A recent Delaware Supreme Court ruling validated a decision of the Delaware Court of Chancery from almost two decades ago which held that federal bankruptcy law does not entirely preempt the Delaware LLC Act in all respects to the extent that the LLC Act provides for a member of an LLC to become an assignee only with economic rights upon the filing of bankruptcy by that member. Zachman v. Real Time Cloud Services LLC, 228 A.3d 1065 Order (Del. April 20, 2021).
For purposes of this short blog post, I am going to provide a few key bullet points and recommend that the reader review the entire decision issued in the form of an Order.
● Section 18-304 of Title 6 of the Delaware Code, which is part of the Delaware LLC Act, provides a description of those situations where a person ceases to be a member of a Limited Liability Company. Section 18-304(1)(b) states that a person ceases to be a member of a Limited Liability Company when he files an involuntary bankruptcy petition.
● The Delaware Court of Chancery in Milford Power Co., LLC v. PDC Milford Power, LLC, 866 A.2d 738, 762 (Del. Ch. 2004), reasoned that to the extent Section 18-304(1)(b) provides that a member who files for bankruptcy ceases to be a member, but becomes an assignee with economic rights only as codified in Section 18-702(b), the normal federal preemption of bankruptcy law does not apply to interfere with the implementation of that aspect of the Delaware LLC Act. The Zachman Court upheld the reasoning in Milford Power which reached the same conclusion.
● The Court’s reasoning included an observation that Section 18-304 is not preempted by federal bankruptcy law because a member filing a personal bankruptcy petition ceases to be a member of the limited liability company at that time.
● Section 18-702(b) of the Delaware LLC Act codifies the status of that former member as an assignee only with economic interests and no further managerial role in the limited liability company post-bankruptcy filing.
● This ruling is best understood in the context of the detailed facts of the case as recited in the Court’s decision.