In the last several years, the limited liability company (LLC) has become the entity of choice for entrepreneurs and new businesses. Borrowers have increasingly provided lenders security interests in limited liability company membership interests (LLC units) as collateral for loans. The Uniform Commercial Code (UCC) dictates a lender’s options after a borrower’s default. Recent economic developments have increased the likelihood of default on many commercial loans so knowledge of the options available under the UCC to a lender which holds LLC units as collateral will become increasingly important.

Let us also assume that the lender has negotiated a security agreement that gives it full rights to take over the LLC upon default. In order for the lender to take ownership of the LLC units, the lender must foreclose on its security interest through one of two processes detailed in the UCC.

Possible Barriers and Drawbacks.

For a lender who has a security interest in LLC units, the borrower’s right to vote on business matters involving the LLC and/or to manage the LLC is very important. If the borrower defaults, a lender may want to control the LLC via the borrower’s voting or management rights. A careless lender or third-party purchaser of the LLC units may only get a financial distribution right instead. Florida law, for example, provides that an assignee of LLC units has no right to participate in the management of the business and affairs of the company, or to exercise any rights or powers of the members, unless the operating agreement provides otherwise.

Even if the operating agreement allows the assignee (in our case, the lender) to exercise rights and powers of a member, the assignee cannot manage the LLC until either all non-assigning members approve of the transfer of management power or the procedure for complying with the transfer of management responsibilities, as stated in the operating agreement, is followed.

As a general rule, it is essential that the lender understand its options under the UCC, compare the benefits of each option, and act promptly upon default. A secured lender that fails to do so jeopardizes its basic remedies under the UCC for a default on a loan secured by LLC units.