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      DATC            U

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         IN THE SUPREME COURT OF THE STATE OF WASHINGTON




 NORTHWEST WHOLESALE, INC., a                  )
 Washington corporation,                       )    No. 90891-5
                                               )
                       Plaintiff,              )
                                               )
          v.                                   )
                                               )
 PAC ORGANIC FRUIT, LLC, a Washington )
 limited liability company; GREG HOLZMAN, )
 INC., a foreign corporation authorized to do  )
 business in the State of Washington; and      )
 HAROLD OSTENSON and SHIRLEY                   )
 OSTENSON,                                     )
                                               )
                        Defendants,            )    EnBanc
                                               )
 HAROLD OSTENSON and SHIRLEY                   )
 OSTENSON, on behalfofPAC ORGANIC              )
 FRUIT, LLC, a Washington limited liability    )
 company,                                      )
                                               )
                        Petitioners,           )
                                                )
          v.                                    )
                                                )
  GREG HOLZMAN, an individual; TOTAL            )
  ORGANIC, LLC, a Washington limited            )
  liability company; and GREG HOLZMAN,          )
  INC., a foreign corporation authorized to do  )
  business in the State of Washington,          )
                                                )
                        Respondents.            )   Filed    SEP 1 0 2015
No. 90891-5




        MADSEN, C.J.-This case concerns whether a 'debtor who has filed a voluntary

bankruptcy petition may maintain a derivative action on behalf of a limited liability

company (LLC), of which the debtor was a former member. The primary inquiry

addresses the interplay of federal bankruptcy law and portions of the Washington Limited

Liability Company Act (WALLCA), chapter 25.15 RCW, and whether the state

provisions are superseded under the circumstances of this case; specifically, whether 11

U.S.C. §§ 541 or 365 preempt RCW 25.15.130(l)(d). 1 We hold that the dissociation

provision found in RCW 25.15. 13 0( 1)(d) is not preempted by federal bankruptcy law and

affirm the dismissal of the former LLC member's derivative claim under the facts of this

case.

                                           FACTS

        Washington orchardists Harold and Shirley Ostenson (collectively Ostenson) and

California organic fruit broker Greg Holzman (d/b/a Greg Holzman, Inc. (GHI)) formed

Pac Organic Fruit LLC (Pac-0) in 1998. GHI held the majority interest and management

responsibilities under the LLC' s operating agreement. Ostenson was required to rent his

local Washington storage and packing facility to Pac-0, to run that facility, and to obtain

and pay a loan to improve that facility. The business operated from 1998 through 2004

but collapsed in 2005. During 2005, Pac-0 defaulted on its operating line of credit and

1
 The legislature amended the WALLCA in May 2015, repealing the provisions discussed herein
and reissuing them in a revised but substantively comparable form relevant to the present matter
effective January 1, 2016. See LAWS OF 2015, ch. 188. All references to the WALLCA (ch.
25.15 RCW) in this opinion are to the version ofthat act in effect prior to the January 1, 2016
effective date of the noted amendment.
                                               2
No. 90891-5


lease payments, Holzman fired Ostenson, and the bank foreclosed on the packing facility.

Thereafter, Holzman, acting as Pac-O's agent, executed a demand promissory note in

favor of GHI and transferred Pac-0' s assets to GHI to satisfy the note.

       On January 9, 2007, Ostenson filed a voluntary chapter 11 bankruptcy petition. In

May 2007, a creditor ofPac-0, Northwest Wholesale Inc., filed the present suit against

Pac-0, Ostenson, and GHI, alleging fraudulent conveyance from Pac-0 to GHI. In

response, Ostenson filed cross claims and/or third party claims against Pac-0, Holzman,

GHI, and Total Organic LLC (another Holzman company). Ostenson's claims against

Holzman and his companies (collectively Holzman defendants or HDs) were as a

derivative action on behalf ofPac-0.

       On January 24, 2011, the trial court dismissed Northwest Wholesale's claims

following settlement of same. Thereafter, the only remaining claims were Ostenson's

responsive claims against Pac-0 (seven counts) and his derivative claim (count VIII)

against HDs. Trial commenced on July 11, 2011. On July 13, after Ostenson rested,

HDs moved to dismiss count VIII under CR 41 (b )(3). l-IDs argued that under the

WALLCA, ( 1) a plaintiff asserting a derivative action must be a member of the LLC (see

RCW 25.15.130(1)(d), .370, .375), (2) when Ostenson filed his bankruptcy petition he

was dissociated as a member of the LLC (and thus had only the rights of an assignee, i.e.

right to share in profits, but no management rights) (see RCW 25.15.130(1)(d)(ii),

.250(1)-(2)), and: (3) as Ostenson had been dissociated from membership in Pac-0 by

filing bankruptcy, he lacked authority (standing) to bring a derivative action on behalf of



                                              3
No. 90891-5


Pac-0. Ostenson answered the motion arguing that HDs had consented to the derivative

action via a stipulation that was previously entered in the Ostenson's bankruptcy

proceeding. 2

       The trial court took the matter under advisement and directed HDs to go forward

and present their evidence. HDs presented witnesses over the remainder of that day

(July 13) and the next day but did not finish their testimony. The trial court then

continued the matter several times. Finally on September 7, 2012, following additional

briefing, the trial court granted HDs' CR 41 motion. In its October 3, 2012 written

findings and conclusions, the trial court (1) rejected Ostenson's contention that HDs had

waived their CR 41 motion by putting on evidence, (2) rejected Ostenson's contention

that HDs had consented to the derivative action in the stipulation in Ostenson's

bankruptcy proceeding, and (3) ruled that Ostenson relinquished membership in Pac-0

with his bankruptcy filing.

       On October 15, 2012 Ostenson filed a motion for reconsideration, arguing for the

first time that federal bankruptcy law preempts W ALLCA regarding dissociation of LLC

members upon filing bankruptcy. The trial court denied Ostenson's motion for


2
  In making this argument, Ostenson relied on the WALLCA, arguing that the consent exception
to the dissociation provision found in RCW 25.15.13 0( 1)(d) applied to bar HDs' challenge to
Ostenson's standing to bring the derivative action. Ostenson also argued that "in addition to the
RCW [i.e., RCW 25.15.130(1)(d), which provided a consent exception to the dissociation
provision], Your Honor, they [(HDs)] should be judicially and equitably estopped" from
challenging Ostenson's standing to bring a derivative action. 3 Verbatim Report of Proceeding
at 601. Ostenson reasserted those contentions on appeal (consent, judicial estoppel, collateral
estoppel, and res judicata), but the Court of Appeals rejected each contention and affirmed the
trial court. See Nw. Wholesale, Inc. v. PAC Organic Fruit, LLC, 183 Wn. App. 459,490-93, 334
P.3d 63 (2014), review granted, 182 Wn.2d 1009, 343 P.3d 759 (2015). Ostenson abandoned the
issues of consent, judicial estoppel, collateral estoppel, and res judicata in his petition for review.
                                                   4
No. 90891-5


reconsideration on January 23, 2013. Ostenson appealed, and Division Three affirmed,

holding that HDs did not waive their CR 41 motion to dismiss, HDs did not consent to

Ostenson bringing a derivative action, and federal bankruptcy law governing bankruptcy

estates and executory contracts did not preempt WALLCA's dissociation statute. Nw.

Wholesale, Inc. v. PAC Organic Fruit, LLC, 183 Wn. App. 459, 474-89, 334 P.3d 63

(2014), review granted, 182 Wn.2d 1009, 343 P.3d 759 (2015). Ostenson sought and was

granted review in this court on only two issues: waiver and preemption.

                                          ANALYSIS

       Waiver

       Ostenson argues that HDs waived their right to seek dismissal of his derivative

claim, based on Ostenson's lack of standing, by presenting defense evidence after the

court took HDs' CR 41 motion to dismiss under advisement. 3 Ostenson contends that the

trial court's granting HDs' motion and the Court of Appeals affirmance of same are at

odds with Hector v. Martin, 51 Wn.2d 707, 321 P.2d 555 (1958). That is incorrect.

Hector stands for the proposition that a defendant waives the right to challenge the

sufficiency of the plaintiffs evidence alone by presenting evidence in defense, thereby

3
 CR 41(b)(3) provides:
      After the plaintiff, in an action tried by the court without a jury, has completed the
      presentation of his evidence, the defendant, without waiving his right to offer
      evidence in the event the motion is not granted, may move for a dismissal on the
      ground that upon the facts and the law the plaintiff has shown no right to relief.
      The court as trier of the facts may then determine them and render judgment
      against the plaintiff or may decline to render any judgment until the close of all
      the evidence. If the court renders judgment on the merits against the plaintiff, the
      court shall make findings as provided in rule 52( a). Unless the court in its order
      for dismissal otherwise specifies, a dismissal under this subsection . . . operates
      as an adjudication upon the merits.
                                                 5
No. 90891-5


allowing the court to consider the motion in light of all of the evidence. !d. at 709-10

("[T]he failure of the trial court to rule on such motion before introduction of proof by a

defendant, is tantamount to a denial of the motion. . . . Therefore, this case must be

viewed in the light of all the evidence."). Here, the question in the motion to dismiss did

not turn on the sufficiency of the evidence; the salient facts, the dates of Ostenson's

bankruptcy filing and the subsequent filing of his derivative claim, were not in dispute.

The motion turned on a legal question-Ostenson's standing to bring the derivative claim

in light ofRCW 25.15.130(1)(d) (discussed below). And even if sufficiency ofthe

evidence bore on any pertinent question, nothing indicates that the trial court limited

itself to considering only Ostenson's evidence.

       Further, Hector does not address the circumstance here, where the trial court

directed HDs to "go forward" and put on their evidence. 3 Verbatim Report of

Proceeding at 603. Under these circumstances, HDs did not waive their CR 41 motion as

Ostenson contends. The trial court did not err in granting the motion to dismiss under

these circumstances. 4




4
 Cf State V. Eide, 2 Wn. App. 789, 791,470 P.2d 220 (1970) (where appellant, at the end ofthe
state's case, started to move to dismiss, but was told by the trial judge that he could do so later
without waiving his rights and then testified in his own behalf, "defendant had a right to rely
upon the assurance of the trial court that he could introduce evidence without waiving his
challenge to the sufficiency of the evidence at the close of the state's case").
                                                 6
No. 90891-5


      Preemption 5

       Ostenson repeats the argument he made below that "[b]oth 11 U.S.C. § 541(c)(1)

and 11 U.S.C. § 365(e)(1) invalidate or render unenforceable ipso facto bankruptcy

clauses." Appellant's Opening Br. at 28; Pet. for Review at 12. 6 We begin by noting the

strong presumption against preemption. While the supremacy clause of the United States

Constitution provides that United States law is supreme, notwithstanding any contrary

state law, see Hue v. Farmboy Spray Co., 127 Wn.2d 67, 78, 896 P.2d 682 (1995) (citing

U.S. CONST. art VI, cl. 2), "any consideration of preemption issues 'start[s] with the

assumption that the historic police powers of the States [are] not to be superseded by ...

Federal Act unless that [is] the clear and manifest purpose of Congress."' (Alterations in

original) (quoting Cipollone v. Liggett Grp., Inc., 505 U.S. 504, 516, 112 S. Ct. 2608, 120

L. Ed. 2d 407 (1992).). Accordingly, this court applies "a 'strong presumption against

finding preemption [of State law] in an ambiguous case. . . . State laws are not

superseded by federal law unless that is the clear and manifest purpose of Congress."' !d.

5
  HDs argued in part to both the trial court and to the Court of Appeals that Ostenson's
preemption assertion, which was first raised in his motion for reconsideration, was untimely.
The trial court denied Ostenson's motion for reconsideration. On appeal, Division Three
rejected HDs' reasserted timeliness argument, stating, '"By bringing a motion for
reconsideration under CR 59, a party may preserve an issue for appeal that is closely related to a
position previously asserted and does not depend upon new facts."' Nw. Wholesale, 183 Wn.
App. at 480 (quoting River House Dev. Inc. v. Integrus Architecture, PS, 167 Wn. App. 221,231,
272 P.3d 289 (2012)). HDs have not raised the timeliness issue in this court, and we express no
opinion on the Court of Appeals discussion of timeliness and issue preservation.
6
  Ostenson's arguments regarding the applicability of§ 365 have been a moving target. To the
Court of Appeals and in his petition for review, Ostenson argued that§ 365(e)(1) prohibitions
applied to the LLC operating agreement here as an executory contract. In his reply in support of
his petition, he stated that the operating agreement was not an executory contract and that§ 365
did not apply. But in his supplemental brief, he argues that§ 365(e)(1) does apply and raises two
new arguments contending that§ 365(e)(2)'s exception to§ 365(e)(1)'s ipso facto clause
prohibitions (discussed below) does not apply here.
                                                7
No. 90891-5


(alterations in original) (quoting Progressive Animal Welfare Soc'y v. Univ. of Wash.,

125 Wn.2d 243, 265, 884 P.2d 592 (1994)). Even ifthere is an express preemption

clause, this court will give it "a 'fair but narrow reading."' Id. at 79 (quoting Cipollone,

505 U.S. at 524).- With this presumption in mind, we turn to the statutes at issue.

       State Law (WALLCA) Provisions

       RCW 25.15.375 provides:

       In a derivative action, the plaintiff must be a member at the time of
       bringing the action and:
              (1) At the time of the transaction of which the plaintiff complains; or
              (2) The plaintiffs status as a member had devolved upon him or her
       by operation of law or pursuant to the terms of a limited liability company
       agreement from a person who was a member at the time of the transaction.

(Emphasis added.f Under RCW 25.15.130(1)(d)(ii), a member of a limited liability

company loses his or her membership upon the filing of bankruptcy. The statute

provides:

       (1) A person ceases to be a member of a limited liability company, and the
       person or its successor in interest attains the status of an assignee as set
       forth in RCW 25.15.250(2), upon the occurrence of one or more of the
       following events:

             (d) Unless otherwise provided in the limited liability company
       agreement, or with the written consent of all other members at the time, the
       member . .. (ii)files a voluntary petition in bankruptcy.

(Emphasis added.)


7
 See also RCW 25.15.370, which provides:
       A member may bring an action in the superior courts in the right of a limited
       liability company to recover a judgment in its favor if managers or members with
       authority t9 do so have refused to bring the action or if an effort to cause those
       managers or members to bring the action is not likely to succeed.
(Emphasis added.)
                                                8
No. 90891-5


       Thus, under Washington law, Ostenson forfeited any right to bring a derivative

action on behalf ofPac-0 when he petitioned for bankruptcy. The LLC agreement did

not allow continued membership but conversely ended the bankrupt petitioning as a

member in the limited liability company. As an assignee, the dissociated member retains

rights to share in profits but loses any management rights. RCW 25.15 .250(2). 8

Ostenson argues only that the dissolution provision of RCW 25.15.13 0( 1)(d) is

preempted by federal bankruptcy law; to this court he does not otherwise challenge the

provisions or effect of the WALLCA.

       Federal Bankruptcy Law Provisions

       11 U.S.C. § 541 provides in part:

              (a) The commencement of a case under ... this title creates an
       estate. Such estate is comprised of all the following property, wherever
       located and by whomever held:

                      (1) Except as provided in subsections (b)[ 9] and (c)(2)
              of this section, all legal or equitable interests ofthe debtor in
              property as of the commencement of the case.

(Emphasis added.) Section 541 (c)( 1) provides:

       Except as·provided in paragraph (2) of this subsection, an interest of the
       debtor in property becomes property of the estate under subsection (a) (I),

8
  RCW 25.15.250(1) and (2)(a) provide in relevant part, "The assignee of a member's limited
liability company interest shall have no right to participate in the management of the business
and affairs of a limited liability company," and "[a]n assignment entitles the assignee to share in
such profits and losses, to receive such distributions, and to receive such allocation of income,
gain, loss, deduction, or credit or similar item to which the assignor was entitled, to the extent
assigned."
9
  Under§ 541(b)(l), the debtor's bankruptcy estate expressly does not include "any power that
the debtor may exercise solely for the benefit of an entity other than the debtor," which, by
definition, would appear to include a derivative claim, the sole purpose of which is to benefit the
entity.
                                                 9
No. 90891-5


      (a)(2), or (a)(5) of this section notwithstanding any provision in an
      agreement, transfer instrument, or applicable nonbankruptcy law-

                     (A) that restricts or conditions transfer of such interest
              by the debtor; or

                       (B) that is conditioned on the insolvency or financial
              condition of the debtor, on the commencement of a case under
              this title, or on the appointment of or taking possession by a
              trustee in a case under this title or a custodian before such
              commencement, and that effects or gives an option to effect a
              forfeiture, modification, or termination of the debtor's interest
              in property.

(Emphasis added.)

       State Law Determines Property Interest

      As can be seen, a bankruptcy filing triggers the creation of a bankruptcy estate into

which the debtor's property interest devolves. See 11 U.S.C. § 541(a). The threshold
                 i

question, however, of how a debtor's interest is determined turns on application of state

law. See, e.g., Butner v. United States, 440 U.S. 48, 55, 99 S. Ct. 914, 59 L. Ed. 2d 136

(1979) ("Property interests are created and defined by state law."). As the Ninth Circuit

Court of Appeals explained inln re Pettit, 217 F.3d 1072, 1078 (9th Cir. 2000):

              Although the question whether an interest claimed by the debtor is
       "property of the estate" is a federal question to be decided by federal law,
       bankruptcy courts must look to state law to determine whether and to what
       extent the debtor has any legal or equitable interests in property as of the
       commencement of the case.

See also Fisher v. Apostolou, 155 F.3d 876, 880 (7th Cir. 1998) ("The nature of a

debtor's interestin property is determined by state law, but the question whether the




                                              10
No. 90891-5


resulting interest should count as 'property of the estate' for§ 541 purposes is an issue of

federal law." (citation omitted)).

       In re Farmers Markets, Inc., 792 F.2d 1400 (9th Cir. 1986), is instructive. Therein

the Ninth Circuit Court of Appeals reversed a bankruptcy court's decision that the

debtor's estate ~ould receive liquor licenses unhindered by transfer restrictions imposed

by a state   statute~   Id. at 1401-02. In so holding, the court addressed the limits of 11

U.S.C. § 541 and how that provision is to be applied. Noting that the bankruptcy court's

decisions rested upon the misinterpretation of§ 541, the court opined:

               [T]he [bankruptcy] court read§ 541(a)(l) to broaden the definition
       of the property of the debtor's estate. Regardless of§ 541(a)'s scope,
       reliance upon it is misplaced. That provision merely defines what interests
       of the debtor are transferred to the estate. It does not address the threshold
       questions of the existence and scope of the debtor's interest in a given asset.
       Under [federal bankruptcy law], we resolve these questions by reference to
       nonbankruptcy law. Section 541 (a) (I) was thus irrelevant to the inquiry.

Id. at 1402 (emphasis added) (citations omitted). The court made clear that the

'"bankrupt estate, insofar as it includes liquor licenses, has only the limited value of the

licenses encumbered as they may be by the terms of the statutes which create the licenses

and provide the conditions of their transfer."' I d. at 1403 (quoting In re Prof'l Bar Co.,

537 F.2d 339, 340 (9th Cir. 1976)). The court held, "Because the estate may take no

greater interest than that held by the debtor, the estate takes the license subject to the

restrictions imposed [by state statute] on the debtor by its transferor." Id.; see also In re

S. Side House, LLC, 474 B.R. 391,402 (Banlcr. E.D.N.Y. 2012) ('"[T]he estate succeeds

to no more interest than the debtor had, and the estate takes its interest subject to the



                                                  11
No. 90891-5


conditions under which the debtor held the interest.'" (quoting In re Depoy, 29 B.R. 466,

469 (Bankr. N.D. Ind. 1983)).

      Farmers also explained that the bankruptcy court had misapplied§ 541(c)(l)(A):

      [The bankruptcy court] read this provision to invalidate upon the
      commencement of bankruptcy proceedings all transfer restrictions on
      property in which the debtor holds an interest. Section 541(c)(1)(A),
      however, avoids only those restrictions which prevent transfer of the
      debtor's property to the estate .... [B]y its terms§ 541(c)(l)(A) applies
      only to "interest[s] of the debtor in property." ... Because [the state
      statute] placed no restrictions on the transfer of their entire interests to their
      respective estates, it does not conflict with§ 541(c)(1)(A).

792 F.2d at 1402 (emphasis added). Applying Farmers to Ostenson's case, his debtor's

bankruptcy estate took his interest as defined, determined, and encumbered according to

state law. In other words, Ostenson's interest that devolved to his bankruptcy estate as

determined by the above Washington statutes was his interest as an assignee and not as a

member of the Pac-0 LLC.

       The Court of Appeals reached the same conclusion applying In re Garrison-

Ashburn, LC, 253 B.R. 700, 707 (Banlcr. E.D. Va. 2000), which applied a Virginia state

law provision comparable to the above noted Washington statutes dissociating an LLC

member upon the member's filing a banlcruptcy petition. In Garrison-Ashburn, an LLC

member filed for bankruptcy and then sought to execute a real estate contract on behalf of

the LLC. !d. at 704. The other members of the LLC disputed the debtor's right to bind

the LLC because under Virginia law, a member is dissociated upon filing for bankruptcy.

!d. at 707. The debtor retained his economic interest-to share in the profits and losses




                                              12
No. 90891-5


of the LLC-but could no longer participate in management. !d. The Garrison-Ashburn

court held that§ 541(c) did not change this analysis:

               This result does not offend the Congressional intention behind
       Sections 54l(c) and 365(c) and (e). These provisions were intended to
       expand the bankruptcy estate to the maximum feasible extent and to
       prevent the loss of valuable assets by the operation of ipso facto clauses
       that terminate valuable leases and other rights upon bankruptcy. Here the
       estate received the entire interest of the debtor in [the LLC] including its
       burdens and restrictions. The economic interest, that is the membership
       interest, remains in the estate and is available for the benefit of creditors.
       The enforcement of [debtor's] statutory dissociation does not cause a
       forfeiture of those rights or impair the legal capacity of the company to
       continue in business.

Id. at 709. 10 Garrison-Ashburn reconciled the application of both state law and the

federal bankruptcy code by recognizing and applying the rule that state law defines the

debtor's interest, including dissociation, then§ 541 brings that interest into the debtor's

bankruptcy estate, burdened by whatever state law requires.




10
  While Garrison-Ashburn has been criticized by some subsequent cases, see, e.g., In re
Klingerman, 388 B.R. 677, 679 (Bankr. E.D.N.C. 2008), other cases agree with Garrison-
Ashburn's approach. For instance, In re Albright, 291 B.R. 538, 540 n.7 (Bania. D. Colo.
2003), observed:
        Where a single member files banlauptcy while the other members of a multi-
        member LLC do not, ... the banlm1ptcy estate is only entitled to receive the share
        of profits or other compensation by way of income and the return of the
        contributions to which that member would otherwise be entitled.
Additional cases that follow Garrison-Ashburn's approach include In re Western Asbestos Co.,
313 B.R. 832, 844 (Banl(r. N.D. Cal. 2003) ("The Court views the meaning of 'property,' as used
in 11 U.S. C. § 541(c)(1)(B), as something that may be sold or collected to generate funds to be
distributed funds to creditors."); In re A-Z Electronics, LLC, 350 B.R. 886, 890 n.12 (Bankr. D.
Idaho 2006) (citing Albright with approval); Fotouhi v. Mansdorf, 427 B.R. 798, 802 (Batllcr.
N.D. Cal. 201 0) (partner dissociated upon filing banlauptcy); Milford Power Co. v. PDC Milford
Power, LLC, 866 A.2d 738, 759-61 (Del. Ch. 2004) (holding that neither§ 365 nor§ 541
preempted state law provisions that deprive barum1pt members of governance rights).
                                               13
No. 90891-5


       Ostenson cites to cases that have reached a result different than Garrison-Ashburn,

but those cases either do not acknowledge or fail to apply Butner, 11 or are otherwise

distinguishable or not persuasive. For instance, In re First Protection, Inc., 440 B.R. 821,

830 (B.A.P. 9th Cir. 2010), held that under§ 541(a) all of the debtor's rights devolved to

the estate and into the hands of the trustee, including the right to manage and control the

LLC. Id. at 830. On the one hand, such holding arguably made practical sense in that the

decision addressed a single-member LLC and, thus, there were no other members to

manage the LLC if the trustee could not do so, nor were there any other non debtor .

members' interests to be considered and protected. 12 However, the court's application of

§ 541(a) is troubling. The court acknowledged the Butner rule-that a debtor's interest is

determined by state law-but failed to apply that rule. The court acknowledged that a

state statute specifically defined an LLC member's interest as '"a member's share of the

profits and losses"' of the LLC and "'the right to receive distributions of [LLC] assets."'

Id. at 828-29 (quoting ARIZ. REv. STAT.§ 29-601(13)). Nevertheless, the court applied§

541(a)'s language, "all legal or equitable interest" in the bankruptcy estate, broadly to

include not just the interest as above defined by state law but also to include management

rights. Such expansive use of§ 541(a) to define a debtor's interest is contrary to the


11
   See In re Klingerman, 388 B.R. 677, 679 (Bankr. E.D.N.C. 2008) (no mention of Butner.and
no analysis of threshold determination of debtor's interest as determined by state law); In re
LaHood, 437 B.R. 330 (Bania. C.D. Ill. 2010) (same); In re Dixie Mgmt. & Inv., Ltd. Partners,
474 B.R. 698 (Bankr. W.D. Ark. 2011) (same).
12
   The Ninth Circuit Banlauptcy Appellate Panel in First Protection acknowledged the
distinction made in Albright (quoted above) that a different result would obtain where the LLC
member who files a bankruptcy petition belongs to a single member LLC or a multiple member
LLC. See First Prot., 440 B.R. at 829 n.13.
                                              14
No. 90891-5


Ninth Circuit's analysis in Farmers. See Farmers, 792 F.2d at 1402 (holding that

§ 541(a) addresses only the transfer of debtor's interest to the estate and is "irrelevant" as

to the threshold determination of the existence and scope of the debtor's interest). As this

portion of the First Protection decision does not adhere to Butner, does not follow Ninth

Circuit precedent, and is contrary to the presumption against preemption that this court

applies, see Hue, 127 Wn.2d at 78, we do not find this portion of First Protection

persuasive.

       Ostensen cites In re Yonikus, 996 F.2d 866, 869 (7th Cir. 1993), abrogated on

other grounds by Law v. Siegel,_ U.S. _,134 S. Ct. 1188, 188 L. Ed. 2d 146 (2014),

for the proposition that§ 541(a)(1)'s establishment of a bankruptcy estate sweeps broadly

to include every conceivable interest of the debtor "future, nonpossessory, contingent,

speculative, and derivative." But all examples given therein concern money. See id. The

availability to the estate of all of the debtor's economic interest is not at issue in this case.

Ostenson's interest as an assignee devolved to the estate. Further, Yonikus acknowledges

Butner for the proposition that determination of a debtor's interest in property is decided

by state law. See id. (stating, "The question whether an interest claimed by the debtor is

'property of the estate' is a federal question to be decided by federal law; however, courts

must look to state law to determine whether and to what extent the debtor has any legal or

equitable interests in property as of the commencement of the case"). Yonikus does not

assist Ostenson.




                                               15
No. 90891-5


       Ostenson also relies on In re Daugherty Construction, Inc., 188 B.R. 607 (Banlcr.

D. Neb. 1995), and In re Warner, 480 B.R. 641 (Banlcr. N.D. W.Va. 2012), in which the

respective bankruptcy courts held that§ 541(c)(1) invalidated state statutory and

contractual dissolution provisions. In those cases, the debtor's filing bankruptcy resulted

in the dissolution of the LLC and the termination of all the debtor's interest therein. See

Daugherty, 118 B.R. at 609-11 (statutory dissolution upon bankruptcy filing); Warner,

480 B.R. at 655-56 (bankruptcy triggering dissolution, liquidation, and distribution of

proceeds per operating agreement). Thus, dissolution of the LLC under the state statute

or operating agreement in these cases would result in depriving the estate of all of the

debtor's interest. That is not the situation here. 13 As explained above, Ostenson's

banlcruptcy estate took his interest, as determined and encumbered by Washington

statutes, as an assignee. By doing so, his economic interest is preserved in his banlcruptcy

estate and "is available for the benefit of creditors." Garrison-Ashburn, 253 B.R. at 709.

       In sum, we find that the Court of Appeals properly followed Garrison-Ashburn,

federal banlcruptcy code, and Washington law. 14



13
 No party has argued that Ostenson's banlauptcy filing resulted in dissolution. But the
operating agreement provides that "the Company shall dissolve upon ... the occurrence of ariy
event of Member dissociation provided in the Act ... unless the business of the Company is
continued with the consent of all of the remaining Members within ninety (90) days following
such event." Defs.' Ex. 5 (Pac Organic Fruit LLC Agreement, page 13 (Article 8.1)).
Presumably, Pac-0 continued operating with the consent of the remaining member, GHI.
14
   Two recent cases from Virginia demonstrate the lack of coherence in this area. In In re
Virginia Broadband, LLC, 498 B.R. 90, 93-94 (Bankr. W.D. Va. 2013), a bankruptcy court
addressed application of a state statute that dissociated an LLC member upon becoming a debtor
in banlauptcy and thereby transformed the member's interest into that of an assignee with only
economic interests. Purporting to rely on Garrison-Ashburn, the Broadband court held that the
state statute in question was an invalid ipso facto provision under § 541 (c)(1 )(B) and that the
                                                16
No. 90891-5


       11 U.S.C. § 365

       Ostenson contends that "11 U.S.C. § 365(e)(l) [as wellll U.S.C. § 54l(c)(l)]

invalidate or render unenforceable ipso facto bankruptcy clauses." Pet. for Review at 12.

The relevant statute, 11 U.S.C. § 365 provides in relevant part:

       (e)(l) Notwithstanding a provision in an executory contract or unexpired lease, or
       in applicable law, an executory contract or unexpired lease of the debtor may not
       be terminated or modified, and any right or obligation under such contract or lease
       may not be terminated or modified, at any time after the commencement of the
       case solely because of a provision in such contract or lease that is conditioned
       on-

               (B) the commencement of a case under this title ...

               (2) Paragraph (1) of this subsection does not apply to an executory contract
       or unexpired lease of the debtor, whether or not such contract or lease prohibits or
       restricts assigmnent of rights or delegation of duties, if--
                      (A)(i) applicable law excuses a party, other than the debtor, to such
               contract or lease from accepting performance from or rendering
               performance to the trustee or to an assignee of such contract or lease,
               whether or not such contract or lease prohibits or restricts assignment of
               rights or delegation of duties; and
                       (ii) such party does not consent to such assumption or assignment.

(Emphasis added.) 15




debtor's economic and noneconomic interests in the LLC became property ofhis banlm1ptcy
estate. Jd. at 96-97. However, in In re Williams, 455 B.R. 485 (Bankr. E.D. Va. 2011), another
court, applying the same statute and also purporting to apply Garrison-Ashburn, came to the
opposite conclusion. The Williams court held that§ 541(c)(l) "clearly controls" and that the two
debtors' interests vested in their respective estates, but that such interest was determined by the
state statute. Thus, as defined by the state statute, a dissociated member retained only economic
rights, and since both LLC members had been dissociated through bankmptcy and no one was
left to wind up the affairs ofthe LLC, the court would appoint a liquidating tmstee to do so. Id.
at 501-02. Such ambiguities support applying a "'strong presumption"' against finding
preemption ofRCW 25.15.130(l)(d)'s dissociation provision. Hue, 127 Wn.2d at 78 (quoting
Progressive, 125 Wn.2d at 265).
15
   Similarly,§ 365(c) provides in part:
                                                17
No. 90891-5


                                                         16
       Section 365 applies to executory contracts.             As First Protection explains,

"Generally, the bankruptcy estate automatically succeeds to a debtor's assets. However,

because an executory contract is both a potential asset and a potential liability of the

                                                        17
debtor it is treated differently." 440 B .R. at 83 0.         Notably, "if the operating agreement

is an executory contract ... § 365 governs the trustee's rights rather than§ 541(c)(l). In



        The trustee may not assume or assign any executory contract or unexpired
        lease of the debtor, whether or not such contract or lease prohibits or
        restricts assignment of rights or delegation of duties, if--
                         (l)(A) applicable law excuses a party, other than the
                  debtor, to such contract or lease from accepting performance
                  from or rendering performance to an entity other than the
                  debtor or the debtor in possession, whether or not such
                  contract or lease prohibits or restricts assignment of rights or
                  delegation of duties; and
                         (B) such party does not consent to such assumption or
                  assignment ....
(Emphasis added.)
16
   Ostenson argues in his petition that the LLC's operating agreement is an executory contract
and thus subject to the ipso facto prohibition in§ 365(e)(1), but in his reply he contends that
§ 365 does not apply. Then he reasserts in his supplemental briefthat § 365(e)(1) does apply
while raising two new arguments to avoid§ 365(e)(2)'s exception to§ 365(e)(l)'s prohibition.
In any event, as the Court of Appeals held, it ultimately does not matter whether the Pac-0
operating agreement qualifies as an executory contract because, even if it does, under the
circumstances of Ostenson's case§ 365(e)(2) would apply to negate the application of§
365(e)(1)'s prohibition, as explained herein.
17
   Executory contracts do not automatically devolve to the bankruptcy estate.
                  "The trustee's power to reject those executory contracts which he finds
        burdensome to the bankrupt's estate is an extension of his power to renounce title
        to and abandon burdensome property which is already a part of the estate.
         Because executory contracts ... involve future liabilities as well as rights,
         however, an affirmative act of assumption by the trustee is required to bring the
         property into the estate in order to ensure that the estate is not charged with the
         liabilities except upon due deliberation. Thus, executory contracts ... -unlike
         all other assets-do not vest in the trustee as of the date of the filing of the
         bankruptcy petition. They vest only upon the trustee's timely and affirmative act
         of assumption."
 First Prot., 440 B.R. at 830 (alterations in original) (quoting In re Lovitt, 757 F.2d 1035, 1041
 (9th Cir.1985) (citations omitted)).
                                                 18
No. 90891-5


that event, the restrictive provisions under [a state] LLC Act or the operating agreement

that affect the transfer of [d]ebtor's rights and interests in [an LLC] may be enforced

through operation of§ 365[(e)(2)] in some instances." Id. at 830-31.

       Whether a contract is executory within the meaning of the Bankruptcy Code is a

"question of federal law." Id. at 831 (citing In re Alexander, 670 F.2d 885, 888 (9th

Cir.1982)). "A contract is executory only when the 'obligations of both parties are so far

unperformed that the failure of either party to complete performance would constitute a

material breach and thus excuse the performance of the other."' Id. (quoting In re

Ehmann, 319 B.R. 200, 204 (Bankr. D. Ariz. 2005)).

       Here, the Court of Appeals analyzed the obligations in the Pac-0 operating

agreement and noted that while they "may suffice to create an executory contract," the

court ultimately "need not decide" whether the Pac-0 operating agreement is an

executory contract because the court otherwise held that"§ 365(e) of the bankruptcy code

excuses further performance under the agreement." Nw. Wholesale, 183 Wn. App. at

487-88; see In re Tsiaoushis, 383 B.R. 616, 620 (Bankr. E.D. Va. 2007) (Mem. Op.)

(noting that the "final step" in any analysis of executory contracts under § 365 is the

applicability of§ 365(e)(2)'s exemption from§ 365(e)(l)'s ipso facto prohibition). To

address this issue, Division Three applied Finkelstein v. Security Properties, Inc., 76 Wn.

App. 733, 888 P!2d 161 (1995). See Nw. Wholesale, 183 Wn. App. at 488.

       Ostenson asserts that Division Three's reliance on Finkelstein was error because

that case addresses partnerships and not LLCs. Pet. for Review at 17. But Division



                                              19
No. 90891-5


Three's reliance on a partnership case was not improper. See Tsiaoushis, 383 B.R. at 618

(noting because LLC's are relatively new statutory creations, "decisions concerning

partnership agreements are helpful"). 18 Accordingly, Division Three did not err in

applying by analogy a partnership case that addressed application of section§ 365(e)(2).

       In Finkelstein, Division One held that a state law provision that dissolved a

general partnership upon the filing of bankruptcy by any of the partners was not

superseded by§ 365(e)(1)'s invalidation of ipso facto provisions. Therein, Finkelstein

was a minority partner in two related general partnerships, each of which served as

general partners for several limited partnerships. Finkelstein filed for bankruptcy under

chapter 11 and later converted to chapter 7. Before the bankruptcy filing, each general

partnership agreement provided that the partnership would not dissolve or terminate upon

the death, incapacity, or bankruptcy of any partner. After Finkelstein filed bankruptcy,

each general partnership then amended its partnership agreement to exclude Finkelstein

as a partner. Finkelstein then sued the general partnerships for an accounting and breach

of fiduciary duties and brought a derivative action on behalf of several of the limited

partnerships. The trial court dismissed Finkelstein's claims on statute of limitations

grounds, and Division One affirmed, holding in part that state partnership law was not

superseded by federal bankruptcy law, that the partnerships dissolved under state

partnership law when Finkelstein bankruptcy case was converted to chapter 7, and that as

18
  See also Sally S. Neely, Partnerships and Partners and Limited Liability Companies and
Members in Bankruptcy: Proposals for Reform, 71 AM. BANKR. L.J. 271, 317 (1997)
("[B]ecause of the similarities between LLCs and partnerships in this area of inquiry, the cases
[involving partnerships] also provide guidance regarding the appropriate consequences of the
bankruptcy of a member or member-manager of a[n] LLC.").
                                                20
No. 90891-5


a former partner Finkelstein had no standing to bring breach of fiduciary duty claims or a

derivative action on behalf of the limited partnerships. Finkelstein, 76 Wn. App. 733.

       Relevant here, noting that courts have "'generally assumed that partnership

agreements are ... executory contracts,"' Division One held that "[debtor's] bankruptcy

trustee was not free to assume the contract under § 3 65 because the other partners were

not obligated to accept such an assumption." !d. at 736-37 (quoting In re Cutler, 165

B.R. 275, 279-80 (Bania. D. Ariz.1994)). This is so because "[p]artnerships are

voluntary associations, and partners are not obligated to accept a substitution for their

choice of partner." !d. at 737. The court additionally held that "[t]he restraint on

assumability also makes the deemed rejection provision of§ 365[(d)(l)] inapplicable to

the partnership agreement. Therefore,§ 365(e)'s invalidation of ipso facto provisions

does not apply, and state partnership law is not superseded." !d. (citation omitted). The

Finkelstein court relied on a Fifth Circuit case, In re Phillips, 966 F.2d 926, 935 n.ll (5th

Cir. 1992), which noted that

       [C]ourts which have ruled that§ 365(e) supersedes state partnership law
       have failed to apply§ 365(e)(2) to their analysis. Section 365(e) was
       designed to invalidate banlm1ptcy termination clauses (ipso facto
       provisions) in contracts. Section 365(e)(2) clarifies Congress' intention to
       prevent only private contracts from counteracting the Banlauptcy Code, not
       to prevent state law, such as partnership law, from determining the status of
       a partnership.

Finkelstein, 76 Wn. App. at 737 n.3. Division One further explained, "Section 365 is

clearly not applicable to the executory portion of the partnership contract [i.e., described

as management rights and duties] because partnership agreements are purely consensual



                                              21
No. 90891-5


and the freedom of the partners to associate and dissociate is the heart of partnership

law." !d. at 738. Accordingly, the Finkelstein court held that§ 365 was not applicable

and did not supersede state partnership law. !d.

       The only ~uties owed to [debtor] after his removal from the partnership
       were the duties to account and pay to him (or his estate) the value of his
       share. [Debtor] ceased to be a member of the partnership upon dissolution,
       and has no rights against the remaining partners for their continuing
       business. It follows that he has no claims against the remaining partners for
       any alleged subsequent self-dealing. For the same reasons, we also affirm
       the trial court's dismissal of[debtor's] derivative action.

!d. at 740 (emphasis added).

       Here, the Court of Appeals sustainably relied on Finkelstein in holding that§ 365

did not preempt Washington law that removed Ostenson as a member of Pac-0 upon his

bankruptcy filing. See Nw. Wholesale, 183 Wn. App. at 489. The same rights of

voluntary association on which the Finkelstein decision turned apply equally to LLC

membership. Se(! Daugherty Constr., 188 B.R. at 611 ("Like a partnership, members of

the LLC have voluntarily associated in a business enterprise and the relationship among

members may be personal in character.''); see also Sally S. Neely, Partnerships and

Partners and Limited Liability Companies and Members in Bankruptcy: Proposalsfor

Reform, 71 AM. BANKR. L.J. 271,312 (1997) (same); First Prot., 440 B.R. at 832 (plain

language of§ 365(c)(l) and§ 365(e)(2)(A) makes clear that the provisions are not for the

debtor's protection). "These sections[§ 365(c)(1) and§ 365(e)(2)(A)] were designed 'to

protect non-debtor third parties whose rights may be prejudiced by having a contract

performed by an :entity other than the one with which they originally contracted."' First



                                              22
No. 90891-5


Prot., 440 B.R. at 832 (quoting In re C. W Mining Co., 422 B.R. 746, 761 (B.A.P. lOth

Cir. 2010)). The WALLCA clearly protects the voluntary association rights ofnondebtor

LLC members. For instance, while RCW 25.15.250 authorizes the assignability of a

member's LLC interest "in whole or in part," that statute nevertheless expressly protects

the associational interests of the remaining members by providing:

      The assignee of a member's limited liability company interest shall have no
      right to participate in the management of the business and affairs of a
      limited liability company except . .. [u]pon the approval of all of the
      members of the limited liability company other than the member assigning
      his or her limited liability company interest.

RCW 25.15.250(l)(a) (emphasis added). Similarly, RCW 25.15. 260, which addresses

the right of an assignee to become a member, states in pertinent part, "An assignee of a

limited liability company interest may become a member upon ... [t]he approval of all of

the members of the limited liability company other than the member assigning his or her

limited liability company interest." RCW 25.15.260(1)(a) (emphasis added). Given the

strong protection ofLLC members' voluntary associational interests, comparable to

partnerships, the Court of Appeals did not err in applying Finkelstein to Ostenson's case

and affirming the dismissal of his derivative claim.

       Ostenson does not effectively argue otherwise. He cites to Summit Investment &

Development Corp. v. Leroux, 69 F.3d 608 (1st Cir. 1995) for the proposition that

§ 541(c)(l) and§ 365(e)(l) invalidate or render unenforceable ipso facto bankruptcy

clauses. But the Summit court addressed only § 365( e) and did not undertake any

analysis of§ 541. !d. at 614 n. 8. And while the First Circuit indeed held in Summit that



                                             23
No. 90891-5


§ 365(e) preempted a Massachusetts statute comparable to RCW 25.15.130(1)(d)(ii), the

Ninth Circuit expressly rejected Summit's approach in In re Catapult Entertainment, Inc.,

165 F.3d 747 (9th Cir.), cert. dismissed, 528 U.S. 924 (1999). The Ninth Circuit Court of

Appeals noted that under the statute's plain language, while§ 365(e)(l) nullifies ipso

facto clauses, "§ 365(e)(2)(A) expressly revives 'ipso facto' clauses" under the

circumstances noted therein. Id. at 753 n.6. The Ninth Circuit held, "[W]here applicable

nonbankruptcy law makes an executory contract nonassignable because the identity of

the nondebtor party is material, a debtor in possession may not assume the contract

absent consent of the nondebtor party." Id. at 754-55. As noted, RCW 25.15.250(1)(a)

and RCW 25.15.260(1)(a) of the WALLCA require the express approval ofthe LLC

nondebtor members regarding any transfer or assumption of member management rights.

To the extent the LLC operating agreement may qualify as an executory contract

concerning management, the noted "applicable law excuses a party, other than the debtor

[i.e., the nondebtor members], ... from accepting performance from or rendering

performance to ... an assignee," and "such party [i.e., the nondebtor members have] not

consent[ed] to such assumption or assignment." 11 U.S.C. § 365(e)(2). Accordingly,§
                                                                                         19
365(e)(2)'s exception to§ 365(e)(1)'s prohibition of ipso facto provisions applies.


19
  Ostenson raises two new issues in his supplemental brief. First, he contends that because his
bankruptcy petition was filed under chapter 11 (reorganization), he is a debtor in possession and
thus he may be treated as the same entity before and after his bankruptcy filing. Because there
will be no assignment of the operating agreement to a different entity, the§ 365(e)(2) exception
to§ 365(e)(1)'s prohibition to ipso facto provisions is not triggered. Second, Ostenson contends
that the stipulation entered in his bankruptcy proceeding qualifies as the required consent under
§ 365(c)(1)(A) and§ 365(e)(2) and thus the§ 365(e)(2) exception is not triggered. See Pet'rs'
Suppl. Br. at 17-20. We decline to address Ostenson's newly raised arguments. "Under the
                                               24
No. 90891-5


                                      CONCLUSION

       We conclude that HDs did not waive their CR 41 motion to dismiss and that

federal bankruptcy law, 11 U.S.C. §§ 541 or 365, does not preempt RCW

25.15.130(1)(d)'s dissociation provision. As to the latter issue, we hold that state law

defines what the bankruptcy debtor's interests are and that § 541 brings such interests

into the bankruptcy estate, burdened by whatever state law requires. Additionally, if

executory contracts are involved, § 365 applies to determine what may be done with such

contracts. But here, the express protections of associational rights ofnondebtor members

found in the WALLCA triggers§ 365(e)(2)'s exception, rendering§ 365(e)(1)'s

prohibition against ipso facto clauses inapplicable. We affirm.




Rules of Appellate Procedure, 'the Supreme Court will review only the questions raised in ...
the petition for review and the answer, unless the Supreme Court orders otherwise upon the
granting of the ... petition."' Denaxas v. Sandstone Court of Bellevue, LLC, 148 Wn.2d 654,
671, 63 P.3d 125 (2003) (alterations in original) (quoting RAP 13.7(b)).
                                               25
No. 90891-5




WE CONCUR:




              26
