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LLC and Partnership Transfer Restrictions and
UCC Article 9 Overrides: Resolving the Conflict
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THURSDAY, JANUARY 9, 2020
Presenting a 90-minute encore presentation featuring live Q&A
Professor Carl S. Bjerre, Kaapcke Professor of Business Law, University of Oregon, Eugene, Ore.
Daniel S. Kleinberger, Professor of Law Emeritus, Mitchell Hamline School of Law, St. Paul, Minn.
Edwin E. Smith, Partner, Morgan, Lewis & Bockius, New York and Boston
Steven O. Weise, Partner, Proskauer Rose, Los Angeles
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Intersection of UCC and LLC Law
LLC and Partnership Transfer Restrictions and UCC Article 9 Overrides: Resolving the Conflict
Carl S. BjerreUniversity of Oregon School of Law
Daniel S. Kleinberger
Mitchell Hamline School of Law
Edwin E. Smith
Morgan, Lewis & Bockius LLP
Steven O. Weise
Proskauer Rose LLP
Intersection of UCC and LLC Law
Overview
•Overall goals of organic entity law versus UCC Article 9
•Anti-assignment overrides as currently on the books
•Opting in to Article 8 status
•2018 amendments to UCC overrides
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Intersection of UCC and LLC Law
I. Background
•LLC and partnership law
o “Pick your partner” principle
•UCC Article 9
o Enable financing based on personal property
•Possibility of clashes between the two
3
Intersection of UCC and LLC Law
Entity law’s bifurcation of rights
•Governance rights
o Voting
o Consents
o Information
•Economic (financial) rights
o Distributions
•Most ownership interests include both
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Intersection of UCC and LLC Law
Typical statutory default rules
•Restriction on transfer of governance rights. E.g.:o ULLCA § 401(c)o Delaware act § 18-702(b)(1)
•Enabling of transfer of economic rights. E.g.:o ULLCA § 502(a)(1)o Delaware act § 18-702(a)
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Intersection of UCC and LLC Law
Possibility of alteration in organic documents
•Transfer of governance rights may be enabled
•Transfer of economic rights may be restricted
o E.g., to ensure those with governance rights also have an economic stake
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Intersection of UCC and LLC Law
Scope of Article 9 and hence its overrides
•Transfers as ordinary security interests
o All personal property
•Outright sales
o Only certain property
▪ Generally, subtypes of receivables
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Intersection of UCC and LLC Law
Article 9 property “types”
•Most not germane here
o Goods (incl. inventory, etc.); chattel paper; accounts; deposit accounts; etc.
•Focus here is on general intangibles, incl. payment intangibles
•Also investment property (Part III below)
8
Intersection of UCC and LLC Law
Caution regarding non-UCC terminology
•Delaware LLC Act defines “limited liability company interest” as covering economic rights only
•New York LLC Act defines “membership interest” as covering both economic and governance rights
•Informal terms “interests,” “units,” etc.
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Intersection of UCC and LLC Law
Important formulation concerning economic rights
•ULLCA definition of “transferable interest”•“the right, as initially owned by a person in
the person’s capacity as a member, to receive distributions from a limited liability company, whether or not the person remains a member or continues to own any part of the right. The term applies to any fraction of the interest, by whomever owned.”o ULLCA § 102(24)
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Intersection of UCC and LLC Law
General intangibles and payment intangibles
•Article 9’s catch-all or residual type
o § 9-102(a)(42)
•Important subtype of the catch-all: “payment intangible”
o “principal obligation” of the “account debtor” is “a monetary obligation.” § 9-102(a)(62)
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Intersection of UCC and LLC Law
Further on “payment intangibles”
• Definition of “account debtor,” § 9-102(a)(3)o obligated on the general intangibleo the LLC or partnership itself o not generally its members or partners
• Is the account debtor’s “principal obligation” “monetary”?o Are there any substantial governance rights?o Complete ownership interest will generally
not be payment intangible
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Intersection of UCC and LLC Law
Article 9’s relevant scope
•“security interest in personal property,” § 9-109(a)(1)
•“sale of . . . payment intangibles,” § 9-109(a)(3)
o Not other general intangibles
•See also § 1-201(b)(35) (security interest includes interest of a buyer of a payment intangible)
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Intersection of UCC and LLC Law
First look at scope of overrides
• Restrictions on “assignment or transfer” of general intangibles, including payment intangibles, are overriddeno Ordinary security interests in:
▪ payment intangibles▪ other general intangibles
o Sales of payment intangibleso Not sales of other general intangibles,
implicitly• Ignoring other receivables here
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Intersection of UCC and LLC Law
“assignment or transfer”
•§ 9-102 cmt. 26: “assignment” generally refers to transfers of payment rights, among other property
•“Depending on the context,” term may refer to “outright ownership interest” or “limited interest, such as a security interest”
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Intersection of UCC and LLC Law
“assignment or transfer” cont’d
• Durham Capital Corp. v. Ocwen Loan Servicing, LLC, 777 Fed.Appx. 952 (11th Cir. 2019) seems to misconstrue “assignee”o Ordinary secured lender to law firm instructed
client to pay lender rather than law firm. See UCC §9-406(a).
o Client nonetheless continued to pay law firm. o Held, lender has no cause of action against client,
apparently based at least in part on definition of “assignee”
• Possibility of P.E.B. Commentary highlighting existing analysis in § 9-102 cmt. 26
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Intersection of UCC and LLC Law
II. Closer look at the overrides
•§ 9-406: narrow although strong
•§ 9-408: broader but weaker
•Difficult because:
o Dense content
o Similarity of formulations
o Intricate coordination with each other
o Important difference in consequences
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Intersection of UCC and LLC Law
Central text of § 9-406 override
•Subsection (d) invalidates any “term in an agreement between an account debtor and an assignor” . . .
•to the extent that the term “prohibits, restricts, or requires the consent of . . . the account debtor” . . .
•to “the assignment or transfer of, or the creation, attachment, perfection, or enforcement of a security interest in . . . the payment intangible.”
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Intersection of UCC and LLC Law
Narrowness of § 9-406
•Applies only to payment intangibles
•Applies only to ordinary security interests in them
o Subsection (e) specifies generally inapplicable to sales
•Applies only to restrictions in agreements, not statutes (except on types of collateral not relevant here)
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Intersection of UCC and LLC Law
Narrowness of § 9-406, cont’d
•Agreements covered are only those with “the account debtor"
o Not agreements with other equity owners
o Is the LLC or partnership even a party to its own organizational agreement?
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Intersection of UCC and LLC Law
Narrowness of § 9-406, cont’d
•Summing up:
o No override for outright transfers of complete ownership interests
o No override of requirements of consent from transferor’s fellow owners
•But N.B. its strength: “enforcement”
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Intersection of UCC and LLC Law
Central text of § 9-408 override
•Subsection (a) invalidates any “term in an agreement between an account debtor and a debtor which relates to . . . a general intangible” . . .
•that “prohibits, restricts, or requires the consent of . . . the account debtor” . . .
•to “the assignment or transfer of, or creation, attachment, or perfection of a security interest in . . . the . . . general intangible.”
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Intersection of UCC and LLC Law
Central text of § 9-408 override, cont’d
•Subsection (c) invalidates any “provision of a statute or other rule of law” . . .
• that similarly “prohibits, restricts, or requires the consent of . . . [an] account debtor” . . .
•to “the assignment or transfer of, or creation of a security interest in, a . . . general intangible.”
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Intersection of UCC and LLC Law
Breadth of § 9-408
• Applies to general intangibleso Including but not limited to payment
intangibleso Applies to security interests in general
intangibles that are not payment intangibleso Applies to outright sales of payment
intangibleso Overrides restrictions whether in agreements
(again provided they are with the account debtor) or in statutes
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Intersection of UCC and LLC Law
Important issue affecting both of the overrides
• Suppose LLC is manager-managedo Also suppose the operating agreement
allocates approvals of transfers to the manager on behalf of LLC
• Manager is agent of LLC• LLC may be party to operating agreement
o Or deemed by statute to be a party• Possible result: LLC would be the account
debtor, and the Article 9 overrides would apply
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Intersection of UCC and LLC Law
Breadth of § 9-408 (concl.)
•Summing up:o Does apply to outright transfers of
complete ownership interests
▪ Even those otherwise barred by statute, as is nearly universal
o Also applies to ordinary security interests in complete ownership interests
o As well as to outright sales of economic rights
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Intersection of UCC and LLC Law
Relative weakness of § 9-408
• In all of the above applications, applies to “attachment, creation, or perfection” of the interest
• Not to “enforcement” thereof• Subsection (d) makes explicit that a security
interest that is subject to an otherwise enforceable restriction is o “not enforceable” against the “account
debtor,” and “does not entitle the secured party to enforce the security interest.”
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Intersection of UCC and LLC Law
Relative weakness of § 9-408, cont’d
•Transaction goes forward as between the parties
•Relationship between transferee and LLC or partnership is separate matter
•Transferee’s property rights remain valuable, e.g.:o If proceeds take different form o If later consent of required parties
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Intersection of UCC and LLC Law
More on enforcement
•2010 amendments to Article 9 clarify that § 9-406(d)’s inapplicability to a sale of a payment intangible does not preclude a secured party from conducting a foreclosure sale (§ 9-610) or accepting the collateral in satisfaction of debt (9-620).
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Intersection of UCC and LLC Law
Foreclosure strategy and trap
Owner
Guaranty +
security interest in
equity in Borrower
Ownership
Borrower
Security
interest
Secured
party
Payment
obligation
Loan
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Intersection of UCC and LLC Law
Foreclosure strategy and trap (cont’d)
Owner
Foreclose on
ownership interest
Ownership
Borrower
Security
interest
Secured
party
Payment
obligation
Subrogated to
security interest
Subrogated to
payment obligation
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Intersection of UCC and LLC Law
Foreclosure strategy and trap (cont’d)
Owner
Ownership
BorrowerSecurity
interest
Secured
party
Payment
obligation
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Intersection of UCC and LLC Law
III. Opting in to Article 8 status
•The overrides are inapplicable to securities or other investment property
o Defined by reference to UCC Article 8
•Transferee is also eligible for protected purchaser status
o Take free of adverse claims
•Re enforceability of restrictions on transfer of securities, see e.g. § 8-204
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Intersection of UCC and LLC Law
Is the LLC or partnership interest a security?
• § 8-103(c): not “unlesso it is dealt in or traded on securities exchanges or in
securities markets,o its terms expressly provide that it is a security
governed by this Article, or o it is an investment company security.”
• Issuer opt-in is the process by which the terms can expressly so provide
• Federal law characterization is immaterial except at the margins of foreclosure by public sale
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Intersection of UCC and LLC Law
Opt-in mechanics
•Language should appear in operating agreement or partnership agreement
•Interests can be certificated (reified) or uncertificated (book-entries of issuer)
o Mere existence of piece of paper not determinative
•Safeguards to protect against opting back out without consent
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Intersection of UCC and LLC Law
Take-free consequences of Article 8 treatment
•Transferee of security may be “protected purchaser” (§ 8-303)
o Value
o Without notice of any adverse claim (§ 8-105, not § 1-202)
o Obtains control (§ 8-106)
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Intersection of UCC and LLC Law
Take-free consequences of Article 8 treatment (cont’d)
• Analogous protections in the indirect holding system, if value and no noticeo § 8-502: credit to transferee’s securities accounto § 8-510(a): purchase of interest in security
entitlement• No question that LLC or partnership interest is
financial asset if held by intermediary. E.g., § 8-103(c).o Regardless of whether the LLC or partnership
interest is itself a security
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Intersection of UCC and LLC Law
IV. Non-uniformity and eventual uniformity
•Several states (including Delaware) exclude application of UCC anti-assignment overrides to LLC and partnership interests
o May appear in state’s enactment of UCC; organic law; or both
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Intersection of UCC and LLC Law
2018 amendments to §§ 9-406 and 9-408: black letter
•New subsections 9-406(k) and 9-408(f):
•Overrides do not apply to “a security interest in an ownership interest in a general partnership, limited partnership, or limited liability company.”
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Intersection of UCC and LLC Law
2018 amendments to §§ 9-406 and 9-408: Official Comments
• “This section does not apply to an ownership interest in a limited liability company, limited partnership, or general partnership, regardless of the name of the interest and whether the interest:
• (i) pertains to economic rights, governance rights, or both;• (ii) arises under: (a) an operating agreement, the applicable
limited liability company act, or both; or (b) a partnership agreement, the applicable partnership act, or both; or
• (iii) is owned by: (a) a member of a company or transferee or assignee of a member; or (b) a partner or a transferee or assignee of a partner; or
• (iv) comprises contractual, property, other rights, or some combination thereof.”
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Intersection of UCC and LLC Law
2018 amendments to §§ 9-406 and 9-408 (cont’d)
•Approval process completed:
o P.E.B. for the UCC
o Joint Editorial Board on Uniform Unincorporated Organization Acts
o American Law Institute and Uniform Law Commission
•Separate processes for enactments by each state
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Intersection of UCC and LLC Law
Conflict of laws
•Where override provisions differ, a court should probably apply the override of the jurisdiction in which the entity is organized
o Cf. internal affairs doctrine
•Inapplicability of UCC § § 9-301 to 9-307
o Not “perfection,” “effect of perfection or nonperfection,” or “priority”
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Intersection of UCC and LLC Law
Conflict of laws (cont’d)
•Choice-of-law clause in security agreement or other transfer agreement is inapplicable to third-party effects of an override
o See § 9-301 comment 3
•Wide enactment of 2018 amendments is desirable
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Intersection of UCC and LLC Law
Thank you
Carl S. BjerreUniversity of Oregon School of Lawcbjerre@uoregon.edu
Daniel S. KleinbergerMitchell Hamline School of Lawdaniel.kleinberger@mitchellhamline.edu
Edwin E. SmithMorgan, Lewis & Bockius LLPedwin.smith@morganlewis.com
Steven O. WeiseProskauer Rose LLPsweise@proskauer.com
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