Judgment Awarding Value of Withdrawing Member's Interest in an LLC Subordinated

On behalf of Macdonald Fernandez LLP on Thursday, June 13, 2013.

In O'Donnell v. Tristar Esperanza Properties, LLC, BAP No. CC-12-1340-KIPaDu (9th Cir. BAP Mar. 8, 2013), the Ninth Circuit Bankruptcy Appellate Panel held that a judgment awarding the value of a withdrawing member's interest in a limited liability company is vulnerable to mandatory subordination under Bankruptcy Code Section 510(b) as damages arising from the purchase or sale of a security.
Jane O'Donnell withdrew her 14% membership interest in Tristar Esperanza Properties, LLC. Pursuant to the operating agreement, O'Donnell hired an appraiser, who estimated the value of her interest to be $399,918. Tristar objected; O'Donnell brought an arbitration and obtained an award for $399,918 less $60,000 previously received. The award was confirmed and a judgment was entered.
Tristar filed a chapter 11 bankruptcy case and an adversary proceeding to subordinate O'Donnell's claim. The debtor prevailed, and the BAP affirmed.
Although a membership interets in an LLC is not among the enumerated examples of a "security" under Bankruptcy Code Section 101(49), the BAP reasoned that it is analogous to "the interest of a limited partner in a limited liability partnership." The BAP also analyzed the legislative history of Section 510(b) and prior cases, and held that O'Donnell's withdrawal was "nothing other than her cashing out her equity (at a value that the Debtor insists is highly inflated)."
The scope of the BAP's broad view of what constitutes a claim arising from the purchase or sale of a debtor's securities. Any claim with a nexus or causal relationship with a transaction involving securities may be subject to mandatory subordination.