF. LTD. P'SHIP ACT § 603(6)(A) (2001), 6A U.L.A. 73-74 (2008) (stating a general partner is dissociated upon becoming a debtor in bankruptcy).

178. Bankr. Code, 11 U.S.C. § 541(c)(1) (2006); Bankr. Code, 11 U.S.C. § 365(e)(1); compare In re Daugherty Constr., Inc., 188 B.R. 607 (Bankr. D. Neb. 1995) (invalidating state law provision mandat- ing automatic dissociation upon filing), with In re DeLuca v. DeLuca, 194 B.R. 65 (Bankr. E.D. Va. 1996) (DeLuca I) (holding state law provision enforceable), and In re DeLuca, L.C. v. D & B Venture, L.C., 194 B.R. 79 (Bankr. E.D. Va. 1996) (DeLuca II) (holding state law provision enforceable), and In re Garrison-Ashburn, L.C., 253 B.R. 700 (Bankr. E.D. Va. 2000) (holding dissociation does not dissolve the LLC under the applicable statute).

179. See, e.g., In re Garrison-Ashburn, 253 B.R. 700. 180. See UNIF. LTD. LIAB. Co. ACT § 502 (1996), 6A U.L.A. 604 (2003); REV. UNIF. LTD. LIAB.

CO. ACT §§ 502(a)(3), 502(g) (2006), 6B U.L.A. 496-97 (2008). 181. Bankr. Code, 11 U.S.C. § 541(a)(1).

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for purposes of administering the bankruptcy estate, 182 exercise all the rights of the bankrupt member. 183 The transfer restriction would however be applicable to mandate that the trustee could not transfer any greater right than the bankrupt member possessed and thus could not transfer the interest in a sale to a third par- ty without invoking the transfer restriction.

Notwithstanding this analysis, a bankruptcy case analyzing the bankruptcy of the only member of a Colorado limited liability company adopted a different route in In re Albright.184 Rather than analyzing the case from the perspective outlined, the Albright court assumed a transfer occurred, the transfer stripped the bankruptcy trustee of management rights under the executory contract limitation unless the transferor consented to admit the trustee, and that consent could be implied. 185 The court determined that the transfer restriction was meaningless in the context of a single member limited liability company because there were no other members to protect or consent. Consequently, the bankruptcy court deter- mined that the trustee was admitted as the sole member under a suspicious "im- plied consent" theory.186 Curiously, other courts have followed the same im- plied consent theory.187

In the bankruptcy context, the Albright decision is suspect for several rea- sons. While the outcome appears reasonable, the doctrinal approach should not withstand strict scrutiny. First, the court determined that upon the bankruptcy filing of the only member, the member "effectively transferred her membership interest to the estate."' 188 The court cited 1 1 U.S.C. § 541189 as authority for the transfer theory. 190 However, under the referenced bankruptcy statute, all legal or equitable interests of the debtor in property becomes property of the bankruptcy estate by operation of law, not by transfer. 19 1 Indeed, the operation of law result is reinforced by a separate provision that mandates this result notwithstanding any provision in the operating agreement or limited liability company law.

192

The latter provision controls notwithstanding any provision that restricts or con- ditions the "transfer" of such an interest 193 or that is conditioned on insolvency

182. See id. § 363. 183. In re Ehmann v. Fiesta Invs., L.L.C., 319 B.R. 200 (Bankr. D. Ariz. 2005). The implied con-

sent theory does not apply in the context of a multi-member limited liability company. In such cases, the trustee will succeed to all the debtor's rights unless the membership interest is an executory contract. That question turns largely upon a specific analysis of whether the membership interest imposes any per- sonal service obligations on the bankrupt member. If not, the trustee will normally step into the shoes of the bankrupt member to exercise all that member's rights.

184. 291 B.R. 538 (Bankr. D. Colo. 2003). 185. Id. 186. Id. at 540. 187. F.T.C. v. Peoples Credit First, L.L.C., No. 8:03-CV-2353-T-TBM, 2006 WL 1169677 (M.D.

Fla. May 3, 2006). The issue was certified to the Florida Supreme Court and a decision is pending. See F.T.C. v. Olmstead, 528 F.3d 1310 (1 th Cir. 2008).

188. In re Albright, 291 B.R. at 540. 189. Bankr. Code, 11 U.S.C. § 54 1(a) (2006). 190. In re Albright, 291 B.R. at 540. 191. Bankr. Code, 11 U.S.C. § 541(a)(1). 192. Id. § 541(c)(1). 193. Id. § 541(c)(1)(A).

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or the commencement of a bankruptcy case. 194 The bankruptcy override of con- tract and state law restrictions on transfer and case commencement are not mere- ly a matter of supremacy but a reference to methods by which contract and state law generally operate. Other federal law corroborates the fact that the com- mencement of a bankruptcy case does not create a transfer of the debtor's prop- erty.1

95

Once the property becomes part of the bankruptcy estate, it must be deter- mined whether the trustee or the member will exercise the member's rights in the property, including management rights over the limited liability company. Gen- erally, the trustee, and not the debtor, may use or sell any property that is part of the bankruptcy estate. 196 Also, the trustee's right to use or sell such property ex- ists notwithstanding any contract or limited liability company law provision conditioned on the commencement of a bankruptcy case provided that the con- tract or law provision creates "a forfeiture, modification, or termination of the debtor's interest" in the property. 19 7 This provision assures that neither contract nor limited liability company state law provisions will be permitted to diminish the economic value of the limited liability company membership interest. An important exception respects such contract and state law provisions with nega-198 tive impact if they qualify under the executory contract provisions. This gen- erally means that value restrictive provisions in state limited liability company law (transfer restrictions) and contract law (operating agreement) will be res- pected only if the nature of a limited liability company membership interest is in the nature of an executory contract, the subject of the Section 365 limitation.

Generally, the trustee may assume or reject any unperformed executory contract. 19 9 Thus, even if the membership interest is an executory contract, the trustee may assume and exercise the debtor's rights in the membership interest even though the executory contract itself prohibits or restricts assignment of rights or delegation of duties. 20 Since every membership interest is subject to the terms of the member's operating agreement, any provisions therein are in- operative if they prohibit or restrict assignment of the member's rights or delega- tion of the member's duties. However, a trustee may not assume an executory contract, regardless of its restrictions on assignment and delegation, where state law excuses a "party, other than the debtor, to such contract" from accepting per- formance from a person other than the debtor or rendering performance to a per- son other than the debtor. 20 1 Obviously, this provision is designed to protect other parties to the executory contract from being coerced into dealing with the

194. Id. § 541(c)(1)(B). 195. I.R.C. § 1398(f)(1) (West Supp. 2009) (stating the "transfer" of debtor's property to estate not

treated as a disposition of the property by the debtor). 196. Bankr. Code, II U.S.C. § 363(b)-(c). 197. Id. § 363(/). 198. Id. (stating section 363() is "[s]ubject to the provisions of section 365 ... . 199. Id. § 365(a). 200. Id. § 365(c) (stating "whether or not such contract... prohibits or restricts assignment of rights

or delegation of duties"). 201. Id. § 365(c)(1)(A).

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trustee where the identity of the debtor was materially important. Importantly, the bankruptcy provision relegates the determination of this

matter to state common and statutory law. Two provisions are considered. First, all state limited liability company statutes provide that a transfer of a member- ship interest is only effective to transfer the economic rights to the transferee un- less the remaining members consent to admit the transferee as a member. While not expressed as a limitation on assignment of rights or delegation of duties, it operates as a statutory restriction on the delegation of duties. Secondly, all state common law similarly prevents delegation of duties where the assignment or delegation would materially affect the rights of the other party to the contract. The issue is then to what extent these statutory and common law assumptions are effective to prevent the trustee from assuming the rights or duties of the bankrupt debtor.

Since there are no other members in a single member limited liability com- pany, literally there are no other possible parties to the purported executory con- tract. Therefore, by definition, there are no other parties to protect and thus state law does not excuse a "party, other than the debtor, to such contract" from ac- cepting performance from a person other than the debtor or rendering perfor- mance to a person other than the debtor. 202 As a result, there simply is no effec- tive way to prevent a trustee in bankruptcy from choosing to assume all the deb- tor's rights and duties in a single member limited liability company. There are no other persons other than the debtor to protect. Indeed, albeit stated in the con- text of an implied consent argument, Albright provides as much:

However, the charging order, as set forth in Section 703 of the Colorado Limited Liability Company Act, exists to protect other members of an LLC from having involuntarily to share governance responsibilities with someone they did not choose, or from having to accept a creditor of another member as a co-manager. A charging order protects the autono- my of the original members, and their ability to manage their own enter- prise. In a single-member entity, there are no non-debtor members to pro- tect. The charging order limitation serves no purpose in a single member limited liability company, because there are no other parties' interests af- fected.

203

No other bankruptcy case has yet considered the bankruptcy of the only member of a single member limited liability company. As a result, the Albright outcome and analysis controls. Perhaps the issued analyzed herein will help courts focus in the future. Finally, one other single member case has been de- cided but through a route of the charging order and not the bankruptcy route. As a result, state law and contract analysis is not trumped by the supremacy of the bankruptcy rules.

202. Id. 203. In re Albright, 291 B.R. 538, 541 (Bankr. D. Colo. 2003) (emphasis in original).

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B. FEDERAL TAX LIENS AGAINST THE MEMBER OF A SMLLC

Any person who fails to pay any tax due shall be subject to an automatic tax lien. 20 4 The automatic lien attaches to all the taxpayer's property and rights to property, whether real or personal, tangible or intangible. 2R5 The lien continues until the assessment is satisfied.2 °6

Typically, upon a determination of any deficiency, the taxpayer is provided a notice of the deficiency. 2 07 The taxpayer has ninety days to contest the defi- ciency during which the tax may not be assessed nor any collection procedure initiated.20 8 Upon failure to contest and the expiration of the ninety-day period, the tax is assessed against the taxpayer by recording the tax as a liability with the Service. 20 9 The taxpayer is entitled to a copy upon request. 2 1° Within sixty days after assessment, the Service must make written demand for payment.

The demand notice may be left at the taxpayer's dwelling, usual place of busi- ness, or sent by mail to the last known address. 2 12 The Service is required to ex- ercise fair collection procedures in communicating with the taxpayer 2 13 and is prohibited from harassing the taxpayer in collecting the tax.2 14 The Service is subject to civil damages for any reckless or intentional violation of the fair col- lection procedures.Z1

Once the tax is assessed and the sixty-day written notice for demand period expires with the tax unpaid, the Service may begin the levy process. Typically, no levy may be made upon any property of any person (including the taxpayer) until that person has been notified in writing of their right to an administrative hearing before a levy is made.2 16 A taxpayer has thirty days after a final deter- mination to appeal to the United States Tax Court. 2 1 7 After a final determina- tion, the Service may levy upon all property and rights to property belonging to such person or on which there is a lien after a ten-day written notice and de- mand. 2 18 The levy may not be against exempt property but the exemption is ra- ther narrow. 2 19 Upon levy the taxpayer is required to surrender the property.

2 20

A taxpayer refusing to comply with a levy is personally liable for damages

204. I.R.C. § 6321 (West Supp. 2009). 205. Former Treas. Reg. § 301.6321 -1 (as amended in 1978). 206. I.R.C. § 6322. 207. Id. § 6212. 208. Id. § 6213. 209. Id. § 6203. 210. Id. 211. Id. 212. Id. 213. Id. § 6304(a). 214. Id. § 6304(b). 215. Id. § 7433(a). 216. Id. § 6330(a)(1). 217. Id. § 6330(d)(1). 218. Id. § 6331. 219. Id. § 6334. 220. Id. § 6332(a).

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caused thereby and a penalty equal to fifty percent of the tax. 2 2 1 After levy, the taxpayer is sent another notice stating the nature of the property seized and in- formed of the forthcoming sale. 2 2 2 The time, manner and conditions of sale are governed by statute.2 23 The taxpa'er has a right to redeem the seized personal property at any time before sale. Sale proceeds are applied against expenses and then to the tax liability.

225

These procedures are largely administered by the Service except for judicial review of the administrative appeal of a final levy determination. The key ingre- dient is the determination of whether the taxpayer has a property interest upon which the Service may levy. In the case of a SMLLC, the Service may levy against the membership interest and sell that interest. However, the Service may not generally levy against property of the SMLLC for the tax liability of its own- er unless the member has a property interest therein. The Service has a lien against all the taxpayer's property and rights to property, whether real or person- al, tangible or intangible. 2 2 The Service may levy against all property and rights to property belonging to such person or on which there is a lien after a ten-

227day written notice and demand. The levy may not be against exempt property but the exemption is rather narrow. 2 2 8 Since the lien and levy right extends to all personal property rights of the taxpayer, the Service is entitled to lien and levy against SMLLC assets if the taxpayer member has any rights therein. Alterna- tive to the levy process, the Service may foreclose a lien by judicial foreclo- sure.

2 2 9

Typically, a member is not a co-owner and has no transferable interest in limited liability company property. 2 3 Thus, the Service cannot levy against the SMLLC property to satisfy a tax assessment and lien against its sole member. Notwithstanding, a recent Chief Counsel Advisory Opinion provided that the Service had levy authority against certain SMLLC assets. 2 3 1 In the opinion, an attorney formed a SMLLC to practice law. The attorney incurred unpaid federal tax liabilities. The only potential asset identified as available to satisfy the attor- ney's tax liabilities is the income paid to him by the SMLLC. The SMLLC in- come is generated from sporadic stream of accounts receivable from personal in- jury contingent fee agreements.

The Service acknowledged that it could not levy on the SMLLC's assets to satisfy the only owner's tax liability. It also acknowledged that seizing the at-

221. Id. § 6332(d). 222. Id. § 6335. 223. Id. § 6335(e). 224. Id. § 6337. 225. Id. § 6342. 226. Former Treas. Reg. § 301.6321-1 (as amended in 1978). 227. I.R.C. § 6331. 228. Id. § 6334. 229. Id. § 7403. 230. UNIF. LTD. LIAB. Co. ACT § 501 (1996), 6A U.L.A. 604 (2003). 231. Chief Counsel Advisory, I.R.S. CCA 200836002, 2008 WL 4102684 (Sept. 5, 2008).

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torney's SMLLC membership interest was not viable because of few potential purchasers for the interest on a sale. The Service then concluded that the attor- ney had a right to receive income from the SMLLC that could be classified a property right under state law.

The advisory then erroneously concluded that such a property right existed. The theory advanced was that the owner of the SMLLC had a right to be repaid capital and all profits upon dissolution of the entity. That future right created a current property right subject to levy. The opinion clearly ignores the clear dec- laration that an owner has no property interest in any SMLLC assets. Nonethe- less, if the levy rule is sustained, it will allow the Service to bypass the owner and levy against the SMLLC for the tax liabilities of the owner.

C. ARTICLE 9 SECURED CREDITOR OF THE MEMBER OF A SMLLC

The charging order provisions clearly contemplate two separate types of liens. A judicial lien may be defined as a lien obtained by judgment, levy or other legal or equitable proceeding. 2 3 2 In contracts, a lien may be defined as a charge against or interest in property to secure payment of a debt or performance of an obligation. 2 3 3 A charging order, obtained only by force of an application by a judgment creditor, is therefore in the nature of a judgment lien. A lien is then a collective set of creditor and debtor rights between a particular obligation and debtor property referred to as collateral. The term collateral may be defined as the debtor's property subject to a security interest.

234

An Article 9 security interest is defined as "an interest in personal property.... .i n ,235 or fixtures which secures payment or performance of an obligation." Indeed, the scope of Article 9 applies to any transaction regardless of form that creates a236 security interest in personal property. An Article 9 security interest is created by a security agreement between a debtor and creditor that provides for the secu- rity interest. 37 The terms of a security agreement govern the contractual nature of the creditor's security interest in the debtor's personal property described therein as collateral. 2 3 8 A security interest attaches when the agreement "be- comes enforceable against the debtor with respect to the [described] collater- al." 2 39 Generally, a security interest is enforceable against the debtor only if240 . 241 .... 242 value is given, the debtor has rights in the collateral[,] and the debtor

232. Bankr. Code, 11 U.S.C. § 101(36) (2006). 233. Id. § 101(37). 234. U.C.C. § 9-102(a)(12) (2000), 1 U.L.A. 51 (2002). 235. Id. § 1-201(b)(35), 1 U.L.A. 19 (2004).

236. Id. § 9-109(a)(1), 1 U.L.A. 105. 237. Id. § 9-102(a)(73), 1 U.L.A. 58. 238. Id. § 9-201(a), I U.L.A. 122. 239. Id. § 9-203(a), 1 U.L.A. 129. 240. Id. § 1-204, 1 U.L.A. 30 (2004) (defining value broadly). 241. Id. § 9-203(b)(1), 1 U.L.A. 129. 242. Id. § 9-203(b)(2), 1 U.L.A. 129.

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authenticates a security agreement that provides a description of the collateral.24 3

For this purpose, a collateral description is sufficient if it reasonably identifies the collateral 244 such that the collateral is objectively determinable. 2 45 Overly broad and super generic descriptions such as "all the debtor's personal property" are not adequate. 246 A debtor typically authenticates a written security agree- ment by signing but technically any act designed with the present intent to iden- tify the person and adopt a record will suffice.

2 4 7

This voluntary procedure permits the secured creditor to negotiate the terms of the security agreement in advance. When the only member of a SMLLC pro- poses to borrow secured credit from a lender who will accept the SMLLC mem- bership interest as collateral, the lender would be well advised to avoid all the problems that will occur in the event of default. The lender has two pathways that will allow it to overcome the normative statutory pattern problem. First, the lender can have the SMLLC guarantee the member loan. Secondly, the lender can make certain that the written and signed security agreement states the ad- vance consent of the debtor to admit the creditor as the substituted member upon default, foreclosure, and sale of the interest to the creditor.

D. REVERSE PIERCING & FRAUDULENT TRANSFERS

The important question remaining is whether a transfer of assets to a whol- ly-owned single member limited liability company may be attacked on fraudu- lent transfer grounds, whether made before or after a creditor's status as such is known. Such transfers may be attacked but only upon the predicate that the transfers are either a fraudulent conveyance or transfer.

A fraudulent conveyance is generally defined as one made with actual in- tent to hinder, delay, or defraud present or future creditors. 24 8 Importantly, since a conveyance or transfer of assets to a limited liability company is made in ex- change for full and fair value in the form of the only membership interest, such a conveyance or transfer is not fraudulent under the fair consideration doctrine

249

and the creditor has no remedy. 25 As a consequence, it is difficult to imagine that the owner of assets may not transfer those assets to a single member limited liability company for the purpose of protecting those assets. 25 1 While the pro-

243. Id. § 9-203(b)(3)(A), 1 U.L.A. 129. 244. Id. § 9-108(a), 1 U.L.A. 98. 245. Id. § 9-108(b)(6), 1 U.L.A. 98. 246. Id. § 9-108(c), 1 U.L.A. 99. 247. Id. § 9-102(a)(7), I U.L.A. 50 (defining authenticate). 248. UNIF. FRAUDULENT CONVEYANCE ACT § 7 (1918), 7A U.L.A. 378 (2006); UNIF. FRAUDU-

LENT TRANSFER ACT § 5 (1984), 7A U.L.A. 129 (2006). 249. UNIF. FRAUDULENT CONVEYANCE ACT § 3, 7A U.L.A. 277; UNIF. FRAUDULENT TRANSFER

ACT § 3, 7A U.L.A. 47. 250. UNIF. FRAUDULENT CONVEYANCE ACT § 9, 7A U.L.A. 482; UNIF. FRAUDULENT TRANSFER

ACT § 7, 7A U.L.A. 155-56. 251. See, e.g., David M. Repp, Asset Protection (For the Rich and Not) In Iowa, 56 DRAKE L. REV.

105 (2007). Additionally, Professor Ribstein notes: The fraudulent conveyance remedy does not, however, quite fit the reverse limited liability situ-

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tection is mostly outside of bankruptcy, the value of the protection is in the fact that the single member can remain the only member even if a creditor acquires the related economic interest. This does not appear fraudulent within the mean- ing of the statutory law defining objectionable transfers. Indeed, the existence of the single member limited liability company negates that argument. Of course, if the transfer is to the entity itself for a bargain price, the form of the transaction might permit fraud to attach even though the asset value accrues entirely to the single and only member. 252 In any event, one decision involving a transfer to a family limited partnership recognized the evils associated with controlling distri- butions to the detriment of a creditor:

[E]ven if plaintiff were able to secure a charge against [the transferor's] partnership interest, she would have to wait until a distribution was made before she could collect any money, and [the transferor's], as the sole general partner, has sole discretion as to distributions. The partnership is not set to terminate until December 31, 2030, and the partnership agree- ment allows for an extension beyond that date. Moreover, [the transfe- ror's] has sole discretion to dissolve the partnership, and even upon his death, the other partners retain the right to vote to continue the partner- ship. Consequently, the conveyance of the Haddonfield property from [the transferor's] to the Family Partnership serves to greatly hinder and delay plaintiffs ability to collect the debt [the transferor's] owes her.

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Another court utilized the equitable charging order remedy to grant the creditor a seventy-five percent interest in the single member entity while leaving the defendant the remainder.

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Since fraudulent conveyance and transfer laws do not reach asset transfers to a single member limited liability company while the debtor is solvent, the fi- nal question is what remedy outside bankruptcy may a creditor utilize to reach the entity assets? Generally, typical corporate veil piercing applied to a limited liability company permits an entity creditor to press its claims against the entity owner.2 5 5 A related but rarely used doctrine referred to as reverse veil pierc-

ation because it covers only the transfer into the partnership-type entity, not the structure of the entity itself. Thus, if the debtor in Dorfman had the foresight to form the LLC before the judg- ment-or perhaps even before the claim, knowing only of the general potential for future mal- practice claims-fraudulent conveyance law probably would have afforded no basis for voiding the transfer. This future planning would permit doctors and other professionals to shield assets from creditors while continuing to use them. The problem is inherent in the LLC statute rather than in the fraudulent nature of the specific conduct.

Larry E. Ribstein, Reverse Limited Liability and the Design of Business Associations, 30 DEL. J. CORP. L. 199, 215-16 (2005).

252. Firmani v. Firmani, 752 A.2d 854 (N.J. Super. Ct. App. Div. 2000) (holding that the transfer was fraudulent against first wife even though husband owned approximately ninety-five percent of the entity interests).

253. Id. at 858. 254. Baker v. Dorfman, No. 99 Civ. 9385(DLC), 2000 WL 1010285, at *10 (S.D.N.Y. July 21,

2000). The decision has been criticized as exceeding the intent of the charging order remedy. See Ribs- tein, supra note 251, at 215.

255. Some argue the extension of the corporate doctrine to the limited liability company is not sup- ported on legitimate policy grounds. Stephen M. Bainbridge, Abolishing LLC Veil Piercing, 2005 U. ILL. L. REv. 77 (2005). Others disagree. Geoffrey Christopher Rapp, Preserving LLC Veil Piercing: A Response to Bainbridge, 31 J. CORP. L. 1063 (2006).

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ing 2 56 reverses the process and seeks to impose the entity owner's obligations against the entity's assets. 2 57 The Revised Limited Liability Company Act commentary expressly notes that the exclusivity of the charging order remedy is not designed to override reverse piercing: "This subsection is not intended to prevent a court from effecting a 'reverse pierce' where appropriate. In a reverse pierce, the court conflates the entity and its owner to hold the entity liable for a debt of the owner."

2 58

In the referenced Litchfield Asset Management Corp. v. Howell,2 59 the cred- itor, Litchfield Asset Management Corporation, brought an action to collect a judgment against the debtors Jon and Mary Ann Howell and their two limited liability companies. 26 The judgment arose out of disputes relating to an agree- ment between Mary Ann Howell Interiors Inc. to perform services for Lit- chfield. 26 1 While the litigation proceedings were in process, Mary Ann Howell and her family formed two new limited liability companies. 2 62 Later, Mary Ann Howell contributed $144,679 from her life insurance policy in exchange for a ninety-seven percent interest in one entity. 263 Jon Howell and the couple's two daughters received a one percent ownership interest for a contribution of ten dol-

264lars each. Still later, that entity contributed $102,901 to the other entity in ex- change for a ninety-nine percent interest with Mary Ann Howell acquired the remaining one percent interest for ten dollars. 265 The court pierced the veil, em- phasizing the control exercised by the majority owner, the owner's unauthorized use of company funds to pay personal expenses (instead of drawing a regular salary or distributions that a creditor might have reached through a charging or- der), and the owner's commingling of business and personal affairs and funds:

The instrumentality rule requires, in any case but an express agency, proof of three elements: (1) Control, not mere majority or complete stock con- trol, but complete domination, not only of finances but of policy and busi- ness practice in respect to the transaction attacked so that the corporate entity as to this transaction had at the time no separate mind, will or exis- tence of its own; (2) that such control must have been used by the defen-

256. The reverse piercing doctrine is a derivative of the corporate veil piercing doctrine. Elham Youabian, Reverse Piercing of the Corporate Veil: The Implications of Bypassing "Ownership" Inter- ests, 33 Sw. U. L. REV. 573 (2004).

257. Ribstein, supra note 251, at 216. For a discussion of the state law applicable to veil piercing claims, see Gregory Scott Crespi, Choice of Law in Veil-Piercing Litigation: Why Courts Should Dis- card the Internal Affairs Rule and Embrace General Choice-of-Law Principles, 64 N.Y.U. ANN. SURV. AM. L. 85 (2008).

258. REVISED UNIF. LTD. LIAB. Co. ACT § 503(g) cmt. subsection g (2006), 6B U.L.A. 498-501 (2008) (citing Litchfield Asset Mgmt. Corp. v. Howell, 799 A.2d 298, 312 (Conn. App. Ct. 2002) (ap- proving a reverse pierce where a judgment debtor had established a limited liability company in a patent attempt frustrate the judgment creditor)).

259. 799 A.2d 298 (Conn. App. Ct. 2002). 260. Id. at 303. 261. Id. 262. * Id. 263. Id. 264. Id. 265. Id.

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dant to commit fraud or wrong, to perpetrate the violation of a statutory or other positive legal duty, or a dishonest or unjust act in contravention of plaintiff's legal rights; and (3) that aforesaid control and breach of duty must proximately cause the injury or unjust loss complained of. 266

Later, in a certified case, the Virginia Supreme Court cited the Litchfield case and determined that reverse veil piercing could be applied to reach the as- sets of a limited partnership for the obligations of a limited partner.

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The challenge for the reverse piercing doctrine, as a proxy for equity, is to balance the rights of creditors against the statutory designs embracing entity li- mited liability in cases where fraudulent conveyance law is inapplicable. A transfer of assets to an entity when the transferor is solvent and in return for a proportionate interest is not fraudulent. Indeed, it is the specific promise of the statutes. A single member limited liability company specifically protects the owner from the business risks associated with the business (other than personal torts or personal contract liability). Likewise, the charging order statutes make clear that creditors of the owner cannot reach the assets of the entity and are li- mited to reaching the distributions determined by the owner and otherwise avail- able to that owner. But when the charging order is foreclosed and the creditor purchases the limited liability company interest, what equitable limits are placed upon the residual statutory design? Without equitable limitations, the single member-owner remains the member with management rights and the purchaser owns only economic rights waiting patiently unless and until the member dec- lares distributions. The member can thus exercise control over the assets to pre- fer its own economic interest over that of the creditor owner of the transferable interest. Equity must interpose reasonable limitations on member abuse and, specifically, where abuse is established allow the creditor direct access to entity assets. The reverse piercing doctrine appears to be the best doctrinal fit outside of bankruptcy.

V. CONCLUSION

The sensible statutory restrictions applicable to transfers of a membership in a multiple member limited liability company are justified and intuitive. Spe- cifically, the rules that permit a member to freely transfer economic rights to fu- ture distributions while at the same time requiring the consent of the remaining members to admit the transferee as a member are appropriate to balance the rea- sonable expectations of members of a close business association. However, when applied to a SMLLC, the same rules create a perverse and unexpected re- sult. The transferee creditor who purchases at a foreclosure sale acquires all the economic rights while the debtor member retains the right to control and manage the limited liability company. There are no other remaining partners to protect

266. Id. at 312-13 (emphasis omitted). 267. C.F. Trust, Inc. v. First Flight L.P., 580 S.E.2d 806 (Va. 2003). See Leslie C. Heilman, Com-

ment, C.F. Trust, Inc. v. First Flight Limited Partnership: Will the Virginia Supreme Court Permit Out- sider Reverse Veil-Piercing Against a Limited Partnership?, 28 DEL. J. CORP. L. 619 (2003).

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as in the case of a multi-member limited liability company. Worse, the debtor member no longer owns any economic interest in the limited liability company. Statutory rules that permit such a result create a creditor paradox and force courts to seek equitable remedies to allow the creditor transferee to access the assets of the SMLLC since it is the only person with an economic equity owner- ship position. Creditor access to the SMLLC assets allows the business to be sold and the proceeds paid to the creditor. One promising and perhaps the only judicial equitable remedy may be found in the reverse piercing doctrine. But un- less courts liberalize that doctrine to take into consideration the fact that the deb- tor member no longer has any legitimate economic interest in managing the enti- ty, that doctrine too will fail the creditor.

Ultimately, these perverse results are best cured by statutory amendment. Preferably, every state would amend its SMLLC legislation to provide that upon the voluntary or involuntary transfer of the only economic interest in the SMLLC, the transferee will be admitted as a substituted member, with or with- out the consent of the only member.