The United States District (Bankruptcy) Court for the District of Nevada held that an assignee of the economic and membership rights in the debtor-Limited Liability Company did not obtain managerial and voting rights in the debtor-Limited Liability Company because the assignee failed to comply with the requirements of becoming a substituted member with voting and managerial rights as set out in the debtor-Limited Liability Company’s operating agreement.

Paladin Commerce Center, LLC is the debtor in a Chapter 11 Bankruptcy. Prior to filing bankruptcy, Paladin entered into a loan agreement with Heller Financial, Inc., where Paladin borrowed $3.6 million. Paladin executed an Equity Loan Agreement, a Promissory Note, and a security interest in all of Paladin’s individual member interests to Heller.

Paladin’s individual members pledged their interests in Paladin as collateral for the loan by signing a Pledge and Security Agreement. Under the agreement, if Paladin defaulted on the loan, Heller would receive a majority interest in Paladin. Pursuant to Paladin’s Operating Agreement, a member holding a majority interest had the right to change Paladin’s management. Paladin defaulted on the Heller loan and filed a Chapter 11 bankruptcy. Heller filed a claim Paladin’s bankruptcy for $3,706,718.90 and foreclosed upon the interests of Paladin’s members. Heller sold and assigned its interests in Paladin to General Electric Credit Equities (“GE Credit”). Subsequently, GE Credit gave notice to the Bankruptcy court and all of the parties that it was the sole member of Paladin and appointed itself manager of Paladin.

Barry Thalden, one of the managing members of Paladin, objected to GE Credit’s claim that it had voting rights and management authority. Thalden argued that GE did not have voting and management rights because it did not obtain managerial consent to be a substituted member pursuant to the Operation Agreement.

The Operation Agreement states, in part:
In the event any Member Transfers such Member’s Interest to a transferee….such transferee shall be entitled to the Company as a substituted Member….provided that: (a) the consent of the Managers approving such admission is obtained; (b) the transferee named therein executes and acknowledges such other instruments as the Managers may deem reasonably necessary to effectuate such admission; (c) the transferee in writing accepts and adopts all terms and conditions of this Agreement, as the non-transferring Members may reasonably determine, all reasonable expenses incurred in connection with such admission, including, without limitation, legal fees and costs. An assignee of an Interest who does not become a substituted Member shall have no right to…vote on any of the matters….

GE Credit argued that, when read as a whole, the Pledge and Security Agreement and other loan documents between Paladin and Heller rendered Heller a substituted member by default.

The Bankruptcy Court disagreed with GE Credit, ruling that GE Credit did not obtain manager consent for the transfer or comply with any of the other requirements to become a substituted member with voting and management rights in accordance to Paladin’s Operating Agreement. Further, the Bankruptcy Court did not address whether Heller became a substituted member as a result of Paladin’s default. The Court stated that the issue was whether GE Credit was a substituted member and decided that whether Heller was a substituted member was irrelevant.

The district court affirmed the decision of the Bankruptcy Court, holding that the only method by which GE Credit could obtain voting and management rights is pursuant to the Operating Agreement. The district court reviewed the Pledge and Security Agreement, particularly, the section that stated, in part, “any entity acquiring all or any portion of such Pledgor’s Ownership Interests (including voting and managerial rights)….shall have the right to terminate the managing members’ management rights….under the Operating Agreement upon notice….to managing members.”

The district court found that, even if the Pledge and Security Agreement allowed GE Credit to terminate the management rights of the Paladin’s managing members, the agreement did not give GE Credit any voting or management rights. Thus, the court decided that GE Credit could only obtain voting and management rights by obtaining managerial consent pursuant to the Operating Agreement.