limited liability company ORS 63.249 ORS 63.265 operating

limited liability company

ORS 63.249

ORS 63.265

operating agreement

11 U.S.C. § 541(c)(1)

11 U.S.C. § 365

executory contract

ipso facto provisions

Pearce v. Woodfield, Adversary No. 18-3120-tmb

Blair B. Woodfield, Case No. 18-32028-tmb11

5/16/2019 TMB Pub

Debtor holds a 50% interest in three limited liability

companies. Plaintiff, who holds the remaining 50% interests,

filed a complaint seeking a declaratory ruling that Debtor ceased

to be a LLC member upon the filing of his chapter 11 petition,

and that the operating agreement was an executory contract that

had been rejected.

The court first addressed the status of Debtor’s membership

interest. Oregon’s LLC statute and the applicable operating

agreements create a process of “dissociation,” whereby a LLC

member who files a bankruptcy petition is stripped of his voting

and management rights. The court concluded that these provisions

are preempted by 11 U.S.C. § 541(c)(1), which prevents so-called

“ipso facto” clauses from effecting a forfeiture, modification,

or termination of property interests based on the filing of a

bankruptcy petition.

The court next addressed the parties’ dispute over whether

the LLC operating agreements were executory contracts. After

conducting a fact-intensive analysis of both the text of the

operating agreements and the ownership structure of the LLCs, the

court held that the operating agreements are executory. As for

the ability of the debtor to assume the operating agreements, the

court examined Oregon’s LLC statute which allows LLC members to

assign a membership interest, but gives the remaining members

discretion whether to accept an assignee as a member.

Accordingly, the court held that applicable nonbankruptcy law

excuses a non-debtor party from accepting performance, thus

subjecting the operating agreements to the provisions of

§ 365(c)(1). Because § 365(c)(1) applies, Debtor is unable to

assume the operating agreements without plaintiff’s consent.

P19-1

Page 1 – OPINION

UNITED STATES BANKRUPTCY COURT

FOR THE DISTRICT OF OREGON

This matter came before the court on a motion for summary judgment (the “Motion,”

ECF No. 16) filed by plaintiff Parley Pearce. In deciding this matter, I have carefully considered

the written arguments of both parties, the documentary evidence in the record, and applicable

legal authority, both as cited by the parties and as discovered through my own research. In light

of my review, I grant the Motion in part and deny it in part, for the reasons set forth herein.

I. Relevant Facts

This is primarily a legal dispute based on a handful of material facts. Mr. Pearce filed a

concise statement of facts in support of the Motion (the “CSF,” ECF No. 18), as required by

Local Bankruptcy Rule 7056-1(c). Although Debtor responded to the Motion, he did not

In Re:

BLAIR B. WOODFIELD,

Debtor.

Bankruptcy Case

No. 18-32028-tmb11

Adv. Proc. No. 18-3120-tmb

OPINION

PARLEY PEARCE,

Plaintiff,

BLAIR B. WOODFIELD,

Defendant.

Below is an opinion of the court.

_____________________________

TRISH M. BROWN

U.S. Bankruptcy Judge

U.S. BANKRUPTCY COURT

DISTRICT OF OREGON

F I L E D

May 16, 2019

Clerk, U.S. Bankruptcy Court

Case 18-03120-tmb Doc 31 Filed 05/16/19

Page 2 – OPINION

respond to the CSF, as required by Local Bankruptcy Rule 7056-1(b). Accordingly, pursuant to

Federal Rule of Civil Procedure 56(e)(2), I deem the facts alleged in Mr. Pearce’s CSF to be

undisputed.

Notwithstanding Debtor’s failure to respond to the CSF, the pleadings filed by both

parties indicate that most of the material facts are not subject to serious dispute. Debtor and Mr.

Pearce are co-owners of a number of limited liability companies (“LLCs”), including the three at

issue in this proceeding: Triple R Holdings, LLC; PB & R, LLC; and PB & SH, LLC

(collectively, the “Subject LLCs”). Debtor and Mr. Pearce each own 50% of the membership

interests in each of the Subject LLCs. The Subject LLCs are governed by substantially identical

operating agreements (the “Operating Agreements,” see ECF No. 28, Exhs. A – C).

Debtor filed a voluntary chapter 11 petition on June 8, 2018. Oregon law creates a

process of “dissociation” when a LLC member files a bankruptcy petition. Under the Oregon

LLC statutes (chapter 63, Oregon Revised Statutes, the “LLC Act”),

if a member of a multi-

member LLC files a bankruptcy petition, that member ceases to be an LLC member, but retains

the “right to receive and retain . . . the distributions, as and when made, and allocations of profits

and losses to which the [member] would be entitled.” ORS 63.249(3) (applicable via ORS

63.265(2)(a)). Oregon’s dissociation provision applies only as a default rule, i.e., LLC members

may create a different procedure as part of an operating agreement. ORS 63.265. Consistent

with this flexibility, the Operating Agreements depart from the dissociation statute in one

respect: instead of retaining the right to participate equally in distributions, a dissociated member

is only entitled to payment of a set amount of money. Op. Agmt. § 13.2(b).

Despite Debtor’s failure to respond to the CSF, the admissibility of the Operating Agreements

is established because the parties, at the court’s direction, provided copies of the Operating

Agreements and stipulated to their authenticity. See ECF No. 28.

I hold that the internal affairs of the Subject LLCs are governed by Oregon law. This should be

self-evident, but clarification is necessary because the Operating Agreements contain a material

drafting error: each agreement contains an incomplete choice of law provision that fails to

specify what jurisdiction’s law applies. Op. Agmt. § 16.2. Choice-of-law cases overwhelmingly

hold that the internal affairs of a corporation are governed by the law of the state of

incorporation. Restatement (Second) of Conflict of Laws § 313, cmt. e (1971). I hold that the

same rule applies to limited liability companies. See id., ch. 13 introductory note (choice-of-law

rules regarding corporations are usually applied to other types of business entities).

Case 18-03120-tmb Doc 31 Filed 05/16/19

Page 3 – OPINION

Mr. Pearce’s complaint contains two claims for relief and the Motion seeks summary

judgment on both. First, Mr. Pearce seeks a declaratory judgment that Debtor “ceased to be a

member of” the Subject LLCs (in other words, he dissociated) upon the filing of his chapter 11

petition. Motion at 2; Complaint (ECF No. 1) ¶¶ 12-17. Second, he seeks a declaration that “to

the extent certain operating agreements are executory, they are rejected.” Motion at 2; Compl.

¶¶ 18-21. Mr. Pearce’s arguments are grounded in Oregon law, but they find support in some

bankruptcy case law. Debtor opposes the Motion, citing the Bankruptcy Code’s ipso facto

provisions and a different line of cases.

II. Analysis

In their combined eagerness to prevail at the end of the day, the parties’ briefing leaps

over some foundational concepts that are important for purposes of framing and resolving the

ultimate questions. These conceptual building blocks are relevant for several reasons, first

among which is the fact that the Bankruptcy Code makes no mention of LLCs, thus their

treatment in bankruptcy must be determined in reference to broader, generally applicable,

concepts. Accordingly, I will begin with a general discussion of LLCs before proceeding to the

specific matters argued by the parties.

A. The Limited Liability Company

Despite their current popularity, LLCs are a fairly recent invention. When the

Bankruptcy Code was enacted in 1978, only one state (Wyoming) recognized the LLC form of

entity. Mark A. Sargent & Walter D. Schwidetzky, Limited Liability Company Handbook § 1:2

(rev. 2018). LLCs went on to became prevalent in business circles when the Internal Revenue

Service clarified their tax treatment in 1998. Id. Currently, LLCs are a ubiquitous form of entity

for businesses large and small. While many states have adopted the Uniform Limited Liability

Company Act or the Revised Uniform Limited Liability Company Act, Oregon has not.

Oregon’s LLC Act was passed in 1993, before the uniform acts had been promulgated.

1 Advising Oregon Businesses § 7.1-2 (2017). Despite Oregon’s somewhat unique statute, the

general principles governing Oregon LLCs are the same as in most other states, including

definitional concepts related to a member’s interest.

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Page 4 – OPINION

To use an analogy familiar to most lawyers, an LLC membership interest is like a bundle

of sticks

—a member has various rights and obligations, most of which are governed by default

statutory rules that can be varied by the terms of an operating agreement. The rights that

comprise LLC membership can generally be sorted into two categories: economic rights and

governance rights. 1 Larry E. Ribstein & Robert R. Keatinge Limited Liability Companies § 7:3

(rev. 2018). Economic rights include the right to share in the company’s profits and losses, and

to receive distributions. Governance rights include the right to vote on certain matters and the

right to either manage the company’s business (in the case of a member-managed LLC) or

choose a manager (in the case of a manager-managed LLC).

Consistent with this generally accepted framework, the Oregon LLC Act addresses

governance rights of members in sections 63.130 through 63.170; while economic rights are

codified in sections 63.175 through 63.235. As mentioned previously, both the LLC Act and the

Operating Agreements limit Debtor’s governance and economic rights as a consequence of his

bankruptcy petition. In bankruptcy, state law (including the common law of contracts) is used to

determine a debtor’s interest in property. Dunkley v. Rega Properties (In re Rega Properties),

894 F.2d 1136, 1139 (9th Cir. 1990) (“Property interests are created and defined by state law.”

(quoting Butner v. U.S., 440 U.S. 48, 55 (1979) (internal quotation marks omitted)). Yet, even

though state law is the “starting point,” bankruptcy courts can and must “supersede state law

where it conflicts with the federal bankruptcy law which the court is primarily bound to enforce.”

Id. (quoting Ohio v. Collins (In re Madeline Marie Nursing Homes), 694 F.2d 433, 436-437 (6th

Cir. 1982) (citation and internal quotation marks omitted)). Thus, in this case, the provisions of

the LLC Act and the Operating Agreements are enforceable unless they are preempted by the

Bankruptcy Code. Because economic and governance rights are subject to different statutory

and contractual provisions, I will consider them separately.

See Anna di Robilant, Property: A Bundle of Sticks or a Tree? 66 Vanderbilt L. Rev. 869, 878

(2013) (“As capitalism bloomed [in 20th century America], wealth became increasingly

dephysicalized. The country underwent successive depressions, and wealth and power became

increasingly concentrated. The bundle of sticks concept seemed to better account for these

developments. It reflected the dephysicalization, and it allowed greater flexibility in regulating

property.” (citations omitted)).

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Page 5 – OPINION

B. Economic Rights

As previously alluded to, the Operating Agreements specify that one consequence of

dissociation is a member loses the right to receive regular distributions, and instead is entitled to

receive payment of his capital-account balance over four years. Op. Agmt. § 13.2(b). Debtor

argues that the dissociation provisions are overridden by two Code provisions that invalidate

certain ipso facto clauses.

First, § 541(c)(1) overrides ipso facto clauses “in an agreement,

transfer instrument, or applicable nonbankruptcy law.” Second, § 365(e) invalidates ipso facto

clauses in executory contracts.

By its own terms, § 541(c)(1) applies when property becomes property of the estate by

operation of § 541(a)(1), (2), or (5). Here, Debtor’s interests in the Subject LLCs are assets of

the estate because they are personal property in which the Debtor held a legal interest as of the

filing of the petition. See ORS 63.239 (LLC membership interests are personal property).

Accordingly, the interest came into the estate via § 541(a)(1), and § 541’s ipso facto provision is

therefore triggered. That provision states “an interest of the debtor in property becomes property

of the estate . . . notwithstanding any provision in an agreement, transfer instrument, or

applicable nonbankruptcy law . . . that is conditioned on the insolvency or financial condition of

the debtor, [or] on the commencement of a case under this title . . . and that effects . . . a

forfeiture, modification, or termination of the debtor’s interest in property.” 11 U.S.C. §

541(c)(1)(B).

It seems self-evident that the dissociation provision in the Operating Agreements effects a

modification of the Debtor’s interest in the Subject LLCs by ending his right to participate

equally in distributions. See Movitz v. Fiesta Investments (In re Ehmann), 319 B.R. 200, 206

(Bankr. D. Ariz. 2005) (“Code § 541(c)(1) renders [LLC dissociation provisions] inapplicable.

This necessarily implies the Trustee has all of the rights and powers with respect to [debtor’s

“Ipso facto” is Latin for “by the fact itself.” An ipso facto clause is a term of art for a “contract

clause that specifies the consequences of a party’s bankruptcy.” Black’s Law Dict. at 957 (10th

ed. 2014). The Code’s ipso facto provisions variously apply to both contractual and statutory

ipso facto clauses.

The Code includes a third ipso facto provision, in § 363(l), however the parties have not cited

it, and I do not believe this provision is relevant to this proceeding at this time.

Case 18-03120-tmb Doc 31 Filed 05/16/19

Page 6 – OPINION

LLC] that the Debtor held as of the commencement of the case.”). Moreover, the dissociation

process is conditioned on Debtor’s commencement of a bankruptcy case, the precise situation

that § 541(c) is intended to address.

Mr. Pearce cites only one case for the proposition that § 541(c)(1) does not apply.

Quoting California v. Farmers Markets (In re Farmers Markets), 792 F.2d 1400 (9th Cir. 1986),

Pearce asserts that “Section 541(c)(1) applies to avoid ‘only those restrictions which prevent

transfer of the debtor’s property to the estate.’” Pltf. Mem. ISO Motion (ECF No. 17) at 6

(quoting 792 F.2d at 1402) (emphasis by Mr. Pearce)). This reading is too narrow. To begin, the

dissociation provisions arguably do restrict the transfer of property: part of Debtor’s property

interest is his right to receive ongoing distributions and exercise governance rights, yet the

dissociation provisions purport to prevent those rights from being transferred to Debtor’s

bankruptcy estate. More to the point, the Farmers Markets opinion only refers to § 541(c)(1)(A),

when the more salient provision is likely § 541(c)(1)(B). As noted above, § 541(c)(1)(B) speaks

more broadly of preventing forfeiture, modification, or termination of a property right. I believe

that the dissociation provision of the Operating Agreements would modify Debtor’s economic

rights; therefore, I hold that this aspect of the dissociation provision is preempted by § 541(c)(1)

and Debtor has not lost his economic rights by virtue of filing a chapter 11 petition. Because

Pearce’s argument fails under § 541(c)(1), I need not consider Debtor’s alternate arguments

regarding § 365(e).

C. Governance Rights

Mr. Pearce’s Motion is not limited to a determination of Debtor’s economic rights.

Indeed, Pearce seeks a ruling that Debtor “ceased to have any right to participate in the

management or affairs of [the Subject LLCs].” Motion at 2. Mr. Pearce’s framing of this issue

blurs the distinction between general governance and voting rights, versus the right to actually

manage the companies’ day-to-day business activities. Because these two subsets of rights

implicate different legal issues, I will consider them in turn.

Case 18-03120-tmb Doc 31 Filed 05/16/19

Page 7 – OPINION

1. General Governance and Voting Rights

The Operating Agreements and the LLC Act grant LLC members the right to vote on

certain governance matters. To the extent Pearce is arguing that Debtor lost his ability to vote on

such questions, this argument is rejected for the reasons set forth in the previous section—

Debtor’s rights as an LLC member cannot be terminated or modified solely as a result of his

bankruptcy petition. Any provision of the Operating Agreements or the LLC Act that purports to

vitiate Debtor’s voting rights is unenforceable in bankruptcy under § 541(c)(1).

2. Management Rights

Debtor’s right to participate in the management of the Subject LLCs requires a separate

analysis because under the LLC Act, the nature of a member’s management rights depends on

whether an LLC is member-managed or manager-managed. When the court asked the parties to

specify the Subject LLCs’ management structures, Debtor and Mr. Pearce responded that the

articles of organization designate the entities as manager-managed, but that the Operating

Agreements are ambiguous and “open to interpretation.” Stipulation (ECF No. 28) ¶¶ 2-3. I

disagree that there is any ambiguity, because the contents of the Operating Agreements do not

control. The LLC Act defines a manager-managed LLC as an LLC “that is designated as a

manager-managed limited liability company in the limited liability company’s articles of

organization.” ORS 63.001(20). In contrast, a member-managed LLC is defined as an LLC

“other than a manager-managed limited liability company.” ORS 63.001(22). I agree with the

parties that the Subject LLCs’ articles of organization designate all three entities as manager-

managed. See Stipulation, Exh. D. Under the LLC Act, this designation is dispositive,

notwithstanding any contrary language in the Operating Agreements.

The management structure is relevant because it determines the source of Debtor’s

management rights. In a member-managed LLC, all members have equal management rights,

absent a contrary provision in the operating agreement. ORS 63.130(1)(a). In contrast, in a

manager-managed LLC—such as the Subject LLCs—members have no management rights other

Case 18-03120-tmb Doc 31 Filed 05/16/19

Page 8 – OPINION

than to vote on the selection of the manager(s).

ORS 63.130(2). A manager of a manager-

managed LLC “[m]ust be designated, appointed, [or] elected . . . by a vote, approval or consent

of a majority of the members.” ORS 63.130(2)(c)(A). Thus, a manager may be appointed

through an agreement that constitutes an executory contract (thus implicating the ipso facto

provision of § 365(e)); or, a manager could be appointed via some other process that does not

involve an executory contract.

I must deny Pearce’s request for a declaration that Debtor no longer occupies the office

of manager, although I do so without prejudice to Pearce renewing this argument later. At the

moment, I cannot rule on the question because the record contains no evidence indicating how

Debtor came to be a manager of the Subject LLCs. Debtor may have been appointed manager by

the Operating Agreements, or the Operating Agreements may simply memorialize the fact that

Debtor was appointed pursuant to some other process—the record is silent on this question of

fact. Without knowing the authority for his appointment, the court cannot opine on whether

Debtor’s appointment is modified in some way under § 365 or another provision of the

Bankruptcy Code.

D. Executory Contract Issues

Mr. Pearce also seeks a ruling that “to the extent the Operating Agreements . . . are

executory, they are rejected.” Motion at 2. This request is easily denied. In a chapter 11 case, a

debtor-in-possession may assume or reject an executory contract “at any time before the

confirmation of a plan.” 11 U.S.C. § 365(d)(2). No plan has yet been confirmed in this case,

and Pearce points to no action that constitutes Debtor’s rejection of the Operating Agreements;

therefore, the Operating Agreements have not been rejected.

The parties overlooked this simple answer, instead jumping headlong into exuberant

arguments about whether the Operating Agreements are executory contracts. This classification

is significant because only executory contracts can be assumed or rejected under § 365. Mr.

Pearce’s briefing takes the position that Debtor is unable to assume the Operating Agreements as

Of course it is not uncommon for a member of a manager-managed LLC to also be a manager,

which is the case here. Nonetheless, the member in his capacity as a member has no

management rights other than voting on a manager.

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Page 9 – OPINION

a matter of law. Pltf. Mem. at 7-9. Meanwhile, Debtor has filed a chapter 11 plan that proposes

to assume those very same agreements. Ch. 11 Plan Dated April 4, 2019 (Main Case, ECF No.

75), at 10. Clearly the parties have an actual disagreement over whether the Operating

Agreements are executory and this dispute will come to a head during the confirmation process.

Therefore, a declaratory ruling under 28 U.S.C. § 2201 is appropriate. See Societe de

Conditionnement en Aluminum v. Hunter Engineering, 655 F.2d 938, 943 (9th Cir. 1981)

(Declaratory judgment is appropriate where controversy is “definite and concrete, touching the

legal relations of parties having adverse legal interests. . . . It must be a real and substantial

controversy admitting of specific relief through a decree of a conclusive character, as

distinguished from an opinion advising what the law would be upon a hypothetical state of

facts.” (quoting Aetna Life Ins. v. Haworth, 300 U.S. 227, 240-241 (1937) (omission in

original)).

To address the questions concerning § 365, I must analyze two discrete issues: (1) are the

Operating Agreements executory contracts, and (2) if they are, are they the type of contracts

described in § 365(c)(1)(A).

1. Are the Operating Agreements Executory Contracts?

The Bankruptcy Code does not define an executory contract, but most courts adhere to

the definition formulated by Professor Vern Countryman, which was referenced with approval in

the legislative history of the Bankruptcy Code. See 3 Richard Levin & Henry J. Sommer, Collier

on Bankruptcy [hereinafter “Collier”] ¶ 365.02[2][a], at 365-16, n.10 (16th ed. rev. 2019)

(Defining an executory contract as “[a] contract under which the obligation of both the bankrupt

and the other party to the contract are so far unperformed that the failure of either to complete

performance would constitute a material breach excusing performance of the other.” (quoting

Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn. L.Rev. 439, 446

(1973)). The Ninth Circuit Court of Appeals has effectively adopted the same standard, holding

that “[a] contract is executory, and therefore assumable under § 365, only if one party’s failure to

perform its obligation would excuse the other party’s performance.” Zurich Am. Ins. Co. v. Int’l

Fibercom (In re Int’l Fibercom), 503 F.3d 933, 941 (9th Cir. 2007).

Case 18-03120-tmb Doc 31 Filed 05/16/19

Page 10 – OPINION

Given this definition, there are two constituent questions I must answer to determine

whether the Operating Agreements are executory: are there unperformed obligations, and would

a breach excuse performance by the counterparty. Addressing the issue of obligations first, I

must look for unperformed obligations on both sides of the contract as of the petition date.

Agarwal v. Pomona Valley Med. Grp. (In re Pomona Valley Med. Grp.), 476 F.3d 665, 669, n.4

(9th Cir. 2007). On the one hand, numerous courts have found partnership agreements to be

executory contracts. See, e.g., Samson v. Prokopf (In re Smith), 185 B.R. 285, 293, n.10 (Bankr.

S.D. Ill. 1995) (collecting cases). On the other hand, LLCs are different creatures, and some

LLCs adopt operating agreements that do not actually impose obligations on members, but

instead merely provide a structure under which the company is managed. See In re Garrison-

Ashburn, L.C., 253 B.R. 700, 708 (Bankr. E.D. Va. 2000). Thus, the question of whether the

Operating Agreements are executory can only be resolved by a careful reading of the

agreements’ actual text.

After reviewing the Operating Agreements, I do find that there are

several ongoing obligations, which are similar to operating- or partnership-agreement provisions

that other courts have held to be executory. Specifically:

• Authorization of company actions. Under § 2.7(c) the members are obligated to hold

meetings or otherwise authorize company actions and observe required formalities. See

In re Strata Title, 2013 WL 1773619, at *2 (Bankr. D. Ariz. Apr. 25, 2013) (voting on

certain matters); Norberg v. Hawks Prairie Casino (In re McSwain), 2011 WL 4706982,

at *6 (Bankr. W.D. Wash. Oct. 6, 2011) (voting on major decisions and capital

requirements).

The introductory paragraph of the Operating Agreements states that the contract is between the

Debtor, Mr. Pearce, and the Subject LLCs. I am skeptical about whether the LLCs are actually

party to these agreements, since the detailed provision explaining the effect of the Operating

Agreement states that it is an agreement between the members, with no mention of the company.

Op. Agmt. § 2.3. Additionally, there are signature lines for the members, but not for the

company. Id. at p.26. Even assuming, for the sake of argument, that the Subject LLCs are

parties to the Operating Agreements, the companies are clearly subject to ongoing obligations,

such as maintaining separate identities (§ 2.7), reimbursing members’ out-of-pocket expenses

(§ 5.3), and indemnifying members for business-related losses (§ 5.5).

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Page 11 – OPINION

• Management of company business. Members are required to manage the business and

affairs of the company (§ 5.1), to devote such time to this work as may be required

(§ 5.4), and to keep specified books and records (§ 10.5). See Allentown Ambassadors v.

Northeast Am. Baseball (In re Allentown Ambassadors), 361 B.R. 422, 444 (Bankr. E.D.

Pa. 2007) (duty to manage the LLC); In re Garrison-Ashburn, 253 B.R. at 708-709

(operating agreement is not executory because members are not obligated “to participate

in management”); In re Daugherty Constr., 188 B.R. 607, 612 (Bankr. D. Neb. 1995)

(continuing obligation to participate in management); Burley v. Am. Gas & Oil Investors

(In re Heafitz), 85 B.R. 274, 283-284 (Bankr. S.D.N.Y. 1988) (partner’s duty to furnish

financial statements, prepare quarterly reports, and keep partnership books and records).

• Obligation to remain a member. Under § 5.10, members may not resign or withdraw

from the company except as allowed under the Operating Agreement. See In re

Garrison-Ashburn, 253 B.R. at 709 (operating agreement is not executory because

members “may resign at any time by giving written notice”).

• Capital contributions. Members must make additional capital contributions as required.

See In re Allentown Ambassadors, 361 B.R. at 444 (duty to make additional contributions

if needed); In re Daugherty Constr., 188 B.R. at 612 (requirement to make capital

contributions in the event of loss); In re Priestley, 93 B.R. 253, 258 (Bankr. D.N.M.

1988) (limited partners’ obligations to make capital contributions).

• Restrictions on transfer. Members may not assign or sell their membership interest

except as allowed under the Operating Agreement (§ 11.1), which grants the LLC and the

other member rights of first refusal (§ 11.2). A member who disobeys the transfer

restrictions must indemnify the company against resulting damages (§ 11.2(d)). See In re

McSwain, 2011 WL 4706982, at *6 (affirmative restraint from transferring interest or

voluntarily withdrawing); In re Heafitz, 85 B.R. at 277 (prohibition on partner withdraw

without consent); but see Samson v. Prokopf (In re Smith), 185 B.R. 285, 294 (Bankr.

S.D. Ill. 1995) (buyback provision in partnership agreement “does not create a

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Page 12 – OPINION

performance obligation but merely constrains the manner by which a partner may

liquidate his or her holdings”).

• I also note that the Operating Agreements contain additional obligations that appear to be

unperformed, including the duty to indemnify a dissociated member (§ 13.2(b)(ii)), and

the duties to wind down the business of the company and notify the Secretary of State in

the event of dissolution (§§ 14.4 and 14.6).

Given the provisions above, I find that the Operating Agreements impose obligations on

both parties, which obligations were unperformed as of the petition date. The next question is

whether the breach of such obligations would be material, such that the non-breaching party

would be excused from performance. This is a much more difficult question. When determining

whether a contract is executory, the question of materiality is governed by applicable state law.

Hall v. Perry (In re Cochise College Park), 703 F.2d 1339, 1348, n.4 (9th Cir. 1983) (“Although

whether a given contract is ‘executory’ under the Bankruptcy Act is an issue of federal law . . .

the question of the legal consequences of one party’s failure to perform its remaining obligations

under a contract is an issue of state contract law.”).

Oregon courts follow the general common-law principles regarding materiality of a

breach. In Weaver v. Williams, 211 Or. 668, 677-678 (1957), the supreme court endorsed the

six-factor test from the Restatement of Contracts § 275 (1932) to determine whether a breach is

material. That test has been slightly modified and updated in § 241 of the Restatement (Second)

of Contracts (1981), which in turn has been utilized by the Oregon Court of Appeals. Venture

Properties v. Parker, 223 Or. App. 321, 353-354 (2008). As the drafters of the Restatement

acknowledge, the factors are somewhat open-ended, because the standard “is necessarily

imprecise and flexible.” Restatement (Second) of Contracts § 241, cmt. a. The current test, from

the Restatement (Second) asks: (1) whether the injured party will be deprived of the anticipated

benefits under the contract, (2) whether the injured party can be adequately compensated, (3)

whether the breaching party will suffer forfeiture, (4) whether the breaching party will cure the

breach, and (5) whether the breaching party has comported with the standards of good faith and

fair dealing. Id. § 241.

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The ultimate point of the materiality inquiry is to determine whether the breaching

party’s actions are such as to foreclose further performance by the counterparties. Weaver, 211

Or. at 679. In the context of this proceeding, a determination of materiality requires anticipating

the potential results of a hypothetical breach, which can be a challenging exercise. I find it

helpful to compare the facts of the present case to a clearly distinguishable hypothetical: suppose

there is an LLC with an operating agreement substantially identical to those at issue here, but this

LLC has twenty members, each of whom hold a 5% interest. If one of the 5% members failed to

discharge her obligations under the operating agreement (say, by not making additional capital

contributions), would that breach allow the LLC and the other members to not perform their

obligations under the operating agreement? I think the answer is almost certainly negative.

Contrast that with the facts of this case, where Debtor and Mr. Pearce are the only members of

the Subject LLCs, but neither holds a controlling interest. Here, if either LLC member willfully

refused to perform his obligations, the non-breaching member would lack any effective internal

enforcement mechanism because the breaching member holds veto power over any proposed

corporate action. In such a scenario, the non-breaching member’s only apparent remedy would

be judicial dissolution under ORS 63.661(b). Judicial dissolution would necessarily entail

terminating the existence of the LLCs, a process that would vitiate the Operating Agreements

and thereby excuse members from continued performance of their obligations.

Given the particular facts of this case, I hold that a breach of any of the ongoing

obligations in the Operating Agreements would be material, thus making the agreements

executory contracts for purposes of § 365. The next question, discussed in the following

section, is whether the Operating Agreements fall within the scope of § 365(c)(1).

This hypothetical only looks at the narrow question of materiality and I do not mean to suggest

that the hypothetical 5% member could flaunt her contractual obligations without consequence.

See Restatement (Second) of Contracts § 241, cmt. a (“Even if not material, the failure may be a

breach and give rise to a claim for damages for partial breach.”).

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2. Is Debtor’s Ability to Assume the Operating Agreements Restricted under

§ 365(c)?

Previously in this opinion, I resolved the dispute over Mr. Pearce’s first claim by

applying § 541(c), thereby avoiding the need to analyze the ipso facto provision of § 365(e). The

parties’ dispute over Pearce’s second claim implicates a different subsection of § 365, namely

§ 365(c), which enforces certain restrictions on assignment.

The Ninth Circuit employs the so-

called “hypothetical test” governing the assumption of executory contracts. Perlman v. Catapult

Entertainment (In re Catapult Entertainment), 165 F.3d 747, 749-750 (9th Cir. 1999). The

Catapult court adopted a strict literal reading of the statutory text, interpreting § 365(c)(1) as

follows: “where applicable nonbankruptcy law makes an executory contract nonassignable

because the identity of the nondebtor party is material, a debtor in possession may not assume the

contract absent consent of the nondebtor party.” Id. 754-755 (emphasis added).

Mr. Pearce argues that the Debtor’s duties under the Operating Agreements “are in the

nature of contracts for personal services,” and therefore he would not be able to assign his duties.

Pltf. Mem. at 8. Debtor urges the court to reject this claim, arguing that further evidence is

necessary to determine what services he actually renders to the Subject LLCs. Debtor’s Resp. to

Motion (ECF No. 23) at 5-8. I do not believe that fact-finding is necessary. As the Ninth Circuit

noted in Catapult Entertainment, the inquiry is a hypothetical one—regardless of actual facts,

would the debtor be able to assign the contract in a theoretical scenario? See also 3 Collier

¶ 365.07 (“A number of bankruptcy courts concluded that section 365(c) only applies to

‘nondelegable contracts such as personal service contracts.’ But the circuit courts have

concluded that section 365(c) applies more broadly ‘to contracts that are not assignable under

nonbankruptcy law.’” (citations omitted)).

To fully appreciate § 365(c), one must begin with § 365(f), which allows a debtor-in-possession

to assign an executory contract notwithstanding a contractual prohibition on assignment. Section

365(c) then narrows the applicability of § 365(f), by allowing the enforcement of certain

restrictions under nonbankruptcy law. See In re Quantegy, Inc., 326 B.R. 467, 470 (Bankr. M.D.

Ala. 2005) (“At first glance, sections 365(c)(1) and (f)(1) may appear to be at odds because

section 365(f)(1) allows assignment irrespective of ‘applicable law’ while 365(c)(1) restricts

both assumption and assignment based on ‘applicable law.’ In other words, section 365(f)(1)

‘giveth’ and section 365(c)(1) ‘taketh away.’”).

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On the one hand, the LLC Act provides that a “membership interest is assignable in

whole or in part.” ORS 63.249(1). At first glance, this appears to support Debtor’s position.

However, a close reading of § 365(c)(1) reveals that the statute itself does not speak of

assignment or assignability. Rather, the statute refers to “applicable law [that] excuses a

party . . . from accepting performance from . . . an entity other than the debtor.” 11 U.S.C.

§ 365(c)(1)(A). Given this phrasing, the provisions of the LLC Act seem to fit squarely within

the scope of § 365(c): while the LLC Act allows assignment, it provides that the assignee does

not become a member of the LLC unless and until the assignee is accepted as such. ORS

63.249(3). In this respect, the LLC Act does excuse counterparties from accepting performance

from an assignee other than the debtor—while the LLC must render limited performance to the

assignee (e.g., the assignee is entitled to receive distributions on the same terms as other interest-

holders), it need not accept an assignee’s performance (e.g., in the form of services rendered or

votes on governance matters). Notably, this restrictive provision is facially neutral insofar as it

operates whether the assignment is made because of the assignee’s insolvency or for some other

reason.

Accordingly, because the LLC Act allows LLCs and non-assigning members to

insulate themselves from accepting performance from an assignee, I hold that the Debtor may

not assign his interest in the Operating Agreements, absent the consent of the counterparty.

III. Disposition of the Motion

Having decided the legal issues presented, I now must determine how to dispose of the

Motion. Ordinarily I would do this by entering an order granting or denying summary judgment.

But in this case, Debtor has not consented to entry of a final order by this court, stating that

Thanks to § 541(c), this provision of the LLC Act was superseded when the LLC interests

came into Debtor’s estate. But § 541(c) speaks only of what happens when property “becomes

property of the estate;” it does not address the mechanics of property leaving the estate.

Debtor also asserts that the court should deny the Motion because Mr. Pearce allegedly comes

to court with unclean hands. Debtor’s Resp. at 6-8. This argument (which is of unclear legal

relevance to begin with) is rejected for a lack of specific, non-conclusory allegations of bad-faith

conduct. Although Debtor made several allegations of bad faith in support of his third-party

complaint (see Answer (ECF No. 10) ¶¶ 32-44), he subsequently stipulated to dismissal of this

claim, admitting that it was based on inaccurate information. See Stipulation to Allow Dismissal

of Second Counterclaim (ECF No. 25).

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“[t]his is a state law matter and not a core function of the bankruptcy court.” Answer (ECF No.

10) ¶ 27. Although “core function” is not a term of legal significance, it appears that Debtor is

arguing that this is not a core proceeding for purposes of 28 U.S.C. § 157(b). If parties do not

consent to entry of a final order or judgment in a non-core proceeding, this court submits

proposed findings and recommendations for review and entry by the district court. Dist. Ct. L.R.

2100-11(c). However, this court must make the initial determination whether a proceeding is

core or non-core. 28 U.S.C. § 157(b)(3). I conclude that this is a core matter, and Debtor’s

consent is not necessary for entry of a final order or judgment.

To begin, the Debtor’s claim that this proceeding is non-core lacks merit because the only

basis given for this assertion is that the dispute is “a state law matter.” The role of state law can

be a factor in determining whether a matter is core, but it is never dispositive. 28 U.S.C.

§ 157(b)(3) (“A determination that a proceeding is not a core proceeding shall not be made solely

on the basis that its resolution may be affected by State law.”); Johnston Envtl. Corp. v. Knight

(In re Goodman), 991 F.2d 613, 617 (9th Cir. 1993) (“A proceeding is not removed from the

jurisdiction of the bankruptcy court solely because the resolution may be affected by state law.”).

Congress has provided a non-exclusive list of core proceedings in 28 U.S.C. § 157(b)(2).

I conclude that this proceeding is core under § 157(b)(2)(A). In so holding, I am mindful that the

“catch-all” categories of §§ 157(b)(2)(A) and (O) must be narrowly construed. Honigman v.

Weitzman (In re Delorean Motor Co.), 155 B.R. 521, 525 (9th Cir. BAP 1993) (breadth of

§§ 157(b)(2)(A) and (O) “must be tempered by the Supreme Court’s decision in Northern

Pipeline”). Nonetheless, after examining relevant authorities, I believe that the issues presented

here are clearly matters concerning administration of the estate.

Plaintiff’s complaint contains two causes of action. In withholding consent, Debtor only

references the first claim, which asks for a declaratory judgment regarding whether Debtor

dissociated as a result of his chapter 11 petition. Debtor thus seems to implicitly concede that the

second claim (asking for a declaratory judgment on the § 365 issues) is within the court’s core

jurisdiction. For the sake of clarity, I hold that the second claim concerns administration of the

estate, and is therefore a core matter under 28 U.S.C. § 157(b)(2)(A).

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Turning to the first claim, Mr. Pearce asks for a determination that the bankruptcy estate

lost certain rights under the Operating Agreements as a result of Debtor’s bankruptcy filing.

This claim thus asks the court to determine which of Debtor’s property rights transferred to the

estate; or, put another way, this is a dispute over what is property of the estate. Many courts

have held that determination of whether assets are property of the estate is a core matter. Bank of

Los Angeles v. Official PACA Creditors’ Comm. (In re Southland + Keystone), 132 B.R. 632,

638 (9th Cir. BAP 1991) (“Clearly, a determination of whether assets are property of the

bankruptcy estate concerns administration of the estate.”); In re Wash. Mutual, Inc., 461 B.R.

200, 217 (Bankr. D. Del. 2011) (§ 1334(e) jurisdiction over property of the estate “includes

jurisdiction to decide whether disputed property is, in fact, property of the estate”); All Am.

Laundry Serv. v. Ascher (In re Ascher), 128 B.R. 639, 643 (Bankr. N.D. Ill. 1991) (“When a

debtor and its creditors assert interests in property asserted to be part of the estate, the

bankruptcy court has core jurisdiction to adjudicate all of those interests.”); Chase Manhattan

Bank v. Jacobs (In re Jacobs), 48 B.R. 570, 572 (Bankr. S.D. Cal. 1985) (similar holding).

Not only has this conclusion been endorsed by numerous bankruptcy courts, but I also

believe it finds support in recent (i.e., post-Stern) pronouncements from the U.S. Supreme Court.

Specifically, I would note the various opinions in Wellness International Network v. Sharif, 135

S. Ct. 1932 (2015). Wellness International concerned a dispute between the debtor and a

creditor over whether certain purported trust property was actually property of the estate. Id. at

1940-1941. The Seventh Circuit held that the bankruptcy court lacked jurisdiction to enter a

final judgment because the dispute was a so-called “Stern claim”

and the trustee of the alleged

trust had not consented to entry of a judgment by the bankruptcy court. The majority of the

Supreme Court expressly declined to decide whether the creditor’s claim truly was a Stern claim,

instead holding that the trustee had impliedly consented to the bankruptcy court’s jurisdiction.

Id. at 1942, n.7. But the Chief Justice, joined by Justices Scalia and Thomas, wrote separately,

rejecting the majority’s consent ruling and stressing that “[i]dentifying property that constitutes

A Stern claim “is a claim that is ‘core’ under the statute but yet ‘prohibited from proceeding in

that way as a constitutional matter.’” Wellness Int’l, 135 S.Ct. at 1949 (Alito, J., concurring).

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the estate has long been a central feature of bankruptcy adjudication.” Id. at 1952 (Roberts, C.J.,

dissenting).

Under the dissenters’ view, 28 U.S.C. § 157(b), as informed by historical practice,

grants bankruptcy courts the ability to enter final orders and judgments concerning what is

property of the estate. Id. at 1954 (describing property-of-the estate disputes as “a narrow

historical exception that permits a non-Article III adjudicator in certain bankruptcy

proceedings”).

The Court’s opinion in Wellness International gives me no reason to think that the

majority justices would have disagreed with the dissent’s reasoning were the question squarely

before the court. I therefore adopt the Chief Justice’s reasoning in Wellness International and

hold that the adjudication of Mr. Pearce’s first claim for relief is a core matter within the scope

of 28 U.S.C. § 157(b)(2)(A), and that I may enter a final order on the Motion notwithstanding

Debtor’s withholding of consent.

IV. Conclusion

For the reasons explained above, I deny the Motion to the extent that Mr. Pearce seeks a

ruling that: (1) Debtor dissociated upon the filing of his petition, (2) Debtor has rejected the

Operating Agreements, and (3) Debtor has lost his rights to manage the businesses of the Subject

LLCs. I grant the motion to the extent that Mr. Pearce seeks a ruling that Debtor cannot assume

the Operating Agreements without Pearce’s consent.

The court will enter an order granting the

motion in part and denying the motion in part, consistent with this opinion.

At times the Chief Justice’s dissent almost reads as a concurrence. The key to understanding

the dispute is focusing on how the different justices approached the question of whether the

claims were covered by Stern. The majority did not reach that question, holding that the parties

had impliedly consented to bankruptcy-court jurisdiction. The Chief Justice, recognizing the

general bankruptcy jurisdiction over property of the estate, would have remanded the case so

that the bankruptcy court could make the initial determination of whether the dispute was a Stern

claim. 135 S. Ct. at 1953 (Roberts, C.J., dissenting).

Although Mr. Pearce has succeeded in his argument that the Operating Agreements are

governed by § 365(c), I would note that under § 365(c)(1)(B), Mr. Pearce may consent to the

assumption of the Operating Agreements notwithstanding the LLC Act’s restrictions on

assignment. Of course, Mr. Pearce is free to withhold his consent for any or no reason, but he

may want to carefully consider the hazards of forcing Debtor to reject the Operating Agreements.

See In re Henderson, 245 B.R. 449, 453 (Bankr. S.D.N.Y. 2000) (“The effect of rejection is one

of the great mysteries of bankruptcy law.”).

Case 18-03120-tmb Doc 31 Filed 05/16/19