Increasingly, farmers and ranchers are using limited liability companies (LLCs) to conduct their farm and livestock operations. When lending to LLCs, lenders must take care to review carefully and understand the terms of the operating agreements and determine whether the LLCs are member managed or manager managed. The type of operating agreement and management will determine the necessary documents for any secured transaction.
First, a lender must determine whether there are any restrictions on the ability of an LLC borrower to grant a security interest in its assets to secure loans. For example, the operating agreement may prohibit any encumbrance on its assets without the approval or consent of all or a majority of the members. Typically, this requirement can be satisfied by having all members sign the note and the security agreement.
Second, the lender also may take a pledge of the membership interest of an individual member. Most operating agreements prohibit such pledges without the prior consent of all members and satisfaction of the additional requirements contained in those agreements. For example, the other members may agree to consent but require that the lender give them a right of first refusal in the event that the lender decides to do a Uniform Commercial Code foreclosure of the pledged interest. Additionally, some operating agreements have an absolute prohibition against any pledge of a membership interest.
It is imperative that the lender document the necessary consents or approvals in the manner required by the operating agreement. Failure to do so is fatal. See In re Weiss, 376 B.R. 867 (Bankr. N.D.Ill. 2007) (compliance with operating agreement controlling procedures for transfer of interest is required for proper assignment).
Problem Ag Loan
In Weiss, the court provided a chart showing the provisions from the operating agreements of eight different LLCs that restricted, and in some cases absolutely prohibited, the transfer of a membership interest. The court also noted that the operating agreements required that the written consents be obtained “prior to” any transfer. 376 B.R. at 873. If the operating agreement contains an absolute prohibition, best practices dictate that the lender require that the agreement be amended to delete that prohibition or that all of the members affirmatively waive the prohibition.
Third, it is equally imperative that the form of consent provide that the assignee, and any ultimate third party who acquires the interest once it is foreclosed on, be entitled to all of the economic and noneconomic (management) rights of the assignor. The Limited Liability Company Act, 805 ILCS 180/1-1, et seq., provides that a transferee of an interest in an LLC takes the interest “in accordance with authority described in the operating agreement or all other members consent.” 805 ILCS 180/30-10(a). See also Bobak Sausage Co. v. Bobak Orland Park, Inc., No. 06 C 4747, 2008 WL 4814693 (N.D.Ill. Nov. 3, 2008). Most operating agreements not only restrict assignments or pledges, but also limit the rights of any approved transferee to take only an economic distributional interest (i.e., the right to monetary profit distributions from the LLC). The lender must demand that the interests transferred include all voting and management rights in order for the membership interest to have any real market value.
The consent must be clear that the lender, as the collateral assignee, is not restricted and is affirmatively authorized and permitted to subsequently transfer the entire membership interest to any third party. A right of first refusal of any bona fide offer can be included in the consent. It is insufficient, however, for the remaining members to consent merely to the pledge or transfer of the interest to the lender without the right of subsequent transfer. No lending institution will want to bid at a UCC foreclosure sale to hold a membership interest as an investment. Instead, lenders will seek to transfer the membership interest once acquired to a third party to make a recovery on the loan.
Provisions in an operating agreement purporting to place limitations or restrictions on a membership’s interest as a result of the member filing bankruptcy are unenforceable. LaHood v. Covey (In re LaHood), 437 B.R. 330, 336 (C.D.Ill. 2010).
In conclusion, whether there is a security interest in the assets of the LLC or a collateral assignment of the membership interest in an LLC, a lender must exercise care to determine whether the security interest taken is valid and enforceable.
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