Chapter 6 - § 6.2 • GENERAL DISCUSSION

• Jurisdiction: Colorado

§ 6.2 • GENERAL DISCUSSION

§ 6.2.1—Introduction

LLCs, partnerships, and limited partnerships provide extremely flexible tools for business owners and family members. These entities are significantly less flexible for creditors, either those who wish to take an interest in the entity as collateral or for creditors seeking to reach a membership interest or partnership interest to enforce a judgment against a member or partner. Obviously, the discussion in § 6.2.2, "General Discussion of a Security Interest," and § 6.3.1, "Grant of a Security Interest in a Membership Interest or Partnership Interest," applies to contract creditors. Contract creditors who do not protect themselves through adequate security arrangements as well as all tort creditors of a member or partner must avail themselves of the remedies discussed in § 6.4, "Post-Debt Collection," and § 7.2.3, "Veil Piercing in General," through § 7.2.10, "Single-Member LLCs."

Members and partners may grant a security interest to collateralize debt obtained from a creditor. If a creditor negotiates this security interest in advance of becoming at risk, the creditor should be able to obtain the cooperation of the proposed debtor and the entity ("pre-debt negotiation"). A prospective creditor should in all cases examine the applicable operating or partnership agreement. If the LLC or partnership entity will not cooperate with the creditor in extending debt to the member, the creditor should ensure that it has adequate additional collateral securing whatever debt is being advanced.

Creditors may seek to collect a debt against an LLC member or a partner, or enforce a judgment or other obligation against the member or partner. Generally, the debtor will oppose this effort, and the debtor may be able to enlist the cooperation of the entity in opposing the creditor's collection efforts ("post-debt collection").

In addition to statutory issues, the rights of a creditor to negotiate a security interest in pre-debt negotiation or to accomplish post-debt collection of debt depend in part on the terms of the operating agreement or partnership agreement as well as the character of the LLC or partnership. In some cases, the operating or partnership agreement may prohibit the granting of security interests or require approval of the other members or partners. Unless varied by the operating agreement or partnership agreement, the Colorado statutes provide that the transferee of an interest who is not admitted as a member or partner has no right to vote or to receive information. See §§ 3.3.3, "Assignment and Admission of New Members to an LLC," and 3.5.3, "Transferability of a Partnership Interest." See also §§ 5.1.1, "Limited Liability Companies," and 5.1.2, "General Partnerships." In addition, operating agreements and partnership agreements frequently include transfer restrictions and impose significant limitations on the rights of transferees who are not subsequently admitted as members or partners. These statutory provisions and agreement restrictions and limitations may impede post-debt collection or a pre-debt negotiation.

Where a bankruptcy is involved and the LLC in question is a single-member LLC or an LLC with more than a single member where all members file for bankruptcy protection, creditors are more likely to succeed in their post-debt collection efforts. The bankruptcy of a member of a...