Working Group on Small Business, Partnerships, and Single Asset Real Estate Proposal #3:
Effect of General Partner’s or LLC Member’s Bankruptcy Filing

I. INTRODUCTION

Partnerships, like all other types of business entities in the United States, are created and largely governed by state law. [ FN: A partnership is defined in virtually every state as " an association of two or more persons to carry on as co-owners a business for profit. " 6 Unif. Partnership Act § 6(1), 6 U.L.A. 235 (1914)(hereinafter " U.P.A. " ). A " person " within the meaning of the definition " includes individuals, partnerships, corporations and other associations. " Id. § 2. The law contemplates that the associates of a partnership operate as co-owners of the business. " Ownership involves the power of ultimate control. To state that partners are co-owners of a business is to state that they each have the power of ultimate control. " Id. § 6 cmt. 1. The feature of co-ownership and the fact that the relationship is imbued with the obligations of fiduciaries makes a partnership among the most intimate of business associations.] In circumstances such as bankruptcy, however, partnerships and other business entities are subject to federal law which preempts inconsistent state law. [ FN: See U.S. Const. art. VI, cl.2.] Although partnerships vary in size from two to hundreds of persons, the often complex and tortuous interaction between the Bankruptcy Code and state partnership law is a common thread that plagues all partnerships in bankruptcy. Also, when a general partner seeks relief under the bankruptcy laws, decisional law and scholarly opinion are far from consistent on a number of important issues includingthe effect of the debtor general partner’s bankruptcy on the continuity of the partnership relation and the enforceability in bankruptcy of contractual provisions which operate to terminate, modify or adversely affect the management and economic rights or interests of the debtor general partner. The discordant body of law that has developed due to the inconsistent application of an executory contract analysis does not satisfactorily resolve the difficult issues presented when a general partner or a member of a limited liability company seeks protection under the Bankruptcy Code.

Over the past several decades, significant attention has been given to partnership bankruptcy issues, beginning with the Commission on Bankruptcy Laws of the United States ("1971 Commission"), which dealt with three concerns of the time: (i) the test for an involuntary petition against the partnership, (ii) the definition of partnership insolvency, and (iii) the abolition of the "jingle rule." [ FN: Gerald K. Smith, I SSUES IN P ARTNERSHIP AND P ARTNER B ANKRUPTCY C ASES AND R EORGANIZATION OF P ARTNERSHIP D EBTORS , in course materials for ALI-ABA, Partnerships, LLCs, and LLPs: Uniform Acts, Taxation, Drafting, Securities, and Bankruptcy , at 648 (1995) (footnotes omitted). The " jingle rule " states that partnership assets are to be applied first to partnership debts and a general partner ’ s assets are to be applied first to his or her separate debts. If there is a surplus of the partnership assets over the partnership debts, it shall paid to the partners or their estates. If there is a surplus of a general partner ’ s assets over his or her separate debts, it shall be added to the partnership assets and applied to payment of the partnership debts.] As other issues were largely academic during the tenure of the 1971 Commission, it did not comprehensively address partnership bankruptcy issues. [ FN: I d. at 648.] As the incidence of partnership bankruptcies has increased, significant time, attention, and resources have been devoted to such issues by a number of bankruptcy organizations, including the National Bankruptcy Conference and the American Bar Association.

These issues are some of the most complex in bankruptcy and have made consensus among the organizations considering them difficult to achieve. Thus, despite the significant amount of work performed over many years by such an experienced group, bankruptcy law as yet does not adequately address partnership issues. [ FN: See id. at 645.] To improve uniformity and consistency in the application of the Bankruptcy Code, provide clarity and certainty for the commercial world and to reduce the costs of litigating this unsettled area of law, it is imperative that the current Commission propose meaningful reform for this complex area of partnership bankruptcy law. The Working Group on Small Business, Partnership and Single-Asset Real Estate has developed a proposal aimed at addressing some of the problems encapsulated by the prophetic conclusion that "[t]he bankruptcy law has not adequatelydealt with partners and partnerships over the years." [ FN: Gerald K. Smith, Survey of Partnership Issues and Problems in chapter 11 and Bankruptcy , CA86 ALI-ABA 639 (1996)(emphasis added).]

II. HISTORICAL DEVELOPMENT

Partnerships have played a significant role in the economy from the early days of American history. In the nineteenth century, the general partnership was a widely utilized form for conducting business for all kinds of enterprises. Since business employs both capital and services from outside, nonmanagement sources, a need quickly developed for a form of association which permitted capital investment without responsibility for management or for losses beyond the amount invested.

Underlying the uniform general partnership laws is a basic assumption that the archetype partnership is a small, closely-held business formed by a few individuals who are working together in a common enterprise. [ FN: A leading commentator has explained: Personal liability is consistent with close supervision of co-partners. Passive ownership is riskier if a co-partner or agent can take an action that has the effect of inflicting personal financial ruin on the owners. As a result, partners are often managers or at least closely supervise management. Also, co-equal participation in management is less costly where owners are not numerous. . . . Alan R. Bromberg & Larry E. Ribstein, Partnership § 1.01(b)(2), at 1:5 (1996).] Thus, the uniform laws set forth what essentially operates as a "standard form contract" that is designed to meet the needs of such business associations, even though partnerships come in myriad sizes and types and operate in different industries. The needs of business and investment have now, for example, resulted in publicly-owned and publicly-traded limited partnerships with sometimes tens of thousands of limited partners. The partnership form of business, both general and limited, is prevalent in such disparate industries as real estate, agriculture, oil and gas, entertainment, professional services, wholesale and retail trade, and technology. Partners are able to use the partnership form to accommodate their various needs by significantly varying the terms of their agreement from the statutory default rules imposed by the uniform laws.

A. Uniform Partnership Act

Prior to the promulgation of a uniform set of laws, the law of partnership was governed primarily by a discordant body of case law. The law varied from one jurisdiction to another and therewas no authority on a number of important issues. [ FN: As reported by the Chairman of the Committee on Commercial Law in the Prefatory Note to the Uniform Partnership Act: There is probably no other subject connected with our business law in which a greater number of instances can be found where, in matters of almost daily occurrence, the law is uncertain. This uncertainty is due, not only to conflict between the decisions of different states, but more to the general lack of consistency in legal theory. . . . [T]here exists an almost hopeless confusion of theory and practice [in a number of areas], making the actual administration of the law difficult and often inequitable. Another difficulty of the present partnership law is the scarcity of authority on matters of considerable importance in the daily conduct and winding up of partnership affairs. In any one state, it is often impossible to find any authority on a matter of comparatively frequent occurrence, while not infrequently and exhaustive research of the reports of decisions of all the states and federal courts fails to reveal a single authority throwing light on the question. U.P.A. Prefatory Note 127.] In 1902, the National Conference of Commissioners on Uniform State Laws (the "Conference") addressed the subject of a uniform law of partnership in order to provide clarity and certainty to the business world. The Conference approved the Uniform Partnership Act ("UPA") in 1914.

The UPA, which applies to general partnerships and to limited partnerships, [ FN: See infra notes 22-23.] serves a dual function. First, it establishes certain fundamental principles of law which operate regardless of any contrary agreement between the partners. [ FN: See , e.g. , U.P.A. § § 11-15 (defining when a partnership is bound by the admissions of or notice to a partner as well as the nature of the partner ’ s liability).] Second, it defines certain principles which function only in the absence of an agreement between the parties. [ FN: See , e.g. , id. § 18 (setting forth the rules governing the " rights and duties of the partners in relation to the partnership " which are " subject to any agreement between them " ).] The UPA was ultimately enacted in every state except Louisiana with relatively few variations.

The years following the adoption of the UPA have experienced the introduction and development of entire systems of law which heavily impact upon general and limited partnerships. The nationwide adoption of the Uniform Commercial Code and a federal securities law provide illustrative examples. [ FN: Donald J. Weidner, The Revised Uniform Partnership Act Midstream: Major Policy Decisions , 21 U. Tol. L. Rev. 825, 826 (1990).] In addition, bodies of law which existed at the time the UPA was first conceived, such as the bankruptcy and tax laws, have since experienced significant change. Yet, the UPA remained unchanged for seventy-eight years and did not either make course corrections in policy or changes which harmonized with developments in other areas of the law.

B. Revised Uniform Partnership Act

In an attempt to respond to the needs of modern business, a new Revised Uniform Partnership Act ("Revised Act" or "RUPA") was designed by the Conference in 1992 to supersede the UPA originally adopted in 1914. [ FN: See generally Donald J. Weidner & John W. Larson, The Revised Uniform Partnership Act: The Reporters ’ Overview , 49 Bus. Law . 1 (1993); Donald J. Weidner, Three Policy Decisions Animate Revision of Uniform Partnership Act , 46 Bus. Law . 427 (1991).] Changes were made to the RUPA in 1993 and 1994. [ FN: 6 Revised Uniform Partnership Act § § 101-1007, 6 U.L.A. 10 et seq. (1994) (hereinafter " R.U.P.A. " )] The Revised Act has only been adopted so far by a small handful of states. [ FN: Id. Prefatory Note, at 1. As of December, 1995, only seven jurisdictions had adopted the RUPA. Id. ]

The RUPA accords supremacy to the partnership agreement in virtually every situation. Across almost all substantive areas, the Revised Act reflects a policy judgment that partners are permitted to govern relations among themselves by agreement. [ FN: Id . § 103(a). Section 103 of RUPA provides: Except as otherwise provided in subsection (b), relations among the partners and between the partners and the partnership are governed by the partnership agreement. To the extent the partnership agreement does not otherwise provide, this [Act] governs relations among the partners and between the partners and the partnership. Id .] The RUPA is therefore largely comprised of a series of "default rules," rather than mandatory canons, that govern the relationshipin situations which have not been addressed in a partnership agreement. [ FN: Id . Prefatory Note at 3.] Its primary focus is on the small, and often informal, partnership arrangements which do not generally have comprehensive written agreements governing the relationship. The basic idea is that the default rules are intended to reflect what most partners would regard as implicit in their relationship had they embodied their intentions in a written instrument.

C. Uniform Limited Partnership Act & Revised Uniform Limited Partnership Act

In contrast to general partnerships, limited partnerships have always been governed by statute. The first limited partnership act was adopted by New York in 1822, with other states following suit over the next thirty years. [ FN: Id. § 1 cmt. at 313.] These early statutes were, however, restrictively interpreted to deprive limited partners of limited liability in many cases and therefore lacked "any practical usefulness." [ FN: Id.] Accordingly, the Conference promulgated the Uniform Limited Partnership Act ("ULPA") in 1916. [ FN: Under the Uniform Limited Partnership Act, "[a] limited partnership is a partnership formed by two or more persons . . . having as members one or more general partners and one or more limited partners. The limited partners as such shall not be bound by the obligations of the partnership. " Unif. Limited Partnership Act § 1, 6A U.L.A. 312 (1916) (hereinafter " U.L.P.A. " ).] The ULPA was superseded by action of the Conference in 1976 when it adopted the Revised Uniform Partnership Act ("RULPA"), which was amended in 1985. [ FN: See Revised Unif. Limited Partnership Act § § 101-1106, 6A U.L.A. 59-304 (1976) (as amended in 1985) (hereinafter " R.U.L.P.A. " ). As of 1995, the RULPA has been adopted in forty-eight states and the District of Columbia.]

There is a clear statutory link between general and limited partnerships through the UPA which applies "[t]o limited partnerships except insofar as the statutes relating to such partnerships are inconsistent herewith." [ FN: U.P.A. § 6(2) 6 U.L.A. 235.] Although RUPA provides no such directive, at least one leading commentator has concluded that the same results are reached when the RUPA, the ULPA and theRULPA are considered together. [ FN: See, e.g. , Bromberg & Ribstein, supra note 4, Introductory Note, at viii-ix. See R.U.L.P.A. § 101(7) (defining a " limited partnership " as a " partnership " ); R.U.L.P.A. § 403 (indicating that a general partner of a limited partnership has all of the rights, powers, restrictions and liabilities of a general partner); R.U.L.P.A. § 1105 (providing that "[i]n any case not provided for under this [Act], the provisions of the Uniform Partnership Act Govern " ); U.L.P.A. § 9 (providing that, with certain exceptions, a " [g]eneral partner shall have all the rights and powers and be subject to all of the restrictions and liabilities of a partner in a partnership without limited partners " ); U.L.P.A. § 29 (providing that " [i]n any case not provided for in this act the rules of law and equity . . . shall govern " ).]

D. Uniform Limited Liability Company Act

In 1977, Wyoming initiated a national movement by introducing this country’s first limited liability company act. After the pronouncement by the Internal Revenue Service some ten years later that the limited liability company ("LLC") would be taxed like a partnership, every state has adopted or is considering adopting its own distinct limited liability company act. The allure of the LLC is in its ability to provide its members or owners with both the partnership pass-through tax benefits and the corporate liability shield. In this respect, the LLC is a hybrid.

The limited liability acts promulgated by the various states displayed a significant degree of diversity. This lack of uniformity in an era in which multi-state activities by businesses are widespread prompted the Conference to develop the Uniform Limited Liability Company Act ("ULLCA"). The ULLCA was adopted by the Conference in August of 1994 and is in many respects similar in operation and effect to the RULPA. [ FN: Unif. Limited Liability Company Act Prefatory Note, 6A U.L.A. 426-27 (1995) (hereinafter " U.L.L.C.A. " ). An LLC may be either member-managed or manager-managed. For all practical purposes, a member-managed LLC bestows members with partner-like authority to bind the LLC. However, it is the manager, not the member, that has the authority to bind the enterprise in a manager-managed LLC.]

III. STATE LAW: PRINCIPLE CHARACTERISTICS OF A PARTNERSHIP

A. General

A fundamental premise of the law governing partnerships, either general or limited, is that theterms of the partnership and the relationship will be governed by "agreement." [ FN: See R.U.P.A. § 101(5) ( " ‘ Partnership Agreement ’ means the agreement, whether written, oral or implied, among the partners concerning the partnership. " ).] The statutory provisions of the various uniform laws generally apply only if the partners have not agreed to other terms. [ FN: See supra notes 16-17 and accompanying text.] This ability to "opt out" of statutory default rules provides the partnership business form with significant potential for flexibility. There are only a limited number of basic rules which cannot be altered by agreement. For example, general partners are liable to partnership creditors for partnership obligations despite any agreement to the contrary. [ FN: U.P.A. § 15.]

The law of agency applies to the law governing partnerships. [ FN: U.P.A. § 4(1).] Indeed, each general partner is an agent for the partnership and the other general partners, and may generally bind the other general partners by his or her actions. [ FN: Id. § 9(1). Accord R.U.P.A. § 310(1).] Each general partner is therefore personally responsible for the actions of every other general partner which bind the partnership. [ FN: U.P.A. § 15; R.U.P.A. § 306(a) (imposing joint and several liability on all partners for partnership obligations).] Historically, this personal liability based on mutual agency has been one of the principal distinguishing disadvantages of the partnership business form. [ FN: Cf. U.P.A. § 17 (providing that a newly admitted partner is not personally liable for pre- admission debts of the partnership, and a former partner does not generally retain personal liability for obligations incurred after withdrawal from the partnership).] In order to retain the fundamental advantages of the partnership form while shedding the risk of unlimited personal liability, "limited liability partnerships" and "limited liability companies" have recently emerged as popular business entities. [ FN: See, e.g. , U.L.L.C.A. § § 101-1206. See supra notes 20-24 and accompanying text.]

B. Nature of Interest

State law defines the "bundle of rights" held by a general partner in a general partnership. A general partner under UPA has three distinct interests arising from the partnership: (1) rights in specific property of the partnership; (2) rights to his or her "partnership interest" (i.e., profits andsurplus); and (3) rights to participate in the management of the partnership. [ FN: U.P.A. § 24.]

The UPA makes clear that the specific property of the partnership is owned by the partnership as tenants in partnership, under which no individual partner has the ability to transfer his or her right or interest in such partnership property "except in connection with the assignment of rights of all the partners in the same property." [ FN: Id. § 25(b).] The partnership interest is, however, personal property which may be conveyed or assigned without the consent of the other partners. [ FN: Id. § 27(1).] Such a transfer or assignment does not itself dissolve the partnership. [ FN: Id.] Nor does it permit the assignee to interfere in the operation of the business. [ FN: Id.] The assignee is merely entitled to the interest which has been transferred, i.e. the right to receive the profits to which the assigning partner would otherwise be entitled and any surplus upon a dissolution. [ FN: Id. § 27(1), (2).]

The community of interest that is an essential element of a partnership relation entails co-ownership of control, or a community of interest in the administration of the affairs of the enterprise. [ FN: See supra note 1.] A general partner’s right to participate in the management of the business is inherent in the ability of general partners to bind the partnership and the other partners by their acts or engagements performed within the scope of the enterprise. All general partners are thus entitled to equal rights in the management of the affairs of the partnership business and cannot be excluded agreement. [ FN: U.P.A. § 18(e); U.L.A. § 401(f).] The exercise of management rights is so fundamental that it may not be enjoined [ FN: See, e.g. , Hauke v. Frey , 93 N.W.2d 183 (Neb. 1958).] and excluding a general partner from participation in management may be grounds for dissolution. [ FN: U.P.A. § 31(1)(d).]

C. Consensual Nature of Partnership: Dissolution vs. Dissociation

As partners act as agents of the partnership, the uniform partnership laws scrupulously protect the consensual nature of partnerships. For example, no person may become a member of the partnership without the consent of all of the partners. [ FN: Id. § 18(g).] Furthermore, while a partner may assign his or her economic interest in the partnership, the assignee is not entitled to exercise management rights absent the consent of the other partners. [ FN: Id. § 27(1).]

If a partner ceases to be associated with the partnership, the partnership automatically "dissolves" under the UPA. [ FN: Id. § § 29, 31. Under the U.P.A., dissolution designates the pont in time when the partners cease to carry on the business of the partnership together. Id. § 29 cmt. More specifically, a dissolution of the partnership is defined as " the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on . . . the business. " Id. § 29.] A partner may thus effect a statutory dissolution by simply withdrawing from the partnership. [ FN: Id. § 30(1).] When a dissolution occurs, the existence of the partnership is not "terminated." Rather, the partnership continues until the partners "wind up" the affairs of the partnership, [ FN: Id. § 30 ( " On dissolution the partnership is terminated, but continues until the winding up of partnership affairs is completed. " ); id. § 33 ( " Except so far as may be necessary to wind up partnership affairs or to complete transactions begun but not then finished, dissolution terminates all authority of any partners to act for the partnership. " ).] which may mean the liquidation of the partnership business or, under certain circumstances, the reconstitution of the partnership as a new entity. [ FN: Id. § § 38(2)(b), 41.]

The rationale for the relative ease of dissolvability of a partnership under the UPA is the basic principle of delectus personam--that is, partners may choose their associates. [ FN: This notion is embodied in requirement under the UPA and the RUPA that one cannot " become a member of a partnership without the consent of all the partners. " U.P.A. § 18(g).] Application of this principle follows from the assumption underlying the UPA that a general partnership is a close association of co-owners each of whom has the equal authority to manage and bind the partnership. Dissolution upon dissociation of any partner thus presupposes a vital role in the business by eachmember of the partnership. The UPA’s general approach to partnership dissolution, while well suited to closely-held businesses which do not ordinarily desire continuity of life, is not well adapted to businesses that ordinarily desire continuity such as larger operations.

The result under RUPA is somewhat different. As under UPA, no person may become a partner absent the consent of all the partners and an assignee of a partner’s economic interest in the partnership has limited rights. [ FN: R.U.P.A. § § 401(i), 503.] Likewise, the RUPA permits a partner to "disassociate" at will from the partnership, even if to do so is wrongful. [ FN: Id. § 602(a). Upon a partner ’ s dissociation, the partner ’ s right to participate in the management of the partnership business terminates. Id. § 603.] A disassociation of a partner under the RUPA does not, however, automatically effect a dissolution or termination as under the UPA. [ FN: Indeed, the events which actually cause a dissolution of the partnership under the RUPA are limited. See id. § 801.] The RUPA explicitly provides for the continuation of the same partnership after a disassociation, but requires the partnership to purchase the dissociated partner’s interest based upon a statutorily prescribed formula. [ FN: Id. § 701. The buy-out price upon dissociation is: the amount that would have been distributable to the dissociating partner under [his or her capital account] if, on the date of dissociation, the assets of the partnership were sold at a price equal to the greater of liquidation value or the value based on a sale of the entire business as a going concern without the dissociated partner and the partnership were wound up as of that date. Interest must be paid from the date of dissociation to the date of payment. Id.] Although payment of the requisite buy-out price may be deferred under certain circumstances, the payment must be adequately secured and bear interest. [ FN: Id.]

When a partner files for bankruptcy protection, both sets of uniform laws continue to protect the partnership’s consensual nature. Under both the UPA and the RUPA, the nondebtor partners are afforded virtually total discretion over their future relationship with the bankrupt general partners. Under the UPA, the bankruptcy of any partner causes the automatic dissolution of the partnership. [ FN: U.P.A. § 31(5).] Likewise, a general partner under the RUPA is automatically dissociated from the partnership when he or she becomes a "debtor in bankruptcy." [ FN: U.P.A. § § 33, 35(3)(b); R.U.P.A. § 601(6)(i). The RUPA provides that a partner is dissociated from the partnership upon: (6) the partner ’ s: (i) becoming a debtor in bankruptcy; (ii) executing an assignment for the benefit of creditors; (iii) seeking, consenting to, or acquiescing in the appointment of a trustee, receiver, or liquidator of the partner or of all or substantially all of the partner ’ s property obtained without the partner ’ s consent or acquiescence, or failing within 90 days after the expiration of a stay to have the appointment vacated . . . . Id. § 6. A general partner ’ s membership in a limited partnership is likewise terminated upon the commencement of a bankruptcy case absent agreement to the contrary. R.U.L.P.A § 402(4).] Under both statutes, the partner’s bankruptcy filing strips him or her of management rights. [ FN: R.U.P.A. § § 603(b)(1). Accord U.L.L.C.A. § 603(b)(1).] The same fundamental alteration occurs when a petition for relief is filed by or against a member of a limited liability company ("LLC"). [ FN: The same dissociation that transpires under RUPA occurs upon the bankruptcy filing of a member of a limited liability company. See U.L.L.C.A. § 601(7).]

IV. FEDERAL LAW: TREATMENT OF GENERAL PARTNERS IN BANKRUPTCY

Few issues have engendered as much controversy as the effect a bankruptcy case of a debtor general partner should have on the partnership and on the debtor general partner’s economic interest in and management rights with respect to the partnership affairs. Some argue that these matters should be governed exclusively by applicable nonbankruptcy law, which includes the agreement of the partners and the governing partnership law. Others contend that federal bankruptcy law should govern so that the interests of the debtor general partner’s creditors will be considered in addition to the contractual rights of the nondebtor partners. The Working Group has adopted a hybrid approach which attempts to strike a balance between the often competing interests of various constituencies when state and federal law collide.

Although there are a number of provisions in the Bankruptcy Code relating to a debtorpartnership, [ FN: See 11 U.S.C. § § 101(16), (31), (32), (41), (49); 303(b)(3), (d); 346; 502(a); 508(b); 723; 728; 747; 1141(a), (d); and 1227 (1994).] the only references in the Code made to a debtor general partner pertain to special tax issues. Thus, under the current scheme, issues concerning the effect of a bankruptcy filing upon the nondebtor partners and the partnership have been left predominantly to judicial development.

Under both the UPA and the RUPA, the event of a bankruptcy filing by a general partner fundamentally alters the relationship of the general partner to the partnership. [ FN: The RUPA defines " debtor in bankruptcy " as a person who is the subject of: (i) an order for relief under Title 11 of the United States Code or a comparable order under a successor statute of general application; or (ii) a comparable order under federal, state, or foreign law governing insolvency. R.U.P.A. § 101(2). Accord U.L.L.C.A. § 101(4). The UPA defines " bankrupt " to include " bankrupt under the Federal Bankruptcy Act or insolvent under any state insolvent act. " U.P.A. § 2. It is significant to note, however, that the term " bankruptcy " under the Bankruptcy Act did not contemplate a reorganization when the UPA was promulgated in 1914, but, rather, signified that the petition seeking liquidation had been filed. Morris W. Macey & Frank R. Kennedy, Partnership Bankruptcy and Reorganization: Proposals for Reform , 50 Bus. Law . 879, 901 (1995).] Under the UPA, the partnership is dissolved upon the bankruptcy filing and the bankrupt general partner may not participate in winding up the affairs of the partnership. [ FN: See supra notes 55-57 and accompanying text.] Under the RUPA, the debtor general partner is dissociated from the partnership, which may or may not result in dissolution. [ FN: See supra notes 25-27 and accompanying text.] These state law results do not reflect state policy determinations regarding the rights of general partners, since most of the statutory provisions can be varied by agreement and serve only as default provisions when the partners do not explicitly agree otherwise. [ FN: See Summit Investment & Dev. Corp. v. Leroux , 69 F.3d 608, 611 n.5 (1st Cir. 1995).]

The operation of nonbankruptcy law can have a detrimental impact on the debtor general partner’s bankruptcy case, especially if relief under a reorganization chapter is contemplated. [ FN: Even in liquidation bankruptcies, however, ipso facto clauses are likely to erode value and provide unwarranted leverage to creditors with whom the debtor hopes to continue a relationship.] Apromising business enterprise could be prematurely terminated and the value of its future success be lost to the estate or nondebtor partners. If, for example, the identity of the partner is material to the very existence of the partnership and its success, a compelling argument could be made that the value realized by the bankruptcy estate for the debtor’s economic and management interests in the partnership will not accurately reflect the actual value of the business. This is particularly true if the value of a general partner’s management rights cannot be realized either by being assigned or retained. [ FN: Sally S. Neely, Partnerships and Partners, Limited Liability Companies and Members: What Happens in Bankruptcy , at 39 (July 23, 1996)(unpublished manuscript on file with the Commission).] Examples of such circumstances might include (1) a single-asset real estate development partnership in which the general partner is responsible for administering the planning, construction, and leasing of the property; (2) an investment partnership where the general partner is responsible for identifying and evaluating the investments of the partnership; or (3) any partnership in which the general partner is responsible for contributing or procuring additional capital. [ FN: See In re Antonelli , 148 B.R. 443, 449 (D. Md. 1992).] By contrast, the identity of the general partner may be much less significant, or even immaterial, to the success of the partnership in other circumstances which might include (1) a real estate partnership owning matured projects which require only routine management and leasing functions and (2) a large syndication operation which administers a network of separate partnerships. [ FN: Id.] In these cases, it is arguable that any other organization or general partner could assume the responsibilities of the original general partner without material detriment to the partnership. [ FN: Id.]

The operation of nonbankruptcy law to dissolve a general partnership, deprive a debtor general partner of management rights, or the like may negatively impact the administration and value of the debtor, general partner’s bankruptcy estate. The fundamental inquiry in this regard represents a policy choice of whether ipso facto provisions, arising by agreement or applicable nonbankruptcy law, should be enforced in bankruptcy.

A. Ipso Facto Provisions

In the context of bankruptcy, an ipso facto clause is any provision in a prepetition contract or under applicable law that effects, or gives a party an option to effect, a forfeiture, modification or termination of a debtor’s interest in property and is triggered by the debtor’s financial condition or the filing of a bankruptcy petition. There are five provisions in the Bankruptcy Code which invalidatesuch clauses. [ FN: See 11 U.S.C. § § 363(1), 365(e)(1), 365(f)(3), 541(c)(1)(B) (1994). Section 363(l) provides: Subject to section 365, the trustee may use, sell, or lease property under subsection (b) or (c) of this section, or a plan under chapter 11, 12, or 13 of this title may provide for the use, sale, or lease of property, notwithstanding any provision in a contract, a lease, or applicable law that is conditioned on the insolvency or financial condition of the debtor, on the commencement of the case under this title concerning the debtor, or the appointment of or taking possession by a trustee in a case under this title . . . and that effects . . . a forfeiture, modification, or termination of the debtor ’ s interest in such property. Id. § 363(l). Section 365(e)(1) provides: Notwithstanding a provision in an executory contract or unexpired lease, or in applicable law, an executory contract or unexpired lease of the debtor may not be terminated or modified, and any right or obligation under such contract or lease may not be terminated or modified, at any time after the commencement of the case solely because of a provision in such contract or lease that is conditioned on-- (A) the insolvency or financial condition of the debtor at any time before the closing of the case; (B) the commencement of a case under this title; (C) the appointment of or taking possession by a trustee in a case under this title or a custodian before such commencement. . . . Id. § 365(e)(1). Section 365(f)(1) provides: Except as provided in subsection (c) of this section, notwithstanding a provision in an executory contract or unexpired lease of the debtor, or in applicable law, that prohibits, restricts, or conditions the assignment of such contract or lease, the trustee may assign such contract or lease under paragraph (2) of this subsection . . . . Id. § 365(f)(1). Section 365(f)(3) provides: Notwithstanding a provision in an executory contract or unexpired lease of the debtor, or in applicable law that terminates or modifies, or permits a party other than the debtor to terminate or modify, such contract or lease or a right or obligation under such contract or lease on account of an assignment of such contract or lease, such contract, lease, right, or obligation may not be terminated or modified under such provision because of the assumption or assignment of such contract or lease by the trustee. Id. § 365(f)(3). Section 541(c)(1) provides in pertinent part: [A]n interest of the debtor in property becomes property of the estate . . . notwithstanding any provision in an agreement, transfer instrument, or applicable bankruptcy law-- (A) that restricts or conditions transfer of such interest by the debtor; or (B) that is conditioned on the insolvency or financial condition of the debtor, on the commencement of a case under this title, or on the appointment of or taking possession by a trustee in a case under this title or a custodian before such commencement, and that effects or gives an option to effect a forfeiture, modification, or termination of the debtor ’ s interest in property. Id. § 541(c).] These provisions expressly render ineffective contractual or statutory provisionswhich purport to modify or terminate rights of the debtor based upon the commencement of a case under Title 11 or the debtor’s financial condition, and assure that, despite such provisions, property interests of the debtor become property of the estate which can be used, sold, or leased. In addition, these anti-ipso facto provisions negate contractual and statutory provisions which forbid or penalize (through modification or termination) assignment of the debtor’s executory contracts and unexpired leases. The inclusion of these provisions in the Bankruptcy Code was one of the primary achievements of the Bankruptcy Reform Act of 1978 and was considered by the Commission on the Bankruptcy Laws to be among its "major recommendations." [ FN: See Report of the Commission on the Bankruptcy Laws of the United States , Part I at 17 (1973).]

The Commission found that the principal need for changing the provisions concerning executory contracts and unexpired leases in the present Act concerns the enforceability of lease termination clauses in arrangement and reorganization cases. Lease agreements typically contain "bankruptcy clauses" that terminate the lease automatically upon the lessee’s bankruptcy or grant the lessor the option to terminate upon that event. As a result, a debtor may be forced to give up operating quarters or other premises vital to the success of a reorganization plan or submit to new terms unilaterally imposed by the lessor as a condition of continued occupancy.

The Commission recommends that both executory contracts . . . andunexpired leases be enforceable in business reorganization cases, notwithstanding such a "bankruptcy clause" or anti-assignment clause . . . .

The . . . policy is justified on the ground that in reorganization cases the purpose of assumption is the continuation of the business. In [that] situation the reorganization of the debtor should be paramount, provided that the nondebtor party is protected. [ FN: Id. at 198.]

The legislative history surrounding the promulgation of the anti-ipso facto provisions, albeit sparse, reiterates the Commission’s theme. For example, the House and Senate Reports on section 365(e) provide that:

Subsection (e) invalidates ipso factor [sic] or bankruptcy clauses. These clauses, protected under present law, automatically terminate the contract or lease, or permit the other contracting party to terminate the contract or lease, in the event of bankruptcy. This frequently hampers rehabilitation efforts. If the trustee may assume or assign the contract under the limitations imposed by the remainder of the section, then the contract or lease may be utilized to assist in the debtor’s rehabilitation or liquidation. [ FN: H.R. Rep. No . 595, 95th Cong., 1st Sess. 347 (1977), reprinted in 1978 U.S.C.C.A.N. 5963; S. Rep. No . 989, 95th Cong., 2d Sess. 581 (1978), reprinted in 1978 U.S.C.C.A.N. 5787.]

Unfortunately, Congress did not specify whether or not these anti-ipso facto provisions apply to the bankruptcy of a general partner or a member of a LLC. Thus, a confused and conflicting body of law has developed in the application of these revolutionary anti-ipso facto provisions to issues surrounding the effect of a general partner’s bankruptcy filing has on the partnership relation and the nondebtor partners.

B. Applicability of Anti-Ipso Facto Provisions to a General Partner’s Bankruptcy Case

Certain ipso facto clauses are clearly invalid in bankruptcy, such as those clauses which purport to prohibit transfer to the bankruptcy estate of a partnership interest. [ FN: E.g. ,In re Cardinal Indus. Inc. , 105 B.R. 834, 848 (Bankr. S.D. Ohio 1989);In re Plunkett , 23 B.R. 392, 393-94 (Bankr. E.D. Wis. 1982).] The intricacies of partnership law, however, combined with the limited abrogation of ipso facto provisions under theBankruptcy Reform Act, have caused courts to struggle considerably over the enforceability of certain other ipso facto clauses when a general partner files bankruptcy.

For many reasons, the most difficult issue with which courts have had to wrestle is the enforceability of ipso facto restrictions on a general partner’s management rights with respect to the partnership, including the right to manage and the right to vote. Although courts have reached a variety of discordant solutions, each and every one of these patchwork of cases involve fundamental policy choices about the appropriate treatment of a general partner’s interests in the partnership once the partner files bankruptcy.

1.Dissolution of the Partnership, Management Rights, and the Automatic Stay

A vigorously contested issue when a partner files bankruptcy is often the status of the partner’s management rights, which can be a critical asset of the debtor’s bankruptcy estate. [ FN: See , e.g. ,In re Cardinal Indus. Inc. , 116 B.R. 964, 984 (Bankr. S.D. Ohio 1990)( " The loss of the [debtor partner’s] right to manage and control the Partnerships would directly impair the most basic, and at present, the primary profitable aspect of the business. " ).] As discussed above, state law provides that a general partner’s bankruptcy dissolves the partnership or dissociates the general partner from the partnership, [ FN: Whether the event is entitled " dissolution " or " dissociation " depends upon whether the jurisdiction has adopted, respectively, the UPA or the RUPA. See supra notes 45-54 and accompanying text.] and strips the debtor of his or her management rights, which may derive from statute, agreement or both. [ FN: Sally S. Neely, Partnerships and Partners, Limited Liability Companies and Members: What Happens in Bankruptcy 41 (July 23, 1996) (unpublished manuscript, on file with Commission).] These management rights may involve broad responsibility for managing partnership business, or may be limited to the right to vote on certain matters, or something in between. [ FN: Id.] There may be management fees tied to the management rights, or the general partner’s unique skills may be critical to maximizing his or her "partnership interests" (i.e., rights to profits and surplus). Given the importance of these rights, and the effect of dissolution to strip the general partner of them, one of the first major issues litigated when a general partner seeks bankruptcy protection is often the issue of dissolution (rather than the companion issueof whether termination of management rights to the debtor partner violates the automatic stay). [ FN: Whether a nondebtor ’ s enforcement of state law dissolution rights would violate the automatic stay is unclear. See In re Cardinal Indus. Inc. , 116 B.R. 964, 971 (Bankr. S.D. Ohio) (warning that unilateral action taken to terminate the debtor general partner ’ s management rights would probably violate the automatic stay); Quarles House Apartments v. Plunkett (In re Plunkett ), 23 B.R. 392 (Bankr. E.D. Wis. 1982)(debtor general partner ’ s right to manage nondebtor partnership is property of the estate);In re Group V Partnership, L.P. , 73 B.R. 342 (D. Ill. 1987) (holding that, even if the limited partners ’ removal of the debtor general partner violated the automatic stay, the bankruptcy court had authority to confirm the substitute general partner under § 105(a)).]

Under current law, courts have limited statutory tools for determining whether dissolution and forfeiture of management rights are invalid ipso facto provisions. Despite the complexity of partnership agreements and partnership statutes, [ FN: Partnership agreements and statutes are particularly complex as they define a variety of relationships, including the relationship of a partner to the partnership, the other partners, and third parties. Sally S. Neely, Responses to Issues Identified by the National Bankruptcy Review Commission in the Draft Issues List Regarding Small Business and Partnerships (Sept. 11, 1996) (unpublished manuscript on file with the author and the National Bankruptcy Review Commission).] differences in the composition of partnerships and their interplay with various bankruptcy chapters, the Bankruptcy Code does not provide clear statutory guidance on issues arising out of a general partner’s bankruptcy filing.

As a starting point of analysis, courts traditionally hold or assume that a partnership agreement is an executory contract. [ FN: See , e.g. , Calvin v. Siegal (In re Siegal ), 190 B.R. 639 (Bankr. D. Ariz. 1996);In re Clinton Court , 160 B.R. 57 (Bankr. E.D. Pa. 1993);In re Priestly , 93 B.R. 253 (Bankr. D.N.M. 1988); Heafitz v. American Gas & Oil Investors (In re Heafitz ), 85 B.R. 274 (Bankr. S.D.N.Y. 1988).] Although the Bankruptcy Code does not define an "executory contract," the legislative history provides that the term "generally includes contracts on which performance remains due to some extent on both sides." [ FN: H.R. R EP . N O . 595, 95 th Cong., 1 st Sess. 347 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6303, S. R EP . NO. 989, 95 th Cong. 2d Sess. 581 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5844.] The legislative history cites with approval to Professor Countryman’s definition of an executory contract under the former Bankruptcy Act:

A contract under which the obligation of both the bankrupt and the otherparty to the contract are so far unperformed that the failure of either to complete the performance would constitute a material breach excusing the performance of the other. [ FN: Vern Countryman, Executory Contracts in Bankruptcy: Part I , 57 M INN . L. R EV . 439, 466 (1973).]

Many courts follow the Countryman definition of executory contracts, while others do not. [ FN: Lewis R. Kaster & Jerry K. Cymbler, The Impact of a General Partner ’ s Bankruptcy Upon the Remaining Partners , 21 R EAL P ROP . P ROB . & T R . J. 539, 544 (1986). See e.g. , Skeen v. Harms (In re Harms ), 10 B.R. 817 (Bankr. D. Colo. 1981).] Regardless of the exact definition used, however, an executory contracts analysis is an inappropriate conceptual tool for analyzing issues arising under partnership or operating agreements when a bankruptcy intervenes. Whereas a partnership or operating agreement determines a partner’s rights relative to the partnership or LLC, the other partners and third parties, executory contracts analysis turns on the existence of mutually unperformed obligations among the partners.

According to the Bankruptcy Code section on executory contracts, ipso facto provisions which would otherwise be invalid under the Code are nonetheless enforceable if the contract is in the nature of a personal services contract. [ FN: 11 U.S.C. § 365(c), (e) (1994).] As these statutory exceptions are not models of clarity, courts, even within the same circuit, have inconsistently applied them [ FN: Compare Breeden v. Catron (In re Catron ), 158 B.R. 629 (E.D. Va. 1993), aff ’ d mem. , 25 F.3d 1038, 1994 WL 258400 (4 th Cir. 1994) with In re Antonelli , 148 B.R. 443 (D. Md. 1992), aff ’ d mem. , 4 F.3d 984, 1993 WL 321584 (4 th Cir. 1993).] and have developed two diametrically opposed tests to determine the assumability and assignability of management rights under a partnership agreement: the hypothetical test and the facts and circumstances test. [ FN: See id.]

Under the "hypothetical test" strand of cases, courts generally uphold ipso facto clauses prohibiting assumption or assignment of the debtor’s management rights. These courts reason that, as a matter of law, a partnership agreement creates a fiduciary relationship among partners which is based on trust and confidence. [ FN: E.g. , Breeden v. Catron (In re Catron ), 158 B.R. 629 (E.D. Va. 1993), aff ’ d mem. , 25 F.3d 1038, 1994 WL 258400 (4 th Cir. 1994); Heafitz v. American Gas & Oil Investors (In re Heafitz ), 85 B.R. 274 (Bankr. S.D.N.Y. 1988);In re Sunset Developers , 69 B.R. 710 (Bankr. D. Idaho 1987).] The partnership agreement is therefore necessarily in the nature ofa personal services contract under which a nondebtor party could hypothetically refuse performance from an assignee. [ FN: E.g. , Breeden v. Catron (In re Catron ), 158 B.R. 629 (E.D. Va. 1993), aff ’ d mem. , 25 F.3d 1038, 1994 WL 258400 (4 th Cir. 1994).] Thus, the partnership agreement and the management rights thereunder cannot be assumed or assigned. By contrast, the courts which apply a "facts and circumstances" test examine the actual consequences to the nondebtor party of allowing the management rights under the partnership agreement to be assumed or assigned. [ FN: E.g. , Summit Investment & Devp. Corp. v. Leroux , 69 F.3d 608 (1 st Cir. 1995)(noting that Congress did not envision an abstract analysis of § § 365(e)(2)(A) and (c)(1)(A), but rather " [c]ontemplated a case-by-case inquiry into the actual consequences to the nondebtor party--of permitting these executory contracts to be performed. . . " );In re Antonelli , 148 B.R. 443 (D. Md. 1992), aff ’ d mem. , 4 F.3d 984, 1993 WL 321584 (4 th Cir. 1993).] If the court affirmatively finds that substitute performance would not deprive the nondebtors of the full benefit of their bargain, the debtor may assume or assign the contract. [ FN: E.g. , id.]

2. Transferability and Valuation of Debtor’s Economic Interest in the Nondebtor Partnership or LLC

The law with respect to whether contractual provisions compelling the sale of the debtor’s economic interest at a predetermined and agreed upon buy-out price (which may or may not reflect a fair market valuation) is simply not clear. Under the Bankruptcy Code, property of the estate includes "all legal or equitable interests of the debtor in property as of the commencement of the case." [ FN: 11 U.S.C. § 541(a)(1) (1994). The interest of a general partner in the partnership ( i.e. , profits and surplus) is property of the estate of a debtor, general partner. In re Signal Hill-Liberia Ave. Ltd. Partnership , 189 B.R. 648, 652 (Bankr. E.D. Va. 1995); Magers v. Thomas (In re Vannoy ), 176 B.R. 738, 770 (Bankr. M.D.N.C. 1994)(concluding that " when a debtor owns an interest in the partnership his interest in the partnership is property of the estate " ). However, partnership property does not become property of the debtor, general partner ’ s bankruptcy estate. FDIC v. Howard Shoreline Assocs. , 183 B.R. 33, 36 (D. Conn. 1995).] "[A]n interest of the debtor in property becomes property of the estate" notwithstanding any provision in an agreement or under applicable nonbankruptcy law conditioning or restricting the transfer of such an interest upon the commencement of a bankruptcy case or the financial conditionof the debtor and which "effects or gives an option to effect a forfeiture, modification, or termination of the debtor’s interest in property." [ FN: 11 U.S.C. § 541(a)(1)(c) (1994). See supra note 69 (for text).] Most courts that have been confronted with the issue have concluded that a debtor’s economic interest in the partnership or limited liability company, i.e., an interest in profits and surplus, [ FN: See supra note 69 and accompanying text.] is transferable by the trustee but remains subject to the terms and conditions of the partnership/operating agreement or applicable nonbankruptcy law. [ FN: Sally S. Neely, Responses to Issues Identified by the National Bankruptcy Review Commission in the Draft Issues List Regarding Small Businesses and Partnerships , at 3 (September 11, 1996).] However, a significant number of courts have concluded that the debtor’s interest cannot be abrogated in bankruptcy by ipso facto provisions in an agreement which operate to effect "a forfeiture, modification, or termination." [ FN: See, e.g. , Connally v. Nuthatch Hill Assocs. (In re Manning ), 831 F.2d 205 (10th Cir. 1987);In re Grablowsky , 180 B.R. 134, 136-38 (Bankr. E.D. Va. 1995); Cutler v. Cutler (In re Cutler ), 165 B.R. 275, 277-80 (Bankr. D. Ariz. 1994).] Accordingly, these courts have refused to enforce buy-out clauses as "illegal" ipso facto provisions and have thereby declined to give effect to the prepetition agreement of the parties despite the fact that the event of bankruptcy may have been contemplated at formation.

V. PROPOSAL

.EXECUTORY CONTRACT STATUS

Section 365 of the Bankruptcy Code should be amended to expressly exclude partnership and LLC operating agreements from the definition of an executory contract and the operation of the statutes and rules governing executory contracts. A new section concerning partnership or LLC operating agreements should be added to the Bankruptcy Code .

An executory contract analysis is not an adequate analytical construct for addressing the myriad interrelated issues arising under the Bankruptcy Code regarding a debtor general partner’s or member’s continuing relationship with the partnership or LLC. This Proposal would materially simplify issues related to the filing of a bankruptcy petition by or against a general partner or member of a LLC. Concepts such as whether partnership or operating agreements need to be assumed orrejected, [ FN: See, e.g. ,In re Norquist , 43 B.R. 224 (Bankr. E.D. Wa. 1984)(permitting the debtor, general partner to reject a partnership agreement and the provision containing a covenant not to compete).] whether they are personal services contracts or whether they are executory contracts which may be assigned all become irrelevant. Treatment of such issues would be specifically tailored to partnerships under a new section in the Bankruptcy Code.

.IPSO-FACTO PROVISIONS

Any and all ipso facto clauses which purport to determine the rights or interests of the partners or members of a limited liability company are invalid upon the commencement of the case. This would include any provision in applicable nonbankruptcy law or any provision in a partnership agreement or LLC operating agreement which would modify or change the rights of a partner or member based upon insolvency, financial condition, commencement of a case under Title 11 by or against a general partner or member of a LLC, or appointment of a trustee or custodian.

Despite the prevalence of ipso facto clauses in partnership or operating agreements and the acceptance of nonbankruptcy law dissolution or dissociation provisions, the judicial authority and commentary are divided on whether a partnership or LLC dissolution occurs when a bankruptcy case is commenced by or against a general partner or member of a LLC. [ FN: Compare Phillips v. First City, Texas-Tyler, N.A. (In re Phillips ), 966 F.2d 926 (5th Cir. 1992); Connolly v. Nuthatch Hill Assocs. (In re Manning ), 831 F.2d 205, 207 (10th Cir. 1987); Turner v. Lee (In re Minton Group Inc. ), 46 B.R. 222, 224 (S.D.N.Y. 1985); Holcomb v. Fulton (In re Fulton ), 43 B.R. 273, 276 (Bankr. M.D. Tenn. 1984); Houchen v. Gadberry (In re Gadberry ), 30 B.R. 13, 13 (Bankr. C.D. Ill. 1983)(authority following the black-letter partnership law of the state under which the partnership was formed and holding that a bankruptcy filing by a general partner effects an automatic dissolution of the partnership);In re Daugherty Constr. Inc. , 188 B.R. 607 (Bankr. D. Neb. 1995)(concluding that the provisions of the state limited liability act, which provided for automatic dissolution, are unenforceable) with In re Todd , 118 B.R. 432, 435 (Bankr. D.S.C. 1989);In re Hawkins , 113 B.R. 315, 316 (Bankr. N.D. Tex. 1990);In re Corky Foods Corp. , 85 B.R. 903, 904 (Bankr. S.D. Fla. 1988); Petralex Stainless, Ltd. v. Bishop Tube Div. of Christiana Metals (In re Petralex Stainless, Ltd. ), 78 B.R. 738, 741-42 (Bankr. E.D. Pa. 1987);In re Safren , 65 B.R. 566, 569-70 (Bankr. C.D. Cal. 1986)(authority rejecting both state law and the governing partnership agreement in refusing to allow dissolution upon the commencement of the case by or against a general partner).] Similarly, the courts have reached different conclusions with respect to clauses which automatically convert a general partner’sinterest in the business to a limited partnership interest. [ FN: Compare Summit Investment & Dev. Corp. v. Leroux (In re Leroux ), 69 F.2d 608 (1st Cir. 1995)(invalidating ipso facto provisions which would purported to automatically divest the general partner, who was the managing partner, of its general partnership interest) with Breeden v. Catron (In re Catron ), 158 B.R. 629 (E.D. Va. 1993), aff ’ d , 25 F.3d 1038 (4th Cir. 1994)(Table)(finding the Code ’ s anti- ipso facto provisions to be inapplicable).] This disagreement has created a substantial amount of confusion with respect to the practical effect of a general partner or member’s bankruptcy on the partnership or LLC and has generally destabilized the relationship between state and federal law.

This Proposal embraces the view that such provisions, whether founded in an agreement or in nonbankruptcy law, are unenforceable as a matter of public policy. The Working Group has concluded that no compelling interest is served by mandating an automatic dissolution of the business enterprise upon the commencement of a bankruptcy case by or against a general partner or member of a LLC, particularly when the general partner or member has sought relief under the reorganization provisions of the Code. The Proposal therefore fosters predictability and preserves the status quo while striking a balance between competing state and federal law policies.

A provision in a partnership or operating agreement establishing the amount to be paid for a partner’s or member’s interest that is automatically triggered or expressly conditioned upon the insolvency or financial condition of the debtor, on the commencement of the case under title 11, or on the appointment of a trustee or custodian would likewise be unenforceable. [ FN: A proposal promulgated, but not adopted, by the ABA Ad Hoc Committee on Partnership would have likewise rendered such ipso facto provisions regarding valuation of a general partner ’ s economic interest unenforceable in bankruptcy. See Macey & Kennedy, supra note 7, at 903. See also Proposed 11 U.S.C. § 569(b) (on file with the Commission).]

.AUTOMATIC STAY

With respect to management rights only, subject to the invalidation of ipso facto clauses, the Bankruptcy Code should be amended to except from the automatic stay any actions of the partnership or limited liability company as against the partner or member in implementing the rights of the partnership under the partnership/operating agreement against a debtor general partner or member that could have been taken under applicable nonbankruptcy law or the partnership/operating agreement; provided, however that the stay would apply as to all other acts specified in section 362, including any effort by the partners or partnership to liquidate, assess or collect any money or property (other than management rights) from the debtor or the estate.

Partnership democracy should prevail, whether or not the partnership or any partner is in bankruptcy. The ability of nondebtor partners or members to terminate or modify a debtor partner’s or member’s management rights in accordance with the nonbankruptcy law or the partnership/operating agreement on the filing of a bankruptcy petition by or against a general partner or member becomes clouded by Bankruptcy Code section 362. Section 362 stays, among other things, "any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate." [ FN: 11 U.S.C. § 362(a)(3) (1994).] A number of courts have held that the general partner’s management rights are protected by the automatic stay upon the commencement of the case notwithstanding contrary provisions in the partnership agreement or under applicable nonbankruptcy law. [ FN: See, e.g. ,In re Cardinal Indus. Inc. , 105 B.R. 834, 849 (S.D. Ohio 1990). The court in Cardinal Industries held that the the automatic stay operated to stay any actions by the partners to directly take or exercise control over the debtor, general partner ’ s interests and prevented them from indirectly doing so by taking action to dissolve the partnership or otherwise interfere with the partner ’ s interest. Id. The court also noted in dictum that: [v]arious parties have asserted throughout these proceedings that the chapter 11 filings terminated these Debtors ’ Management Interests as general partners under state statutory law and under the terms of the partnership agreements. Without extensive written analysis of this critical but somewhat tangential issue, the Court finds that the Supremacy Clause of . . . the Constitution . . . defeat [s] such arguments and wishful thinking by the defendants. This result is especially compelled in reorganization cases where the debtors fare the managing general partners . . . . Id. (citations omitted). Cf. Carroll v. Tri-Growth Centre City, Ltd. (In re Carroll ), 903 F.2d 1266 (9th Cir. 1990)(holding that a general partner ’ s management agreement was property of the estate and may not be terminated without seeking relief from the automatic stay).] This Proposal would clarify that, with respect to a debtor partner’s management rights only, nondebtor partners or members have the ability to exercise their state law or contractual rights and replace a general partner or member without seeking prior authorization from the bankruptcy court. This Proposal recognizes the primacy of delectus personam and preserves the fundamental attributes of the partnership relation. [ FN: See supra note 49 and accompanying text.]

D. PROPERTY OF THE ESTATE, TRANSFERABILITY AND VALUATION

.Property of the Estate. "Property of the Estate" under section 541 of the Bankruptcy Code shall include all rights, including the full present and future value of all the management rights, economic rights (including goodwill and all profit, loss and other rights to payment) and other rights, if any, (hereinafter collectively "Interests") which a partner or member (hereinafter collectively "Partner") has in a partnership or limited liability company (hereinafter collectively "Entity"), except that in a case of an individual debtor who both (a) continues to function as a Partner after the order for relief and (b) in respect of whose interest the estate receives or is more likely than not going to be entitled to receive the Value of the Interest as defined below, "property of the estate" shall not include those Interests in the Entity which arise, accrue or are exercisable after the order for relief. [ FN: This would overrule many cases which retain for the estate postpetition distributions to the partner which are attributable to return on capital or profit on services of others. Such result is urged because the buyout provided for below is going to pay the estate the capitalized value of those future profits through either the highest buyout price provided for in the partnership agreement or a fair value determined by the court. Creditors who choose to extend credit to a partner whose partnership agreement provides for a low buyout price, do so at their peril. Such result is akin to an individual with stock in a close corporation who must sell back the stock at book value if he or she quits, retires, or is fired. While the departing shareholder (and is creditors) lose the value of the goodwill in the enterprise, a deal is a deal.] There shall be a presumption, in such a case of an individual debtor, that the estate is more likely than not entitled to receive the Value of the Interest, upon which presumption the parties shall be entitled to rely and function until the court orders to the contrary, after notice and hearing, on motion of the trustee or any party in interest.

.Disposition of the Partnership Interest. For cause shown, the court may, except as provided below, on application of the trustee or any party in interest, unless the Partner’s Interests are or are more likely than not to be retained as an asset pursuant to a plan confirmed or more likely than not to be confirmed under chapters 11, 12 or 13 of the Bankruptcy Code, order the sale under section 363 of all Interests of the debtor in the Entity and the admission of the buyer to the partnership or membership in the Entity, regardless of any provisions to the contrary in the governing documents for such Entity, except that in the case of an individual debtor who continues to function as a partner after the order for relief the Partner’s Interests may not be sold if the estate receives or is more likely than not entitled to receive the Value of the Interest, as provided below. There shall be a presumption, insuch a case of an individual debtor, that the estate is more likely than not entitled to receive the Value of the Interest, upon which the parties shall be entitled to rely and function until the court orders to the contrary, after notice and hearing, on motion of the trustee or any party in interest.

Notwithstanding the foregoing, in case of a proposed sale of a Partner’s Interest (other than the Interest of an individual debtor as aforesaid), if one or more of the other Partners is entitled under the governing documents to preclude such sale or admission, the court shall, upon motion of such Partner, in lieu of sale, order the Entity to pay the estate the Value of the Interest on the payment terms provided for in the governing documents or, if there are none, on reasonable payment terms which fairly balance the needs of the estate for receipt of cash as rapidly as possible with the needs of the Entity for liquidity and working capital to conduct its operations in a prudent manner.

.Value of the Interest. "Value of the Interest" means the highest price, if any, provided for in the governing documents of the Entity in cases of buyout at the option of the Entity or expulsion of a Partner at the election of the Entity as at the date of the order for relief (excluding the price provided for, if any, in case the Partner becomes a debtor in a bankruptcy case, or based on the insolvency or financial condition of the Partner, or appointment of a trustee or custodian), or, if no such price is so provided, then at a fair value determined by the court as of the date of the order for relief.

.MANAGEMENT RIGHTS PENDING DISPOSITION OF PARTNER’S INTEREST

The right of the Partner to vote, manage and bind the partnership or limited liability company would not be dependent upon its characterization as property of the estate, but rather would be governed based upon who is entitled to exercise Management Rights during the pendency of the bankruptcy case, which varies depending upon the circumstances and the nature of the interest:

1. Chapter 7 Case--Limited Partnership. The trustee will exercise all Management Rights, if any, which the limited partner may have, except that the court would have the power to order, after notice and a hearing and for cause shown, that someone other than the trustee, to appointed by the United States Trustee, shall exercise such Management Rights, if such appointment were in the best interests of the estate.

2. Chapter 7 Case--General Partnership or LLC Interest.

(a) Only One General Partner. The trustee will exercise all Management Rights, except: (i) where an individual debtor continues to function as a Partner and is entitled to future distributions or profits thereafter, in which case the individual debtor has all management powers which are attributable to periods after the order for relief and (ii) the court would have power to order, after notice and a hearing and for cause shown, that someone other than the trustee, to be appointed by the United States Trustee, shall exercise Management Rights if such appointment were in the best interests of the estate.

(b) More than One General Partner or Member. The trustee will exercise all Management Rights with the following exceptions:

(i) If there are one or more other Partners who are not debtors in bankruptcy, and who have complete power to exercise any particular Management Right without need for action on behalf of the general partnership or membership interest held by the debtor Partner, then the Trustee may not exercise any Management Rights. However, where (1) the partnership or operating agreement expressly permits the Trustee to exercise Management Rights; or (2) action cannot be taken under the partnership/operating agreement or applicable nonbankruptcy law unless the Trustee exercises Management Rights, then the Trustee may exercise Management Rights.

(ii) If the debtor is an individual who continues to function as a Partner and who is entitled to future distributions or profits, then the debtor’s Management Rights with respect to periods after the order for relief may be exercised only by the individual debtor.

3. Chapter 11 Case--Debtor-in-Possession ("DIP").

(a) Limited Partnership Interest. Management Rights exercised by DIP.

(b) General Partnership or LLC Interest. Management Rights exercised by DIP without regard to how many Partners there are.

4. Chapter 11 Case--Chapter 11 Trustee

(a) Limited Partnership Interest. The trustee will exercise all Management Rights, if any, the limited partner may have, except that the court would have the power to order, after notice and a hearing and for cause shown, that someone other than the trustee, to be appointed by the United States Trustee, shall exercise such Management Rights, if such appointment were in the best interests of the estate.

(b) General Partnership or LLC Interest.

(i) Only One General Partner. The trustee will exercise all Management Rights, except: (a) where an individual debtor continues to function as a Partner and is entitled to future distributions or profits thereafter, in which case the individual debtor has all management powers which are attributable to periods after the order for relief and (b) the court would have power to order, after notice and a hearing and for cause shown, that someone other than the trustee, to be appointed by the United States Trustee, shall exercise Management Rights if such appointment were in the best interests of the estate.

(ii) More than One General Partner or Member. The trustee will exercise all Management Rights with the following exceptions:

(A) If there are one or more other Partners who are not debtors in bankruptcy, which have complete power to exercise any particular Management Right without need for action on behalf of the general partnership or membership interest held by the debtor Partner, then the Trustee may not exercise any Management Rights. However, where (1) the partnership or operating agreement expressly permits the Trustee to exercise Management Rights; or (2) action cannot be taken under the partnership/operating agreement or applicable nonbankruptcy law unless the Trustee exercises Management Rights, then the Trustee may exercise Management Rights.

(B) If the debtor is an individual who continues to function as a Partner and who is entitled to future distributions or profits, then the debtor’s Management Rights with respect to periods after the order for relief may be exercised only by the individual debtor.

5. Chapter 12 and chapter 13 Case. Debtor exercises all Management Rights.