Receiver for LLC Can be Bound by Operating Agreement’s Arbitration Provisions
Courts often appoint receivers to manage the affairs of LLCs when the internal management is conflicted or broken. General equity receivers (as opposed to more limited receiverships such as deed of trust receivers) enjoy broad powers and essentially “step into the shoes” of the entity’s management. A receiver is an “agent of the court” and has substantial discretion to carry out the duties set forth in the appointment order.
In a recent opinion by the federal Ninth Circuit Court of Appeals — Winkler v. McCloskey — the court evaluated whether a court-appointed receiver for an LLC, who initiated litigation on the LLC’s behalf against certain LLC members, could be bound by the Operating Agreement’s arbitration provisions.
Facts: LLC serves as vehicle for Ponzi scheme; court appoints receiver to pursue recovery from certain enriched LLC members
Ralph Iannelli operated a Ponzi scheme through various related equipment leasing entities, including a corporation and two LLCs. In 2018, the Securities and Exchange Commission (SEC) filed an enforcement action against the corporation, alleging that Iannelli — a securities fraud repeat offender — raised $80 million from seventy investors “based on false and misleading representations.”
The district court appointed Geoff Winkler as the Receiver for the related entities and authorized him to undertake disgorgement efforts against the “net winner investors” — i.e., investors who were paid more than they invested in the Ponzi scheme. The Receiver sued a group of those investors, including Thomas McCloskey and several others, seeking avoidance and recovery of the fraudulent transfers pursuant to California’s Uniform Voidable Transactions Act (formerly known as, and erroneously referred to in the court’s opinion as, the Uniform Fraudulent Transfer Act).
The investor defendants filed a motion to compel arbitration based on arbitration provisions in the Operating Agreement for one of the LLCs.
District Court: motion to compel arbitration denied
The district court denied the investor defendants’ motion to compel arbitration, concluding the Receiver was not bound by the Operating Agreement’s arbitration provisions.
The court relied on a prior opinion by the Ninth Circuit holding that a bankruptcy trustee was not bound by arbitration provisions while pursuing an action to avoid fraudulent transfers by debtors who were Ponzi scheme operators.
Ninth Circuit: reversed; receiver can be bound by entity’s arbitration agreements
The Ninth Circuit reversed the district court’s decision.
The court held that its prior opinion addressing the powers of bankruptcy trustees did not “provide persuasive authority here” because of the differences between bankruptcy trustees and receivers. The bankruptcy trustee in the prior case operated under a specific provision of the bankruptcy code allowing the trustee to bring claims that might be brought by an outside creditor holding an unsecured claim. In those types of claims, “the trustee stands in the shoes of the creditors.” Because the creditors did not sign the arbitration agreements, arbitration was not required.
But, the court held, “a bankruptcy trustee’s standing differs from a receiver’s.” While a bankruptcy trustee acts pursuant to the bankruptcy code, “a receiver’s authority derives from the court’s equitable power” and the court’s appointment order. As explained by the court: “Thus, a receiver has standing to pursue a fraudulent transfer claim because the receiver is acting on behalf of the receivership entity, seeking to claw back transfers that the perpetrator of the scheme fraudulently made to the net winners.” Most importantly, the court pointed out, “the Receiver stands in the shoes of the receivership entities, not in the shoes of the creditors.”
As such, the Receiver could be bound by the receivership entities’ agreements requiring arbitration. The court remanded the case to the district court to address additional factual issues that would determine whether or not the Receiver was bound by the arbitration provisions in this case. (For example, there were factual disputes regarding whether the Receiver’s claims were within the scope of the specific language of the arbitration provisions, and whether the investor defendants were signatories to the arbitration provisions.)
Lesson
Under the holding of Winkler v. McCloskey, a court-appointed receiver for an LLC can be bound by the arbitration provisions in the LLC’s Operating Agreement.