TAKING A CREDIT INTEREST IN STOCK OR MEMBERSHIP INTEREST

First Run Broadcast: May 3, 2016

1:00 p.m. E.T./12:00 p.m. C.T./11:00 p.m. M.T./10:00 a.m. P.T. (60 minutes)

LLC and partnership interests, and stock, are often pledged as collateral to finance companies or

raise funds for personal purposes. Taking and perfecting a security interest in an ownership stake

involves a complex set of choices and processes under UCC Article 9 (secured transactions) and

Article 8 (investment securities), federal securities law and organizational law, each involving

certain risks in terms of enforceability and limitations on the secured party. This program will

provide you with a practical guide to taking and perfecting a security interest in a partnership,

LLC or S Corp ownership stake, the practical remedies and choices available to secured parties

on foreclosure, how to circumvent certain restrictions, and the impact of non-UCC law on taking

a security interest.

How to take a security interest in partnership LLC interest or S Corp stock

Guide to how Article 9 (secured transactions) Article 8 (investment securities) define

security and limit security interests in these ownership stakes

Methods and mistakes in perfecting the security interest

Restrictions on assignment and methods to circumvent

Rights of secured parties, including the right buy, and foreclosure strategies and traps

Securities law and non-UCC legal issues

Speaker:

Steven O. Weise is a partner in the Los Angeles office Proskauer Rose, LLP, where his practice

encompasses all areas of commercial law. He has extensive experience in financings, particularly

those secured by personal property. He also handles matters involving real property anti-

deficiency laws, workouts, guarantees, sales of goods, letters of credit, commercial paper and

checks, and investment securities. Mr. Weise formerly served as chair of the ABA Business Law

Section. He has also served as a member of the Permanent Editorial Board of the UCC and as an

Advisor to the UCC Code Article 9 Drafting Committee. Mr. Weise received his B.A. from Yale

University and his J.D. from the University of California, Berkeley, Boalt Hall School of Law.

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Taking a Credit Interest in Stock or Membership Interest Teleseminar May 3, 2016

1:00PM – 2:00PM 1.0 MCLE GENERAL CREDITS

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Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: May 3, 2016 Seminar Title: Taking a Credit Interest in Stock or Membership Interest Location: Teleseminar - LIVE Credits: 1.0 MCLE General Credit Program Minutes: 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.

Using Interests in LLCs andLPs as collateral

Steve Weise

Proskauer Rose, LLP –

Los Angeles

(310) 284-4515

sweise@proskauer.com

Introduction

• Interplay of UCC Article 8 and Article 9• Characterization of equity interests

o UCC typeo Categories of investment propertyo Effects of characterization

• ‘Opting in’ to Article 8• Article 9 issues (listed on next slide)• Opinions• Secured party remedies and duties• Non-UCC considerations (state entity statutes, federal

and state securities laws)

2

UCC Article 9 issues

•Description/indication of collateraloFunctional v. UCC type

•Choice of law•Perfection methods•Control/possession priority•Protected purchaser/free of adverse claims•Restrictions on assignment•Remedies and duties

oArticle 9 and non-UCC law

3

Relation to Article 9

•Article 8 determines what is asecurity/investment property for purposes ofArticle 9 [UCC §§ 8-102, 8-103]

•Treatment under securities laws or other non-UCC law does not determine whether anequity interest is a security/investmentproperty for UCC purposesoCharacterization under Article 8 doesn’t

determine for non-UCC purposes [UCC § 8-102(d)]

4

Benefits of investment property andapplication of Article 8

•‘Protected purchaser’ – free of adverse claims[UCC § 8-303]

•Security entitlement – not subject to adverseclaim [UCC §§ 8-502, 8-510]

•Perfection by possession or control [UCC §§ 9-313, 9-314]oPossession ‘super priority’ [UCC § 9-328(5)]oControl ‘super priority’ [UCC §§ 9-328(1),

(3)]

5

Meaning of ‘security’

• ‘Security’ – share or similar equity interest issued by:o Corporationo Business trust/statutory trusto ‘Similar entity’

• Not a ‘security’ (unless, see below):o Partnership interesto LLC interest

• Exceptions to exclusion of LLC and partnership interests:o Override exclusion of LLC and partnership interests by

‘opting in’ [UCC § 8-103(c)]o Held in a securities account as a ‘financial asset’o Registered investment company / publicly traded

6

Categories of investment property

•Certificated securitiesoEvidenced by a certificate under non-UCC

law•Uncertificated securities

oBook-entry on issuer records•Security entitlement

o‘Securities account’ is collection of securityentitlements

oHeld at a ‘securities intermediary’oDifferent from an uncertificated security

7

Opting in to Article 8

•UCC § 8-103(c) – LLC or partnershipinterest is a security if ‘its termsexpressly provide that it is a securitygoverned by this Article [8]’oLegend on certificate?

•Certificate doesn’t make interest anArticle 8 security

8

Prevent opt out

•Proxy to vote on Article 8 matters

•Secured party voting/consent rights

•Issuer agreement not to modify optin and certification of interestsprovisions

9

How to perfect

•LLC or partnership interest – if not a‘security’, then is a ‘generalintangible’oOnly filing (even if interest iscertificated)

•If ‘investment property’oFilingoPossession (‘delivery’) if certificatedoControl

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Effect of using different perfectionmethods

•Priority

•Protected purchaser/free ofadverse claims

•Issuer may not be obligated to dealwith secured party absent control[UCC §§ 9-607(e), 9-607 (Comment6), 9-406, 9-408, 8-204, 8-401]

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Non-UCC issues

•Distributions [UCC § 8-207, state entitystatutes, entity organizational documents]

•Sale of interest [UCC § 8-401, state entitystatutes, entity organizational documents]oRestrictions on assignment, admission of

new owner?oIn re Weiss (transfer restrictions upheld, no

security interest created)• Intercreditor agreement (e.g., mezzanine

financing)

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Avoiding adverse claims

• ‘Protected purchaser’ [UCC § 8-303(a)]o Gives value [UCC § 1-201(44), R 1-204]o Does not have notice of any adverse claim to the

security [UCC §§ 8-102(a)(1), 8-105]o Obtains control of the security [UCC § 8-106]o Applies to buyers and secured parties

[UCC §§ 1-201(32) & (33), R1-201(a)(29) & (30), 8-116]

• Substantially equivalent for securities accounts/securityentitlements relating to the adverse claim [UCC §§ 8-502, 8-510]

• Takes free v. priority [UCC § 9-331, Comment 2]

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Restrictions on assignment

• UCC §§ 9-406 and 9-408 negate certain restrictions onassignment

o Do not apply to investment property

o May not negate all restrictions (e.g. private placement,‘40 Act, tax, qualified transferee in mezz financing)

• Do UCC §§ 9-406/9-408 apply to membership interests?

o Apply to agreement between ‘account debtor’ and theassignor – does LLC or partnership agreement qualify?

o Non-uniform: Delaware, Virginia, Kentucky, Texas, NY

• Choice of law [UCC §§ 9-401, Comment 3; 1-105(1) andR 1-301(a); 1-102, Comment 2, R 1-302, Comment 3]

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Getting around the problem?

• Hold membership interest in a securities account?• Security interest in distributions and other

proceeds (and not the underlying interest)?o When does security interest attach? [UCC §§ 9-

408, Comments 3, 7, and 8, 9-322, Comment 6, 6to 9-203, Comments 2 and 6]

o Bankruptcy Code § 552 cut off?o Does person with priority in security have

priority in proceeds? [UCC § 9-322(e)]• Waiver by entity and other owners?

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Opinion letters

• Creation/attachment• Perfection

o By filingo By possession (delivery)o By control

• Priorityo Control priorityo Protected purchaser or ‘free of adverse claims’

• TriBar Report on secondary sales and UCC Article 8issues will be in May 2011 issue of The Business Lawyer

• Choice of law

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Remedies

•SP may sell, lease, license or otherwisedispose of any or all of its collateral [UCC§ 9-610]

•Every aspect of disposition must becommercially reasonable

•‘Commercially reasonable’ requirementis non-waivable [UCC § 9-602(7)]

•Possible state remedy limitations(Olmstead)

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Commercial reasonableness

•Case-by-case analysis•Efforts to find a buyer

oGeneral and specialized advertising /solicitations

oContent of advertisingoUse of brokers, dealers, websites,

auctioneer•Location of sale, other access for bidders•Restrictions on bidders•Provision of information about the collateral

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Remedies by agreement

• Parties may determine by agreement standardsmeasuring fulfillment of:o Rights of debtor or obligor and duties of SP under

Part 6 (even if UCC § 9-602 provides provisioncannot be waived or varied by agreement) [UCC §9-603(a)]

o Performance of secured party’s obligations of goodfaith, diligence, reasonableness and care [UCC §§1-102(3), R 1-302(b)]

o Standard cannot be ‘manifestly unreasonable’• Agreement may not bind all with the right to seek

remedies for SP failure to comply with Article 9requirements [UCC § 9-625]

19

Private dispositions

•Private dispositions are encouraged [UCC § 9-610, Comment 2]oAssumption is that they frequently will

result in higher realization on the collateralfor all concerned

•Vornado - debtor raised objection to publicsale (at which secured party was thepurchaser) based on this commentoCourt held that excluding SP as a bidder

would not likely improve the price obtainedand SP could not bid at private sale

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Can the secured party buy?

• Secured party may purchase collateral [UCC § 9-610(c)]:

o At a public disposition

o At a private disposition only if the collateral is of a kindthat is customarily sold on a recognized market or thesubject of widely distributed standard price quotes

• Prohibition on secured party buying at private sale notlisted in UCC § 9-602 as non-waivable

o UCC § 9-624, Comment 2 (nonwaivable as substantivepurchase by secured party at private sale)

o New Comment coming

• ‘Recognized market’ – narrow definition

21

Public sales

•Meaning [UCC § 9-610, Comment 7]

o Price is determined after the publichas had a meaningful opportunity forcompetitive bidding

o Some form of advertisement orpublic notice must precede the sale

o Public must have access to the sale

22

SEC issues

• Is the collateral a ‘security’ under Federal and statesecurities laws?

o Securities law (not UCC) test

• UCC public sale has to comply with securities laws

o Series of SEC no-action letters sets outprocedures and limits

o Often reflected in security agreement provisions

• State securities laws

• Other considerations (‘40 Act, ‘34 Act, Reg S, resaleby foreclosure purchaser)

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Foreclosure strategy and trap

OwnerGuaranty +

security interest inequity in Borrower

Ownership

Borrower

Securityinterest

Secured

party

Paymentobligation

Loan

Foreclosure strategy and trap

Owner

Foreclose onownership interest

Ownership

Borrower

Securityinterest

Secured

party

Paymentobligation

Subrogated tosecurity interest

Subrogated topayment obligation

Foreclosure strategy and trap

Owner

Ownership

BorrowerSecurityinterest

Secured

party

Paymentobligation

Resources

• Burns v. Anderson (4th Cir. 2004) (unpublished)http://pacer.ca4.uscourts.gov/opinion.pdf/032162.U.pdf

• Ford & Vlahos v. ITT Commercial Finance Corp., 8Cal. 4th 1220, 885 P.2d 877 (1994)

• Vornado PS, L.L.C. v. Primestone InvestmentPartners, L.P., 821 A.2d 296, 49 UCC Rep.Serv.2d1348 (Del. Ch. 2002)

• In re Weiss, 376 B.R. 867 (Bankr. N.D. Ill. 2007)

• Olmstead, 44 So.3d 76 (Supreme Ct Fla. 2010)

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Resources

• ‘Securities Law and the UCC: When Godzilla Meets Bambi,’ 38 UCC LJ3 (2005)

• ‘It’s a Matter of Collateral: LLCs, Partnerships and the UCC,’ 14Business Law Today 53 (Jan./Feb. 2005)

• ‘Mezzanine Loans – The Vagaries of Membership Interests as Collateral’(N. Powell and J. Prendergast) (2010) - available at American Collegeof Commercial Finance Lawyers Inc. (www.accfl.com ) website:

o http://accfl.com/system/datas/25/original/LLC_Mezz_Foreclosure_Article__Master_with_footnotes_2010_.pdf

• ABA Commercial Finance Committee

o http://www.abanet.org/dch/committee.cfm?com=CL190000

• ABA UCC Committee

o http://www.abanet.org/dch/committee.cfm?com=CL710000

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