Edited by Robert W. Hillman and Mark J. Loewenstein
Chapter 8: Mitigating the impact of a counterparty LLC’s financial distress
Doing business by contract in an unincorporated entity form can create certainty for owners but it also can generate ambiguity and confusion for parties doing business with the entity. For example, can an LLC operating agreement alter the LLC’s or its members’ rights under federal bankruptcy law and in turn indirectly affect the rights of creditors in any subsequent bankruptcy case? If so, how do creditors anticipate and protect themselves against such bankruptcy clauses? This chapter summarizes certain key issues facing creditors of unincorporated entities, including: the enforceability of waivers and ipso facto (bankruptcy termination) clauses in prepetition operating and partnership agreements; the impact of the automatic stay and plan injunction provisions on creditors’ rights against the members or partners of a bankrupt entity; and the effect of charging orders in the bankruptcy context. Although these issues can arise in most any bankruptcy case, the interplay of federal bankruptcy law, applicable state entity law, and the parties’ contractual rights can create unique circumstances and unexpected consequences that potential creditors of an unincorporated entity should at least consider at the beginning of the business relationship.
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