357 P.3d 650
Wash.2015Background
- Harold Ostenson (former member) and Greg Holzman formed Pac Organic Fruit LLC; Holzman/GHI controlled the company and Ostenson operated a packing facility that later foreclosed. Pac-O transferred assets to GHI after defaults.
- Ostenson filed a voluntary Chapter 11 bankruptcy petition on January 9, 2007. A creditor sued Pac-O; Ostenson filed responsive claims and a derivative claim (Count VIII) on behalf of Pac-O against Holzman and related entities.
- Washington law (pre-2016 WALLCA) provides that a plaintiff in a derivative action must be a member when bringing the action (RCW 25.15.375) and that a member is dissociated (becomes only an assignee with economic rights) upon filing a voluntary bankruptcy petition unless the operating agreement or all members consent (RCW 25.15.130(1)(d)(ii), RCW 25.15.250–260).
- Defendants moved to dismiss the derivative claim under CR 41(b)(3), arguing Ostenson was dissociated by his bankruptcy filing and thus lacked standing to pursue a derivative suit. The trial court granted dismissal; the Court of Appeals affirmed. Ostenson sought review on waiver and federal preemption grounds.
- The Washington Supreme Court considered whether federal bankruptcy law (11 U.S.C. §§ 541 and 365) preempted the WALLCA dissociation rule and whether defendants waived the standing defense by presenting evidence after the motion was taken under advisement.
Issues
| Issue | Plaintiff's Argument (Ostenson) | Defendant's Argument (Holzman/HDs) | Held |
|---|---|---|---|
| Waiver of CR 41(b)(3) defense | Defendants waived the standing dismissal defense by presenting evidence after the court took the motion under advisement | Presenting defense evidence after advisement does not waive a legal standing challenge when the facts are undisputed and the motion raises a legal issue | Defendants did not waive; dismissal was proper |
| Whether 11 U.S.C. § 541(c)(1) preempts RCW dissociation rule | § 541(c)(1) makes debtor’s entire interest property of the estate and invalidates ipso facto forfeiture/dissociation on bankruptcy filing | State law defines the nature and scope of debtor’s interest; § 541 brings that state-defined interest into the estate subject to state-imposed burdens (so dissociation stands) | § 541 does not preempt RCW dissociation; estate takes debtor’s interest as defined by state law (assignee/economic interest) |
| Whether 11 U.S.C. § 365(e)(1) invalidates dissociation or ipso facto clauses in LLC agreements | § 365(e)(1) prohibits termination of contracts solely because of bankruptcy; thus operating agreement dissociation should be unenforceable | § 365(e)(2) and § 365(c)(1) exempt situations where applicable nonbankruptcy law (or the nature of association) excuses performance by/acceptance of an assignee and nondebtor members have not consented—protecting associational rights | § 365(e)(1) is inapplicable here because § 365(e)(2)/365(c)(1) rescues state associational rules; federal law does not preempt the WALLCA protection of nondebtor members’ associational rights |
| Standing to pursue derivative claim after bankruptcy filing | Ostenson contended consent or bankruptcy stipulation preserved his standing | WALLCA dissociation converts member to assignee (no management/derivative rights) absent agreement or unanimous consent; no applicable consent here | Ostenson lost membership and derivative standing on bankruptcy filing under state law; dismissal affirmed |
Key Cases Cited
- Butner v. United States, 440 U.S. 48 (U.S. 1979) (state law defines property interests for bankruptcy purposes)
- In re Farmers Markets, Inc., 792 F.2d 1400 (9th Cir. 1986) (§ 541 does not alter the threshold existence or scope of interests created by state law; estate takes interests subject to state restrictions)
- In re Pettit, 217 F.3d 1072 (9th Cir. 2000) (courts must look to state law to determine the debtor’s legal or equitable interests for § 541 purposes)
- In re Catapult Entertainment, Inc., 165 F.3d 747 (9th Cir.) (where nonbankruptcy law makes a contract nonassignable because identity matters, debtor in possession may not assume absent consent)
- Finkelstein v. Security Properties, Inc., 76 Wn. App. 733 (Wash. Ct. App. 1995) (state partnership dissociation on bankruptcy not superseded by § 365; associational rights protect nondebtor partners)
- Hector v. Martin, 51 Wn.2d 707 (Wash. 1958) (defendant presenting evidence may waive a motion challenging sufficiency of plaintiff’s case in certain circumstances)
- In re Garrison-Ashburn, L.C., 253 B.R. 700 (Bankr. E.D. Va. 2000) (bankruptcy does not negate state-law dissociation; estate receives the debtor’s economic interest but not management rights)