By: Jeff Dutson, King & Spalding LLP
Pledge of security interest in a Virginia LLC does not include debtor’s indirect membership interests in such LLC absent explicit language in security agreement. Wells Fargo Bank, N.A. v. Highland Constr. Mgmt. Servs., L.P., 807 F. App’x 246, 248 (4th Cir. 2020)
The issue before the Fourth Circuit Court of Appeals arose from a post-confirmation fee application filed by the debtor on behalf of its counsel and authorized agent. Wells Fargo Bank, N.A., f/b/o Jerome Guyant IRA, a secured creditor, objected to such fee application, arguing debtor lacked funds to satisfy creditor’s claim before paying such fees. Therefore, the court needed to determine the extent of creditor’s security interest.
The pertinent security agreement provided that debtor assigned to creditor “[f]ifty percent (50%) of [debtor]’s membership interest in Sanford LLC….” Debtor had a 20% interest in such LLC. Therefore, debtor argued it had assigned to creditor a 10% interest in Sanford, LLC. But creditor argued that its security interest amounted to a 16% interest in Sanford LLC, relying on a recital stating that the parties had agreed the assignment was “equal to sixteen percent (16%) of the total membership interest in Sanford LLC….”
Separate from its 20% interest in the LLC, debtor also had a 50% interest in Foothills LLC—an LLC not referenced in the security agreement. In turn, Foothills LLC had a 24% interest in Sanford LLC. In other words, debtor effectively had a 20% (direct) and 12% (indirect) interest in Sanford LLC. The question was whether the 12% indirect interest arising from debtor’s interest in Foothills LLC was subject to the security agreement.
Affirming the bankruptcy and district courts, the Fourth Circuit held that debtor had only assigned half of its direct 20% interest for the following reasons—(1) a membership interest in an LLC constitutes personal property under Virginia law; (2) debtor had a personal property interest in Sanford LLC and Foothills LLC, separately; (3) the assignment only pertained to debtor’s membership interest in Sanford LLC; (4) debtor had no authority to assign Foothill LLC’s property (i.e., it’s membership interest in Sanford LLC) and it only had a 50% interest in Foothills LLC, not a 12% indirect interest in Sanford LLC; (5) the security agreement was devoid of language granting creditor an interest in distributions received by debtor from Foothills LLC on account of the Sanford LLC membership interest; and (6) recitals are not binding on the parties absent ambiguity, which the court held was not present.
