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Collateral Assignment of an Entity Interest: Economic v. Governance Rights

Posted on September 26, 2012 by Bernstein-Burkley

Bernstein-Burkley, P.C.

In these difficult economic times, debtors have become more creative in proposing additional or substitute sources of collateral to secure a debt or obtain a forbearance or loan modification. As real estate values have plummeted, alternatives have become more attractive, including an assignment of the debtor’s interest in an operating entity with good cash flow.

However, the recent decision of the Pennsylvania Superior Court in Zokaites v. Pittsburgh Irish Pubs, LLC , 962 A.2d 1220 (Pa. Super. 2008), appeal denied 972 A.2d 523 (Pa. 2009), provides food for thought in terms of structuring and drafting a collateral assignment of an interest in a limited liability company or partnership. In Zokaites , a creditor was attempting to enforce its judgment lien by executing upon the debtor’s interest in two limited liability companies (“LLC”) that owned and operated several Pittsburgh area restaurants. The creditor sought a court order to compel the debtor to transfer its ownership interest in the LLCs so those interests could be sold at sheriff’s sale. After much procedural wrangling in both state and bankruptcy court, the case ended up in the Superior Court, which looked to Pennsylvania’s Limited Liability Company Law, 15 Pa.C.S. §8901 et seq . (“LLC Law”), for guidance.

The Superior Court focused on a provision in the LLC Law that prohibits a transferee of an LLC interest from becoming a member or participating in the company’s management without the approval of all other LLC members. The same provision, however, allows a transferee to receive the LLC member’s distributions or other return of capital contributions. Because of this protection of an LLC’s “close-knit structure,” the Superior Court decided that a judgment creditor can secure a debtor’s economic rights to distributions and return of contributions from the LLC, but cannot obtain the debtor’s governance rights to vote and participate in managing the LLC. The Superior Court equated this remedy of obtaining the economic rights in an LLC interest to the “charging order” that is permitted against a partnership interest under Pennsylvania’s Uniform Partnership and Limited Partnership Acts (“Partnership Acts”).

In light of the decision in Zokaites , lenders considering accepting a collateral assignment of an entity interest should keep a few things in mind for due diligence and drafting purposes. First, where a debtor has interests in multiple related entities, have the debtor provide an organizational chart. It is often easier to understand a complex organizational structure from a chart or “tree” than from a description. The chart should show the relationship among the entities and include the names of each entity and the percentage interest the debtor owns. For example, in a recent transaction where several guarantors were proposing to pledge their interests in a variety of LLCs and partnerships that in turn were the general and limited partners of other entities, an organizational chart prepared by the debtor was a crucial tool in pinpointing who owned what and in targeting the collateral.

Second, once you understand what entity interest(s) the debtor owns, it is essential to carefully review a copy of the organizational agreement and any amendments (the LLC Operating Agreement or the Partnership Agreement) for each entity. Key provisions include transfer or assignment rights or restrictions and default and dissolution provisions. If the organizational agreement expressly permits assignment, then the limitations under the LLC Law and the Partnership Acts do not apply 1 . Most likely, however, the LLC or partnership interest will not be assignable without the other members’ or partners’ consent. It is also important to understand whether an assignment will trigger an unwanted result such as a dissolution or default.

Third, once you know what is owned and can be pledged, draft the assignment to specifically identify the entity interest being pledged. Taking into account the ruling in Zokaites , where not all of the LLC members or partners are involved, a pledge of economic rights only is more likely to be enforceable than a collateral assignment that appears to transfer governance and other rights as well. In most instances, the cash flow from the right to receive distributions, profits, and return of capital is the true collateral anyway.

In describing complex or multiple entity interests or owners, consider attaching as exhibits the organizational chart and a table identifying each debtor, the entity, and the percentage interest owned. Include in the body of the assignment representations and warranties by the debtor confirming all of the information on the chart and table as true, complete and correct and that the debtor’s interest has not already been pledged or assigned.

Fourth, since the creditor will not have governance rights, the pledge agreement should also contain covenants to protect the creditor’s right to receive distributions. Such covenants would include prohibiting the debtor from voting to amend the Operating or Partnership Agreement or to dissolve the entity. Another useful provision would be the debtor’s authorization for the LLC or partnership and its officers to recognize and give effect to the collateral assignment by paying distributions directly to the creditor or lender upon demand. Finally, when the assignment is being made by a married individual, if possible have the spouse join in to waive any marital or spousal interest.

Assignment of a debtor’s interest in an LLC or partnership can be a valuable and useful form of collateral. But the creditor should follow the money and remain mindful of the Zokaites decision by taking a pledge of the economic rights and leaving the governance rights alone, unless all of the entity owners consent.

1. Similar to the LLC Law, the Partnership Acts contain provisions that, unless otherwise agreed, the assignee of a partner’s interest does not become a partner or share in partnership liability and cannot exercise a partner’s management, inspection of records, or accounting rights, but has the right to profits. 15 Pa.C.S. §8344(a) and 15 Pa.C.S. §8562(a)(2)and (c).

Assignment of Rights Example: Everything You Need to Know

A good assignment of rights example is if a party was entitled to collect $100 for painting, they can transfer the right to receive payment to another party. 3 min read

Updated October 28, 2020:

A good assignment of rights example is if a party was entitled to collect $100 for painting, they can transfer the right to receive payment to another party. An assignment contract takes place when one party to an existing contract (the assignor) transfers the contract's obligations and benefits to another party (the assignee). 

What Is an Assignment Agreement?

A contract assignment occurs when a party assigns its contractual rights to a third party. The benefit the issuing party would have received from the contract is now assigned to the third party. The party appointing their rights is referred to as the assignor, while the party obtaining the rights is the assignee. Essentially, the assignor prefers that the assignee reverses roles and assumes the contractual rights and obligations as stated in the contract.

Before this can occur, all parties to the original contract must be notified. The party creating the assignment usually does so with the motive of profit. Generally, assignments are perfectly legal. In specific situations, they may be illegal when they have been prohibited by a clause in the contract or prohibited by law.

Use of an Assignment Agreement

In situations where you don't have the staff to perform a task, it may be necessary to outsource the work to another party. Assignment agreements are created to formally transfer the contractual responsibilities and rights to a third party, while also making sure to preserve your own obligations and legal rights. The use of an assignment agreement is appropriate when you're:

A contract assignment may also be referred to as an assignment agreement. An assignment agreement should include the:

Parties Involved in a Contract Assignment

Generally, a contract assignment is made up of the following parties:

The steps in an assignment are:

How Is a Contract Assignment Created?

In most cases, it is not necessary to notify the obligor of an assignment. The assignor needs to definitively establish their intent in assigning rights to the assignee. Generally speaking, assignment contracts can be both written and oral. However, it is recommended that the contract is written. 

It is important that the contract is written in the present tense. If any past or future tense is used, it will make the contract legally nonbinding.

How Assignments Work

The specific language used in the contract will determine how the assignment plays out. For example , one contract may prohibit an assignment, while another contract may require that all parties involved agree to it before proceeding. Remember, an assignment of a contract does not necessarily alleviate an assignor from all liability. Many contracts include an assurance clause guaranteeing performance. In other words, the initial parties to the contract guarantee the assignee will achieve the desired goal.

When Assignments Will Not Be Enforced

The following situations indicate when an  assignment of a contract is not enforced:

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ASSIGNMENT OF GOVERNANCE RIGHTS OR FINANCIAL RIGHTS TO MEMBERS Sample Clauses

Related clauses.

Related to ASSIGNMENT OF GOVERNANCE RIGHTS OR FINANCIAL RIGHTS TO MEMBERS

Certain Additional Rights of Lender (VCOC) Notwithstanding anything to the contrary contained in this Agreement, Lender shall have:

Certain Additional Rights In case the Company shall, by dividend or otherwise, declare or make a distribution on its Company Common Stock referred to in Section 13.4(c) or 13.4(d) (including, without limitation, dividends or distributions referred to in the last sentence of Section 13.4(c)), the Holders of the Debentures, upon the conversion thereof subsequent to the close of business on the date fixed for the determination of stockholders entitled to receive such distribution and prior to the effectiveness of the Conversion Price adjustment in respect of such distribution, shall also be entitled to receive for each share of Company Common Stock into which the Debentures are converted, the portion of the shares of Company Common Stock, rights, warrants, evidences of indebtedness, shares of capital stock, cash and assets so distributed applicable to one share of Company Common Stock; provided, however, that, at the election of the Company (whose election shall be evidenced by a resolution of the Board of Directors) with respect to all Holders so converting, the Company may, in lieu of distributing to such Holder any portion of such distribution not consisting of cash or securities of the Company, pay such Holder an amount in cash equal to the fair market value thereof (as determined in good faith by the Board of Directors, whose determination shall be conclusive and described in a resolution of the Board of Directors). If any conversion of Debentures described in the immediately preceding sentence occurs prior to the payment date for a distribution to holders of Company Common Stock which the Holder of Debentures so converted is entitled to receive in accordance with the immediately preceding sentence, the Company may elect (such election to be evidenced by a resolution of the Board of Directors) to distribute to such Holder a due xxxx for the shares of Company Common Stock, rights, warrants, evidences of indebtedness, shares of capital stock, cash or assets to which such Holder is so entitled, provided, that such due xxxx (i) meets any applicable requirements of the principal national securities exchange or other market on which Company Common Stock is then traded and (ii) requires payment or delivery of such shares of Company Common Stock, rights, warrants, evidences of indebtedness, shares of capital stock, cash or assets no later than the date of payment or delivery thereof to holders of shares of Company Common Stock receiving such distribution.

Preservation of Purchase Rights Upon Merger, Consolidation, etc In case of any consolidation of the Company with or merger of the Company into another corporation or in case of any sale, transfer or lease to another corporation of all or substantially all of the property of the Company, the Company or such successor or purchasing corporation, as the case may be, shall execute with the Warrantholders an agreement that the Warrantholders shall have the right thereafter upon payment of the Exercise Price in effect immediately prior to such action to purchase upon exercise of this Warrant the kind and amount of shares and other securities and property which such holder would have owned or have been entitled to receive after the happening of such consolidation, merger, sale, transfer or lease had this Warrant been exercised immediately prior to such action; PROVIDED, HOWEVER, that no adjustment in respect of cash dividends, interest or other income on or from such shares or other securities and property shall be made during the term of this Warrant or upon the exercise of this Warrant. Such agreement shall provide for adjustments, which shall be as nearly equivalent as practicable to the adjustments provided for in this Section 5. The provisions of this Section 5 shall apply similarly to successive consolidations, mergers, sales, transfers or leases.

CONFLICTS WITH TRUST’S GOVERNING DOCUMENTS AND APPLICABLE LAWS Nothing herein contained shall be deemed to require the Trust or the Fund to take any action contrary to the Trust’s Agreement and Declaration of Trust, By-Laws, or any applicable statute or regulation, or to relieve or deprive the Board of Trustees of its responsibility for and control of the conduct of the affairs of the Trust and Fund. In this connection, the Advisor acknowledges that the Trustees retain ultimate plenary authority over the Fund and may take any and all actions necessary and reasonable to protect the interests of shareholders.

PRESERVATION OF PURCHASE RIGHTS UPON RECLASSIFICATION, CONSOLIDATION, ETC In case of any consolidation of the Company with or merger of the Company into another corporation, such successor corporation shall execute with the Holder a Warrant providing that such Holder shall have the right thereafter upon payment of the Warrant Price in effect immediately prior to such action to purchase upon exercise of this Warrant the kind and amount of shares and/or other consideration which he would have owned or have bean entitled to receive after the happening of such consolidation, merger, sale or conveyance had such Warrant been exercised immediately prior to such action. The Company shall mail by first class mail, postage prepaid, to the Holder, notice of the execution of any such agreement. Such Warrant shall provide for adjustments, which shall be as nearly equivalent as may be practicable to the adjustments provided for in Section 10 hereof. The provisions of this subsection 10(c) shall similarly apply to successive consolidations, mergers, sales or conveyances.

ADDITIONAL RIGHTS OF HOLDERS In addition to the rights provided to Holders of Notes under the Indenture, Holders will have the rights set forth in the Registration Rights Agreement dated as of September 2, 2020, among the Company, the Initial Guarantor and the other parties named on the signature pages thereof or, in the case of Additional Notes (if applicable), Holders of such Additional Notes will have the rights set forth in one or more registration rights agreements, if any, among the Company, the Initial Guarantor and the other parties thereto, relating to rights given by the Company and the Guarantors to the purchasers of such Additional Notes. The Holders shall be entitled to receive certain Additional Interest in the event such Exchange Offer provided for therein is not consummated or the Notes are not offered for resale and upon certain other conditions, all pursuant to and in accordance with the terms of the Registration Rights Agreement.2

No Inconsistent Agreements; Additional Rights Neither the Company nor any of its subsidiaries shall hereafter enter into, and neither the Company nor any of its subsidiaries is currently a party to, any agreement with respect to its securities that is inconsistent with the rights granted to the Holders by this Agreement. Neither the Company nor any of its subsidiaries shall enter into any agreement granting registration or similar rights to any Person, and the Company hereby represents and warrants that, as of the date hereof, no registration or similar rights have been granted to any other Person other than pursuant to this Agreement.

Action upon Instructions; Certain Rights and Limitations (a) Subject to the terms of Sections 2.13, 4.03, 4.04(a) and (b), 4.08, 5.01 and 5.03 hereof, upon the written instructions at any time and from time to time of a Majority in Interest of Note Holders, the Mortgagee shall, subject to the terms of this Section 5.02, take such of the following actions as may be specified in such instructions: (i) give such notice or direction or exercise such right, remedy or power hereunder as shall be specified in such instructions; (ii) give such notice or direction or exercise such right, remedy or power under the Lease, the Participation Agreement, the Purchase Agreement, the Purchase Agreement Assignment, or any other part of the Trust Indenture Estate as shall be specified in such instructions; and (iii) approve as satisfactory to the Mortgagee all matters required by the terms of the Lease to be satisfactory to the Owner Trustee, it being understood that without the written instructions of a Majority in Interest of Note Holders, the Mortgagee shall not approve any such matter as satisfactory to the Mortgagee; provided, that anything contained in this Trust Indenture, the Lease or the other Operative Agreements to the contrary notwithstanding, but subject to the next paragraph hereof:

Obligations with Respect to Transfers and Exchanges of Securities (i) To permit registrations of transfers and exchanges, the Issuer shall execute and the Trustee shall authenticate, Definitive Securities and Global Securities at the Registrar’s request.

Liability for Failure to Stop Payment of Preauthorized Transfers If you order us to stop payment of a preauthorized transfer three (3) business days or more before the transfer is scheduled and we do not do so, we will be liable for your losses or damages.

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Assignment is a legal term whereby an individual, the “assignor,” transfers rights, property, or other benefits to another known as the “ assignee .”   This concept is used in both contract and property law.  The term can refer to either the act of transfer or the rights /property/benefits being transferred.

Contract Law   

Under contract law, assignment of a contract is both: (1) an assignment of rights; and (2) a delegation of duties , in the absence of evidence otherwise.  For example, if A contracts with B to teach B guitar for $50, A can assign this contract to C.  That is, this assignment is both: (1) an assignment of A’s rights under the contract to the $50; and (2) a delegation of A’s duty to teach guitar to C.  In this example, A is both the “assignor” and the “delegee” who d elegates the duties to another (C), C is known as the “ obligor ” who must perform the obligations to the assignee , and B is the “ assignee ” who is owed duties and is liable to the “ obligor ”.

(1) Assignment of Rights/Duties Under Contract Law

There are a few notable rules regarding assignments under contract law.  First, if an individual has not yet secured the contract to perform duties to another, he/she cannot assign his/her future right to an assignee .  That is, if A has not yet contracted with B to teach B guitar, A cannot assign his/her rights to C.  Second, rights cannot be assigned when they materially change the obligor ’s duty and rights.  Third, the obligor can sue the assignee directly if the assignee does not pay him/her.  Following the previous example, this means that C ( obligor ) can sue B ( assignee ) if C teaches guitar to B, but B does not pay C $50 in return.

            (2) Delegation of Duties

If the promised performance requires a rare genius or skill, then the delegee cannot delegate it to the obligor.  It can only be delegated if the promised performance is more commonplace.  Further, an obligee can sue if the assignee does not perform.  However, the delegee is secondarily liable unless there has been an express release of the delegee.  That is, if B does want C to teach guitar but C refuses to, then B can sue C.  If C still refuses to perform, then B can compel A to fulfill the duties under secondary liability.

Lastly, a related concept is novation , which is when a new obligor substitutes and releases an old obligor.  If novation occurs, then the original obligor’s duties are wiped out. However, novation requires an original obligee’s consent .  

Property Law

Under property law, assignment typically arises in landlord-tenant situations.  For example, A might be renting from landlord B but wants to another party (C) to take over the property.   In this scenario, A might be able to choose between assigning and subleasing the property to C.  If assigning , A would be giving C the entire balance of the term, with no reversion to anyone whereas if subleasing , A would be giving C for a limited period of the remaining term.  Significantly, under assignment C would have privity of estate with the landlord while under a sublease, C would not. 

[Last updated in May of 2020 by the Wex Definitions Team ]

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COMMENTS

  1. 41 U.S. Code § 6305

    In subsection (b)(8), the words “is not liable to make any refund to the Federal Government” are substituted for “no [liability] . . . shall create or impose any liability on the part of the assignee to make restitution, refund, or repayment to the United States of any amount heretofore since July 1, 1950, or hereafter received under the ...

  2. ASSIGNMENT OF GOVERNANCE RIGHTS Sample Clauses

    ASSIGNMENT OF GOVERNANCE RIGHTS. Effective upon its dissolution of the Partnership pursuant to the Second Amendment, the Partnership hereby assigns to the Representative Class A Limited Partner and th...

  3. Collateral Assignment Of An Entity Interest

    If the organizational agreement expressly permits assignment, then the limitations under the LLC Law and the Partnership Acts do not apply 1. Most likely, however, the LLC or partnership interest will not be assignable without the other members’ or partners’ consent.

  4. Assignment of Rights Example: Everything You Need to Know

    Assignor: The party that is the initial beneficiary of the benefits or rights. They are responsible for making the assignment. In other words, they will be handing over the rights they were initially going to receive. Assignee: The party that will be accepting the benefits and rights from the assignor. A transfer may have multiple assignees.

  5. ASSIGNMENT OF GOVERNANCE RIGHTS OR FINANCIAL RIGHTS TO

    ASSIGNMENT OF GOVERNANCE RIGHTS OR Subject to Section 9.2herein, any Member desiring to assign such Member's Governance Rights or Financial Rightsshall notify the Board of Managersof such desire.

  6. assignment

    Assignment is a legal term whereby an individual, the “assignor,” transfers rights, property, or other benefits to another known as the “ assignee .”. This concept is used in both contract and property law. The term can refer to either the act of transfer or the rights /property/benefits being transferred.