Foreclosing on a Limited Liability Company Interest

Prior to making a loan secured by a limited liability company (LLC) interest, a lender should understand the difficulties involved in foreclosing on such an interest.

It is first important to note how an LLC interest is defined under the Uniform Commercial Code (UCC) for purposes of obtaining perfection of a security interest. Under the UCC, an LLC interest may be either a general intangible or a security. Generally, if an LLC interest is a security, perfection is achieved by filing a financing statement, obtaining “control” over the interest or (if the interest is represented by a certificate) taking possession of the interests. If a general intangible, perfection is achieved only by filing.

There are effectively two options to foreclose on an LLC interest: “strict foreclosure” or “commercially reasonable sale” under the UCC.

In a strict foreclosure context, a lender may accept an LLC interest in “full satisfaction” or “partial satisfaction” of the debt due from the borrower. If accepted in full satisfaction, the balance of the borrower’s obligations, if any, is extinguished. If accepted in partial satisfaction, the lender may attempt to obtain a deficiency judgment. Strict foreclosure, as simple as it may sound, is not simple. To strictly foreclose, consent of the borrower, other secured parties and (in some cases) any guarantors is required. Further, consent is only valid if it is obtained after default.

In a commercially reasonable sale, the lender sells the LLC interest in a commercially reasonable manner. As a technical matter, the sale can be either private or public. A private sale is subject to certain restrictions. No doubt, a motivated borrower will raise opposition to any sale and will attempt to argue that any sale by a lender would not be commercially reasonable (as a lender bidding on an LLC interest at a public sale by way of a credit bid would likely depress others’ interest in the same). A commercially reasonable sale must also be structured so as to not violate applicable securities laws.

It is also important to note that a lender or other buyer that succeeds to the interest of a borrower in an LLC has its own set of worries; in the first instance, unless certain consents were obtained or other actions were taken when the loan was made, the lender or other buyer may only acquire the right to receive distributions and may not become a member of the LLC. Even if the lender or other buyer does become a member, there are potential fiduciary and contractual obligations to co-members. There may also be obligations owed to third parties.

If your firm is considering taking an LLC interest as collateral, perfecting such an interest, or exercising your rights to foreclose upon any such an interest, please contact a member of Seyfarth Shaw’s Corporate & Finance Group for assistance.